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Should You Sell Franchises or Build a Chain?

The Other Side of the Coin and Should You do Both?

The Other Side of the Coin
Of course, franchising is not without its drawbacks.

First of all, as a franchisor, you will no longer be entitled to every dollar that goes to the bottom line. Franchisors typically receive a royalty that is a percentage of gross revenues. So as a franchisor, you do not share in profits. So while you would recognize 100 percent of your revenues if you owned the unit, your revenues as a franchisor might be limited to 4 to 10 percent of the unit's revenues, plus perhaps some product sales, rebates and advertising fees.

Likewise, if the operating units were to generate profits in the 20 percent range and you required a 6 percent royalty, you might need to sell four or five franchises or more to achieve the same level of dollar profitability as you would with just one company-owned operation. So as expected, reduced risk (in the form of franchisee investment) results in reduced returns-at least at the unit level. Of course, franchising does allow for faster growth to offset these reduced unit level returns. But if you have the capital to adequately develop the markets you desire to penetrate without franchising, you may well be sacrificing total dollar returns-although your ROI would likely be higher through franchising.

The way in which franchisors are compensated is even more noticeable if you're looking to demonstrate revenue growth. While revenue growth may not mean much to some companies, for public companies or companies considering going public, this metric can be important for valuation purposes.

Similarly, company-owned operations offer the other financial advantage of building the balance sheet. With franchising, the only assets built are franchise contracts and the "goodwill" associated with them. Company-operations, on the other hand, will build hard assets-which can also help from valuation purposes.

Likewise, it is important for you to have a personality that is well suited to franchising. Certain leadership styles (see "Determine Your Leadership Style") are better-suited to franchising, and if you find you aren't comfortable with the more open communications you will receive from franchisees, perhaps you may be better suited to a company-owned environment.

Should You Do Both?
Lastly, for the company trying to choose a growth strategy, it is important to point out that it does not have to be a tradeoff between building assets and speed of growth. The vast majority of franchisors use both company-owned and franchised strategies in combination.

Some franchisors will choose to own and operate the best locations/markets while franchising secondary and tertiary markets. Others will choose to develop a company-own presence in their core marketplace and franchise in more distant markets. And some choose to treat company growth and franchise growth opportunistically.

Regardless of the strategy taken to integrate these two growth models, the combination of franchising and company-owned growth, for many companies, provides the best of both worlds.

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Mark Siebert is the CEO of the iFranchise Group, a franchise consulting firm that has worked with 98 of the nation's top 200 franchisors. He can be reached at 708-957-2300 or at info@ifranchise.net.
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