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Interest rates

By Anita du Toit, Partner at Franchising Plus

There is little doubt that 2016 promises to be a difficult trading year.  On a macro level, the world economy is taking strain with events like Brexit adding to uncertainty and financial woes.  We can expect the Rand to devalue further, interest rates to rise, increased taxes and further job cuts.  Additionally, the average consumer has maxed his credit limits and finds himself over extended and in severe debt. 

The prevailing drought will also hit the economy and consumers at various levels.  Added to this, we are experiencing political uncertainty and a ratings downgrade is still looming.

Rising interest rates and an uncertain environment usually lead to a challenging environment for franchising.  Finding franchisees are not easy and supporting them in a tough economy is a challenge. 

Franchisors mainly have their own cash flow to consider since increased lending rates equates to increased loan repayments on any interest bearing debt a franchise company may have.

Franchisors will also need to be cognisant of the fact that their franchisees’ cash flow will similarly be negatively impacted by having to service larger loan repayments on establishment costs or revamps that have been financed.  Here the franchisor should try to assist by negotiating the best prices on franchise setup costs items, such as machinery and equipment required to setup or revamp an outlet (the cheaper the capital requirements, the lesser the interest bearing loan that may be required).  

Another economic factor is the deterioration of the Rand. Franchisors should review set-up costs frequently as this may have an impact on the price of imported equipment. Franchisees could discover that the set-up cost anticipated becomes much higher and this may put additional pressure on a new franchisee. Imported products are becoming increasingly expensive, so it would be good to attempt sourcing equipment locally.

Franchisors should assist franchisees to try save up funds wherever possible for upcoming revamps. The more funds a franchisee has saved up, the less interest bearing debt they will require in order to cover the costs of a revamp for their outlet.

Increased interest rates may have a negative impact on franchisee recruitment as potential franchisees may be deterred from opening a new business by potentially higher loan repayments.

Newly established franchisors may have difficulty to secure financing for franchisees due to the issue of risk pricing.  Franchisors that don’t have well proven concepts and brands are seen as more risky by financial institutions and therefore franchisee loans are priced at higher interest rates to mitigate any perceived risk.  One way of mitigating risk is to enter into a buy-back agreement with the bank, but not all franchisors can afford to do this.

Another important factor for franchisors to consider is that waning household disposable income may lead to lower franchisee turnover, which of course should cause great concern to the franchisor. The challenge would be for franchisors to come up with a smart value offering which satisfies the consumer and keeps a healthy balance of growing turnover and profitability for franchisees.For example a common trend is to have a loss-leader product which is not profitable for the business to sell, however it drives traffic into the franchised outlet and ultimately drives sales of other products. Such is the case where a bakery café offers bottomless coffee, and upsell customers to purchase food with that coffee.  Spur has done this expertly with their R20 breakfast offering.

Franchisors should be watching the broad economic environment and tweak their business models where needed. Site selection in retail is more important than ever, mediocre locations in a difficult trading environment would hinder any franchisee from trading successfully.

Here are some other measures franchisors should consider in 2016 to ensure continued franchise success:

  1. Compile a training programme to show all franchisees how they must adapt their businesses to the current economy.  This is a preventative measure that needs to the implemented before it is too late.
  2. Facilitate a programme that enables and encourages strong franchisees to acquire marginal franchises for turnaround purposes.
  3. Royalty breaks are not a good idea – Rather use the royalty to stimulate franchisee sales eg local marketing campaigns.
  4. Work closely with suppliers and service providers.  Be transparent with them and try to secure extended credit and special deals to assist the marginal franchisees.  Remember, suppliers are also finding it difficult and it will be a buyer’s market.
  5. Don’t cut back on marketing but put more emphasis and allocation of expenditure on promotional activity. Special offers must be tailored to prop up quiet times.  Consumers will be looking for value in this economy.
  6. Difficult times call for an appropriate price strategy, tailored to promote Key Value Items (KVI’s).  Consumers are looking for value, but not at the expense of quality.
  7. Franchisees need assistance, motivation and mentoring in these difficult times, so franchisors should make themselves and their staff freely available to them.
  8. Consider developing an “intensive care” team that is available to go out and assist franchisees in distress.  This service could be charged for on a deferred payment basis as a performance improvement incentive.
Finally, franchisors should maintain open communication with their banking partner to assist them in navigating these uncertain times.