The Franchise Trap

Yet another company is falling into what I call the franchise trap, as Krispy Kreme's woes continue, including closure of its Arizona stores.  Just about 5 years ago, I remember when they first showed up here in Phoenix - there were long lines and police directing traffic around the stores.  Now, they're dead.  And the corporate parent is struggling.

If memory serves, Boston Chicken (now Boston Market) and Jiffy Lube both had their corporate parents go into bankruptcy at the back end of their wild growth phases.  This is what I mean by the franchise trap:  Franchises generally start out as a single location that does well.  Wanting to grow quickly, and lacking the capital to build their own stores, they adopt a franchise model for growth.  Soon, wild growth may ensue if their concept is good, and they discover that selling franchises is more profitable than selling whatever they sold in the store.  Once the growth phase ends, though, they often hit an iceberg.  Inevitably, they find that many of their franchisees either can't cut the mustard or chose poor locations and go bankrupt.  In addition, they must make the transition back from growing by selling franchises to growing by incrementally improving the core business.  Many can't make this transition back, corporate bankruptcy ensues, and someone who is an operator rather than a franchise promoter comes in and cleans up the house.

  • It is certainly possible that a firm with a popular product or service can "grow itself into bankruptcy." Anecdotes do exist (e.g., Cosmo.com). Amazon also came very close.

    Of course, the alternative is simply that the product ceased being popular. Demand is not a constant. That was certainly the case with KKD, which was simply an irrational mania (their donuts are disgusting, IMHO). See also "Atkins," "Blockbuster."

  • Bob Smith

    I don't understand why the corporate parent of a franchise operation goes bankrupt. Done right, it seems like the franchisor should have few expenses and lots of franchise fees coming in. The franchisee takes all the real risk, since they actually have to sell product, hire employees, etc.

  • Matthew Brown

    Generally because the corporate parent tries so hard to keep the growth figures up, to keep the stock price healthy, that they go bankrupt "under the table" through over-extension.

    Looks to me that one of the duties of responsible corporate officers is keeping investor expectations reasonable as much as they can. Unfortunately that doesn't always happen.

  • Walt Disney's philosophy for his theme parks also applies to managing wall street expectations: "underpromise and overdeliver".

    If a company's earnings beat expectations, they'll be handsomely rewarded. But if they miss, they'll be punished...even if the earnings themselves were reasonably good and the expectations they missed were wildly unrealistic. Which is why in 2000 and 2001, quite a few technology companies had a market capitalization lower than their liquidation value.