What Is the Real Survival Rate of Franchised Businesses?
This story appears in the August 2013 issue of . Subscribe »
Imagine you're thinking of leaving your job to open a business and decide to do a little research into franchising. A Google search may lead to an evenly balanced sermon on the pros and cons of franchise ownership. Or you may land on this gem from About.com: "Some studies show that franchises have a success rate of approximately 90 percent as compared to only about 15 percent for businesses that are started from the ground up. The increased probability of success usually far outweighs any initial franchise fee and nominal royalties that are paid monthly."
Most experienced franchisees would laugh themselves hoarse after reading that statement. But what about a novice entrepreneur who is considering going it alone? That's the type of thing that might get their heart set on franchising.
Dig a little deeper and you'll find that About.com is not alone in espousing such numbers. That claim and myriad variations are all over the internet, from business articles written by people who should know better to puffery put out by franchise brokers and consultants. It's known as "The Stat"--the notion that franchises have a success rate of 90 to 95 percent--and it has helped fuel franchise fever for decades. It's also completely unproven.
As an industry model, franchising has been poked and prodded and analyzed by economists since its inception. There are figures on how much franchising contributes to the economy, ownership rates among various demographics, loan performance and a monthly index that shows the strength of the sector as a whole. But that one stat, the success rate of franchised businesses vs. independent shops, has had the biggest impact, even though its origins are dubious. In the absence of solid data, The Stat, which is based on a discredited study, has stepped in to fill the void.
Bad information is the bread and butter of the internet, but this particular nugget is especially troubling. Franchising is one of the most heavily regulated industries in the U.S. for a reason--it has suffered from high-profile cases of misrepresentation and fraud. Critics point to The Stat as a willful misrepresentation and an attempt to sucker people into buying franchises. In many ways it really does lure people into franchising, even if a franchisor has never made the claim. The ubiquity of The Stat means that many candidates come into their businesses thinking franchise ownership is practically guaranteed success.
Robert Purvin, who believes his 1994 book The Franchise Fraud was the first to cast doubt on The Stat, contends it has had an even bigger impact. "Even if the success rates were true, focusing on franchising as a path to riches instead of small-business ownership has caused the industry to evolve in ways detrimental to franchisees," he says. "They've become less and less protective of franchisees over the years."
The Stat was not just created from whole cloth. In the 1980s, the U.S Department of Commerce published the results of a voluntary survey of nearly 2,000 franchisors who submitted data disclosures. Some analysts interpreted the data to say that over a five-year stretch, 5 percent of units closed. Flip that around, and you have the stat that franchises have a 95 percent success rate over a given five years. Here's the catch: The data was not audited, and since franchisors chose whether or not to answer the questions, it is likely that the pool of respondents included more successful franchises than unsuccessful ones.
The Stat, with the imprimatur of the Commerce Department, took on a life of its own. Even after the survey was discontinued and the International Franchise Association sent out a letter asking franchisors and brokers to scrub the stat from the web--a request it has repeated several times since--it has been difficult to close Pandora's box. The SBA has also put out numerous calls over the years to disregard the data, making its latest plea last fall.
But many in the industry haven't gotten the message. "It's amazing the number of franchise brokerages still putting it on their website," says franchise consultant Joel Libava, who has written several articles critical of The Stat. "It gives prospective buyers a false impression. There's enough spin out there telling people to buy a business in a box or turnkey business. The Stat welcomes them to take a risk and make bad assumptions about their chance for success."
The main reason The Stat has survived a quarter century of rebuttal and criticism is that no credible number has emerged to replace it. The SBA has released papers showing that in the early 2000s, defaults on its loans were higher for franchised vs. independent businesses. But the most comprehensive study was conducted in 1994 by Timothy Bates, professor emeritus at Wayne State University. His analysis of more than 20,500 small businesses found that 65.3 percent of franchises survived after four years, compared to 72 percent of independent businesses. Retail franchises fared worse, with a 61.3 percent survival rate, vs. 73.1 percent of independent retail businesses.
Brian Headd at the SBA's Office of Advocacy points out that all these studies are long in the tooth and don't represent the current economy. More broadly, he questions the overall usefulness of calculating franchise success rates at all. "Survival isn't everything," he says. "Business owners have to make up startup costs and try to break even. Just existing for five or six or seven years doesn't necessarily mean success."
So why has no ambitious economist or franchise maven taken on the research? Jania Bailey, president of franchise brokerage FranNet, says looking at franchising as a whole would be extremely difficult, and the results would likely not be useful. "You'd have to look at the FDDs [Franchise Disclosure Documents] of 3,100 companies in 80 industries," she says. "There are new franchises and mature franchises. The success rates between the two are going to be night and day."
However, her company did want to investigate the success rate of its own clients, so last fall FranNet looked at 1,500 individuals it had helped get into franchised businesses between 2006 and 2010. According to the internal research, 91.2 percent of the businesses were still open after two years, and 85 percent were operating after five years. But Bailey is quick to point out that those stats don't extend to franchising in general--she attributes the high success rate to the FranNet system. "Arguably, the time period we studied had the worst economic conditions since the Great Depression," she says. "That success rate speaks volumes about our ability to match a person and their skill set to the right franchise concept."
Libava, a former FranNet franchise broker, is skeptical of any studies that attempt to quantify franchising as a whole. Each case is unique, he argues, and success is mediated by the performance of individual franchisees, not by the strength of the franchising model. "Here's how I look at it: The perfect franchise candidate is in the perfect time of their life, has funds and chooses the right franchise for his geographic area," he says. "A lot of things have to line up, and if they do, I feel in my heart a franchisee has a better chance of success than an independent startup. But there's no guarantee of that."
Headd at the SBA takes a more practical view of success. His research has shown that bigger fish tend to survive longer, whether they are independent or part of a chain. "The bottom line is, the larger you are at startup, the more likely you are to stay open," he says. "It helps to start larger and faster, but it has a cost. And it's up to the individual to decide if franchising is the right formula for them, or being independent."
Purvin agrees that research that lumps together thousands of unrelated business concepts, from gyros to muffler repair, into one statistic is ultimately meaningless. "Franchising is just a way of doing business; it's not a script for success," he says. "The world is constantly evolving, and all of those 'proven' systems have to evolve, too. Proven success does not guarantee success tomorrow. Look at McDonald's: Thirty years ago it was focused on burgers and shakes; now it's a coffee shop. It has constantly innovated. Any company standing still and focused on its 'proven method' is a company that will be a dinosaur. Buying a company that holds back from change is not a path to success."
So are franchises more successful than independent businesses? Bailey at FranNet believes franchising can have benefits over going it alone, but she's not willing to put a number on it. "I think the crux of what we do and the reason we're so committed is that franchising works," she says. "You have the support of the franchisor and the experience of other franchisees. You have a back room you don't have when you go out on your own."