/ 22 October 2009

Fans of franchising

Trust the franchising industry to come up with a positive spin on the recession. Franchising, they say, actually grows during economic downturns because a retrenchee with a severance package is a prime recruit for the industry.

The scientific basis for the claim is buried underneath a mountain of press releases quoting some vague research from the United States. This is of little concern in an industry where hype is fanned by franchisors constantly selling to franchisees selling to consumers, consultants selling to franchisors and a core of hardy evangelists selling franchising as the answer to all the country’s woes to anyone willing to listen.

It is difficult to gauge the real state of affairs in a sector that exudes such aggressive marketing, but a number of factors are affecting the industry — and not all in a good way. The first is the double-edged sword of the recession.

There may be more people looking to buy a franchise with their retrenchment packages, but few of them are able to do so without additional finance from the bank. Bank finance, however, has slowed to a trickle as a direct result of the recession. Franchisors have had to scale down their expansion strategies as the recession kicked in and financiers clammed up, says Vera Valasis of the Franchise Association of South Africa (Fasa).

‘I think the franchise industry expected it, but last year this time they didn’t appreciate the level of impact that [the recession] would have. It’s just as a result of funders being more prudent when it comes to lending money. They’re really looking at risk mitigation in every possible way.” One such way is through stricter gearing criteria, says Valasis.

A rule of thumb in the industry is to finance no more than half of a franchise’s start-up costs so as not to burden the business with unsustainable loan repayments. In the boom times a few years ago new franchisees received finance to the value of up to 70%. Not any more, says Valasis.

Trudie van Niekerk, chief executive of Nando’s franchising division who joined the group from Absa’s franchise desk, says apart from the lower gearing, banks have tightened their security requirements — the value of assets a new franchisee must put down as collateral for a bank loan.

Marius Rautenbach, head of Standard Bank’s franchise unit, says there are franchisees who have ‘climbed out” because of the economic slowdown, but franchising is fairly unscathed compared with the number of independent ownermanagers who have gone bust.

Van Niekerk says food franchising has been particularly hard hit in recent times. A predicted shift by consumers in response to the recession from sit-down meals to takeaways has failed to materialise. Not only are food franchises seeing fewer customers, they are also buying cheaper options, she says. An indication of just how severe the downturn has been comes from a sector that many believed to be recession-proof.

The franchise manager of security products and services franchise Yale Security, Greg Pearce, says: ‘We’re doing okay but it’s tight. Hey, 18 months to two years ago people would come in and say: ‘Give me everything you’ve got to secure my home.’ Now they’re coming in and saying: ‘What’s the basic alarm system?”

Adding to the pain is a long-standing headache for food and retail franchisees — the sky-high rentals charged by shopping centres. Since South African shoppers started moving off the main road and into shopping malls in the past few decades, franchisees and other small tenants have not stopped begging shopping centre landlords to be let in.

Pearce describes South African shopping mall rentals as ‘horrific”. Internationally, Yale Security’s business model is based on a total rental, including shopping-centre marketing and maintenance levies of 14% to 15% of turnover. ‘But some of our stores [in South Africa] pay nearly 22% of their turnover in rental. It’s quite scary.”

Is the recession, coupled with the unprecedented expansion of shopping centre space in the boom years, finally shifting retail from a landlord’s to a tenant’s market?

‘There is definitely a softening of attitude that individual tenants have experienced from landlords of late,” says Fasa’s Valasis. ‘Landlords are far more willing to negotiate.” But Stephen Walters, chief executive of property consultants Fernridge, describes the process as uneven and very painful. ‘When the economy is down, it’s not the landlord that receives the first blow.

The retailer will suffer for a number of months until such time that he or she decides: ‘I can’t go on like this. I will have to close down.’ Up until that time the landlord doesn’t really feel the impact of the economy. The landlord starts to feel it only when people are throwing keys back.”

Walters says the pain and the resultant ‘correction” in rentals are taking place mainly in ‘secondtier” convenience centres, whereas it’s business as usual in the ‘bluechip centres” such as Sandton and Menlyn.

Pearce, whose Yale Security stores are found in the big centres, agrees: ‘I attended quite a few rent negotiations for my stores and these guys don’t give a damn. They’re not coming to the party.”

But Walters says there are signs that landlords are starting to realise that the wellbeing of small tenants maximises the long-term performance of a centre. This change of attitude may be enhanced by the Consumer Protection Act, which is set to change the franchising industry radically when it comes into effect in October 2010.

The Act will give provide franchisees an unprecedented level of protection against franchisors and landlords. Its main thrust is to shift the onus on to the franchisor or the landlord to prove that the agreement they signed with an unhappy franchisee was fair. And instead of having to go through a lengthy and expensive court case, the Act will allow franchisees to approach a tribunal.

Valasis says Fasa is applying to become a tribunal for the franchising industry in terms of the Act. Many aspects of the Act still have to be clarified by ministerial regulations, says Ian Jacobsberg of the law firm Eversheds.

‘The most important one is the actual content of franchise agreements. The Act says that an agreement will have to contain such information as is prescribed by regulation,” says Jacobsberg.

‘What we suspect is that the franchise association’s disclosure-document requirements will be pretty much the basis of what a franchise agreement will have to contain.”

Realistic profit predictions, accurate estimates of start-up costs and the contact details of both existing and ex-franchisees may soon have to form part of all South African franchisors’ marketing pitches, no matter how hyped they are.