Starting a business requires a lot of gumption. Entrepreneurs often quit stable jobs, invest their savings, or max out credit cards to get a business started, and endure months or even years of furious work without much return.
A franchise, in contrast, can seem like a safer bet. In return for a franchise fee and ongoing royalties, a franchisee expects six very important benefits in return: a recognized brand, an established and vetted operating system, group buying power, marketing power, a protected market, and a franchisor that is supportive and dedicated to the success of their franchisees. These six factors can have a big influence on whether or not a franchise succeeds.
As we’ve explored in the past on the AAFD Franchise Voice Blog, franchise organizations, like the International Franchise Association, have drastically inflated the success rate of franchises. In fact, the Small Business Administration has found that franchise businesses fail at a similar or greater rate than independent businesses. So, is a franchise always worth the investment?
That depends on the six factors listed above. If your franchise can’t deliver a solid brand, an effective operating system, and franchisee buying power, then you might be better off simply starting your own business.
Robert Purvin, Chairman of the AAFD, recently told me about a call he received from a man – let’s call him Steve – interested in purchasing a janitorial franchise. The franchise was located in the Midwest, but Steve wanted to start his business in Southern California. Steve asked Robert’s advice on whether he should move forward with the franchise purchase or not.
Robert asked Steve, “Has anyone in Southern California heard about XYZ Cleaning Company?”
Steve’s answer, of course, was “No.”
A proven brand is not always an essential expectation, but the value of a brand should be reflected in the ‘price’ of the franchise opportunity. Franchisees should also take into consideration whether it is worth the effort to help a new franchise grow its brand awareness or do the same amount of work on behalf of their own business. If Steve does open an XYZ Cleaning Company, he will need to build brand awareness, customer by customer, as well as through networking, marketing, and other outreach. This is virtually the same thing he would have to do if he opened his own business, minus the large franchise fee and ongoing royalties.
On the flip side, if Steve wanted to invest in a McDonald’s, Robert’s question would have gotten a completely different response. Yes, the vast majority of people living in Southern California have not only heard of McDonald’s, but have eaten there. This high level of brand awareness would be a huge benefit to Steve’s efforts to get customers in his door.
Another promised benefit of a franchise is the operating system that it provides. If Steve opened up a McDonald’s, he would immediately gain access to all of McDonald’s methods of operation, training, vendors, recipes, employee training manuals, etc… Some franchises have unique products or services – a famous secret sauce or patented technology that will immediately drive business and or control costs.
Let’s think back to Steve’s original situation. He wants to open up a janitorial service company. Does Steve really need a franchisor to tell him how to mop a floor or vacuum? Not likely. A janitorial business is not rocket science. With some planning, Steve can easily build this type of business without the help of a franchisor. On the other hand, XYZ may have developed a great scheduling system, incorporated some unique efficiencies and cost containment methods that provide a significant competitive advantage—the franchise advantage. These are all factors Steve must take into consideration.
Group Buying Power
Subway has thousands of franchise locations all around the world, which allows it to negotiate discounted pricing on ingredients and supplies that it can pass onto its franchisees. Significantly, Subway has authorized its independent franchisee association to organize a purchasing cooperative that works hard to improve franchisee buying power. By comparison, Subway’s biggest competitor, Quiznos, exerts control of its supply chain and profits from this control at franchisee expense.
Group buying power, when wielded honestly by the franchisor, can drastically lower the cost for franchisees to operate their business, not to mention save them lots of time and effort that they would otherwise have to spend developing their own vendor networks. Not surprisingly, Subway boasts a very low SBA loan failure rate, while Quiznos’ SBA failure rate is among the highest. Both are quality brands, the difference is a higher cost of food and supplies for Quiznos franchisees.
If Steve wanted to start his own sandwich shop, called Steve’s Big Subs, he would need to find meat producers, pickle vendors, and suppliers of napkins, paper cups, and everything else he needed. He wouldn’t be able to depend on huge volume for discounts. He would likely pay more for his supplies, which he would then have to pass onto his customers. You can see what a big advantage the Subway franchisee has in this situation. However, that advantage isn’t equal among all franchisors.
The janitorial franchise Steve is interested in is still new and relatively small. They probably don’t have enough franchisees in their system to qualify for large purchasing discounts. Additionally, since Steve wants to operate out on the West Coast, away from the company’s home base, he may need to find his own local vendors anyway.
Another major benefit a franchise can offer is marketing power. Think about how ubiquitous McDonald’s marketing is. You can hardly watch a sports game without seeing at least a dozen McDonald’s television commercials. Drive down any highway, and you’re bound to see a McDonald’s billboard or those golden arches plastered on the side of a bus. McDonald’s is everywhere, and all that exposure adds up to lots of sales at their franchise locations.
Few franchises can come even close to this amount of marketing, and some provide very little marketing at all. In Steve’s case, XYZ Cleaning Company operates out of the Midwest. They may put ads in the local paper, sponsor a local race, and even air a commercial or two on the local radio station, but how does this help Steve out in Southern California?
Answer – it doesn’t!
. Some – but not all – franchisors offer franchisees a protected market or territory. When a franchisee is approved for a franchise, he or she may earn the exclusive right to a specific territory, depending on the franchise. The franchisor agrees not to let any other franchisees within their system set up shop in that territory. That doesn’t mean you won’t find a two sub shops across the street from each other, but at least a franchisee can be content knowing that an identical store won’t pop up nearby and cannibalize business.
Not all franchisees enjoy this type of market and territory protection. Notably, McDonald’s and Subway, the two franchises I’ve been using as examples in this article, don’t offer territory protection to their franchisors. In fact, market encroachment is the most frequent complaint leveled at these franchise systems. A franchisee expects his or her brand to beat the competition – not to be the competition.
Additionally, independent business owners don’t enjoy any type of market protection, but in some cases it doesn’t matter. XYZ Cleaning Company wasn’t anywhere near the West Coast anyway, so Steve earns no benefit from territory protection unless the company expands dramatically in the ensuing years.
Goodwill and Good Faith.
Franchisors like to characterize themselves as in the corner of their franchisees and dedicated to the success of all their franchisees. A supportive and caring franchisor can help franchisees overcome many unexpected obstacles. Strong franchise opportunities have a culture of franchisee support, the very best put the commitment in writing. But increasingly, the AAFD is finding franchisors who exploit their franchisees by squeezing profits, piling on fees, and generally acting in opportunistic ways against the franchisee’s interests.
If Steve’s franchise agreement disavows a duty to act in good faith with respect to franchisor-franchisee relations, he should turn the page and look for another opportunity.
Steve was considering handing over $50,000 in franchise fees plus a royalty to XYZ Cleaning Company, when he wasn’t getting much in return. The company had no brand visibility in his market, their operating system wasn’t anything Steve couldn’t develop on his own, they weren’t large enough to offer significant group buying power, and their brand presence was minimal. In Steve’s case, he should strongly consider starting his own business. He can use the money he would have paid the franchisor to begin marketing his company, purchasing supplies, and printing business cards.