From a comment on Mark’s blog:
I don’t remember who said this, but recently I read something interesting about business
mom and pop kind of business, do what they want and offer it to you. (meaning if you like it, they will have your business, if you don’t like it, they won’t. but they do what they want.)
big business machine, do a lot of research and offer what their customer really want.
That’s a nice maxim if it wasn’t for the fact that it is complete bullshit.
By what metric do you measure a “mom and pop business” vs. “big business” at targeting what the “customer really wants”? I don’t know, but since a customer votes with their dollars, I’d say that the success of such business would be an indicator. However, if a business is successful it is, by definition, “big”. So the metric would be polluted.
Let’s instead take a franchisee, which is big business targeting with “mom and pop” money1, vs. new businesses. The failure rate of franchisees with the same capitalization is greater than that of a new business in the same market.2
If you do a net search, you won’t find it, instead you’ll find a wealth of sites that will refute this claim in one sentence as they try to sell you a franchise in the next sentence. Am I buying a time-share here?
Consider that the studies that they are quoting are done by franchise-promotion lobbies. The 90% success rate you read is based on surveys of franchises that are still in business. The actual survival rate is somewhere around 60% after four years and drops to 25% after ten.
How about small business failure rate? Well small businesses have a 2% higher survival rate after four years. Most franchise lobbies take a given that the failure rate for small businesses is much higher:
“The reason that most franchised businesses tend to have a lower failure rate is that most franchise companies do a better job of financially qualifying the franchisee before they start the business. The reason that most independent businesses fail is due to inadequate capitalization—which means that people don’t have enough money to live on while they’re getting their businesses off the ground.”
—John Reynolds, executive vice president of the International Franchise Association in Entrepreneur
Okay, dumbass, you really know how to misuse statistics. First, you base “success” by interviewing the few franchisees that have remained in business after five years and asking them, “Are you successful?”3 Then you count “small business” as any idiot who starts a business no matter what their capitalization is? You have to compare it to small businesses who have the same capitalization in the same market sector as you. Ask yourself, if franchises are so successful then why is he paid to lobby the government for more corporate handouts to franchises?
It should be “intuitively obvious to the casual observer.”4 that small businesses should do better than franchisees. Huh? Let’s take A Random Walk Down Wall Street. Basically buying a franchise is like investing in a mutual fund and starting a small business is picking stock by throwing darts. Which returns more money for the same investment? Throwing darts. Why? Because the market is efficient. If someone could “game the system,” the exploitation of that arbitrage will equalize prices.
Wait! Why isn’t it the same? Well some of your income will be going to support the mutual fund manager (the franchise takes its cut).5 Honestly, if the franchise was so successful, why don’t they strike out on their own. Or, conversely, why doesn’t Walmart franchise their supercenters?
Libertarians should be rejoicing when small business outperforms big business by a small percentage. It means we have a pretty efficient market. When big business does better than small business then we have have grave cause for worry. It means that social politics or market defects (monopoly, externality, public goods) have thrown a monkey wrench into market efficiency and exposed another flow in their free market ideals.
I’ll never understand it: I had a friend in graduate school who would precede a statement by saying, “If I won the lottery…” to which I would immediately respond, “Why would you want to win the lottery?” Somewhere along the way, America’s values diverged from mine. Maybe it is the Protestant in me, but why would someone ever want money they didn’t earn?