Why Do Franchise Stores Close?
It’s the elephant in the Discovery Day Boardroom; Franchise Unit Closures. The Franchisor may not even bring up the fact that there have been store closures under their watch, but it’s important for you as a potential buyer to find out how many and why. In today’s post, I’m going to cover:
1) the reasons why a franchise store may close, 2) how closures reflect on the brand, and 3) at the end of this post, I’ll discuss a metric tied to store closings that can help you reduce your risk when choosing a franchise.
Reasons Why a Franchise Store May Close
Not Making Money
The unit is Not Making Money; simple as that. A store can be generating revenue, but if its not turning a profit then there’s an issue. It may be that the initial sales projection was to high or it could be that the expenses are higher than expected.
Bad Location / Bad Access
If I had to list the reasons why a franchise unit doesn’t make it, bad location would be at the top of the list. If people have to work to find you or its challenging to get to you, its going to affect your potential customer base. Customers will find an easier alternative, and it won’t take long to see that impact on your bottom line.
Issues with Operations could include bad service at the unit level, or it could be, in the case of a restaurant, a bad kitchen layout which in turn will effect the ticket times. Operational issues drive customers away because the service is not dependable. With a dwindling amount, or no customers at all the unit will eventually close.
I’ve seen bad PR destroy units. Here are two examples that I’ve seen:
1) I’ve seen a Franchisees make inappropriate remarks to staff or to customers that resulted in a store closing due to the bad press.
2) I’ve seen a restaurant get featured on the nightly news because a customer said they saw a roach.
Each of these instances resulted in the closure of the Franchised unit.
The Franchise Agreement is a contract. Make sure you personally read it. It’s not enough to have your attorney read it. There are requirements in the agreement with regards to brand standards. If you deviate from those standards, the Franchisor can legally default you. If the default is not cured, then the Franchisor has the right to close the unit, or in some cases take over operations.
The same way your Franchise Agreement is a contract, so is a Lease Agreement. If you enter into a lease agreement, you are committing to certain requirements, whether that’s paying rent, or staying open until a certain hour. If the LL places a Tenant in default, a consequence maybe the revocation of the Tenants access to the premises.
I’m sure you’ve witnessed competitive intrusion. You’ve seen this happen when they build a Walgreen’s on the corner, and right across the street they put a CVS. Or they build a Home Depot, and across the street another group builds a Lowe’s. There are ways to limit competitive intrusion, but it’s often difficult to completely eliminate it.
Lease and/or Franchise Agreement Expiration
When you enter into a Lease Agreement or a Franchise Agreement, they aren’t in perpetuity. They expire and in most cases, that’s in 10 years from the date you executed the agreement. In the case of a Franchise Agreement, the Franchisor will evaluate whether they want to renew your agreement. They will likely have specific criteria to weigh the evaluation. In the case of a lease, you may consider negotiating renewal options up front so that you aren’t edged out or price gouged.
There are several entities that may inspect the franchise operation. Some examples are the health department, and another, the Franchisor. If either of those inspections fail, wither entity could close the unit.
How Do Unit Closure Reflect on the Brand?
Overall store closings are not favorable, but they happen. The important thing to find out is how may have closed and why.
Unit closings may reflect:
Flailing Product or Service
A classic example of this circumstance is Blockbuster. The product or service is less in demand or there may be an alternative product in the market that is cheaper/cooler/more interesting/has better marketing.
The Brand is Tired
People have been there and done that; perhaps there is no recent innovation to keep the Brand interesting to the customer base. If the brand is not kept ‘fresh’ customers will move on to the newest thing.
Operations Team is Lacking / Field Ops is Weak
Store closing can be a symptom of a weak operations team. In a franchise this can really hurt the brand. If there is inadequate field support, then a downward trend in sales has the tendency to spiral.
Too Much Competition in the Niche
If there are too many players in a geographic area, the niche could be saturated. The customer will have an array of choices and, assuming all your competitors are giving it their all, sales volumes will likely be split between you and all your competitors.
If the Brand falls into any of these categories, find out what the Franchisor is actively doing about it. Do they recognize this as the important issue it is? Do they have a plan in place to turn things around?
At the beginning of this post, I mentioned a metric that is tied to store closings. That metric is called Continuity Rate.
Continuity Rate is a measure of how many stores are open and running at the beginning of a period vs at the end of a period. Those periods can be annual periods; I’ve also seen them expressed in 5-Yr periods. The Continuity Rate is also one of the basic criteria that institutions use to rank franchises. In general, the high the Continuity Rate the higher the success rate, and vice versa, the lower the continuity rate, the lower the success rate.
Here is an example of how to calculate Continuity Rate.
Continuity Rate = (Net # of Units in a given period / Total # of Units in a given period);
Say I have 50 units opening and operating at the start of the year, and I added 20 additional units. At the end of the year I have 70 units in total. Let’s say 10 of them closed due to one of the reasons cited above.
To calculate the Continuity Rate, take the net store count for the given period so 70 units minus the 10 that closed. And divide that number by the total number of unit I opened, so 70.
Continuity Rate = (70-10) / (50+20)
Continuity Rate = 60/70 = 85.7%
In this case my Continuity Rate for a 1-yr period is 85.7%, not great. You want that continuity rate to be high. Generally speaking, the higher the continuity rate, the better; just be sure to factor growth into your thinking. A brand can have a continuity of 100% and also have added zero units to their fleet over the given period.
That wraps up this post. Please share this with someone that is interested in franchising.
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Franchise Frankness does not know your individual circumstances and provides information for general educational purposes only. Franchise Frankness is not a substitute for, and should not be used as, professional legal, credit or financial advice.