THE 2005 FRANCHISE BUSINESS DEVELOPMENT FORECAST AND INDUSTRY TRENDS ANALYSIS

Franchise executives are an optimistic lot and project that franchising will see a 6 percent growth in net new unit development during 2005. This projection of significant system expansion is the forecast of 100 of the top U.S. franchise executives surveyed for the 14th Annual Franchise Business Development Forecast and Industry Trends Analysis. Each year, Franchise Recruiters Ltd., an international executive search corporation with offices in the U.S. and Canada, conducts this one of a kind study and analysis of the world of franchising.

Franchise Recruiters asked franchise executives a series of questions about current business concerns and strategic initiatives they foresee in 2005. The responses review branded system forecasts and opinions for chains, nationally and internationally. The statistics collected incorporates personal projections, calculations, and business planning data compiled through Franchise Recruiters' 27 years of professional relationships within the franchise business community.

Net unit growth is the result of subtracting real unit closures from new unit sales; this figure provides the accurate, annual new unit growth for systems in 2005. Ignoring the extremes, top management projects a consistent opinion for development and expansion within the business of franchising. This commanding economic engine continues on an Oz- like quest up and down the Yellow Brick Road, producing sustained mutual success for franchisees along main street America and around the globe.

Franchise executives spoke of "softness" in overall revenue growth for units through 2005. Despite solid new unit expansion, sales numbers are flat or predicted to be less than same-store sales last year (2004). The executives, however, are still pleased with new unit construction growth figures projected for 2005. Furthermore, they point out that the foreseeable, formidable challenges include slower overall economic retail expansion, relatively high energy prices, real estate tribulations, and rising interest rates. Pricing, however, emerges as their greatest worry, and it is within this area that they feel the impact of competition as consumers lose the lubrication that new tax cuts and incentives brought to business in 2004. Franchise chains will also be hit with shipping cost surcharges, outlays that will add to bottom line erosion in 2005.

The U.S. gross domestic product growth is projected to slow to 3.3 percent in 2005, well behind that of 2004, according to government statistics. Consequently, an increase in same-store sales will be difficult to achieve for many brands. Shoppers, regardless of income or where and how they live, demand that they not overpay for anything; consequently, price points will be particularly significant.

Throughout 2005, the field of major brand ownership will be thinned as more national chains acquire competition. An overcrowded market, especially in the food and hotel venues, means brutal competition to win consumers. Franchisors articulate that they intend to save substantially through improved merchandising and non-merchandising purchasing scale, a more efficient supply chain, and more effective administrative and operational systems. This commitment to savings will force suppliers to yield to franchisors' buying power, lest they go elsewhere.

Retail franchisors are selling products at the counter that, in the past, may have seemed out of place as they stretch to catch consumers at the point of sales with their wallets open. We are told a number of chains will no longer stick to just staples when it comes to selling "stuff." Almost anything goes to please the customer as merchandisers blur the lines of retailing to squeeze out more sales.

New revenue channels will be urbanized to meet the changing needs of consumers by stocking products not usually found in the branded store. They buy limited numbers of special goods to sell through and then move on to the next new thing. Channels are fusing; franchisors can now say that they are getting into new businesses and effectively selling to enhance bottom line efficiency for their franchisees. Examples are Ace Hardware selling products such as ice cream and fresh flowers, coffee franchises offering top selling music CD's, and video rental brands with electronic stores sharing the retail floor selling cell phones and accessories.

Franchise decision-makers report that in an increasingly self-service economy, computer kiosks are moving well beyond common financial tasks. Franchisors are turning to kiosk technology to allow customers to send branded goods across the country. As they become central to franchise operations, the kiosk will become ubiquitous for retailing products, packaged food, hotel reservations, and franchisor branded gift cash cards. The consumer is moving to a more self-service strategy, and kiosks are becoming an integral part of the sales strategy for chains. Time starved consumers will use them near parking lots, outside big box stores, in office campus environments, gas stations, convenience stores, and malls.

Revamping, rehabilitating, and regenerating older branded systems will engender new customer loyalty in 2005. Franchisors that have not executed new restructuring plans for consumer contentment face loss of market share. The "doom loops" cycle has shocked a number of national and international franchisors into reality. We have seen it in the Goliath brands around the planet in recent years. Once a company is in the loop, a turnaround becomes much harder to achieve. Franchisors keep cutting expenses; morale suffers, product and service erode distancing the brand from the customer. Too often franchisors spend their time protecting their turf rather than moving forward with new products and services to suit the capricious consumer in a mercurial marketplace.

