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Assessing the merits of whether to franchise

Written by: Rod Young

Article Overview: Franchising has been hailed as the way of the future for business but Rod Young, Executive Director of DC Strategy, says not all roads lead to franchising and businesses need to weigh up many issues in deciding whether to head down the franchising path.

Assessing the merits of whether to franchise


More businesses than ever before are embracing franchising. The yet to be released 2006 survey on franchising will almost certainly show substantial growth beyond the 850 Australian franchisors identified in the 2004 survey.

The 2006 survey could identify that more than 1000 Australian businesses operate within the definition of franchising in the Trade Practices Act (TPA). When you consider that Australia has almost 1,000,000 businesses and that 999,000 are not engaged in franchising, you might consider the decision to franchise is a radical one.

“Many franchisees have opted for franchising as a low risk enterprise, and by and large the vast majority of franchisees are successful”

However, careful consideration of the wording of the definition of franchising in the Franchising Code of Conduct which is unambiguous black letter law might lead business owners who do not consider themselves engaged in franchising to think again. Many co¬operatives, buying groups, dealerships and distributorships may be caught by the above definition and describing the arrangement as a 'license' does little to protect those who breach the Code.

Putting aside those businesses which are caught by the Franchising Code, but which either choose to breach the Code by not complying or who are ignorant of it, what exactly has prompted around 1000 organisations to embrace franchising and therefore deviate from the traditional business development path that has evolved since the industrial revolution?

The answer to this question is a rich tapestry of fact and fiction that has been built around the franchising phenomenon since the early 1950s in the United States and the early 1980s in Australia.

One chapter of the fiction could be paraphrased by franchisors that promote to their prospective franchise buyers: "Buy a franchise and buy success". Many of these franchisors have believed that by franchising, success will follow. The reality is less certain among those new franchisors who believe and promote this half truth as the key feature of their business when they jump onto the franchising bandwagon.

Many franchisees have opted for franchising as a low risk enterprise, and by and large the vast majority of franchisees are successful. Many would-¬be franchisors have seen and read about the franchising success of McDonalds and KFC and other world wide businesses such as Coca Cola, Pepsi, Ford, Toyota, Shell and BP. Each has built a massive enterprise through franchising.

Australian franchising icons such as Australia Post, Forty Winks, Bakers Delight, Boost Juice, Donut King, Hairhouse Warehouse, Dymocks, Cartridge World, Fernwood, Mortgage Choice, Cash Converters and Healthy Habits have been held up as shining examples of what franchising can do.

Franchisors are not shy about promoting the success of their franchise. The rapid growth of franchise networks is hailed as an 'economic miracle' and regular lists of the fastest growing franchises are published to demonstrate the success of franchising.

Any reader of the business press will see stories of successful franchisors and franchisees. Over the past 20 years the growth in the number of franchising companies and their 60,000 franchised owner operators make franchising a powerful magnet for those business owners keen to expand.

Does franchising make franchisors successful?

The reality is that while the majority of franchisees are making money, the performance of many of the 1000 franchisors is less clear. An understanding of how a franchisor generates revenue and profit is instructive.

A franchise network that has no company operated outlets and is 100% franchised relies for its profitability on the sale of franchises and the ongoing royalty stream flowing from the successful operations of the franchises. In some cases, supply side rebates and renewal fees after the initial franchise term help supplement revenue and profits for the franchisor.

Depending upon the magnitude of the initial franchise fee and the rate of the initial franchise fee and the rate of franchise sales, the initial franchise fees can support the overheads of a franchisor of personnel, infrastructure and facilities and still create good profitability during the growth phase of the franchise.

However, as a franchise system grows, the reality is that new franchise sales will decline once market penetration approaches its peak. It will grind to a sudden halt if existing franchisees do not validate the viability of the financial performance of the business.

Unless there is continued growth and a harmonious relationship with franchisees, cash flow generated from initial franchise fees will dry up and the franchisor must rely on ongoing income from the current franchise pool to maintain profitability. When franchisee viability is marginal and franchisor/franchisee relationships are strained, the income stream from ongoing royalties may come under stress, leaving the franchisor with a modest or even dwindling revenue stream and little prospect of further growth.

In a franchise network, ongoing franchise sales and therefore royalty growth are dependent on the early franchisees achieving profitability quickly with a reasonable degree of satisfaction about their decision to buy their franchise. Future franchise sales are heavily dependent on existing franchisees confirming to potential franchisees that the franchisor has a good system and the choice of that particular franchise is a wise decision.
Fully franchised networks need to deliver the promise of profitability early in each of their franchisees' establishment periods, and grow to a significant number of franchised units before the franchise network can make decent profits (more than $1 2 million per annum) and create a worthwhile magnitude of enterprise value ($5 10 million) to make franchising worthwhile.

The reality is that many fully franchised networks are failing to reach critical mass and are not making decent profits or building worthwhile enterprise value from franchising because either the business is unprofitable or the franchise system on which the franchise is to be based is poorly conceived and developed, or both.

Should franchising be considered?

