More consolidation, fewer new units to come
We are deep enough in the pandemic to see consumer habits more clearly. The initial weight of inflation has been absorbed and its implications are better understood. Labor shortages and supply chain issues running through the economy are revealing their impact.
We’re far enough into 2022 to begin to get an idea of how franchise development is being affected, based in part on our recent compilation of unit activity across thousands of brands. Understanding how all of these negative economic influences affect the franchise will help us better understand the development of the franchise in 2023. Of course, we must also take into account the likely next wave that is about to crash in the form of a recession. (and/or the most recent Covid variants).
The basis of franchise development is consumer behavior trends. However, Covid has forced noticeable shifts in consumer preferences, the permanence of which is becoming increasingly clear. The pandemic has changed not only how and where consumers shop, but also what they buy, why they bought it, what influenced their purchase decision, and how they adjusted their long-term comfort with these changes in traditional consumption activities.
Across the franchise, we are seeing business models adapt to changing customer bases. Figuring out which parts of the customer experience can be automated with greater impact on fast delivery and turnaround time, as well as which customer interactions are better handled with a human touch, is an ongoing challenge for brands that affects almost all sectors. The impact on retail brands is obvious, but even in personal services, technology is increasingly integrated into their delivery. This has been a silver lining for many brands struggling with labor issues, as consumers today are much more willing to embrace technology integration than they were before. the pandemic.
Effects on franchise development
How does all of this affect the development of the franchise? Potential franchisees are also consumers and have their own ideas and concerns. Based on some of our franchisee survey work, we’ve heard that many want to know that models have adjusted and are asking how brands are staying ahead of these accelerated changes in consumer behavior. One consequence is that new brands have an advantage in how they present themselves to prospects. A challenge for many mature brands is to show off a new look with existing units projecting a pre-pandemic look.
As we are reminded, inflation is very disruptive. We have spent the last twelve years in a constant cost cutting mode because price flexibility was almost non-existent. Now the world we live in is the exact opposite. Supply chain disruptions, low unemployment, rising interest rates, etc. have increased the cost of doing business. While consumers psychologically accept rising prices for almost everything, value judgments are more influential now, affecting which brands can actually hold higher prices.
Two important keys to being able to raise prices are maintaining quality expectations and delivering reliability. Without raising prices, can brands demonstrate to potential franchisees that their units have the ability to absorb rising costs while still showing good unit economics? They better be able to because prospects will want to see proof.
Consolidation on the rise
Another consequence of the pandemic and now inflationary pressures is an increase in unit consolidation. Consolidation of franchise units generally accelerates when economic uncertainty increases. We saw it in 2008-2010, and we are seeing it now. Covid, changing consumer preferences, labor shortages, supply chain issues, inflation and now possibly a recession are pushing single unit and multiple unit operators less efficient to look for exits to a much greater extent.
To avoid the negative consequences of closed units and bankrupt franchisees, history shows us that the consolidation trend is accelerating further as franchisors strive to address underperforming units facing stronger headwinds. , which often means that the large multi-unit operators buy the units of the small operators. We see this happening now.
This has important implications as multi-unit operators represent the main source of new unit expansion. However, during periods of consolidation, multi-unit operators invest significantly more in existing unit transactions, reducing their appetite (and capacity) for new unit growth.
The money factor
Funding will likely be another bottleneck that will slow down both the flow of new units and the flow of transfer transactions. Many of our lending clients tell us that they insist on unit economics to even consider loans. The underwriting teams are factoring in a 2% increase in loan interest charges for business plans.
Finally, the belief that a recession is imminent has permeated business decisions, including those of franchise candidates. At this point, whether or not it happens is less important than the people who believe it will. History shows that in the early stages of a recession, franchise development declines. In the latter phase of a recession, when layoffs have become a concern for many, franchise development becomes a major driver of recovery.
The shadows of the pandemic and inflation, combined with the anticipation of a recession, will slow down development activity in the second half of the year and, as history shows, probably well into 2023 as well.
Our advice to franchisors? To be successful over the next 24 months, focus on specific operational activities that will allow you to demonstrate compelling transparency in key attributes tailored in different ways to two key audiences: potential franchisees (candidates and multi -units) and lenders.
Darrell Johnson is CEO of FRANdata, an independent research firm providing information and analysis for the franchise industry since 1989. He can be reached at 703-740-4700 or [email protected].