Why Do Franchisors Fail?

Bennigan's in particular felt the impact of these trends because of the high number of non-franchised units in its chain.

One of the big advantages to company-owned growth is that the parent company keeps every dime that goes toward the bottom line. But the flip side is that the same parent company also absorbs every loss its corporate stores generate.

Thus the corporate-owned development route can be seen as high-cost, high-risk but with potential for high-return. When times are good, the company can bring more money to the bottom line -- but when the market turns, the results can be disastrous.

If corporate store losses are in excess of the royalty (and other) revenues generated by franchisees, the parent company may not be able to survive -- even if its franchisees can. Moreover, when a marketplace changes, franchisees that are doing poorly will not validate well -- making it difficult for the franchisor to sell additional franchises or divest itself of its corporate stores, further exacerbating cash flow concerns.

To avoid such problems, many franchisors will carefully evaluate their risk exposure when planning the development of corporate locations. And, of course, they'll always make sure their primary focus is on unit-level profitability, because they know that without a concept that works for everyone -- from the consumer to the franchisee to the franchisor -- franchising is destined to fail.

A 9-Foot Leap Across a 10-Foot Ditch: Capital

Unfortunately, the set of circumstances that often drives people to franchise in the first place -- capital -- can also be a culprit in some franchisor failures. While franchising is a low-cost, low-risk means of expansion, it's not a no-cost, no-risk means of expansion.

New franchisors will have significant legal and development costs associated with the creation of their franchise programs. They'll also need to budget adequate working capital for the startup phase of their franchise efforts.

Aside from the costs associated with creating the franchise program, working capital will fall into two major categories: personnel and franchise marketing. Neophyte franchisors may under-allocate in both areas, thinking they can simply finance growth out of their franchise fees. And while some franchisors may achieve this feat, the franchise graveyard is littered with those that didn't understand that faster growth requires significantly more initial capital -- as franchise royalties will often take months after the initial sale to start flowing with any regularity.