Currents..

Stalled sales

Experts react to slow sales, tight credit

By Jonathan Maze
As published in: Franchise Times - January 2009

We all know franchise sales are slowing, but what are franchisors doing about it?

Mt. Vernon is a small town of just more than 16,000 along U.S. Interstates 64 and 57 in southern Illinois. The city is getting a new overpass along the freeway in a couple of years, which will open some land for development.

The Jefferson County Chamber of Commerce felt this land would be perfect for franchises that can build and cater to travelers, and invited several to a franchise fair November 15. The response from franchisors was low, however, and the chamber postponed the fair until April.

The problem, according to chamber president, Curt Mowrer, was the economy.

Wallace Aldea didn't let the economy keep him from opening Salsarita's locations.

"We just thought it'd be best to hold off," said Mowrer, who also serves as director for the Small Business Development Center at Rend Lake College in Mt. Vernon. "Historically, in election years, the economy is in bad shape. Then after the election, things start getting better. And we felt we had enough time to wait."

Historically, a recession results in booming franchise sales, because when large numbers of people suddenly find themselves out of work many go to their nearest franchise expo. Yet so far, at least, rising unemployment has not translated into rising franchise sales. "There was a significant drop in our activity in the fourth quarter," said Kurt Landwehr, president of BrandOne Franchise Development. The main reason: Credit markets have kept banks from lending as much as they did only a few months ago. And franchising depends heavily on credit. In addition, falling housing prices and the plummeting stock market erased the funds many investors might have used to buy a franchise.

"With the market in such a decline, the down payments for a lot of these transactions have probably dwindled away," said Joe Bazzano, a principal at Private Equity Transitions. He noted that sellers might have to be more flexible on the price they get for their franchises, and added that if franchisors want to sell franchises soon they may have to consider financing themselves.

Not all franchises are reporting down sales. Chris Cheek, vice president of development for the bagel chain Brueggers, said his company met its sales target last year, though the company had to aggressively court lenders to ensure they had financing.

And the economy has actually helped Great Clips sell franchises, said Rob Goggins, the chain's vice president of franchising. The lower-cost salon chain has seen business grow as customers trade down from more expensive places - which makes it attractive to prospects. Even so, the company managed to secure a $14 million fund from InSource to provide financing to help new and existing franchisees open units, consolidate business debt or acquire salons. "It's been a nice shot in the arm," Goggins said, adding that leads were up 30 percent this year.

Still, other franchisors are taking aggressive steps to boost sales and assure wary prospects their business is sound. Kelly's Coffee & Fudge is offering six months free royalties - a common sales tactic these days. Budget Blinds, meanwhile, is offering franchise fee refunds to franchisees who don't make $750,000 in sales in their first three years. And execs at the auto body shop Maaco say they will buy back any franchise that doesn't make $750,000 in the first 15 months of operation.

Texas-based pizza buffet chain CiCi's recently announced it plans to waive the franchise fee when it sells existing locations to existing franchisees. The plan was designed to encourage franchisees to buy closed locations.

Some efforts are subtler. At the American Bar Association's Franchise Forum in October, no fewer than five franchises approached Bob Purvin, president of the American Association of Franchisees and Dealers, and asked what they needed to do to get their contracts accredited by the organization.

"I'd like to think that we're gaining a reputation, and that may be part of it," Purvin said later, "but I don't think that's the main reason." He speculated that the franchise systems were looking for ways to boost sales prospects.

Still, many experts say sales will not stay cold for long. Tom Portesy, president of MVF Expositions, said he expects the franchise sales climate to warm up with the new year. And BrandOne's Landwehr is confident he'll have a strong 2009. "I believe that 2009 could be a good year in franchise development," he said. "The people losing their jobs are going to find it difficult to find jobs in corporate America. That will force them to seek out other options."

Landwehr provides two key caveats to his prediction: Credit markets must thaw, and the stock market must stabilize.

The good news for him is both appear to be happening, but how long it'll take to loosen up franchise sales remains to be seen.

Mark Siebert, chief executive of The iFranchise Group, believes the declining economy will ultimately result in a boost to franchise sales. "I absolutely think it's going to happen this time around," he said. "People aren't going to behave any differently. When you find yourself out of a job, the first thing you do is send out resumes. When you realize that you're not going to make the income you used to at another job, you're going to look at other alternatives."

