Survival of the Fittest: Why Do Some Franchise Systems Survive When Other Fail?

by Nexsen Pruet, PLLC
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What had 28 flavors, nearly 1,000 locations, and a ubiquitous orange roof?  If you answered Howard Johnsons Restaurants, then you are one of a shrinking number of people who can still appreciate the power that brand once had.  At one time, Howard Johnsons was the largest restaurant chain in the United States, with sales exceeding those of McDonald’s, Burger King, and Kentucky Fried Chicken combined.  HoJo’s was a highway landmark.  But today, there are only two remaining Howard Johnson’s Restaurants, and except for an occasional reference on AMC’s Mad Men, the restaurant brand has all but ceased to exist.  What happened?

The marketplace is littered with once high-flying franchise brands that have succumbed to the power of “creative destruction” (a term coined by economist Joseph Schumpeter in the 1940s to describe how progress occurs in a free market).  To avoid being one of the concepts that fails to survive this Darwinian process, both franchisors and franchisees must ask themselves: What makes for lasting success in a franchise system?  How can franchisors provide value to the franchise network and to investors?  How can franchisees discern when a franchise system offers not only a proven track record but also a business model that is sustainable for years to come?  

Franchise concepts come in all shapes and sizes.  But systems that are “survivors” have common characteristics that set them apart from the rest.  Among these are strong management with a strategic long-term view, a culture that is collaborative but still controlled by the franchisor, and an emphasis on system standards and training.  In short, whether a franchise system is likely to last depends in large measure on how well it is operated. 

Strong Management with a Strategic Long-Term View

A well-run franchise system typically includes both managers who have experience and institutional knowledge and managers who have fresh and innovative ideas.  (Of course, those characteristics are not mutually exclusive – sometimes the same manager possesses all of them.)   Knowledge gained through experience with the brand and the industry can help a system learn from past mistakes and build on past successes.  At the same time, the perspective of those new to the brand and the industry can help ensure that a system does not get so locked into its traditional ways of doing business that it misses opportunities to grow and evolve.

The systems most likely to survive the challenges of changing markets and technologies are those that make strategic, long-term thinking a priority.  Consider, for example, how the market for soft-serve yogurt has changed from being the exclusive province of specialty shops to being sold in many different venues.  Consider how changes in technology have extended the useful life of automotive mufflers and extended their replacement rate from three years to eight years or longer.  These are only two examples of changes that have required franchise systems to adapt their methods of operation in order to remain relevant in their markets.

Franchise systems that engage in long-term strategic thinking will take a proactive approach to challenges such as these, rather than a reactive one.  But staying ahead of the curve, rather than playing catch-up, requires a commitment to invest both human and financial resources.  Without this commitment, a system may find it harder to survive and thrive in the face of change.

Again, Howard Johnson’s Restaurants is a case in point.  Tom Dougherty, CEO of the branding company Stealing Share, Inc., said the answer to why Howard Johnsons Restaurants failed is “simple. Because it stayed static. Its brand . . . needed to adapt to the changing market but it failed to do so, remaining stuck in one place.”  Chains such as McDonald’s, Burger King, and Kentucky Fried Chicken sprang up at virtually every highway exit and became the new standard in roadside dining.  These fast food chains offered menus that were more specialized and food that was cheaper, faster, and available to carry out.  Meanwhile, except for price changes, Howard Johnson’s menu, like its business strategy, stayed largely the same.  Consequently, Howard Johnson’s Restaurants all but disappeared.

A Culture of Collaboration, but Control

Hindsight is 20-20, but identifying and addressing changes to the market as they are happening can be daunting, to the say the least.  A strong franchise system will take full advantage of its best resource for spotting these changes – its franchisees.  A franchisor that fosters a collaborative culture is more likely to make informed business judgments. A franchisor that ignores input from its franchisees and imposes changes unilaterally not only deprives the system of valuable insights and ideas, but also lessens the chance that franchisees will buy into changes when it tries to enforce them.

A franchisor would be foolish not to listen to its franchisees.  But it should not cede decision making responsibility or governance of the chain to them.  As the ultimate steward of the brand, the franchisor must be the ultimate decision maker.  A franchise system that is a survivor is responsive to both the needs of its franchisees and the need to maintain the integrity of the system.  Most franchisees expect the franchisor to protect the system from external and internal threats.  A franchisee that makes a significant investment in the franchise concept does not want to see the brand’s goodwill dissipated by rogue franchisees, former franchisees, or others that infringe or misuse the brand or business system.  Franchisors that fail to enforce their trademark or post termination contract rights send a message that these fundamental tenets of the system can be disregarded with impunity.  Taken to its extreme, failure to govern the chain will lead to its general unraveling. 

An Emphasis on Standards and Training

A franchise system that is a survivor will be focused on the importance of maintaining system standards.  When Howard D. Johnson founded Howard Johnson’s Restaurants, he was, by all accounts, obsessive about the quality of the food and the cleanliness of the restaurants.  He was known for paying surprise visits to the restaurants to make sure system standards were being followed.  Eventually, however, these standards slipped, and ultimately the chain became known not for the high quality of its food, service, and surroundings, but for the reverse.  In a talk about why Howard Johnson’s Restaurants failed, advertising executive Lou Carbone spoke of working for the franchise system late in its lifecycle, when discussions focused on “taking a quarter of an inch off a straw” or “switching from four-ply napkins to two-ply” to save money for the system.  “It was all about value extraction,” he said.  “No one was thinking about value creation for the customer.  No one understood what these clues and signals meant.”   Customers do understand, however, and when quality disappears from the system, customers will disappear as well.

Training is an essential component of maintaining quality and system standards.  Keeping franchisees well trained throughout the tenure of their franchise is a mark of a good franchise system.  In most any franchise contract, one of the most prominently stated obligations of the franchisor is to train the franchisee.  Although some systems consider this mission accomplished after a franchisee completes its initial training, a well-run system will take a different view.  It will encourage franchisees to continue their training by offering them various methods and venues to make training a natural part of the franchise experience.  It will hold regular training conferences or conventions.  In addition, in the currently wired world, it may well offer web-based training opportunities.  Franchisors that do not offer a broad based training curriculum risk letting the franchise system slide into mediocrity and apathy. 

The FDD as a Tool to Validate the Strength of a System

A prospective franchisee that understands the characteristics that make a franchise system a survivor should use the Franchise Disclosure Document (FDD) to validate them.  By reviewing, among other disclosures, the ownership of the franchise system, the description of the management team, the system’s litigation history, and the census of which franchisees have left the system through termination, resale, or failure to renew, a prospective franchisee can gain a sense of the vitality of the franchise system that it wishes to join.  If, however, the FDD leaves the prospect with unanswered questions, then it should have frank discussions with the franchisor to fill in those blanks. 

No single attribute can guarantee the long-term success of a franchise concept.  But a system that takes a strategic long-term view, that fosters collaboration but maintains control of its brand, and that focuses on quality and training has the best chance of surviving the process of creative destruction and prospering well into the future.

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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