In Franchise Your Business, author and franchise consultant Mark Siebert delivers the ultimate how-to guide to employing one of the greatest growth strategies ever -- franchising. Siebert shares decades of experience, insights, and practical advice to help grow your business exponentially through franchising while avoiding the pitfalls. In this edited excerpt, Siebert reveals six ways other than franchising that you can choose to grow your business.
When making a decision to franchise, a prospective franchisor should determine not only if their company is franchisable but also if franchising is the best expansion strategy to pursue. No franchising decision is complete without an understanding of the alternatives available to the business owner intent on growth using the resources of others.
1. Company-Owned Operations
The most obvious expansion method for many companies is the development of additional company-owned outlets. This strategy offers several advantages over franchising. Perhaps most important, company-owned growth allows owners to keep 100 percent of each unit’s profits rather than sharing those profits with franchisees. It also offers increased control over unit management, as owners can hire and fire management largely at will. This control allows for increased flexibility and the ability to react to market changes more quickly. For the company contemplating first-time franchise expansion, it also represents a more predictable method of growth, as there's no need to learn the new business of franchising. Finally, the addition of company-owned locations allows the business owner the opportunity to build tangible assets in the business, which can have a very positive impact on the company’s valuation when the owner begins to consider exiting the business.
Of course, along with the advantages, there are some disadvantages. First and foremost is risk. While you get to keep 100 percent of the profits, you're also responsible for 100 percent of the losses. And the more money you invest in corporate operations, the more you have at risk.
Increased control also comes with increased responsibility. Sexual harassment, EEOC violations, ADA violations, slip-and-fall, workers’ compensation, and other worker or customer liability issues will all be directed at you. A franchisee, by contrast, is an independent contractor, and assuming you direct them appropriately, the ultimate responsibility for all these issues will likely remain with them. And while a corporate-owned-and-operated chain can institute concept changes more quickly, the costs for these changes (new décor package, new equipment, etc.) will be theirs as well.
2. Business Opportunities or Licensing
The advantage to the business opportunity (biz opp) route is that in many cases, the licensor doesn't have to comply with the FTC’s franchise disclosure regulations, which saves money and makes the sales process less complex. That said, a biz opp may still have to comply with franchise disclosure laws in some states and will need to comply with the patchwork quilt of biz opp laws that exist in more than two dozen states. So while the biz opp licensor may avoid some legal costs if a company plans to roll out the offering on a local level, a national rollout may require them to pay more in the way of legal fees and make it only marginally easier to sell.
At the same time, avoiding a common brand identity often puts the licensor at a long-term disadvantage over its franchising brethren. Even a one-unit chain looking to expand through franchising will likely double their advertising expenditures with the sale of their first franchise, whereas the licensor who sells 100 biz opps will get little, if any, in the way of brand recognition -- because their operators will do business under their own names.
Moreover, because each biz opp will operate under a different name, the licensor can't legally control how the licensee operates. For this reason, the fees charged by an unbranded biz opp tend to be substantially lower and often have no long-term component or royalty -- unless it involves ongoing purchases from the licensor. On the other hand, without a common name, you can't exercise control, and without control, it's difficult to provide the value of a franchisor that is developing common advertising campaigns, marketing initiatives, merchandising schemes, and other ways of enhancing value and performance at the unit level.
On balance, biz opps don't substantially reduce the burden of legal compliance, and, at the same time, they offer far less quality control than franchising, And since fees are generally lower and there is no ability to create a national brand, this expansion method is often not a satisfactory alternative to franchising.
3. Trademark Licenses
The second option available to those looking to expand through third parties is the use of a trademark license. For those of us without famous names, trademark licenses are exceptionally difficult to market—especially if we're branding a business instead of a product. After all, if someone is going into a business, it's the system of operation -- the recipes, the advertising, the operating procedures, and the knowledge of how to succeed -- that the prospective buyer is looking to obtain, not simply the name.
