Unit Profitability: Full Service or Lip Service?

February 02, 2017

“The day may come when a franchisor is judged by the profitability and satisfaction of its franchisees, and not by the number of units. It will be more difficult to measure, but more gratifying for all concerned,” said one Profit Mastery sponsor. Perhaps that day is here.

By Steven C. LeFever, CFE

A disaster waiting to happen: “I’ve been in this system for four years, when should I start making a profit?”

This is a disturbing question at best. As if profits were somehow time-sensitive: just wait long enough and, presto, profits. If it was only that easy.

Unit profitability and performance are, at their core, a function of three key drivers: financially trained franchisees, an effective performance model and accurate financials. Whether due to cost or priorities, many franchise networks are lacking in one or more of these areas. Franchisors that have focused to an extreme on increasing the number of units to the exclusion of developing strong, knowledgeable franchisees are putting both the franchisee and the network in peril. Here are some ways to refocus.

Reach Out and Teach Someone

Traditionally, if there are two people involved in a business, one knows how to make it and one knows how to sell it. The financial-management side of the business is typically left to the accountant, the banker, your spouse, or no one. People just hope it works. Sadly, most discover that hope is not a strategy.

Most franchisors do an excellent job in training for initial startup, operations, and sales and marketing. Financial training is often overlooked completely or delivered by the corporate accountant who reinforces the expectation that finance is “dull and boring.” Since the mind can only absorb what the rear-end can tolerate, you miss most key points if you’re asleep.

Financial education is probably the most difficult curriculum to deliver. So, make finance fun. Use the KISS principle. Incorporate application case studies. Teach franchisees to use the numbers to tell the story of the business, and show them how to use their financial intelligence to develop a performance report card. It will clearly identify strengths and weaknesses — and point the way to developing a spot-on action plan. It will also increase survivability.

Asked the question “When did you learn the most about running a business — in good times or bad?” most entrepreneurs answer: “Bad times.” So, perhaps it’s time for some learning.

The Three-Legged Stool

During my days as a commercial banker, I discovered that it was easy to make business loans; the hard part was getting repaid. And the first number I learned was 80 percent — the percentage of businesses that fail in the first seven years. So, what to do? Either make loans only to businesses more than seven years old or accept that you’ve got only a one in five chance of guessing right.

After several years of practicing with depositors’ money, it became clear that what was needed was a performance model to accompany the loan. The performance model that emerged is essentially a three-legged stool: education to provide the foundation, benchmarking to provide the yardstick, and accountability to provide the discipline.

Built around the key word “measure,” this process (a program we call Profit Mastery) consistently drives performance improvement. Over the past 30-plus years, documented results confirm that a Profit Mastery approach improves performance and satisfaction.

Leg 1: Education beats shooting from the hip

There are many paths to a better life. Education happens to be the most reliable. At a minimum, teach franchisees and your corporate staff the four lynchpins of finance: how a company makes a profit i.e., break-even analysis; how to develop and use a financial performance scorecard; understanding the crucial role of the balance sheet in managing cash flow; and managing the credit line and bankability.

Without a common language and approach with respect to the financials, it is impossible to develop and share a group perspective on both performance and best practices. And, an effective financial curriculum provides franchisees both the framework and tools to make insightful decisions in an uncertain economy rather than simply “shooting from the hip.”

Leg 2: Benchmarking

Talk is cheap. Everyone has a story about how they’re doing. Just listen during conventions; you’ll often hear franchisees stretching the truth. Producing a financial benchmarking study cuts through the rhetoric, provides a performance report card for the network, profiles the top performers, and provides a reliable framework to measure best practices. Clearly, a well-developed financial benchmarking process is an indication of both a maturing network and a professional approach to performance.

Virtually every franchise agreement mandates that franchisees provide financial statements, at least annually. Sadly, this requirement is rarely met and virtually never enforced. Furthermore, in the relatively rare instances where financial data is submitted, it is rarely cumulated and, even rarer, returned to the franchisees in the form of benchmarks.

Financial benchmarking presents an unexcelled opportunity for networks to do what everyone talks about: work together. For the relatively few systems that produce timely, meaningful benchmarks, franchisees consistently experience measurable increases in performance and they regularly report these benchmarks as among the most valuable resources provided by the franchisor.

Leg 3: The power of peer groups

Imagine a group of eight to 12 franchisees meeting quarterly — twice onsite and twice online — to share complete financial performance results that have been packaged side-by-side in a scorecard format. The group is led by a trained facilitator, often a trained member of the franchisor’s management team. Each group member prepares a concise situation analysis to present to their surrogate board of directors, the other group members. This is the basis for a performance group.

