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The Outlook for Franchising in 2011

Consumer spending and hiring aren't expected to increase much in 2011. But for some franchises, it will be a different story.

This story appears in the January 2011 issue of Entrepreneur. Subscribe »

The will inch forward next year, but slowly and sporadically. That's the consensus of many economists.

Tough times will persist, they say, for most small- owners, especially independents, as they continue to struggle with lower profitability and decreased access to . Job creation will lumber along as well. But thanks in part to corporate support, some franchise sectors will thrive, particularly those--such as fast-food chains-- that offer good deals at low prices.

It took 39 months for the country to recover all the jobs lost during the 2001 recession, says Martin Regalia, chief economist to the . It will take twice that long to bounce back from the recession that started in 2008, he says. A recent study backs him up. creates about 65 percent of new jobs, but when the National Small Business Association in Washington, D.C., surveyed its members this past July, it found that only 14 percent said they expected to hire new employees in the following 12 months.

The drop in household income and the corresponding decrease in means most franchisees will be unable to raise prices in 2011. But here's the silver lining: Lower household income should benefit franchises that provide perceived value to the consumer, says Darrell Johnson, president of FRANdata, a franchise research and consulting firm in Arlington, Va.

Take restaurants, for example. Johnson predicts that sales at full-service operations will continue to be depressed in 2011, but many fast-food chains will enjoy revenue and unit growth. And, he says, franchises that serve value meals will continue to offer discounts in 2011.

On the housing front, Regalia says the market will remain depressed until the effect of foreclosures is over. This means that franchise systems catering to new homeowners--from real estate offices to carpet, flooring and window treatment installers--are not likely to rebound soon. Home equity loans, which fueled the boom in new business starts in the middle of the last decade, also will remain flat.

Regalia and other economists predict that credit will remain tight. According to the small-business association,

41 percent of the nation's small businesses are unable to secure adequate financing. Independent small-business owners must cope on their own, but many franchisees will continue to receive help from their franchisors, through direct loan programs or a waiver of royalties and other fees.

Franchisors are also helping their franchisees increase sales with new marketing programs and by providing them with new products and/or services to offer their customers. That help is so crucial, Johnson says, that even sectors of the economy that are expanding, such as child care and senior care, have a better chance of growing within the franchise .

Startup capital is especially scarce. Banks, too, are under pressure. "Their margin for error is smaller and they have a tighter credit box," he says. But again, prospective franchisees have an advantage. The Small Business Jobs and Credit Act passed last fall includes $30 billion in funding available to community banks to lend to small business.

Franchisors are helping new franchisees obtain loans by submitting documentation to show lenders that existing franchisees within their systems are successful. "In a rising economy," Johnson says, "no one asked for that proof."

Franchises with successful franchisees tend to be established systems; applicants who wish to join new systems that have no history of loan repayments are still being turned down. As long as the economy remains stagnant, stronger franchise systems will grow at the expense of their smaller competitors. According to FRANdata research, the average franchisor grew by 45 units in 2005 and 2006; that number fell to 35 units in 2009.

This emphasis on performance will leave a lasting imprint on franchising, Johnson says. Because lenders are now scrutinizing franchisee failure, "franchisors will have to step up their support." Weaker players, without the resources to help franchisees stay open, will struggle. Some may disappear, or be bought up by stronger systems or private equity firms that specialize in turnarounds.

"Franchising," Johnson says, "will go through a cleansing that will, ultimately, strengthen its business model."

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