Are Franchise Networks Measuring What Matters?
By Daniel Alberto Bernard
Daniel Alberto Bernard explains how weak financial controls and poor performance data can undermine otherwise successful franchise networks.
Evaluating the Financial Performance of Franchise Networks: Practices and Challenges
A franchise network that wants to reach its financial goals can count on independent support from a consultant, an advisory board, or a board of directors. This topic can also be part of the agenda of a fiscal and/or financial council.
As William Edwards Deming said: "You cannot manage what you do not measure, you cannot measure what you do not define, you cannot define what you do not understand, and there is no success in what you do not manage."
Every organization must keep track of its financial results. It should use classic indicators, such as the return on invested capital, liquidity, debts, profitability, and overall return. It also needs spreadsheets for the monthly income statement, which will feed the Annual Balance Sheet. Small organizations usually rely on their accountant. Larger ones can count on internal and external auditors to check that the data is true and accurate. Management advisors must make sure the strategy is being followed and help leaders make decisions based on the data collected.
In practice, this process is harder and more complex than it seems, especially in franchises and networks. At the start of my career, in the late 1980s, I worked as an Economic-Financial Consultant in the Small Business division at the Arthur Andersen office in São Paulo (today Accenture). I took part in and led inventory counts. It was common to find differences between the physical stock and the data in the management system. In other words, companies made decisions based on wrong information about their available stock. This created problems, such as not knowing the minimum stock level or the point where stock runs out.
About 25 years ago, a franchisee of the leading Brazilian skateware company asked for our help. He wanted to understand why he was drowning in debt. He had been in the network for 3 years, ran 3 units, and had lost about US$ 300,000. We soon saw this was a systemic problem. The solution would only work if we involved the franchisor, its own stores, and the other franchisees. Everyone agreed to work with us. We found that all the other franchisees had the same problem — but not the network's own unit. The internal team could only see the numbers on a cash basis, not on an accrual basis. When we organized the data better, the problem became clear: the stores were giving very high discounts on a very large number of items when collections changed. There were three collections a year: fall-winter, summer, and high summer. The store supervisor had been told to boost sales. To clear the stores at each collection change, she sold below cost. This created growing losses and debts with the franchisor and the banks. The franchisor took a paternalistic view and did not push franchisees to pay their debts. That only increased the debts without solving the problem. When the problem was found, the supervisor simply resigned! But there was no need for that. It was enough to follow the Strategic Contingency Plan we created for the network. The units went from a loss of about -6.7% to a profit of 14.1% in 8 months, and 19.1% in 12 months. In other words, the business gained about 25% in margin in one year, just by fixing its financial organization! Later, the business faced new problems: it imported a lot from China, the supplier went bankrupt, and the company lost a few million dollars. It is a pity the company did not have an Advisory Board at the time. That could have prevented its downfall.
About 20 years ago, we built the franchising system for one of the largest HR consultancies in Southern Brazil and São Paulo. We were almost done when the businessman we worked with showed deep frustration. It was not with our work, which he praised. It was with the management system he used. He told us he had tried many off-the-shelf software programs, but none fit how he wanted to run his company, which had more than 100 employees. This left him frustrated. He worked long hours every day, always the first to arrive and the last to leave. So we added a new module to our work: we mapped the company's processes, suggested improvements, created procedure flowcharts, and defined performance indicators. At the end, we sent all this material to a software developer, who built a custom system just for the company. It was not the fastest or most practical solution, but it solved the problem for good. At the final meeting, the owner thanked us. He said we had given him a true "letter of freedom" — he no longer felt like a slave to work! With tools to monitor both people and processes, he could finally delegate tasks and take vacations. He even took clients fishing in the Amazon on his own boat, which was his dream. Our work was supposed to last 6 months. It ended up lasting two and a half years! One member of our team even went to work at the company. The company is still going strong today.
Finally, about 10 years ago, our team trained 700 managers of one of the largest supermarket and hypermarket chains in Brazil. We gave advanced training on Performance Indicators to unit managers who had worked at the company for 20 to 25 years. They told us they had never received training in this area. That surprised me a lot! They also said they only saw their units' results between the 15th and 20th of the following month. That is a real test for the heart, because they received no previews. The good or bad result came too late, so it was hard to connect daily actions with the monthly result. The outcome: the operations had high sales but still lost money. Everything was saved by the suppliers. They invested in promotional marketing, which turned an operating loss into profit on the bottom line of the income statement. This logic is common in the sector. Being a supplier to the big chains is a great privilege, because it creates large sales volume. Suppliers make up for this by charging higher margins to small and medium-sized networks. This practice covers any operational failure and keeps the biggest networks at the top of their segment, protecting their shareholders' wealth. And as long as there is credit and the market accepts this practice — no game over!
In all these cases, consultants, advisory board members, and/or board members could have helped with Corporate Governance, based on ESG guidelines and Compliance principles. These examples show how important performance indicators are, especially financial ones. Monitoring them is essential to attract investments, grow the business, and keep the organization alive.