But it doesn’t stop there. Before the meeting finishes, usually two-and-a-half days for onsite meetings, participants pair up and set goals — both quarterly and annually — along with identifying specific action steps that will lead to the accomplishment of those goals. Progress is updated and goals/action steps revised and refined quarterly.

In addition, group members share activities that have worked best and also gain input on key challenges. Often, a single topic is identified for group brainstorming. Always, the comparative financial profile is the cornerstone for these discussions.

One member likens the initial meetings as “getting naked in front of strangers” but adds “it’s the most beneficial business-related activity I’ve ever undertaken.” The bottom line: in networks that utilize peer performance groups, group members consistently outperform non-members.

Accurate Financials: Garbage In, Garbage Out

For many franchisees, completing the financial statements is a major chore that leads to a sigh of relief: “My work here is done.” The fact is, nothing could be farther from the truth; the owners’ job has just begun. Their job is to take these statements, and based on the story the numbers tell, evaluate their performance and chart a course for the future.

Sadly, this management perspective is often sidetracked by faulty financial information. Without accurate and timely financials, one becomes a member of the Christopher Columbus School of Management: When he left, he didn’t know where he was going. When he arrived, he didn’t know where he was, and, when he returned, he didn’t know here he’d been.

There are many fine accounting software programs. However, they are only as good as the knowledge, skill, and motivation of the user. In addition, franchisors that have a standard chart of accounts can greatly assist their franchisees by insisting they use it.

The fact is, most franchisees would be well-served by using an outside accounting service. There are some excellent services that provide quality information at a very reasonable cost. They will utilize whatever chart of accounts you provide, and the information is timely and accurate. Also, if it isn’t, you can fire them. That’s more difficult when your spouse does the books.

For a decade, franchisors have focused on increasing the number of units and growing sales. This top line focus at the expense of building profitable, sustainable networks through the practices described in this article creates a vulnerability that is magnified by market saturation. All that is required is an economic downturn to put franchisors and franchisees at risk.

The good news? It’s never too late to focus on your network and provide the direct support and resources that foster performance and survivability. Your franchisees have invested their capital, time, hopes, and dreams in your network. Each month they send you a piece of their bottom line — yes, their bottom line. It just happens to be your top line.

Recently, many franchisors have made significant cuts in corporate staff to expedite their own bottom line. By reinvesting in their networks, franchisors will not only gain the trust and cooperation of their network, but they will also be in a significantly stronger position to build a long-term, sustainable network in both good times and bad.

Performance Checklist for Franchisees

Every business owner is asking: "What can I do now to improve the performance and survivability of my business?" The checklist below identifies opportunities to assist franchisees in surviving and thriving. These are actionable, effective ways to support your network and improve its performance.

Chart of Accounts: If you don't have a standard chart of accounts, get one. Beyond that, distribute it to franchisees and insist they use it. Creating a consistent recordkeeping format gets everyone "on the same page" and paves the way for productive comparative analysis.
Financial Statements/Bookkeeping: Without timely, accurate data, no organization knows its status and sharing data is impossible. Encourage franchisees to use an outside service; it is cost effective and removes a major burden from the franchisee.
Develop a Performance “Scorecard”: Implementing a one-page financial report card is the most effective action step you have to introduce and maintain focus and accountability. By teaching both franchisees and field staff to understand and use it, you deliver support that generates performance and satisfaction.
Benchmark Your Network: Every network of businesses should benchmark themselves. By providing profiles or both median and top-performers, you not only provide the yardsticks of performance, but you also create a "best practices" environment that is real.
Know Your Costs: In this tight, post-recession economy, it is an absolute must for franchisees to know their costs. "Break-even" is absolutely the most valuable financial management tool available. Make sure your franchisees and field staff know how to calculate and use a comprehensive break-even analysis. When it comes to cost analysis, you must be able to cut with a scalpel, not a hatchet.
Field Staff as Advisors: Train your field staff in financial analysis and expect them to be able to use all the tools listed here to assist franchisees in performing a strategic assessment of the business. You will increase franchisee performance and field staff confidence and self-esteem.

Steven C. LeFever, CFE, is the Chairman and Founder of Profit Mastery and a former commercial banker. The Profit Mastery program helps franchisors and franchisees improve unit profitability and survivability, by focusing on education, benchmarking, and performance groups. It is also a core component of the IFA’s Certified Franchise Executive curriculum.