Franchising is, was, and will continue to be hot! And with good reason. Not only is it a reduced-risk way to launch a business, but there are many other benefits, along with a few drawbacks. Is franchising right for you?
There’s no way to completely eliminate risk from business. It comes with the territory. The key is risk management, based on the rough formula that says: the fewer variables (risks), the greater the probability of success. That’s the concept behind the phenomenal boom in franchising — from auto dealerships to fast food to print shops to lawn services, pest control and more. That’s also why, over the last several decades, the franchise form of doing business — now with more than 3,000 franchise companies and better than 750,000 franchise units in operation — has changed the way small business does business in this country.
THE FRANCHISE BOOM
The franchise concept is not new. The first franchises appeared shortly after the Civil War (established by the Singer Sewing Machine Company and other large corporations to distribute their products). The idea took off earlier this century with the rise of auto dealerships.
But franchising has truly come of age in the decades since World War II, with the boom in retail and service franchises. Franchises now account for account for between 40% and 50% of all retail businesses, employ more than 18 million workers, and generate better than $2 trillion annually in economic output, creating what would be the fourth largest GNP in the world!
The franchise concept is simple. The franchisee or franchise buyer purchases a legal right to sell a good or service from the franchisor. This includes the parent company’s trademark and other services. In return, the franchisee agrees to certain restrictions and pays an ongoing fee.
That’s perhaps why franchises have become the domain of the small business owner. In fact, about two-thirds of franchises are organized as single establishment sole proprietorships, with approximately 5 employees per establishment.
FRANCHISES REDUCE RISK
The number one advantage of franchising for the business owner is risk reduction. Purchasing a franchise gives franchisees the opportunity to build a business of their own, but not necessarily on their own. They share in the expertise and support of the parent company.
This is especially significant in the start-up, since new businesses, as a group, have the highest failure rate. However, franchises from established companies generally have a lower failure rate than businesses either started from scratch or bought as a going enterprise. A study by the U.S. Chamber of Commerce found that, after five years, 86% of new franchises opened are still under the same ownership and 97% of them are still open for business. That’s a phenomenal track record.
Other advantages for franchise buyers include:
- Availability of start-up funding and ongoing credit (a key factor, since many banks are reluctant to lend money to start-ups, and many start-up companies fail due to undercapitalization).
- The ability to tap into the established goodwill and logo/name recognition of the franchise.
- Ongoing professional management support, training and promotional assistance.
- Cost savings for supplies and equipment.
THE PRICE OF REDUCED RISK
Each of the above benefits reduces the risk factor for the franchisee, thereby increasing the probability of building and maintaining a successful, profitable operation. But there are drawbacks. These include:
- Start-up costs can be high, from several thousand to several hundred thousand dollars …excluding real estate.
- There is a loss of independence. As one franchisee explained: "You might feel more like a worker or a junior partner than a boss."
- There is limited if any control over product line and pricing.
- There is ongoing revenue splitting, with the franchise company receiving from 1 % to 20 % of gross, with the average being 3 % to 4 %.
- There is potentially heavy administrative paperwork, since a high degree of documentation must be provided to the franchisor.
- Perhaps the greatest drawback is lack of equity in the business. The franchise contract generally includes a buy-back clause that sets the price at the time of the franchise purchase. Under most circumstances, the franchisee does not have the option to sell on the free market the business he or she has built. It is possible that a franchise purchased for several thousand dollars, then built up to a multi-million dollar enterprise, will revert to the parent company upon termination of the agreement for little more than the original purchase price.
IS FRANCHISNG RIGHT FOR YOU?
A well-managed parent company can greatly increase the probability of long-term success for the franchisee. However, risk — both long-term and short-term — cannot be eliminated completely. Is franchising right for you? The best answer is to do your homework. Shop around. Two good places to start include The American Franchisee Association at www.franchisee.org, as well as the American Association of Franchisees and Dealers at www.aafd.org.
Work hard. Make money. Have fun.
(The Freestyle Entrepreneur)