More important, it's extremely easy to step over the line of providing “significant operating control or significant operating assistance.” Some of the elements cited by the FTC as being significant are controls over site approval, design specifications, production techniques, promotional campaigns requiring franchisee participation, and territory restrictions. And the FTC has stated that training programs, management and personnel advice, site selection assistance, and operations manuals are all forms of “significant assistance.” One slip in the wrong place, and, oops, you're an inadvertent (and illegal) franchisor.
Even if you didn't provide any support or exercise any control, wise trademark owners should be asking themselves, “Do I really want to allow someone to use my name on a business without the ability to control how my name is used?” The damage done by a single rogue operator could harm a brand that took years to build. For that reason alone, developing a system of related businesses through trademark licensing is usually not a viable alternative.
The “No Fee” Options
The last alternative to franchising involves removing the fee element from the equation. These no-fee options include:
4. Dealerships and Distributorships
This format involves the provision of products to a third party at a bona fide wholesale price for resale, a tried-and-true means of establishing a distribution channel. Of course, this method is only appropriate for manufacturers and wholesalers. But be careful: Selling equipment, displays, and other items that aren't intended for resale-- even if not sold at a profit -- will trigger the fee element of the definition and potentially create legal problems.
Moreover, many manufacturers these days are finding that the traditional dealer model is much less efficient and much less profitable than franchising. Because the dealer relationship lacks a fee, support must be provided for free -- essentially eating into the manufacturer’s wholesale margin. And while dealers will clamor for more and more support as competition increases, they'll often have little loyalty to the manufacturer’s brand when a competitor comes calling with a product that provides for increased sales, improved margins, or is perhaps just the flavor of the month. In a franchise, the franchisee commits to your product line long term and generally pays fees on top of the wholesale margin you'd otherwise receive -- allowing manufacturers to benefit from service components that often aren't part of the wholesaler’s revenue stream.
5. Agency Relationships
In an agency structure, an independent salesperson sells a service on your behalf -- so again, this form of relationship is only appropriate for companies for which fulfillment of the contract is provided by the corporation and not by the agent. The easy distinction here is that all money flows downward (from corporate to the agent) and not upward (from the franchisee to the franchisor). If your agent is taking money and sending you any, the relationship has likely triggered the fee element of the franchise laws. Minimal brand loyalty, high turnover, and support-specific margin erosion typify these types of relationships.
6. Joint Venture
A joint venture partnership is characterized not by fees but by sharing both equity and profits. So, for example, your joint venture partner might put up 70 percent of the money and work at a salary that was below market for one year. You'd put up 30 percent of the capital, sign personally on a bank note, and provide your intellectual property. Based on your negotiations, you might end up in a 60/40 split of the ownership of the company. Your 40 percent would entitle you to 40 percent of any profits that are distributed -- but only if profits are distributed.
You'd also be required to pay taxes on 40 percent of the reported profits of that company -- even if no profits are distributed. So if, for example, the controlling partner chooses to make a capital expenditure in the company (which is not tax-deductible) instead of making a distribution, you could be on the hook for the taxes, even though you didn't see any of the money.
One major issue encountered by those who use a joint venture structure is defining and tracking profits. How should the operating partner get compensated for their time? When does an expense become a perk? What constitutes overhead, and how does that get allocated? How does the non-operating partner get compensated for their time? What kinds of controls need to be established to ensure all profits are, in fact, reported?
Even in relationships in which the operator is honest and well-meaning, the process of tracking profitability for a single unit can be cumbersome; across a hundred units or more, the accounting involved quickly becomes daunting. And one more cautionary note here: Any joint venture that pays fees to the owner of the intellectual property will be deemed both a joint venture and a franchise, even if the intellectual property owner is one of the joint venture partners.
Finally, the joint venture relationship itself is extremely difficult to manage. Unlike a franchisee who's obligated to follow the rules by contract, the joint venture partner is, in fact, a partner and will often attempt to take greater latitude with the system of operations than would a franchisee.