From the January 2010 issue of Entrepreneur

For the last 18 months, bad news has dropped on the franchise world like so many mortar shells: Bankruptcies hit hot concepts such as Fatburger and old stalwarts such as Mrs. Fields and Bennigan's. Consumer spending plummeted. The credit market just about vaporized. The result: During 2009, the franchise biz lost an estimated 1.2 percent of its 800,000-plus units, according to the International Franchise Association, and an estimated 35 percent drop in SBA loans resulted in 10 percent fewer new franchises last year.

When it comes to the numbers, the prospects for 2010 aren't stellar, but even a modest push into the black would be welcomed by most business owners. Industry watchers expect a year of slow but steady recovery for the franchise world powered by an upswing in sales among recession-proof categories such as fast food, tax prep and home repair that has already begun. But the significance of 2010, besides being a banner year for burgers, may be its lasting impact on the industry as a whole. As franchisors crawl out of their bunkers, analysts expect the ones who will do best are the companies that have reassessed their systems and profoundly changed the way they do business, in particular how they communicate and collaborate with franchisees.

"A lot of franchisors are still thinking pre-recession," says John Hayes, president of the consulting firm FranchiseMastermind.com in Frisco, Texas. "That's just not going to work anymore."

First, the good news: Fast food is expected to pass the record $170 billion mark in 2010, and casual dining is climbing back after feeling the recession's pinch early on. Many parts of the service sector such as senior care, which has jumped 13 percent per year since 2006, and tax prep--led by Liberty Tax, which added more than 400 new offices in 2009--have weathered the tough times without problems. The home repair sector, including plumbers, handymen and appliance service, are benefiting from the housing crisis as more people opt to fix up their homes rather than move. The Dwyer Group's six home repair franchisors added almost 300 new franchisees in 2009, a record for the company. Many of those were conversions of struggling mom-and-pop service providers. It's a growing trend that other top franchisors are taking advantage of: 7-Eleven has converted more than 100 independent convenience stores in the last three years.

How I turned my Denny's green
Joey Terrell, Mokena, Ill.

For years I've been looking at ways to reduce energy consumption at my Denny's in Mokena, and when I had the opportunity to build a new franchise in Joliet, I took the opportunity to learn about green building. Denny's said, 'You can do this, but bring it in at or near the normal cost of a Denny's. If it's good, we'd like to incorporate ideas into the system.' There were delays--there were lots of new things for the tradesmen to figure out, but we came in $40,000 under what a normal Denny's cost. Skylights let us reduce our lighting by 85 percent during the day, a white roof keeps it cool in the summer, high R-value insulation cuts our heating costs. It's one of the few LEED-certified restaurants in the country, and I estimate we're saving $20,000 in utilities per year. Food services use 285 percent more utilities per square foot than other businesses. There's a god-awful lot of room to save money in restaurants. --Jason Daley
Economists have declared a technical end to the recession, though there's still the possibility of a double dip. Darrell Johnson, president of FranData, which crunches the numbers on the franchising sector, says in his 2010 Outlook report that tight lending, unemployment and high consumer debt will keep things choppy for the next two to four years, though the worst is likely behind us.

Robert Purvin, CEO of the American Association of Franchisees and Dealers, says this year will begin to offer some relief to everyone: "2010 won't be rosy, but it will be a year of improvement," he says. "I think we'll see all sectors start back up again as the general economy rises."

That's partly due to an expected increase in consumer spending, but it stems mainly from renewed confidence in the economy. When the bottom was unknown, potential franchise investors held onto their money. Now, they're converting 401(k)s into loans through lenders like FranFund, more and more franchisors are offering in-house financing, and the long-term unemployed are beginning to invest in businesses rather than wait out the dismal job market.

The news isn't as good on the loans front. According to Bob Coleman, who analyzes SBA lending, 2010 should be better for government-backed loans, but lending will not return to pre-recession levels for several years. To put it in perspective: There were 43 percent more SBA loans going into default in 2008 than the year before, according to the Coleman Report, including 13 percent of all franchise loans. In 2009, SBA lending was off by at least 35 percent.

Naturally, entrepreneurs also need to be aware that the recession has completely remapped franchise financing. "In the past, there were 10 or 12 big national lenders that would finance franchises anywhere in the country," Coleman says. "Now you have to go through a community or regional bank. The national lenders aren't out there."

That's not the only sweeping change. According to franchise consultants, 2010 will be a watershed year. The turbulence of the Great Recession, many believe, has shaken franchising to its core and fundamentally reshaped the way the system operates. Trends that were slowly emerging have accelerated and are now keys to growth and survival. "The franchisor that doesn't realize it's a new world and that it has to make critical changes is going to be in trouble," says Hayes of FranchiseMastermind.com. "A major transformation has occurred."

That transformation involves two significant shifts. First, franchisors and franchisees have realized a greater need for cooperation and exchanges of ideas such as ways of improving system efficiency and trimming fat. Instead of being in a one-way relationship, franchisors are learning to build a team atmosphere and that franchisees can add brand value. Purvin, of the franchisee and dealer association, has seen an uptick in the formation of franchisee associations and efforts to partner more with franchisors during the recession.

"In times of stress, when the blemishes and defects of a system become glaring," he says, "is when people start looking at problems and repairing them."

To that end, many franchisors are paying more heed to franchise advisory councils and associations, are more transparent with financials and brand strategies, and have begun integrating franchisees into strategic planning and board meetings. Tasti D-Lite, the frozen dessert chain based in Franklin, Tenn., that turned to franchising in 2008, believes integrating franchisees into almost every aspect of its business is a winning strategy. Franchisees regularly come up with new products, promotions and, during the recession, cost-saving measures.

"We have the mind-set that we're going to bring products and suggestions to franchisees, and a large part of that is to listen to feedback we get from them and react," says Bill Zinke, Tasti D-Lite's chief marketing officer. During the recession, the company held a system-wide meeting to review and share cost-saving measures. Afterward, the corporate staff went store to store, addressing each franchisee's concerns. "When things tighten up, communication gets more important," he says. "We feel like what we're working on every day has to impact what our franchises need and want."

"Franchises need to stay alive and stay in business, and that now depends on cooperating with each other instead of the franchisor saying, 'Go here, do that,' " says Dick Rennick, who has been a franchise coach in Palm Springs, Calif., for 30 years. "Conflicts are now becoming more resolvable. They're learning to play in the sandbox together."

The second major shift is in the selection of franchisees. "For the last 30 years, the emphasis was on getting the contract signed,"

FranchiseMastermind.com's Hayes says. Now franchisors are asking deeper questions about their franchisees, whether they are a good fit or if the business will satisfy their expectations.

New metrics--such as extensive franchisee satisfaction reports and certifications produced by the Franchise Business Review and the Franchise Research Institute's FranSurvey--are helping franchisors figure that out (and giving would-be franchisees a better sense of the franchisor's culture and systems, too).

But the bottom line is, franchisors are getting pickier. If a candidate doesn't fit their profile, franchisors aren't afraid to redirect or reject qualified applicants. Florida-based PuroClean has used the Franchise Navigator system for the last three years to survey its top franchisees and develop a profile for good candidates for its damage restoration business. "We've been able to attract the right types of franchisees in greater numbers; we're not just weeding out candidates, we're doing a better job of figuring out who our franchisees are and what type of support and training they need," says Keith Gerson, PuroClean's president and COO, who points out that, by assessing its franchisees more thoroughly, the company has dropped its attrition rate and nearly tripled in size in three years. "You're only as strong as your weakest franchisee, and Lord knows we want to get things right."