How to Evaluate the ROI and Profitability of a Restaurant Franchise
Find out how to determine a franchise concept's overall ROI and profit margin.
For the majority of restaurateurs, the goal isn't to earn a Michelin star, and more often than not it's about survivability. It's no secret that most restaurants operate on fairly slim profit margins (2-6%), and external factors that affect fixed costs can sometimes be volatile. So how does a franchise owner evaluate the ROI and profitability of their restaurant? There's a tried-and-true formula to apply, but as we'll see, franchising your way to restaurant ownership does come with some built-in advantages.
Related: So You Want to Open a Restaurant?
Determining gross & net profit margins
Determining an establishment's gross profit isn't as complicated as one might think. There's a simple formula which holds that gross profit is equal to total sales, minus the cost of goods sold (COGS).
Gross Profit = Total Sales - COGS
In restaurant terms, it means that the gross profit can be determined by the difference in value between the selling price of a menu item versus the combined cost of ingredients and materials needed to create it. For successful venues, the gross profit is approximately 70%. However, that's before taking net profit into account. That's the amount remaining from the gross profit margin once the owner deducts the operating expenses. These typically include payroll, commercial rent, utilities, materials and any equipment leases.
Net Profit = [Total Sales – COGS – Labor)/Total Sales] x 100
Advantages of restaurant franchising
Most franchise restaurants provide owners with name recognition and a track record of success. Provided the establishment maintains consistency with the brand's standards, the overall risk is reduced thanks to experience and repetition — that's the inherent value of buying into a turnkey operation.
Franchisees are provided with training, where they learn the brand's industry trade secrets and gain access to established vendor relationships. Every aspect of operating the day-to-day duties of the restaurant is spelled out in the franchise operations manual. If challenges or questions do arise, franchisees can rely on built-in support systems. Of course, the level of this support does vary, but it's not unheard of for brands to offer elevated assistance in the way of field support. This support network also extends to marketing, advertising and promotions designed to attract customers, often all run by the brand's co-op programs.
For franchised restaurant establishments, owners can typically count on lower inventory prices. This is due in large part to the collective bargaining power of the brand, who use reputation and name recognition to negotiate favorable terms on fixed costs for goods and services.
Profit margin range by restaurant type
Franchised restaurant establishments come in many forms. There are full-service restaurants (FSRs), quick-service restaurants (QSRs), fast-casual dining, mobile and food truck operations and even catering concepts. Their profit margins vary, but the averages look similar to this:
Food Trucks 6%-9%
There are two basic ways to elevate profit margins: increasing the volume of sales and decreasing overhead expenses. The strategies and tactics to accomplish these goals are always on the mind of the franchisor, as it's their goal to give the franchisees the best possible opportunity for their ROI and profitability.
Like any business venture, a successful operation requires hard work, great leadership and ongoing operational support. Restaurant owners are responsible for the first two, but the third factor comes from the built-in assistance that's integral to the franchising business model.
When it comes to the best franchise concepts by category, Entrepreneur has you covered. We have business opportunities to share from over a dozen industries. Everything from automotive, home services, and childcare to food, health and beauty, and everything in between. To see what's in our franchisor database, be sure to check out Entrepreneur's Best of the Best Rankings.
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