The answer to this question is an emphatic "yes!," but only after the business model is proven.

Only then can an honest assessment of the scalability of the business to be franchised be undertaken. There are several key signposts that can point a business owner in the right direction along the road to profitable franchising.

The following checklist makes an excellent guide:

1. The business should be proven and profitable before franchising is considered.

2. At least two company operated locations should be developed and operating profitably to prove the viability of the business model in multiple locations.

3. The businesses should be operated under management to test the operating and reporting systems.

4. The businesses should be returning at least a 20% return on capital invested.

5. The market in which the business plans to operate should support at least 20 business units.

The last point is important, as the mathematics of franchising will not support the investment of time and money and infrastructure necessary to develop a franchise system that cannot scale beyond at least 20 units. To franchise or operate company locations is not the question.

Franchising does not mean abandoning the growth of a company owned network. Every business should operate as many company owned units as it can afford to finance and operate profitably. Ultimately, franchising should not replace the development of a company operated network but be considered a growth strategy to complement it.

Franchising is both a sophisticated capital management plan and in today's employment environment, it's a key HR strategy to attract and retain motivated owner operators at the customer end of a business. It also addresses the micro¬management of cost pressures on gross profit margins, labour costs and operating expenses.

In a market where increasing occupancy cost can depress profits, the combination of a core of company owned units supplemented by a network of franchised outlets, especially in distant or potentially marginal areas for company locations, is the ideal business structure.

A well developed franchise program can ensure the economies of scale from buying and advertising can be enjoyed while avoiding the high costs of layered management and travel costs that large company owned networks incur when managing sprawling company networks.

In a limited market like Australia where few networks grow beyond 200 units, the operation of company owned locations contribute critical cash flow and profitability, keep the franchisor close to the marketplace and provide a fertile base to develop staff, train franchisees, trial new products and services, and innovate with new locations and presentation.

Related Articles
  Franchisee checklist - assessing the business type
  Will Your Prospect Franchise Work in Your Area?
  Franchise Legislation in Canada
  Franchising with all its Success
  Choosing a Franchise

Article Tags: Executive Director



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Hello I am a franchise expert - Hello, I recruit franchise owners for successful franchise concepts based in the USA. Many of my franchises are looking to expand north to Canada in all major centers. I enjoy networking and answering questions about franchising. If anyone is interested in the franchise world or looking to buy a franchise then contact me. I have a wealth of information and like to help. Thanks for your time. Michael Somer
Re: Franchising Brokers vs Franchising Consultants - Franchise consultants are free and work with you without any obligation. they do not work for any one franchise but do get a percentage of the franchise fee when a franchisee that was registered with the franchise came from the consultant and the franchisee signs. They will try to match up your interests and skills to franchise businesses that are right for you. They can explain franchise guidelines and help you in any way they can. Franchise brokers usually get paid by the client and/ or franchise (generally get some type of commission). Additionally, they can get points or referral fee off the deal if they refer you to a lending resource too after they sell you on a franchise. Typcally they will try to sell a prospective franchisee on a larger deal so they get a larger commission.
Re: Which franchise would you buy? - The franchise to buy, the one that will succeed is the one that is either underrepresented or not represented in the community. Look at your community, identify what service is missing. That is the franchise to pursue. Too many people buy a franchise based on their "heart". A franchise is a "widget". I have found that once people began to investigate a franchise they had never thought of, but find their is a need; the entrepreneurial "gene" kicks in and they get excited. They began seeing the possibilities of success, and as they uncover the nuances of the franchise, they become more interested. It is the uninformed that are uninspired.
What is the Best Franchise? - As a Franchise Consultant I get asked this question on a daily basis. I work with clients to help them find the right franchise and through those conversations they almost always as me: "What is the Best Franchise?". There is no single answer for this question as the answer truly depends on the criteria you set as a perspective franchise owner. Meaning, maybe you want a retail location with 5 employees or a home based franchise with zero employees. Either way, the word "best" becomes relative to what is important to you. I realized quite some time ago that I could never "sell" a franchise to anyone. The only way someone will buy a franchise is if it makes sense for them & their family. Performing the proper due diligence is key to finding the best franchise for you.
Re: Franchising Brokers vs Franchising Consultants - I don't think you can really prevent this from happening but you must certainly be careful when you choose your franchise broker. My suggestion would be to talk to a broker from a reputable network such a FranChoice or FranNet. These people are good people. I guess you can tell right away if the broker is trying to get you to buy a specific franchise. If he tells you right off the bat that you "have to" buy XYZ franchise, well, to me it sounds like he's trying to "scam" you. On the contrary, if he really listens to you, really consult you and try to find out what's best for you, you will probably be able to tell. When I worked for Franchise.com, we had a brokerage unit called FranFit. The beauty of FranFit was that we were paid the same commission by the franchisor, whatever his industry or franchise fee. This way, there was no incentive for us to match a potential franchisee with a franchise or another. We were truly leveling the playing field and really looking for the right franchise fit for the buyer AND the seller.


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