Systems fail to break the cycle, and the spiral down continues until they become a meal for competing chains or are forced to seek bankruptcy protection. In recent years, some franchisors have fallen into a funk, not because management took a "stupid pill" but because the competitive landscape had changed. The vicious cycle breaks down when disrupters emerge in the system offering customers less for less.

Veteran operators have learned to be circumspect about their customers' on-again, off-again behavior and brief infatuation with new things. We were informed that there are two American public minds: one that drives short-term fads and the other that shapes long-term behavioral trends. The test in franchising is to spot and separate the non-market drivers from those of real change. For example, if taste is important, remember that "it starts with the food your mother made for you, and those tastes don't change quickly."

This year, executives touted a number of franchising trends. One of particular interest to all sales and development department heads is the high level of interest in franchising from uniquely qualified prospects--"they are better capitalized, have better management experience, better education, and are increasingly diverse investors." Franchise concepts continue to evolve to meet changing U.S. demographics. Age, convenience, and the omnipresent blooming boomers squeezing the pocketbook are driving forces behind special service franchising. Interest in this focused area generates more cost effective and efficient solutions in adult day care, health care, home care, beauty, skin and aging treatments, spas, lifestyle, and entertainment. Franchisors predict that health care insurance companies will be entering the market through franchising business plans in order to achieve the cost savings so necessary to improved health care delivery. Senior care franchising systems have more than tripled in units between 2000 and 2004, from 434 to nearly 2000, an annual growth of almost 40 percent.

Seniors are a thriving part of franchising today, and their presence will explode in coming years as record setting retirements take place. For many older Americans, retirement is not a viable option; many are postponing the gold watch party and going back into the work force as franchise employees or franchisees. According to the U.S. Bureau of Labor Statistics, the number of workers age 55 and above rose to nearly 24 million in 2004, up from 22 million in 2003, and from 20.7 million the year before. At the same time, the government is forecasting a significant labor shortage nearing the end of this decade. Franchisors tell us they want and need seniors as a reliable work force for years to come.

Synergistic concepts that combine, under one roof, healthful eating with product retail concepts have launched a splinter co-branding arrangement that brings two consumers groups to the store. As this is taking place, the public and private financial communities continue to move to a more favorable view of franchising as a successful business method.

Equity and investment firms will boost heightened levels of interest in franchising as the perfect model for investors because of solid management, high positive cash flows for franchisors, and clean, straightforward balance sheets. Private equity firms have found franchising to be their new golden goose, a discovery that has fostered more interest than available deals. "Lots of financial firms are buzzing around, trying to find the buried treasure." Private capital from innovative monetary sources is available for low investment franchising, specifically franchises that can be turn-keyed for less than $400,000. Examples of such franchise systems are E-Bay-type drop off stores that have low barriers to entry and require limited entrepreneurial experience.

Across the country and around the world, affinity programs are on the rise in an effort to hold customers close to the brand. By offering perks, franchisors can make sure their core patrons don't defect to another venue. Franchisors offer rewards as a critical part of building marketing relationships with customers and audit customer buying habits to elicit the necessary data to better target and serve consumers as well as to stock inventories, institute sales, and implement special seasonal programs.

The battle for your mind is taking place in the franchise boardroom today. Market position is not easy to obtain or retain. A franchise brand commitment to success has to be different from that of the competitors. "If you don't have something that separates you from the pack, then you better have a good price." There is a problem with going cheap. Your competition can mark things down as fast as you can. The problem with discounting is that once prices are set low, consumers expect them to stay low and will shop around until they find their price. Franchisors believe that corporate fortunes depend on their ability to empathize with customers' changing desires---the internal working of our cranial computers is vital to the bottom line directed mental calculations of the franchise marketplace.

In an increasingly litigious society, franchisors are ever wary of employee conduct. Employees who drive on the job will be required to be exceedingly careful when talking on a cell phone for business purposes, particularly delivery oriented concepts. Accident victims are winning multimillion-dollar settlements against firms whose employees are proved negligent while driving and using phones. A formal written policy for cell phone use must be in place to defend litigation.

Chains that delete electronic mail without consideration run major legal risks. In litigation between franchisees and franchisors, all can count on e-mails being subpoenaed, and compliance is mandatory. Policies must be in place to clarify which business e-mails (including instant messaging through interoffice communications) should be deleted or retained. A clear, definitive statement of policy becomes especially important when recalcitrant franchisees are involved in the discussions. A sizable amount of legal action and adjudication between franchisor and franchisee will pivot on this issue in years to come. Vendors can help with archiving electronic communications.

