Why The IFA is Wrong about Franchise Growth

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In 2010 Carmen M. Reinhart and Kenneth S. Rogoff wrote a book entitled "This Time is Different: Eight Centuries of Financial Folly". Writing on the heels of the Great Recession the book's message was a simple one: no matter how different the latest financial crisis always appears, there are remarkable similarities with past experiences from other countries and from history.

We have been here before.

Other nations and other leaders---notwithstanding the hubris, or maybe because of the hubris--always think that this time is different.

The vast range of crisis considered and analyzed in This Time is Different demonstrates that excessive debt accumulation, whether it be by the government, banks, corporations, or consumers, often poses greater risks than it seems during the boom. "Debt fueled booms all too often provide false affirmation of a governments policies, a financial institution's ability to make outsized profits, or a country's standard of living. Most of these booms end badly."

Almost two years after the Great Recession officially ended the franchise market writ large is still struggling to cope with the boom that ended badly.

The International Franchise Association reported that 2012 will be the year that franchising rebounds. Last month the IFA released its Franchise Business Economic Outlook for 2012.

In short it stated, "after three years of restrained growth, due to the recession and its lingering effects, franchise businesses show signs of recovery in the year ahead." The IFA went on to state that "franchise business growth has been restrained over the past three years due to underlying factors, such as the weak rebound in consumer spending, that have been a drag on the economy as a whole.

In addition, tighter credit standards have limited the formation of new franchise small businesses and the expansion of existing businesses." (I think it important to keep in mind that the IFA has been forecasting for the last 2-3 years that this year will be the recovery year. In fact, the IFA has restated its numbers for the previous year's franchise unit growth in each of the last three years. For example, the 2012 report said that the number of franchise establishments in 2008 was 774,000; the report in 2011 stated that the number of franchise establishments in 2008 was 791,000; and the 2009 report claimed that the number in 2008 was 864,000. )

But in light of This Time is Different what struck me as particularly interesting about this latest pronouncement from the IFA was the statement by Stephen Caldeira, President of the IFA, in which he said in referring to 2012 "the rate of growth is far below the growth trends we experienced before the recession."

Most individuals understand that the growth that franchising experienced in the 4-5 years prior to the recession was fueled by the exact same economic and financial factors that gave rise to the larger American macro-economic bubble--and it subsequent collapse.

Thus I think the most important question that we in the franchising industry must ask is what growth rate do we want and what growth rate should we expect? If we expect a growth trajectory similar to the 4-5 years prior to the recession how do we plan to achieve that without a similar type economic environment? Or, do we care how we get there just so long as we do?

Toward that end, recently I had an executive remark to me that he hopes that we experience another liquidity bubble because it would return the franchise market to its pre-recession days. But is that what we really need and/or want as a country or as an industry?

Turning again to This Time is Different, the book reminds us that the boom we experienced in America was powered by a liquidity bubble--a bubble that was destined to burst--and was fueled in large part by the sub-prime mortgage market. "In the end run-up to the sub-prime crisis, standard indicators for the United States, such as asset price inflation, rising leverage, large sustained current account deficits, and a slowing trajectory of economic growth, exhibited virtually all the signs of a county on the very of a financial crisis--indeed a severe one."

A severe one indeed. We have millions out of work still, and those that are employed have seen their wages stagnate and their home value drop precipitously and not recover. But that is exactly what history has shown always occurred after a financial crisis. Reinhart and Rogoff state: "an examination of the aftermath of severe postwar financial crises shows that these crises have had a deep and lasting effect on asset prices, output, and employment. Unemployment increase and house price declines have extended for five and six years, respectively.

Real government debt has increased by an average of 86 percent after three year....Historical experience is that V-shaped recoveries in equity prices are far more common than V-shaped recoveries in real housing prices or employment. Overall the analysis of the post crisis outcomes for unemployment, output, and government debt provides sobering benchmark numbers for how deep financial crises can unfold."

Notwithstanding the remark of the executive I reference above, I do not think most in the franchise industry--nor the country--consciously want another liquidity bubble. The out-sized short term profits fueled by a large amount of liquidity in the system appear to be Faustian bargain that few in the franchise industry want to engage in again.

What the executive likely meant was that he wanted another great macro-liquidity event in our Nation's economy, he just did not want to have it become a "bubble". In that case, he, as well as most in American business today, is eagerly awaiting the next economic boom. And if that boom is to be fueled by complicated financial instruments and unrestrained access to the debt markets then "this time will be different" is the refrain that is soon to be repeated.

