Alfred P Sloan, the long serving boss of General Motors which, under his direction, became the world’s largest, most successful and most profitable industrial enterprise would presumably have wept if he had lived to witness its dramatic decline.

He is the source of much business wisdom including the proposition The business of business is business.

For this column however it is another Sloan quote that provides the starting point: the strategic aim of business is to earn a return on capital, and if in any case the return is not satisfactory, the deficiency should be corrected or the activity ceased.

This is of course as relevant to franchising as it is to any other business. Franchising exists, from both the franchisor and the franchisee perspective, ultimately for financial reasons. An enterprise does not franchise a successful concept to sharing the love and the wealth. An enterprise franchises its successful concept based on a calculated assessment that franchised development will provide a better return than company owned and managed outlets.

Although in a climate of economic downturn where retrenchment is a reality for some employees the concept of buying a job is frequently referred to, and although many franchisees seek the challenge of business ownership within a franchise network as an attractive alternative to working for the boss, the decision for franchisees too is invariably financial.

Although a franchisor can in theory achieve a greater financial return from company owned and managed outlets than from franchised outlets it does not work like this in the real world of franchising. Although the royalties received by the franchisor from a franchised outlet will invariably be less than the profit it would have received from an owned and managed outlet this equation ignores the massive benefit to the franchisor from the franchisee’s capital in building the outlet and the motivated management of it.

Similarly the prospective franchisee’s financial equation may look healthier under independent as opposed to franchised business operation but this of course ignores the massive benefits of participating in a proven system and the training, management expertise, ongoing operational support, economies of scale and networking that are real and acknowledged factors in the success of franchising.

So, as they say in the classics, it’s all about the money, silly. So, can it all work if everyone is not making money? Not really.

A franchisor who is not making an appropriate return on capital cannot provide the level of service needed and expected by franchisees and cannot devote resources to developing the system for the benefit of all stakeholders. The system cannot grow and never reaches critical mass.

Sloan’s abandoning the activity option is more difficult in a franchised operation where the franchisees have legal interests which must be considered. Sloan’s other option of correcting the deficiency is never easy. It is particularly difficult for a financially struggling franchisor and again is compounded by the interests of franchisees who may resist the cost of remedial action.

We are proud of our record as the most franchised major economy in the world on a per capita basis but the grim reality which lies behind this statistic is that we undoubtedly have too many small financially vulnerable systems struggling to achieve critical mass which results in financial pressures on the franchisor and the franchisees.

A franchisee who is not making an adequate return is particularly vulnerable. Within most franchise systems there is a spread of profitability driven by factors such as location, demographics, personal qualities as well as by both good management and good luck. But if the average profitability of franchisees within a system is low the system itself is under threat. Neither of Sloan’s remedial strategies are particular attractive.

Correcting the deficiency is not an option if it is a system matter outside of the control of the franchisee. Abandoning the franchise is very much the last resort. In the language of the front page of the Code Disclosure Document, entering into a franchise agreement is a serious undertaking.

Due diligence and informed advice in relation to the financial equation is obviously vital.

Andrew Terry, Australian School of Business and DC Strategy