When Not to Franchise Your Business
Franchising involves risks as well as rewards. Our expert reveals what you should know before franchising your business.
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While some of my franchising brethren may think this heresy, I feel compelled to say that franchising is not right for every successful business. In fact, franchising can be a very wrong strategy for certain businesses and certain business owners.
Those of you who've read my columns in the past know that I am a strong advocate of franchising. That being said, when someone decides to franchise a business, perhaps the most important precept to understand is they're starting an entirely new business--the business of selling franchises and servicing franchisees. And, as with any new business venture, there are risks involved.
So how do you assess those risks? And how can you best judge whether franchising is the right strategy to pursue?
The Downside of Franchising
Surprisingly to many, the biggest risk for companies that decide to franchise is not found in the investment that's made in becoming a franchisor. A new franchisor can easily invest $100,000 or more in the development of business plans, legal documents, operations manuals and marketing materials--before the first nickel is spent on franchise advertising. But that risk is largely quantifiable and readily recovered for the franchisor who can sell any franchises at all.
In fact, many people considering franchising for the first time will ask me, "How many franchises do I have to sell to make it worth my investment?" The answer can be as low as "one." What many individuals don't understand is that franchises are, in effect, virtual annuities--providing a stream of royalty revenue that may stretch 20 years or longer. If a franchisor can generate $20,000 to $30,000 a year or more in royalty revenues from a single franchise, even one franchise sale will pay the price of entry--assuming, of course, that no incremental staff is needed to service a single franchisee.
Franchisors looking for early-stage hyper-growth see much more substantial risks. This is because franchisors attempting to grow more quickly need to hire staff to sell and service franchisees. They need to spend money on franchise marketing. And they need focus on the business of franchising--sometimes to the detriment of the core business they've established. When a franchisor gears up for faster growth, suddenly it becomes a balancing act between the resources devoted to franchising and the revenues it generates.
All of these balancing acts are manageable, of course, if you have a good plan, a sound concept and a qualified management team. But the one guarantee that franchising carries is that without a strong and replicable concept, you will certainly fail.
More often than not, franchisor failures are a direct result of failed franchisees. Failed franchisees require more in the way of support. They pay less--or nothing--in the way of royalties. They stall (or stop) franchise sales efforts when they talk to prospective franchisees. They can destroy the franchisor's brand by failing to live up to brand standards. And they can be the source of litigation and bad publicity. In short, not only do failed franchisees threaten the franchise business system, but they can also threaten the core business itself.
Thus, the first decision to franchise must start with an honest assessment of the business itself.
Is Your Business Ready?
All too many business owners think of franchising as some kind of "magic pill" that'll cure the ills of a business through the economies of scale that come from unfettered expansion. It's not.
I am frequently approached by business owners who are so enamored with franchising that they fail to realize there must be a sound and profitable business at the core of every successful franchise.
While there are dozens of questions we ask when making this assessment, there are really three core criteria for franchisability: You must be able to sell franchises, you must be able to duplicate the business, and you must be able to provide your franchisees with an appropriate return on the time and money they invest in the business.
Let's start with salability. In scanning the franchise universe, one can readily find franchises that, on their surface, don't appear to be particularly attractive to potential franchisees. You need look no further than DoodyCalls (yes, they specialize in "pet waste removal") to realize that not every franchise opportunity is glamorous, sexy and fun. But what every business must have is something that sets it apart from its competitors--whether that something is a unique recipe, proprietary products, an innovative marketing approach or support services for their franchisees. Moreover, in order to be "salable," a business must have credibility in the eyes of its franchise prospects. That credibility can come from strength of management, a track record of success, publicity or any of a number of places--but without believability, no one will buy that franchise.
Beyond salability, a franchisor needs to be able to duplicate their success in multiple markets, and some businesses simply don't make good candidates. Food concepts that rely heavily on a highly regional product, retail concepts located in a one-of-a-kind location or concepts that rely on a superstar (as opposed to a system) for performance are all difficult to franchise.
The acid test of franchising, however, is return on investment (ROI). A franchised business must, of course, be profitable. But more than that, a franchised business must allow enough profit after a royalty for the franchisees to earn an adequate return on their investment of time and money.
Profitability is always relative. It must be measured against investment to provide a meaningful number. In this way, the franchise investment can be measured against other investments of comparable risk that compete for the franchisee's dollar. Typically, the iFranchise Group looks for the franchisee to achieve a ROI of at least 15 percent by the second to third year of operation. And that number must be achieved after deducting a market-rate salary for the franchisee if he works in the business.
If your business doesn't meet these criteria, don't franchise. Period.
If it does, however, your analysis is just beginning.
Is Franchising Right for You?
Perhaps just as important as the franchisability of your business is your temperament as a potential franchisor.
Franchising, by its very nature, isn't a business that's well suited to everyone. First of all, it involves a different kind of relationship--in fact, it's all about relationships. Some business owners will find that the independent nature of franchisees isn't well suited to their personalities. If, for example, you tend to be autocratic in your management style, you may find franchisees impossible to manage (or at least understand). Franchisees aren't employees, and if you treat them like they are, conflict is sure to follow.
That is not to say that you cannot enforce standards or lead the company in the direction you see fit. In fact, it's the franchisor's duty to take this role. That said, the best franchisors are often those with the best communications skills.
As with any company, it's important that you have sound management skills, but only in franchising, because of the unfettered growth afforded through the use of the franchisee's capital, do these management skills become of paramount importance. One of the most important of these skills is discipline. You must have the discipline to say "no" to growth that doesn't make sense--because a franchisee is unqualified or a bad "fit," because they aren't ready to expand in a particular market, or because they don't have the resources to support a certain level of growth.
Lastly, as the old saying goes, "You gotta wanna." Even if franchising meets your financial goals, you need to ask yourself if you'll love your new career as much as you do your current one. The founders of more than one franchise company have found that they left their passion behind when they started franchising--some even going to the extent of selling the franchise company in order to return to operating an individual franchise.
It's all About the Goals
Even if both you and your business are well suited to franchise, you need to ask yourself why you're thinking about franchising in the first place. Just because you can franchise doesn't mean you should.
Generally speaking, companies choose to franchise for one of four reasons: time, people, money and risk. Franchising allows companies to grow more quickly to take advantage of market opportunities, as franchisors can leverage off of both the capital and the efforts of their franchisees. It allows companies to capitalize on highly motivated owner-operators. It vastly reduces the need for expansion capital and, of course, risk.
Choosing an appropriate growth vehicle is a lot like choosing any mode of transportation; you need to account for distance, obstacles and speed requirements. If, for example, I wanted to travel from Central Park to the Empire State Building, I could take a bus or a cab, or I could walk if I had a little more time. If, however, my ultimate destination were London, my options would be limited to some combination of planes, trains, automobiles and boats. Need to make the journey in a day? Your options get narrowed further.
Likewise, look at your personal goals before making the final decision. The further you want to go and the faster you want to get there, the more likely franchising will be your answer. If your goals are near and you're not constrained by time, consider a leisurely walk instead.