Betting On (Not Against!) The American Dream

Franchising, at its heart, is a bet on the American Dream. Interestingly, and perhaps uniquely among such bets, both parties are betting on the same outcome. As promised some weeks ago, we’ll begin exploring franchising in this column, and over the coming weeks, while also continuing to cover some of the relevant issues and details of bankruptcy, which has become so prominent as an instrument of financial restructuring in recent years.

This American Life, a radio program produced by Chicago Public Radio, recently teamed up with Planet Money, the NPR finance program covering economic issues, and ProPublica, an independent, investigative journalism service, to produce a program about a hedge fund which bet against the economy -- and won big. The story (text available at http://www.propublica.org/feature/all-the-magnetar-trade-how-one-hedge-fund-helped-keep-the-housing-bubble, audio at http://www.thisamericanlife.org/radio-archives/episode/405/inside-job) is rather similar to the recent accusation that Goldman Sachs may have aided another hedge fund with a similar plan. [Note: the story also resulted in a delightful song, which explains the recent excesses of the bubble economy as well as anything I’ve encountered. It was written by Robert Lopez, one of the people responsible for the success of Avenue Q. The song can be heard at http://www.moveoveramerica.com/.] As I listened, I thought about some of my franchisor and franchisee clients, and how far removed this notion was from their view of success.

As I said, franchising requires two parties, both with the same goal in mind, and both of whom are required for success.

One is the Franchisor. He or she has developed a concept which satisfies, or approaches satisfaction of, several tests.

First, the concept is replicable, meaning the same menu, decor package, staffing model, and service model, with at most modest tweaks, can be recreated in differentmarkets by different operators.

Second, the concept is affordable, meaning the cost -- in time, money, and training -- to establish a unit is not out of range, in comparison with other concepts or in comparison to the resources of the franchisee candidate.

Third, the concept is profitable, meaning that the franchisee will earn enough after operating expenses to pay him or herself PLUS pay the cost of using the concept (the royalty) PLUS pay the cost of any borrowed or invested capital.

The other party is the Franchisee, who requires the concept to not only meet each of the above tests, but a fourth as well: the brand, or concept, must be a better investment than (a) some other franchise concept AND (b) starting an independent concept as an independent owner-operator.

Taken together, these tests provide a relatively high threshold, as well they should where operators’ and investors’ time and money are concerned. So why do some operators choose to franchise, while others do not? And why do some concepts succeed as franchises, while others do not? We’ll discuss these, and invite comments from some successful franchisors, franchisees, and advisors, in coming weeks.