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A recent study conducted by franchise analyst, FranchiseGrade.com, has uncovered a surprising (and slightly alarming) trend in the U.S. franchise industry. According to the report, 135,289 new franchise units opened in the United States between January 1, 2010 and December 31, 2013 (going from 408,118 to 423,624 units over the four-year span). When viewing the increase on a year-over-year basis, this amounts to approximately a 1 percent rise per year.

 

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The more troubling part of the analysis is that those 135,289 new additions only resulted in a net gain of 16,664 units. During that same period, 58,104 ceased operations outright; 40,113 were terminated by the franchisors; 11,997 were not renewed by their owners; and 8,431 were reacquired by the franchisors. That is a total of 118,645 franchise units taken out of existence over four years. One assessment indicates that an additional 46,187 units were transferred or sold to other owners within the same system during that time. When that number is added to those phased out of existence, the total franchise unit turnover from years 2010–2013 was 164,832. As the publication suggests, that is a 122 percent turnover rate with more franchise units leaving than opening new ones over the four-year period.

 

The franchise industry – which is heavily weighted in the retail and service sectors – is highly competitive and prone to demographic shifts and changing tastes. The reasons for this turnover are myriad and not always the result of systemic problems. In many cases, the turnover is natural, as owners look to retire, cash out, or pursue other opportunities. The four-year study period also coincided with the end of the Great Recession, which may explain some higher turnover as businesses and consumers struggled to find their financial footing. There are, on the other hand, instances where a franchisor must protect its brand against those franchisees not adhering to the proper operating standards or jeopardizing brand reputation with consumers. The only way to do so may be to terminate the franchise agreement. Finally, certain franchise concepts just don’t make it over an extended period as the creative destruction of the United States economy picks winners and losers.

 

Nevertheless, this study does not suggest that the franchise model is broken or undesirable. Rather, it should help remind those willing entrepreneurs to understand fully the risks associated with franchising. Potential franchisees must remain vigilant, conducting due diligence when considering both new and established franchise systems. Reviewing franchise disclosure documents, examining current financial statements, engaging in dialogue with other franchisees, understanding lease obligations, vetting potential vendors, and researching the relevant geographic market are good rules of thumb that potential franchisees should follow as they plan to invest time and money in a franchise.

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