An Investigative Report on Franchise Profits
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Franchisors are pretty upfront about what it's going to cost to get you into their systems. They happily outline franchise fees, royalties, marketing requirements and grand-opening costs, and they can ballpark figures for potential franchisees on everything from the amount of printer paper they'll go through each month to the best deals on neon signs.
But franchisors are bashful when it comes to talking about how much moolah franchisees can actually earn running their businesses.
This reluctance makes sense to a certain extent. Any earnings claims that a franchisor makes, either outright or implied, can open the company up to a lawsuit if a disgruntled franchisee doesn't reach those goals. Instead, franchisors direct candidates to their Franchise Disclosure Document (FDD), the detailed prospectus they are required by law to give to interested investors.
Item 19 of the FDD details the financial performance of the franchise and offers a snapshot of the average revenue a franchisee makes. But Item 19 is often calculated with a sleight of hand that would make a magician proud, with the numbers spun to put the system in the best possible light. The earning ranges documented can be so large (e.g., $50,000 to $500,000) as to be meaningless, if they are shared at all, since filling out Item 19 is optional.
So, how much can you earn by opening a franchise unit? According to a large survey by the research firm Franchise Business Review, the average franchisee across the spectrum earns a profit of $66,000 annually. Beyond that, it's hard to generalize, since there can be major differences between concepts even in the same sector.
We spoke with experts, franchisors and franchisees in restaurants, mobile opportunities and personal-service companies to estimate the profits one might expect when investing in different types of businesses. More important, we picked their brains to discover the moves smart franchisees make to increase their margins.
Now Serving: Cracking the Restaurants Model
When people think of franchising, fast food is often the first thing that comes to mind. While restaurants make up a healthy chunk of the franchising world, it's hard to recommend a food-based franchise to beginners. Typically, restaurants have some of the highest startup costs in franchising. At the same time, they offer the biggest returns. "There are a lot of moving parts and specialization in food," explains Alex Cunningham, a Florida-based business consultant who focuses on maximizing franchisee profits. "I would strongly recommend a background in the industry."
Jeff Elgin, CEO of franchise referral firm FranChoice, agrees. He believes that to make a go of it in the food business, operators must be extremely smart right out of the gate. "Restaurants are tough businesses with much, much smaller margins than other franchises," he says. "It's very unforgiving. You have tiny margins and can't afford to make mistakes."
According to a report on food franchising by Franchise Business Review, 51.5 percent of food franchises earn profits of less than $50,000 a year; roughly 7 percent top $250,000, with the average profit for all restaurants coming in at $82,033. That doesn't sound too bad, until you factor in the initial investment. Though some basic restaurant concepts cost less than $100,000 to open, many established brands require as much as $500,000 to start. And a full-service restaurant may require an initial investment of $1 million or more.
There's no question, however, that a well-operated restaurant can be a cash cow, even with the higher overhead expenses. In 2007, when Dean Clarino bought his first Teriyaki Madness location in Las Vegas, he didn't have any food-service experience. But he was passionate about making the store work.
He blanketed the surrounding area with advertising, and each week he invited a local business to come in for a free lunch. His enthusiasm paid off, and he watched customer counts and revenues grow steadily.
When he was ready to open a second location in the endcap of a suburban strip mall, he knew that keeping his rent reasonable was key. In fact, he says he walked away from negotiations with the landlord six times before signing a lease on 2,300 square feet of space.
After securing the lease, the first thing Clarino did was install signs outside of his restaurant facing in all directions; for 72 days during construction, the lunchtime crowd saw his signs from the windows of other restaurants. When his second Teriyaki Madness opened in 2011, it saw $126,000 in business during its first month. Clarino says he made back his investment in just four months.
Currently, his first location grosses $900,000 per year, and his newer store makes $1.2 million. With 20 percent margins--incredibly high for a restaurant--he estimates profits at $400,000 per year.
But Clarino emphasizes that he's not a typical restaurateur. He didn't just follow the franchisor's system; he spent more than advised or required, maxing out his spending on advertising. Doing the minimum required by a franchise system is not the way to make big numbers--he recommends doing as much as possible in the beginning, theorizing that if franchisees are scrimping on advertising or labor in the first year just to keep the doors open, they didn't have enough operating capital to begin with.
Clarino also keeps close tabs on labor and food costs on a daily basis, something many other restaurant franchisees look at only occasionally. "Our [point-of-sale] system gives percentages, and every night I look at lunch, dinner and our labor costs," he says. "Those numbers help you understand the neighborhood, like what happens when the sun is out and weather patterns. I know exactly how much we sell on Tuesdays--it's scary how consistent it is. You know when to advertise, when to have two cashiers scheduled. It makes the restaurant run better and makes the customers happy."
Roll With It: Taking the Wheel of a Mobile Franchise
Denver's Robert Croley has made the Pooch Mobile Six Figure Club--breaking $100,000 in revenue--for the past three years. With the low overhead of a mobile franchise, he says most of that is profit. Not too bad for washing dogs. Besides sudsing up about 2,000 pups each year, Croley contracts out four nearby territories, taking a percentage of the revenue from each.
After 25 years in the corporate world, Croley, who signed on with Pooch Mobile in 2008, saw the appeal in mobile franchising. "I looked into it, and the startup money for a franchise like this is super cheap, so it made sense for me," he says. "There are hardly any expenses, and the sky's the limit for profits. You can make as much as the market will bear."
