Information Retrieval: FDDs Need More Useful, Actionable Detail

When evaluating a brand, experienced operators have two big advantages over first-time prospects. First, they know what questions to ask. Second, most of the time they know what a good answer looks like.

The first advantage really isn't all that much of an advantage. Common sense leads prospects to ask many of the most relevant questions. In addition to how much they will be asked to invest and how much can be made from that investment, some of the more frequently asked questions include: the franchisor's financial position, the experience of the franchisor's management team, the amount of training and support, brand marketing efforts, and the performance of units and franchisees.

The second advantage is usually considered the big one. Knowing what good answers are to the questions above makes all the difference in how a prospective franchisee reaches a decision about a brand. It removes emotion from the equation and puts objectivity in. The primary reason for this advantage is that the franchise business model lacks performance standards to reasonably compare one brand with another. Because of this, even experienced operators have trouble assessing a brand without investing a lot of time and effort.

Let's look at some of these questions... and the state of available information. The amount needed to buy in is, of course, available in an FDD with reasonably sufficient detail to have a decent understanding of the investment, fees, and required payments. Disclosing how much can be made seems to be a big problem for all but a few brands. Experienced operators need only a few key data points on a particular brand's performance to formulate a good idea of the returns that should be achievable (depending on the industry). A small but growing number of franchisors have enough detail in their Item 19 to allow anyone to make that assessment. Why don't more do it? I think brands with really good performance increasingly will do so. I'm surprised it hasn't happened to a greater degree already, as it would clearly enhance a brand's competitive position for the best prospects.

The franchisor's financial position is clearly revealed in an FDD. One could argue that the remainder of the topics listed above also are documented in an FDD. Of course the experienced operator knows that having information and having useful, actionable information are two different things. Take management experience for example. An FDD provides some biographical information about the management team. But how useful is it? The same goes for training, support, and marketing. An FDD contains a lot of information, but is it useful and actionable? For the most part, it isn't. The experienced operator is able to discern and evaluate that information in ways a first-time prospect has no chance of doing. Yet even experienced operators must address a key challenge: context. When is a management team's experience enough? What about individuals within a management team? If the CEO has 40 years of industry and franchise experience but the rest of the team is right out of college, is that okay?

Outcomes and causes

Finding answers to these questions is becoming an imperative, and easier than you might think. Let's separate the possible key factors a prospect, experienced or not, might consider and put them into two groups. Call the first group "outcomes" and the second group "causes."

Let's consider relevant outcomes in franchising to include unit performance, system stability, and franchisor results. Obviously, sales are important in the context of unit performance. In almost all franchise sectors, unit returns are driven by two or three other line items. In retail food, for instance, rent, food, and labor costs get a prospect most of the way to a decent unit performance evaluation. And finally, how quickly a unit gets to profitable performance is important. Franchisors know and track these numbers, or at least they should.

At the system level, continuity rates are important--as is an understanding of the discontinuity rates--with a simple distinction between real financial/operational failure and units that have disappeared for other reasons. Again, any good franchisor should have these numbers. With that information, system stability would be pretty clear.

And last, a franchisor that manages its operations well should be making profits and building a stronger balance sheet. Of all of the outcomes, this is the only one that is easy to get out of an FDD.

If we had just that information, we would have the foundation to consider all the causes in a reasonable context. Causes are often qualitative judgments, such as franchise relations and management experience. But with the right outcomes as a foundation, we should be able to establish benchmarks for causes. For instance, if a management team has developed a brand with solid unit economics, strong system stability, and good financial returns to the brand owners, wouldn't you conclude that the management team has "enough" experience? I'm pretty sure I would.

Darrell Johnson is CEO of FRANdata, an independent research company supplying information and analysis for the franchising sector since 1989. He can be reached at 703-740-4700 or djohnson@frandata.com.