Franchising is Hot, But Not for Everyone: Before Considering - Ask Five Questions about Your Business

by Nexsen Pruet, PLLC
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A new report from IHS Global Insight shows the franchise industry will outpace growth in other business sectors in 2013. The Franchise Business Economic Outlook projects that:

  • Franchises will create jobs at a rate of 2%, compared to 1.8% for all other businesses.
  • The gross domestic product (GDP) of the franchise sector will increase by $18 billion, to $472 billion, or 3.4 percent of U.S. GDP.
  • Franchise jobs will increase by 162,000 to 8.262 million.

The outlook for franchising is bright.  So, too, is its track record.  Franchising has proven to be one of the most effective forms of small business expansion, with more than 3,500 different franchised concepts in operation globally. Franchise systems have succeeded in virtually all business sectors, from restaurant fare to health care to auto repair.

Given the industry’s past success and projected future growth, it is only natural for entrepreneurs to wonder whether their business concepts are suited to franchising. To determine the answer, entrepreneurs should ask themselves five fundamental questions:

1) Does the business concept satisfy a basic consumer need or desire?

When full-service gas stations became all but extinct, then-small companies such as Meineke Discount Mufflers and Jiffy Lube stepped in to fill the need for neighborhood mechanics. When women entered the job market in significant numbers, quick-service restaurants filled a need for alternative dining options. The public’s appetite for new goods and services is forever changing, and entrepreneurs always seek to identify consumers’ needs and desires and find ways to fulfill them. By establishing a profitable prototype business, an entrepreneur can show a concept is viable. But that alone is not enough to show it is right for franchising.

2) Can the business concept be replicated?

Franchising has been described as a “cookie-cutter” form of business because it is based on being able to replicate a business concept in many different markets, with many different types of operators. A sandwich shop is easier to replicate than an art restoration business because the skills for the former are common and easily teachable, while the skills for the latter are not. Likewise, a concept such as a fitness center can be replicated in many different markets, while a concept such as an ice fishing business in all likelihood cannot.

3) Will the business concept be profitable to the franchisee?

Franchising works by putting others in business using the franchisor’s brand and business concept. In exchange for the benefits of being in the franchise system, franchisees pay to the franchisor a pre-determined initial license fee and continuing royalties and advertising fees (typically based on a percentage of their weekly sales). For franchisees to succeed in the long term, they must be able to clear a profit after paying these fees and paying their operating expenses.     

4) Will the franchise concept be profitable for the franchisor?

A franchisor must be able to maintain an infrastructure that allows it both to grow its base of franchisees and to service existing franchisees. The funds to support this infrastructure typically come from the initial license fee and the ongoing royalties paid by franchisees. As the system develops, the franchisor may find additional sources of revenue from the sale of products, equipment, and services to the franchisees. But revenue sources for the franchisor may translate to expenses for the franchisees. Balancing franchisor revenue and franchisee expenses can be a source of dynamic tension in the relationship. A franchise system will have the best chance of long-term success if fees and expenses are balanced in a way that allows both franchisor and franchisees to operate profitably. 

5) Is there enough “glue” to keep the franchisee in the system after it has learned the business concept?

Once franchisees have learned the franchisor’s business concept, what will keep them in the system? Franchise agreements typically bind franchisees for a term of years – sometimes up to 20 years or even longer. But a successful franchisor will not rely on legal reasons alone to keep franchisees in the system; it will offer compelling business reasons as well. A well-known, well respected brand, effectively marketed, can provide a strong motivation to stay. But other benefits that will give franchisees a competitive advantage over their non-franchised competitors are also important. Ongoing training and support, access to a network of suppliers that offer savings on products and services, and innovations in products and services that keep consumers interested can help ensure franchisees’ continued success – and provide the “glue” to keep them in the system.

An entrepreneur who can answer “yes” to each of these five questions may indeed have a business concept that will succeed as a franchise. An experienced legal advisor can help navigate the legal requirements for bringing the concept to the franchise marketplace.

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

© Nexsen Pruet, PLLC | Attorney Advertising

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