Croley is not alone in his thinking. In the past decade, mobile businesses have exploded, with dog washers and groomers, junk collectors, handyman services, furniture technicians, blinds installers and dozens of other concepts coming to the fore.
Business consultant Cunningham says mobile appeals to a certain type of entrepreneur who has no problem running a one-person operation. "You have to be willing and want to be chief cook and bottle washer," he says. "Yet mobile services are significantly less expensive than other businesses. You don't have to sign a five-year lease on a building. You don't start out with labor costs other than yourself. You may have to buy a vehicle, but you can pay for that over time. You can make a handsome profit running a mobile business, and there's an opportunity for a six-figure income."
There is a flip side. When starting a mobile business, Cunningham says, franchisees need to be outgoing and have a sales and marketing mindset to succeed. "People who don't prospect for business are going to have a hard time," he warns.
Croley's experience with Pooch Mobile bears that out. In the beginning, he was washing dogs one day a week. The rest of the time was spent marketing, driving around from parking lot to parking lot to work on his books and make phone calls from his truck, which served as a mobile billboard. At first, his business was 90 percent marketing and 10 percent dog washing. Now, he says, that ratio has flipped.
David Messenger, vice president of market expansion for Memphis, Tenn.-based ServiceMaster, a family of brands that includes the Furniture Medic and ServiceMaster Clean mobile franchises, believes marketing, especially in the startup months, is the differentiator between average and high-profit franchisees.
"Marketing can be the biggest discouragement," he says. "Franchisees can spend a lot of money for two to three months, not see results and then give up. But it will eventually work. That's one area where franchisors need to help guide franchisees, especially if they don't have a lot of experience in marketing."
High-touch, Higher Profits: The Personal-service Sector
Agency-style businesses--like maid services and home healthcare, where the franchisee acts as a hub for independent contractors--are the hottest sector of franchising right now. Home healthcare in particular is in high demand, mainly because aging Baby Boomers want to stay in their homes as long as possible and are opting for in-home nursing care and assistance rather than moving to assisted-living facilities. But the other reason those franchises are so popular is the profit margin. According to Franchise Business Review, the average profit on senior-care franchises is $98,723 per year.
"The typical investment for senior care is less than $100,000, and most are grossing $1 million or more in a year or two," says Elgin of FranChoice. "They are intensely the most profitable franchises. But you have to do lots of marketing."
That's something Brian Petranick, president and COO of Omaha, Neb.-based Right at Home, says franchisees need to be ready for. Overhead on these businesses is low, but any savings can be whittled away quickly by lack of business.
"It's not the hard costs that shock people," Petranick says. "It's the fact that it could take two to three months to find their first client. They need to learn how to be a salesperson. It takes a while. The first three to six months you're introducing yourself to the market, and you have to prove that you can provide quality care. Then the market responds, and business picks up."
The same applies to commercial-cleaning and maid-service companies, which take a lot of time to squeeze their way into a crowded marketplace. Cunningham says the biggest mistake most franchisees make in this area is thinking they will have cash coming in the door from the get-go.
"We encourage people to have realistic expectations. Oftentimes, people haven't thought about the amount they'll need to live on while starting their business," he says. "In reality, a business that looks like it will take $50,000 to start might take $80,000 or $100,000. If you're capitalized well, you don't have the stress and worry thinking about overextending yourself, and the result is you'll grow quicker. That's the real key."
Disappearing Acts: Where Profits Go Up in Smoke
Even though different franchise categories have different issues when it comes to making money, Elgin believes there are three areas that all franchisees need to pay close attention to in order to thrive. "To maximize profitability, good operators focus on three areas--labor, rent and cost of goods sold," he says. "It's often the little stuff that eats away your profits. If you save a few points here and there, your profit and loss statement can get stunningly better."
In fact, with many businesses operating with single-digit profit margins, a half percent here or a percent there is often the difference between being in the red and being in the black. The road to profitability begins in the very first stage, Elgin says, and negotiating rent can be a determining factor.
"You have to make sure you get the right terms or you're going to live with that mistake for years and years," he says. "The best operators have good real-estate attorneys and drive hard bargains. It's fun to watch--they negotiate deals so much better than other franchisees get."
Elgin says labor is another expense that can eat profit margins if it's not controlled, especially in a food franchise. Like Clarino of Teriyaki Madness, restaurateurs need to constantly make sure their staffing levels are in sync with customer traffic. Without a clear understanding of customer patterns, those numbers can quickly get out of whack. "In a food business, if labor is budgeted at 35 to 40 percent of your expenses and you're running at 44 percent, you can change from being profitable to not profitable at all very quickly," Elgin says.
The last area to watch is cost of goods sold. Holding an inventory of products that aren't moving off the shelf or being used is another way to lose profit margin. Restaurants often lose several percentage points to product spoilage and "shrinkage" (a euphemism for employee theft).
Cunningham notes that part of the burden of profitability falls on the franchisor, too. The amount of training and support franchisees receive can be critical in helping them get up to speed quickly. "Support and training are paramount," he says. "If you get two or three weeks of training, that's great. If you have a person assigned to you from the franchisor who works day in and day out with you for the first 90 days, that's even better. All those things drive a more successful business. Those collective resources result in higher profitability if the support is there."