Alicia Miller
The franchise model is attractive for franchisors because it is “asset light.” Operators provide the capital, take on leases and build out expenses, guarantee the debt, hire the staff, put in the effort, and absorb most of the operational and market risk. Tensions often arise around the subject of shared risk and shared demand creation responsibilities, especially when markets are a bit edgy—as they are now.
In a recent management presentation I attended, a franchise development leader explained why their system continues to successfully recruit strong franchisees and has an enviable development funnel: 1) A rigorous sales process that weeds out weak candidates early so they can maximize their time getting to know the top prospects; 2) Strong unit-level economics; 3) Powerful franchisee validation.
Observing this group and the data they presented, it became clear the management team itself was also a key factor in their recruiting success. The entire leadership team was obsessed with protecting franchisee profitability.
Management relentlessly attacked the core drivers of system success: safeguarding franchisee margins; generating national demand; building a thoughtfully designed ramp-up program that prevented early failures; supporting franchisees with precision and urgency. They didn’t simply demand more effort from franchisees—they shared in the risk and attempted to reduce pressure on franchisees through various risk mitigation strategies and by investing in the levers management controlled.
Increased spending on demand creation
The marketing function in franchising is notoriously difficult to get right. If franchisee profitability slips, marketing is inevitably blamed for at least part of the shortfall. But demand creation in the franchise model is a joint responsibility. The marriage can fray when each side feels the other isn’t doing their fair share or marketing strategies are ineffective.
This same management team appeared to feel significant responsibility for helping to drive customer demand. It had the data to demonstrate what portion of customer demand and spending were the franchisor’s responsibility to drive and exactly what franchisees needed to do in the field. They were transparent about spending return on investment and were as rigorous about tracking and sharing data about corporate team marketing activities as they were about tracking what franchisees were doing in the field to build local awareness and relationships.
Franchisees don’t expect a zero-risk business. But they do expect the franchisor to share in the burden of driving the model forward, not merely enforcing compliance. When there is softness in the business, franchisors often start pushing franchisees to work harder, spend more on marketing and make changes that cost franchisees money, such as remodels and adopting service changes. Discounting is tempting, but shifts burden to franchisees while training customers to wait for discounts before spending.
Strong operating training and support can cap downside risk. But given the amount of financial stress many businesses and families are feeling right now, I observe more franchisors are taking on additional responsibility to drive customer demand, whereas in the past they may have depended more on franchisees.
What do M&A buyers want?
Let’s flip the script a bit and look at what private equity sees when they are doing due diligence on a brand. In the first transaction, often there are “good bones” but major scaffolding is still needed to help the brand scale. That’s why bringing in institutional capital for the first time can be so transformational for franchise brands. Sponsors invest in systems, technology, talent and establishing processes that enable sustainable growth.
Farther up PE’s profit ladder during the second or third transaction, however, buyers expect to see those mature processes and programs already in place. They don’t like turnarounds. PE and strategic buyers backed by PE like brands with momentum whose growth story they can confidently underwrite for the next five years.
Buyers get excited when they see a robust onboarding program that demonstrates through real data that franchisees are ramping up well and there is continuous improvement in early results across multiple-year cohorts of franchisees who opened in each time period. This is something you typically see when brands that have already been owned by one PE firm are getting ready to trade to another. These programs are in place and the data proves they are working.
Maturity in the marketing function is also a big factor in the second and third trade. But if that function hasn’t evolved as well as the operational side, stress in the system will be visible and will show up both in the unit data and validation.
By the time a brand has traded multiple times, it may also have faced some amount of refresh or reinvention to keep the growth flywheel spinning. This is another common inflection point in the life of a brand. Customer needs evolve and customers may age in or out of a brand’s orbit.
Having sat through many of these management presentations to potential buyers, I can say that many marketing leaders view their role too narrowly and go on the defensive if results soften.
In this case, the leader’s winning approach was partly due to effective strategies and rigorous monitoring, and partly due to the marketing leader’s approach to marketing as a hedge to risk—not just a demand creation engine. That team was constantly looking for ways to mitigate potential dips in demand and methodically searched the customer journey to see where potential leaks in the funnel are most likely to occur. Instead of pushing franchisees to do more to make up for lost demand, the corporate team looked for specific tactics that both corporate and the franchisees could take at each potential step to ensure both groups were pulling all the available levers, but doing so in coordination, together.
The marketing model was intertwined with the notion of risk mitigation. Methods may have leaned on creative assets, from an execution standpoint, but the thought process grew from protecting franchisee profitability and removing downside risk at every possible juncture.
Alicia Miller is the founder and managing director of Emergent Growth Advisors. Her Development Savvy column covers smart ways to market and grow a franchise. She is also the author of “Big Money in Franchising: Scaling Your Enterprise in the Era of Private Equity.” Reach her at [email protected].