Need To Know: Time To Think Outside The Rule?

Long gone are the good old days of 2002 - 2007, when development jokes about fog-the-mirror tests abounded. As we all have learned over the years, good jokes have a foundation in reality. Development was too easy then, and for the last couple of years it's been too hard. We're gradually seeing an improvement in development activities. We won't have 2011 unit totals for a few months, but what we are seeing is more unit growth.

Where are the opportunities coming from, and how are they getting financed? According to the Franchise Update's Annual Franchise Development Report (AFDR), some of the traditional development sources, including lead generation websites and expos, are declining in importance to franchisors. The AFDR showed modestly better outcomes from search engines through purchased words and optimization, and organically through referrals and a franchisor's own website. While these developments clearly qualify as trends, they are rather subtle so far. I think the bigger implication of the direction suggested by these changes is around the quality of information being provided, not the way it is being delivered.

Development has been so defined by the FTC Rule that I believe we have allowed the Rule to override common sense. As a prospective franchisee, I may want to know how much can I make. What I need to know is whether I will be "successful" over time. If your system has a high percentage of units continuing to operate over time, isn't that the best proxy for success that I could judge from the outside looking in? Every prospective franchisee knows there's no guarantee of success. However, if most of your franchisees are still around after a few years, I can probably infer from that simple fact that your system is doing okay. Therefore, I am likely to do okay. I can't deduce that from an Item 19 or Item 20. I can't judge this fully by talking to a few of your franchisees.

Rather than being constrained by the FTC Rule, why don't you use common sense and develop a means of communicating what prospective franchisees need, regardless of what they are asking for? Wouldn't continuity rates defined around unit longevity be a really strong indicator of success over time? How about renewal rates? The number of units existing franchisees add to their current operations? I could go on. You get the message. This is less about thinking outside the box than it is about simply thinking using common sense.

I think the reason there are changes in the mix of lead generation sources with no clear-cut trend is that it isn't about the delivery vehicle any more. The information age has leveled that playing field to a large extent. It's about where I can get reliable and compelling information. Want an example? Look how banks are changing the way franchise information is being developed and used. Banks are forcing change on the type and quality of information that you produce, so you might as well get used to thinking differently about franchise information. The limitations of FDDs for credit risk assessments have been clearly exposed through this financial crisis. Banks need information that isn't in FDDs; and the information that is in FDDs is, for the most part, misleading (if not irrelevant) for such purposes. Credit risk analysis wasn't the purpose of FDDs. While for years banks have tried to extract credit risk information from FDDs, in reality FDDs give banks very little useful and actionable credit risk information. And forget about asking a bank to validate anything by calling your franchisees unless you want to give them a good laugh.

Banks need a type and quality of information that addresses their credit risk decision-making questions. We're seeing the power of this today with Bank Credit Reports (BCRs), a specialized form of benchmarking designed specifically for banks. While BCRs compare brands within franchising, their real power is that they provide a level of credit risk information for banks that allows them to determine the likelihood they will get repaid; make portfolio commitments to specific borrowers, brands, and sectors; and develop term sheets appropriate for the risk profile that such information suggests. The result will be more capital for franchising. In the process, banks are disproportionately shifting the amount of capital away from independent businesses (where they struggle to have any predictive credit risk ability) and toward franchising (which has a lot of credit risk predictability).

Doesn't the same kind of common sense hold true for prospective franchisees? It certainly does for multi-unit operators, who have the knowledge and sophistication to understand the implications of such information. So why do we stay mired in old thinking?

That brings me back to what I think really is going on with lead sources today. Brands that have good performance are finding ways of communicating that performance to prospective franchisees, regardless of the lead generation vehicle. There are only three requirements: (1) have good performance; (2) find common sense ways to communicate that performance; and (3) when doing so, stay within the good graces of your franchise counsel and the intent of the FTC Rule.

Darrell Johnson is president and 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.