In the past few months we have been closely observing the downgrade of our economic situation and the unfolding ripple effect that came with it. The result – South Africa slipped into a recession as our economy keeps on contracting. This will cause a drastic and widespread knock-on effect on various industries.
A recession is not something that is unheard of, South Africa has been through it before and has recovered. This time round we may experience that this recession might endure longer than previous occasions and we need to be aware of the ramifications that go along with it.
The recession causes a recurrent cycle between three franchise stakeholders namely the franchisor, the franchisees (new and existing) and suppliers/service providers.
Franchisors have been anticipating a further decline in economic conditions after the South African downgrade had been announced. The majority of franchisors have been keeping it in mind and been preparing for these uncertain times. Even with the additional franchise network support, we are heading into tough times and only the strong will prevail.
In short, the recession influences the entire franchise uptake market where it starts with the franchisor supporting existing franchisees and recruiting new franchisees, which is influenced by existing franchisee performance and economic conditions influencing suppliers and service providers. This will ultimately influence consumers and their buying power and behaviour which in turn will influence the entire network. Thus, a recession causes a never-ending ripple effect in the franchise market.
The franchisees’ existing financial performance will be influenced due to a decline in turnover which leads to lower profits. Marginal franchisees will suffer the most from the recession as this may lead to negative financial performances or even bankruptcy and dissolution of franchise agreements if the situation persists. In the market, we have observed that this leads to the tendency to cut prices to reinstate some loss of sales during this period – consumer buying power and capabilities have been reduced therefore they are spending less.
This will negatively affect the both the franchisor and the suppliers. The franchisor’s income which consists of royalties from franchisees will decline due to their financial performance. Franchisees will purchase less from suppliers due to a decrease in customer demand.
Credit impairment and access to additional capital
Credit impairment will be a tremendous factor as the recession affects accounts receivable. Reduced revenues may result in delay in payment to suppliers and service providers which in turn will damage the franchised business’s valuation of debt and the ability to service financial agreements, additional financing from financial institutions will be hard to come by in these tough times and will even be harder to access if there is an undesired credit rating.
As turnover and profits decline, employee status, wages and benefits are negatively influenced. Franchisees will cut back on employees i.e. freezing of hiring new employees and/or retrenchment of existing employees. This may result in productivity increase per employee due to longer hours and persistent effort to get the tasks done, nevertheless it will contribute to a decrease in staff morale and satisfaction. Franchisors will advise against this as they would like franchisees to maintain the current employee levels and keep the company afloat by implementing strategies such as reducing benefits and wages until the situation ceases. Ultimately releasing of employees will contribute to South Africa’s high unemployment rate, which in turn will influence consumer buying power due to lack of income.
This is not only limited to the franchisees the cycle will roll over to supplier and service provider businesses servicing the franchise market.
Franchisee recruitment will become a gruelling task for the franchisor. The current situation may discourage those with an entrepreneurial spirit to invest in franchises as this may be seen as a risky business investment due to economic uncertainty. Not only do potential franchisees not have the required funding requirements to invest in opportunities, they do not have access to the minimum cash requirement. Financial institutions are discouraged to approve loan applications to new ventures due to current trading history and performance of current franchisees. They have stricter lending criteria, structures and policies that are being implemented in their institutions to mitigate profits declining in this economy. Apart from the financial restrictions to expand the network and acquiring new franchisees, it is difficult to find the right franchisee even in normal times. Recruitment has become even more demanding and tough for franchisors.
Franchisors are opening less outlets therefore it Influences suppliers such as equipment manufacturers, landlords, shopfitters, etc.
Innovation, Support and Training
Due to the decrease in franchisee turnover it is becoming more difficult for franchisors to support and train the franchisees effectively on an ongoing basis as their royalties are used for this. The initial fees from new franchisees are extended to continuous research and development, this is now reduced and franchisors are forced to hold back on innovation for new product and service developments due to uncertainty in the market place and how it will be perceived by consumers.
Risk Mitigating Strategies
Franchisors will adapt risk mitigation strategies to assist franchisees in reducing overheads e.g. negotiating better rates from suppliers (which will benefit the franchise network but place the service providers and suppliers at a disadvantage).
Some of the larger franchisors may opt to absorb increasing costs at distribution level, but this will influence their profitability and can’t be sustained indefinitely.
Franchisees contribute a percentage of turnover to a marketing fund which will be affected by the recession. Less marketing initiatives affects consumer confidence in the brand, thus leading to a decrease in spending behaviour.
However, a recession presents opportunities for the stronger franchise groups i.e:
- Mergers and acquisitions
- Acquire good staff
- Increase marketing efforts to strengthen brand and generate sales
- Give great service to differentiate from competitors
History has proven that recessions don’t last forever, each stakeholder in the franchise network and market will need to pull forces together and adapt risk management strategies to overcome these tough times to prevail and sustain operations until the economy stabilises again. The strong brands will survive and prosper while the weak brands risk falling by the way side.