More and more systems are trying to offer forms of health care insurance to their chain's hourly employees. They are hopeful that the plans will pay for themselves through reduction in turnover. Employee bank accounts are also on the wing. About 30% of hourly employees do not have banking relationships. Franchisors contract with financial institutions to open accounts with debit cards for workers. They process payrolls by directly depositing funds into accounts, saving check cashing charges and processing fees, while cutting down on lost or stolen checks.

On the issue of management compensation, franchisors report some slight alterations to past practices. More franchise corporations are opting for "pay for performance" compensation plans, shifting resources away from strict annual bonus payments. These plans are more incentive driven and call for departmental participation. They are paid at specific intervals over the fiscal year, not at the end of the year, following an annual audit of the company's performance. These plans eliminate entitlement issues, encourage increased production, and reward improved individual performance. This matrix can be overlaid at the franchisee unit level as well.

Finally, training, the cradle to grave mainstay of franchising, takes on a new appearance through "learning by doing" principles. Operations manuals and videos are still superlative in the training mode. However, franchisors have learned that people retain more through doing something with team members, a "show me and I will learn faster" theory. "The desire to learn is second only to the sex drive," according to one franchise executive within the food industry. "If you tap into that desire to learn, you create an environment of continuous learning."

On the international front, China, the mother of all franchise markets, comes into play, sporting a new franchise regulation in effect in 2005. This franchise business regulation provides several innovative shields for franchisors and their significant intellectual property, trademarks, and contractual relationships. The allures of the mysterious Orient are not lost on entrepreneurs. With a gross domestic product of $1 trillion and a soaring economic growth rate of nearly 10 percent annually, China beckons as a fabulous place in which franchising will flourish.

Relationships are the key to doing business with this population of 1.3 billion, and a winner-takes-all principle is in play. China is home to about 20 percent of the world's population, yet, produces only about 5 percent of the world's total output which suggests just how high "up" might be for the Chinese economy as it matures. The 21st Century could well become the "Chinese Century" as the country now graduates substantially more engineers and scientists than the U.S.

Franchisors are granting province level versus country level Master Franchises in China and are focusing on Shanghai as the point of entry. The survey shows an evolution in this marketplace of new middle and upper-class consumers who are demanding quality and brand before price.

In the past five years, over 5 million new homes have been sold in China. Yet, only 4 percent of the country's people have household incomes of more than $20,000. That translates into a market of more than 50 million who are spending increasing amounts of money on such things as services, education, health care, travel, food, telecommunications, and packaged goods. Concentration for franchise development is in big eastern cities near the coast, an area that represents 58 percent of the economy, but only 37.8 percent of the population.

China's stock market is the second largest in Asia, after Japan's. The People's Republic of China (PRC) attracts more than $50 billion a year in foreign direct investment, second only to the U.S. In 2004 more Buicks were sold in the PRC than in North America. Interested franchisors will move quickly because Chinese markets evolve swiftly, and the best deals take place before the competitive free-for-all starts. Caution is advised though; western business approaches that fail to match China's reality won't work. Franchisors must respond nimbly to fast-changing market dynamics and rely heavily on skilled local managers who are still rare in the land of emperors and dragons.

International franchising continues global expansion by embracing the Internet and on-line communications, as service franchises become a primary focus. The U.S. is the best in the world at business systems and services. Prospects in far-flung countries, small and large, entice moderate and mid-sized franchisors to consider expansion through master licensing deals. Growth venues are in industries such as auto, business services, chemical application, executive education, logistics, pet care, retail, sports training, moving, residential and personal service franchise concepts as well as in the food and lodging sectors. At the same time in various countries, foreign franchise associations are developing beyond consultant clubs to become bona fide business organizations that benefit franchisors.

The exclamation point in the annual survey this year was piercing for franchise system growth plans. An exceedingly poignant comment from a franchise executive sums up the report around the engine that pulls the train of franchise development and growth. He was addressing investors as well as franchisees. "One thing I have noticed in the post-September 11 era is that people are thirsty for finding a purpose. I recently heard business authors Ken Blanchard and Rick Warren give a presentation.

"It took Blanchard 20 years to sell 10 million copies of The One Minute Manager, the best selling biz book of all time. It took Warren 20 months to sell 20 million copies of The Purpose Driven Life. Blanchard stops at showing managers what to do; whereas, Warren shows people why they should be doing it and from where they should be doing it. Give your investors (franchisee and corporate financier) a good return plus a reason why, other than money, and people will be throwing money at you. Investors (and franchisees) want to know that their lives, careers, and capital stand for something."

From my observation at 30,000 feet after flying the friendly franchising skies for 27 years, I view the legacy of franchising as a doctrine that inspires us to dream, learn, accomplish, and flourish, one and all, while giving us a chance to achieve a successful life purpose and a substantial piece of the American pie.