Thoughts on Franchise Businesses
I recently spent time evaluating an early stage small business offering a franchise model. Without getting into specifics, I want to share a couple of lessons relating to wealth creation, from both the franchisor and franchisee perspective.
I expect these observations to be elementary if you have experience in the franchising sector. If you are unfamiliar but considering opportunities with franchising, this article is for you. The franchisor owns the intellectual property, such as the brand and business processes, as well as offers support to the franchisee in sales, marketing, and operations. Typically, in exchange for using the franchisor’s system, the franchisee pays the franchisor a percentage of revenue and often an upfront set-up cost.
Thoughts for both the franchisor and franchisee:
The key to creating value is a proven model that is centered on a consistent and in-demand product/service, repeatable processes, successful locations (or mobile units or territories), and an appropriate support infrastructure. The franchisor and franchisee need to have a partnership mentality. A lack of success or conflict impacts the other, hurting operating results, limiting growth opportunities, and destroying value.
Thoughts for the franchisor:
You must first develop at least a handful of successful company-owned stores to create meaningful value. I use the term stores, but that can include territories, mobile units, etc. as the franchise business has evolved. Some might say it is better to lay the groundwork and be ready for the opportunity to sell franchises from the beginning. This advice often comes from lawyers who will create the documentation and complete registrations in exchange for hefty fees. The better course of action is to hold off and reach this step once you’ve established success and consistency in a handful of locations. Imagine spending $1 million on documentation, logos, branding, and registrations, but only having one fledging location — would anyone come along and pay a sum commensurate with the investment to date? I believe it is unlikely as value comes from successful results.
Opening a handful of locations or territories also helps dispel any success as luck. It helps identify the core customer base, whether it is single urban professionals or suburban families. Imagine your business sells pizza by the slice and it has unique toppings using quality ingredients. If your first location is next to a row of bars on a college campus, you’ll have plenty of imbibed coeds as late-night taste testers. However, will your product be in demand with the urban professional lunch crowd, or the suburban delivery service where your pricing is at a premium over the national chains? Having a niche market isn’t a bad thing, but not knowing your niche before launching franchises in inappropriate locations will not be good long-term for you or the franchisee.
Thoughts for the franchisee:
Proven success is critical. Do not consider opportunities that do not have multiple successful company-owned locations, and ideally, other proven franchisees. If you do not have years of relevant managerial experience in the same field or similar, consider hiring a general manager. Additionally, utilize all of the training available from the corporate franchisor and network with other local and regional franchisees for best practices. Understand and evaluate the support and assistance you will receive from the franchisor. Too often, particularly for smaller and newer franchise businesses, the franchisor develops a concept and expects to sit back and watch the royalty payments roll in. That shouldn’t be the case. The franchisor needs to offer ongoing support and resources. They should earn their royalties by providing systems and infrastructure, branding and promotions that align with franchisee success, and expertise for any challenges (e.g. expansion efforts). Have a detailed plan for growth before buying a franchise, taking into account the competition from other businesses and franchisees. Franchisors should be resources in the expansion process to scout new locations, suggest more creative delivery channels (e.g. corporate lunch catering in the case of the college pizza business), and help with financing arrangements.
Again, this is a partnership and both sides need to work together to create value. Franchise value can be built and destroyed easily from both sides of the relationship. I hope this short note will help those considering franchise businesses better understand the risks and what is required to create long-term value.