Carnival Games
I've been struggling lately with the number of franchisees whose results are falling short of their expectations when they made their franchise investment. When you talk to most franchisors about why a franchisee may not be succeeding in their system, they will almost always point to the franchisee NOT following the system..and in many, many cases that is true. On the other hand, sometimes the reason that a franchisee's expectations aren't met is that the franchisor made the game look easier than it is or enticed them with a big prize that few ever win.
BEWARE OF THE CARNIVAL GAME
My family and I were recently at local amusement park and were walking by the carnival games...you know, those games that look so easy when they do it, but that turn out to not be so easy for us mortals?
As my mind took in the scene, each game booth took on the brand of a franchise company and I realized that too many franchise companies operate their sales process like a carnival game barker. Let's use one particular game as an example - it is called Jacob's ladder.
When you watch the "sales person" demonstrate the game, they first show you the giant teddy bear you can win and then climb from the bottom of the rope ladder to the top every time without it spinning and dumping them off. Clearly it can be done. When you or I try to climb the ladder, we are lucky to go a few steps before we are on our backs.
Now let's correlate that to the franchise sales process. When investigating a franchise, the franchise sales person will tell you that if you follow the system, you will be successful...and in most cases, if you are adequately capitalized, you should be successful. Here's where I have the problem: they may point to various franchisees or even an earnings claim to "show you how easy it really is." Just like with Jacob's Ladder, it can be done - if you know what you are doing. The problem is that when you watch them do it, you don't really know what to focus on to prepare for your turn. Is it where you put your hands? Where you put your legs? The pace at which you climb? Some combination of these or maybe even something less visible?
Deceptive Practices
Here's how one franchise company I recently came across plays the carnival game with prospective franchisees. They have an earnings claim in their Franchise Disclosure Document that shows revenue and expenses for their top 50% to top 20% of their franchisees for 2007. They show total revenue and total expenses, but leave off the profits. WHY NOT SHOW PROFITS? Because if they do, you'll figure out their game.
Want to know the secret? They show revenue on an accrual basis and expenses on a cash basis(fully disclosed). That means that the revenue number represents total sales for the year regardless if any service or product has been delivered yet or cash received. The expense number represents only those expenses that were actually paid. So, if they made a $5,000 sale in December with a 10% deposit, for a project to start in January they would show $5,000 in revenue for December. That $5,000 sale in December has 0 expenses because the work doesn't start until the next year. That's a 100% profit margin of $5,000 even though you only got $500 of cash. Basically, the franchisor in this case is making the game look easier than it is by using different rules for revenue and expenses to lead you to believe you can have the same results as them. Your accountant and the IRS won't let you keep your books this way though, its either accrual accounting or cash accounting - FOR EVERYTHING!
MAKING THE GAME LOOK EASY
If you watch this particular franchise company's carnival game, you would come to the following conclusion on what you can win by playing their game (calculated from the Item 19 earnings claim):
Top 25% - $233,992
Top 33% - $218,931
Top 50% - $185, 544
With 50% of the franchisees making $185k+ a year, you are going to play this game - Right?
The Real Game
Since the earnings claim shows the amount of royalties paid as part of expenses and knowing that the royalty fee is 10% on gross cash sales, we can recalculate the revenue number on a cash basis. Want to know what the real potential prize is if you are fortunate enough to be in the top 20-50%?
Top 20% - $53,308
Top 25% - $54,544
Top 33% - $32,125
Top 50% - $21,764
STILL WANT TO PLAY?
IMPORTANT MESSAGE
All franchise companies do not engage in this sort of carnival game. Most do not. But how do you as a someone that wants to start a business know what to do? Simple answer: There are hundreds of great franchise consultants all over the country that know how the game is played. They will keep you focused on games that are fair with no hidden secrets or visions of great big prizes that no one actualy ever wins. Stick with those consultants that have been in the business for 5 or more years or those that have actually been franchisors or franchisees in something other than a franchise consulting or broker business. And recognize the difference between a consultant that will stay with you throughout the entire process, from selecting concepts through research and contract review and a broker that will most likely turn you over to a franchise sales person once you've been "qualified."
