Franchising your business: why, when and how to do it

1. Why franchise?

Businesses franchise for different reasons, not all of which are apparent in advance, and which may change in their relative importance over time as the business develops.

1.1 To accelerate growth and increase market share

Franchising can provide a business with opportunities to open in markets not previously accessible. As a method of growth, franchising has the potential to facilitate rapid expansion into new markets that would otherwise be difficult or impossible to access under the constraints of a corporate model.

Not only does this provide growth, but it also enhances first mover advantage – that unique window of opportunity to secure a following for a brand and its services and products before the inevitable arrival of “me-too” competitors.

In the race to dominate a niche, franchising (when done well) may provide the necessary boost to create new market or reinvent an old one. The involvement of engaged and motivated local market specialists (ie. franchisees) can maximise the penetration and potential of a brand.

1.2 To increase outlet efficiency

Even with exceptional operating systems and processes for recognising and rewarding outstanding performance, outlets owned and operated by a corporate chain are unlikely to meet the levels of performance that can be achieved through a franchised operation.

Franchisees are strongly profit motivated – more so than any employee with responsibilities for managing an outlet, irrespective of how strong his or her profit share incentive might be.

Because franchisees have their own money invested in the business (unlike an employee), they choose to be profit focussed because their true reward from the business is the profits that they make, as well as the capitalised value of those profits when the business is sold.

For this reason, franchisees are likely to work longer, harder and more diligently to make their businesses profitable. They see the rewards from building sales, reducing costs, and eliminating waste. By following the franchise system and applying their labour, capital and commitment, franchisees can achieve significantly better outcomes at store level than company-owned chains.

1.3 To overcome capital constraints

A major barrier to the growth of any business is the ability to fund growth. If a business owner is incapable of or unwilling to raise debt or sell equity in the business, then franchising may be the only option for growth without fundamentally changing the business model.

Not only do franchisees contribute their own capital to open additional outlets under the franchisor’s brand and business model, they also bring a focus and commitment which should far exceed that of employed staff. It follows that where both a financial and emotional investment have been made in a brand, that franchisees will work more diligently than employees to get a return on that investment.

1.4 People ask to buy a franchise

The first three reasons for franchising a business are all relatively proactive, however businesses may be prompted to go into franchising because of repeated requests from customers and other brand advocates to buy a franchise.

This is a reactive reason for going into franchising, and may lead to a failure to consider alternative means of growth, an inaccurate assessment of the speed of growth that may be provided, and the premature expansion of a business model that may not yet be robust enough to deliver adequate returns to all stakeholders.

Franchising a business without a proactive strategic plan may meet with some initial success as franchises are granted to those who made the original requests, however it is often the case that prematurely-franchised businesses stall when their lack of preparation catches up with them.

2. When should a business franchise?

The vexed question of when a business is ready for franchising will vary from one business to another. It is almost impossible to apply a precise timeframe so that a business which has been operating for a certain period of time is ready to franchise on this criteria alone.

2.1 Following proof of concept

Entrepreneurs are often impatient and keen to grow their businesses quickly. Franchising can be seen as the means for doing this, but it is essential to first prove that the specific concept to be franchised will actually work.

For example, it is not enough to assume that a coffee shop franchise will work simply because there are many other existing coffee shop franchises. Competition in any market segment can create barriers to entry that may be impossible to overcome. What must be proven is that the specific type of coffee shop concept will prosper in a highly competitive market by being sufficiently unique and distinctive.

Proving that a concept is viable requires patience and a commitment to change if part or all of the concept is unsuited for its target market. In general, this may involve operating outlets in multiple locations over a reasonable period of time (up to several years) to prove that the concept is viable.

2.2 After consideration of alternative methods of growth

Franchising is not the only method of growing a business and may not always be the most appropriate growth method, depending on the business owner’s objectives.

Creating a franchise network as a stand-alone sales channel for a business’ goods or services potential ignores other sales channels which may already exist, and which may provide a faster and more comprehensive method of reaching the target market.

Alternative sales channels might include distribution via an established network, direct to consumers via mail order and the internet, or the licensed production or sale of the goods or services by third parties. Each of these growth methods has their own limitations, and may not provide the full brand experience that may be an important part of the relationship with the target market.

2.3 Once outlets are profitable after allowing for fees

Assuming that the business to be franchised has been established in more than one outlet as it seeks to establish proof of concept, it must further be established that the individual outlets are capable of generating profits after franchise royalties have been taken into account.

For example, a business that returns a profit of 10% of turnover will no longer be profitable if it has to pay franchise royalties of 10% of turnover. In preparing a business for franchising, the potential franchisor must carefully assess the costs of supporting franchisees in determining their franchise royalties, and set the royalties at such a level that there is sufficient profitability in the business for a franchisee to get an acceptable return on their investment.

3. How should a business be franchised?

Even if all the factors outlined above as to why and when a business could or should be franchised are satisfied, the next hurdle is how to go about actually doing it.

3.1 Through education about franchising

The first thing a business owner should do (and which can be done concurrently with the development and proof of concept of their business) is to learn about franchising.

Many books have been written about franchising (including some written by the founders of very successful franchise brands) which provide valuable lessons and insights. There are also a number of formal and informal education seminars, workshops and courses available to potential and existing franchisors around Australia, including those organised or presented by the Franchise Advisory Centre.

By knowing more about this method of business expansion, an entrepreneur can more effectively plan to grow using this or other business models.

3.2 Assessing the leadership required to run a franchise system

In making the decision to franchise a business, an entrepreneur should also assess themselves and their own leadership abilities. Even if all the other factors to franchise a business are present, the entrepreneur’s own leadership skills (or lack thereof) could cause both short- and long-term barriers to growth.

A simple and confronting test is to look in the mirror and ask the following questions:

“Do I know my own limitations, and is it possible to overcome these by engaging more talented people?”

“Can I meet the level of expectations that will be placed on me and my business by franchisees who are likely to invest substantial sums – if not their life savings – in my brand?”

3.3 Through advice from suitably qualified and experienced advisors

The process of franchising a business is one which usually requires external guidance, advice and support. Through a lack of education, excess enthusiasm and unnecessary haste, entrepreneurs may choose inexperienced or unqualified advisors, and fail to appreciate the difference between good and bad advice until problems occur (and in some cases, very early in the process).

Entrepreneurs should seek to deal only with franchise consultants, lawyers and accountants with proper credentials, qualifications and experience in the sector, and who committed to upholding the highest professional standards in their service to clients.

Franchising a business is possible, but not always viable. This article has outlined some key factors to consider along the way. Entrepreneurs considering franchising their businesses should heed these points and explore each in greater depth.

Jason Gehrke is a director of the Franchise Advisory Centre and has been involved in franchising for 20 years at franchisee, franchisor and advisor level. He provides consulting services to both franchisors and franchisees, and conducts franchise education programs throughout Australia. He has been awarded for his franchise achievements, and publishes Franchise News & Events, Australia’s only fortnightly electronic news bulletin on franchising issues.