But as Reinhart and Rogoff detail with much precision it is unlikely from a historical perspective that the next time will be different. "The fading memories of borrowers and lenders, policy makers and academics, and the public at large do not seem to improve over time, so the policy lessons on how to avoid the next blow up are at best limited. Technology has changed, the height of humans has changed, and fashions have changed.

Yet the ability of governments and investors to delude themselves, giving rise to periodic bouts of euphoria that usually end in tears, seems to have remained a constant." Franchising touches all segments of our economic society--technology, labor, finance, consumer, etc. Franchising will wax and wane depending on the over-all economic health of our country.

The question that must be answered is this: will franchising plot a course that is complimentary too, but not dependent on, the next banking and finance led American boom? Or, will franchising as a industry continue to aim for, and the IFA continue to lobby for, the good 'ole days of "outsized profits" and rapid franchise unit growth fueled as it was by what we now know to be an excess of debt accumulation both on the micro- and macro level of our economy?

My guess is that few are even thinking about the future of franchising in these terms. Most simply want growth, and they care not how that growth comes about. (Of course this is how most in our country feel and is the emotional genesis for the boom and bust cycles examined in This Time is Different.)

Every six months the IFA puts out a statement about how the tight lending standards are retarding the growth of franchising. While that is undoubtedly true, it would be helpful to learn exactly what the IFA deems as the optimal level of liquidity in the system. If by loosening the IFA is silently longing for the loose credit standards that reigned supreme in the middle of the last decade then that perhaps is the wrong path down which to proceed. If it is not, then it is incumbent upon the leadership to set forth with more particularity the goals because liquidity in the system is inextricably linked to the franchise growth projections.

In order to assure that we in franchising do not repeat the mistakes of the past, the franchising industry needs perhaps a different approach. The industry needs leadership that does not repeat nor countenance the thread-bare and statistically suspect mantra of "franchises do better in recessions."

We need leadership that understands that while prospective franchisees are more difficult to come by now then they were in 2007 that may not necessarily be a bad thing. In the same way that it is now settled wisdom that there were many who were allowed to take out a mortgage five years ago that should not have been permitted to do so, so too must the leadership in franchising state unequivocally that there were franchisees that should not have been awarded franchises and business that should not have been franchises as well.

And if that be the case, then the growth rate that was experienced in the years leading up to the Great Recession cannot be the benchmark for growth in the next decade.

The economic outlook published for 2012 projects an increase of 1.9% in franchise establishments. But as stated above, the one constant with the economic outlooks produced by the IFA over the last four years is that each year the reports change many of the figures stated in the previous years report.

The reports do have a convenient escape mechanism in that all of the reports state that the numbers are "estimates". In other words, neither the IFA nor the high powered accounting and consulting firms commisioned to compile the reports know conclusively how many franchise establishments exist today--and if you read the reports carefully you will see that the PWC reports state that 2007 was the first time that there was enough data to even put forth a sound estimate.

So while 1.9% may well be the appropriate and realistic growth rate for 2012, given the track record of the reports put forth by the IFA we must be more than a little skeptical about the numbers set forth.

All of us with a stake in franchising want to see franchising grow again. We all believe in the fundamentals that under-gird its special place in our economy. In order to achieve a prudent and sound franchise growth rate we need "tough love" leadership and sober, intelligent responses to the challenging times in which we live.

Doing so, however, requires an honest appraisal of how we got here and whether the good 'ole days were really that good. Simply running the same plays out of the same playbook, and using statistically suspect boom year expectations of growth is not a game plan for long-term success.

We have read this book before. We know how it ends. And no, this time will not be different.

This has been a guest post by Garth Snider, CEO of Franchise Opportunities Network. At FranchiseOpportunities Network we identify, create and distribute valuable information regarding franchising and small business opportunities. The FranchiseOpportunities Network lead generation network was created in order to high-quality franchising and business resources in a secure, collegial, professional and ethical business environment. As the web's largest directory of franchise opportunities, we aspire to continue giving potential franchisees simple and easy search practices, as well as thorough franchise and business resources.

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1 Comment

Sales oriented organizations like the IFA will naturally be more optimistic. Just like the residential and commercial realty brokers forecast accuracy hasn't been good since 2007, but when sales are on the line, they are always hopeful.

The lack of extendable, workable credit is an problem, but so too is subpar franchisee unit level economics and franchisor incentives. Perhaps the IFA should focus on that.

In the restaurant space, check out Papa John's (PZZA) earnings results just this week, noting 124 FY-11 new US store adds (including 7 company units) versus the flat or declining US store counts at Pizza Hut (YUM) and Domino's (DPZ). PZZA has been working aggressive incentives since 2009.

John A. Gordon

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