AUTHOR: Michael H. Seid, Managing Director
Failure Rate
Question: In the past year, several of my franchisees have closed their doors. Most of
our other franchisees are doing extremely well and I am finding no shortage of buyers.
We had a record year in franchise sales in 2007 and this year looks just as good, even
with the downturn in the economy. Should I be concerned that a few units have closed?
Is there something I should be doing to prevent unit failure? What is the average rate of
failure for franchisors? Maybe my rate of closure is no worse than anyone else’s?
Answer: There is little more difficult to deal with than failure. For a franchisee, failure
means more than the loss of their investment and their livelihood. Failure brings with it
all of the emotional stages of loss, which frequently include embarrassment and anger.
Regardless of whether it is warranted, some of that anger will be directed toward the
franchisor.
For a franchisor, the failure of a single franchisee is going to be felt in a less personal
way than it is for the franchisee. The franchisor’s loss of investment and the risk to their
livelihood is diminutive compared to that of the franchisee. They have lost a portion of
their royalty stream and a point of distribution. On the other hand, the franchisor has
gained a negative disclosure in Item 20, a possible negative endorsement the next time
a potential franchisee calls the closed franchisee, and occasionally the franchisor will be
hit by some litigation.
The truth is that in some larger franchise systems, the loss of a single location is so
immaterial it will go almost unnoticed, while in smaller systems the loss could potentially
be devastating. Regardless of degree, failure is never pleasant for anyone. But, failure
is normal, even in franchising. Anyone who expects that by joining a franchisor they
eliminate the risk of failure is being unrealistic. There is a lot to be learned from doing a
forensic review of each unit’s failure.
There are no reliable statistics on franchisee failure. For the most part, when studies
have been performed they only included franchisors still in existence, and franchisees of
defunct systems were never counted. A further problem is that no one has ever come
up with a universally accepted definition of failure. For some, if the unit hasn’t closed its
doors permanently, it never failed and therefore is a successful location. For others, an
© 2011 Michael H. Seid & Associates, LLC
1
indication of failure is if the franchisee sells his or her business before the term is up.
But a transfer is often no more than the sale of a successful operation and the
retirement of the owner. Or, it can indicate a bargain basement sale of a location that
continues to lose money. SBA default rates are not a good indication of success or
failure either. So, how should you view the failure of a few franchisees in your system if
you can’t measurement it against “franchise industry” averages? As we tell our clients,
you view the loss of every single location with concern and as an opportunity to improve
your system’s performance.
In a well-run franchise system, most franchises fail because of something the franchisee
has done or has not done. Failure of management at the unit level is still one of the
leading causes of business failure, and frequently there is little the franchisor can do to
prevent it. The root cause of unit failure can also be found in decisions made before the
franchise opened: site selection, inadequate financial resources, excessive debt service
obligations, etc. But, since the franchisor recruited the franchisee, trained the
franchisee, approved the location, designed and updated the franchise system, and
provides them with ongoing support, the franchisor in some way directly or indirectly
played a part.
Understanding unit failure is a chance to improve your franchise system, and it’s
important for franchisors to understand why each location failed. Do some research:
1. Go back to the franchisee’s recruitment file. Look at the application. Would they
meet your current criteria for prospective franchisees? Did you sell them a
franchise, or did you select them as a franchisee? Were they allowed to take on
too much debt given the expected cash flow?
2. Understand the recruitment process. If you have multiple franchise salespeople
or use brokers, understand if there is some correlation between franchisee failure
and who brought them into the system. If there is, find out why.
3. Review the franchisees’ performance and your library of communications with
them, including field reports, letters, e-mails, etc., to see what issues were in play
while the franchisee was in operation. How did your system deal with each
issue? Were other alternatives approaches available?
4. Talk to your management team and get their perspective.
5. Talk to field staff who worked with the franchisee. They likely will have the best
understanding of what took place.
6. Hold an exit interview with the franchisee. But first, speak with your lawyer. Some
lawyers may have concerns about exit interviews; but remember, the role of a
lawyer is principally to guide you on legal issues and give you advice to help you
© 2011 Michael H. Seid & Associates, LLC
2
Once you have an understanding of why the franchisee failed, schedule time during
your next management meeting to debrief your team on what you have learned and why
you believe the franchisee failed. Discuss ways to improve system processes that may
have prevented or reduced the chance of the franchisee’s failure. Learn from each
instance and make the changes you think are warranted to deal with any shortcomings.
One last comment: sometimes an abundance of sales and a low failure rate are an
indication of what you would expect – a great franchise system. However, with newer
systems it may only indicate a great franchise sales team. Closely monitor your
franchisees’ bottom-line performance to understand their return on investment. Find out
if their cash flow is allowing them to service their debt and provide them with sufficient
income to take care of their family. Franchisee failure rarely takes place immediately,
and monitoring early unit performance and making adjustments to your system may
prevent failures in the future.
Headed by Managing Directors Michael Seid and Kay Ainsley, MSA Worldwide is the nation’s leading
franchise consulting firm providing strategic advice and tactical services to established and emerging
franchisors in the United States and internationally. For additional information on MSA, please visit our
website at www.msaworldwide.com or call 860-523-4257.
© 2011 Michael H. Seid & Associates, LLC
3