21 April 2011

The Franchise Misnomer

In the wake of the largest franchise IPO ever last week (Archos), I was reminded of a topic that I've pondered for quite some time. With franchise chains being the easiest way to get a business jumpstarted, it's no wonder that there are almost 1M locations representing $1T of sales in the US alone. No MBA required, no resume massaging; just a roll-up the sleeves attitude and a propensity to work hard is all you need to sign up. But are franchisees actually entrepreneurs? Do they run their own business or are they merely buying themselves a living?

Let's look at the dynamics of the largest franchisor on the planet, Subway, as an example. Subway makes it easy for new locations: a very small upfront fee ($10k or so), soup to nuts setup and management services, and a straightforward royalty model (take ~12% off the top). This looks great, right? If atmabus wanted to leave the corporate world for business-ownership, this seems to be a low risk option right? Let's look a bit closer of who would actually "own" this business.

Subway controls more aspects of this endeveour than atmabus would. In addition to the branding, Subway mandates your procurement for everything from napkins to lettuce (at a profit for corporate). They dictate how the store should look, how much you need to spend on improvements, and mandate computer and accounting systems. Margins and pricing is controlled at some levels -- most franchises actually lose money on the $5 footlong (but have limited say in what they can do). Sure Atmabus would manage some parts of the operations; but he would not control supply chain, advertising, pricing, and product offerings under this franchise agreement. So what's left?

When you think of entrepreneurship, you think of control and unlimited upside potential. Here you get neither. Given your sales are limited to your foot traffic in a specific geography, the only way to scale is to buy more franchises. Couldn't Subway technically "own" the stores and pay a management fee to operators and accomplish the same thing? This model feels more like a distributor relationship versus a B2B one as advertised by the franchisors. Remember the Coca-Cola bottlers? Look who owns them now.

Certainly new franchisors will command less control and costs than established players like Subway. But ultimately franchise models tilt in favor of the corporations. Incentives are misaligned; the $5 footlong promotion benefits franchisors (Subway sells the ingredients) at the expense of franchisees. Most hotel chains are moving away from ownership to franchise models because their is frankly more profit and less headache for them through the arrangement. As long as their are people willing to live on site and work 7 days a week, they can continue along this path.

Don't get me wrong - there is money to be had for franchisees. Many make a decent living doing them. You just have to do it in a big way since so much of the margin is taken by franchisors. If you get in on the ground floor of a bustling one, you might be able to negotiate a sweet deal. Plus just the mere fact that its considered a "business" gives owners a path to tax benefits associated with ownership. Given the limited control, upside, and autonomy for franchise owners, its hard to consider them entrepreneurial ventures.

05 April 2011

Are You Undervalued or Overvalued ?

There is a long standing debate about whether or not the stock market is 'efficient.' In a perfect world, forces such as the free market system, access to information, and the law of supply/demand would price stocks at their intrinsic value. But as we know, the world is not perfect; stocks tend to be either overvalued and undervalued. Can this same logic apply to jobs and compensation?

In a vacuum, the value created by an individual would guide his or her salary; but it doesn't happen like that in the real world. One's paycheck generally have very little to do with their societal worth or even the intersection of where supply meets demand. Further, similar to daytraders in the stock market, does this inefficiency create a business opportunity?

The most overvalued job that comes to mind is a real estate agent. If you strip it down to its basest level, a real estate broker gets 6% of the value of your home to open your front door. That's it - that's really all they do. Contracts are standardized by the states, risk is mitigated by escrow agents, and frankly the negotiations really lie in the hands of the buyer and seller. Real estate agents do not create demand for your house; they simply post it online to their proprietary MLS closed system. Because of this monopoly, they have been able to keep their fees artificially high. Sure sites like Zillow and FSBO have brought fees down slightly, but there is a opportunity to bring this function to its true intrinsic value. 6% of the housing market - pretty big market size for a hungry entrepreneur.

What about wall street bankers? Goldman Sachs gets gobs of money for advising companies such as AT&T on whether they should buy T-Mobile. Do bankers have more industry knowledge than the brain trust at AT&T? Has the AT&T CEO not heard about T-Mobile ? Is AT&T's legal staff and M&A teams incapable of leading a transaction of this magnitide? If the answer is no (which i think it is), how can the market allow such enormous fees? At least in this case, there is no 'closed' system, but certainly it leaves you to wonder. Don't get me wrong, I see a huge value in the investment banking/brokerage function; its just the value significantly diminishes as the sophistication of buyers and sellers increases. This is precisely why smaller investment banks (usually started from ex-bulge bracket folks) are growing at such a fast clip these days.

On the other side of the coin, what about undervalued jobs? Certainly folks such as policemen and teachers come to mind. The most underpaid job on this planet is a stay-at-home parent. They bring in a whopping $0 and have the uneviable task of shaping our children's future. America's CEO, Obama, only gets paid $400k for the most important position on the planet. Sure, budgetary constraints of government/non-profit limit salaries of high worth positions; but how sustainable is this in the long-run? There are also many instances of this in the for-profit world.

Accountants are underpaid, overworked, and are in short supply and high demand. Yet their salaries are the lowest in the business world. The Big 4 can't find enough talent to fill open positions (PwC spent millions in a desperate attempt on LinkedIn), yet they continue to underpay and experience high turnover. Another example is the primary care physician. Demand continues to soar, supply is falling, and wages are flat at best. Without accountants, we couldn't rely on financial statements; without PCP's, we wouldn't be healthy. Not exactly low value positions; These fields will either face a major restructuring, a significant drop in quality, or a healthy rise in fees.

You would think money always follows where the world is going and intersect at the point of equibrium. There seems to always be external factors that create a market imbalance between compensation and value creation. For example, the value of atmabus' business insight relative to how much he gets paid for it is grossly imbalanced. So are you undervalued or overvalued? Where else are there market inefficiencies to capitalize upon?