On the front lines

People in their 40s and 50s who get laid off often find franchising to be the best way to equal their previous income. Others simply want to avoid losing their jobs again.

Nick Paluzzi worked 12 years for a computer software company before he was laid off in early 2007. He got another job quickly, but was laid off a second time, nine months later.

Two layoffs in less than a year were a clear sign for the 40-something Paluzzi. "I figured that the only way to not get laid off again was to be my own boss," said Paluzzi, who opened his Floor Coverings International in Morrisville, North Carolina, last August.

The biggest question now is when the others getting their layoff notices will join Paluzzi in the franchise world. "At some point in time the banks will start lending again," Siebert said. "Whether that's going to be six months from now or eight, then boom. You're going to start seeing deals get done."

Optimistic franchisees undeterred by downer economy Danny Bone spent months researching franchises before settling on Elevation Burger and signing a contract last spring. Then the economy went south. Bone remains undeterred. Construction will begin on his Austin, Texas, franchise this month and should be open by May. "I'm hoping that things will begin to do better," Bone said. "By the time we open up, we'll do well." It's safe to say that most new franchisees, if not all, hold a certain level of optimism. It's also safe to say that, for those entering the business world now - especially in industries like restaurants - that optimism is receiving a stiff test. Yet rather than view the timing as heralding some sort of early demise, the franchisees view it as an opportunity, echoing the investment philosophy of Warren Buffett to be fearful when others are greedy, and greedy when others are fearful. "Yes, the economy is down," said Glenn Gross, who signed a deal in October to open a MassageLuxe franchise in Memphis, Tennessee. "But I look at it this way: Getting into business, franchising especially, is like getting into the stock market. You buy low and sell high." Indeed, Gross signed his deal - which also includes a 10-unit development agreement - just weeks after the pivotal Lehman Brothers collapse that signaled the current recession. He felt a slow economy would be good for business. Mostly, he believed he'd be able to get better deals from developers eager to lease space in new buildings. Many other franchisors and consultants echo that view, saying landlords are more likely these days to give better deals so they can fill empty space. Gross said he can negotiate better lease prices, and ask property owners to do the remodeling or provide buildout money they wouldn't consider paying in a stronger economy. "That could amount to quite a sizable chunk of your investment when you open a store," Gross said. Wallace Aldea may be able to thank the declining economy for his franchise opportunity. Aldea worked for Radisson and Hooters before returning to his native Puerto Rico five years ago and taking a job at a construction company. He urged his bosses to buy a franchise to diversify the company's income, but they agreed to do so only once the economy slowed and sales fell. The company now has invested in a separate entity that will open three Salsarita's in Puerto Rico - Aldea owns 20 percent of the company. "I think it's actually a great time to invest," he said. He noted that few restaurants are opening on the island right now, and that there is a need for good customer service. "I think that is actually good for our brand. People still have to go out to eat, and most do it in less than an hour. If we're out there, we're exposed." Like Aldea, Nick Paluzzi believes good service will help set him apart in a troubled economy. Paluzzi bought a Floor Coverings International franchise last spring after he was laid off twice in nine months. He liked the company's focus on sales staff who act like design consultants rather than salespeople. The economy isn't affecting his mindset as he starts his new career. "Psychologically, from a planning standpoint, I was starting at zero revenue, anyway," he said. "Anything I got was more than that." By starting in a recession, he added, he has to be more sensitive to competitors' pricing and his company must focus heavily on customer service to attract what customers are out there. He said his franchise isn't burdened by high expectations. "As the business grows, it's all very positive," he said. Danny Bone, meanwhile, is confident in his brother's ability to run the restaurant during a tough economy. Bone worked in the insurance industry, and his brother approached him to start a franchise after their parents sold their Dunkin' Donuts store. Bone is the investor and will continue to work in insurance. His brother will operate the store. Bone believes their plan is sound. They have a good location, and he said Austin should be a good place to operate a franchise that specializes in burgers made from organic ingredients and fries cooked in olive oil. The customers will come, and the company will focus on running an efficient operation. "We'll run a good operation," he said. "We'll keep our payroll down and control our food costs. We'll hang in there until it turns around." He added that his parents opened their Dunkin' Donuts in 1974, when the business environment was far worse, and they succeeded. "It was far worse than it is today," Bone said. "The inflation rate (12 percent) and unemployment (7 percent) was unbelievable."

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Franchise Times - January 2009