Growth: The Lifeblood of a Franchise System

by Nexsen Pruet, PLLC

At a recent meeting of Charlotte’s Franchise Business Network, sponsored by the International Franchise Association (the IFA) and Nexsen Pruet, 40 participants from a range of franchise concepts discussed paths to growing a franchise system, from the perspective of franchisors and franchisees.  The discussion was led by Ken Walker, former Chief Executive Officer of Driven Brands, Inc. and former chairman of the IFA, the largest trade association for franchising.  

Growth is the lifeblood of a franchise system.  Franchising allows the franchisor of a business concept to leverage that concept through a network of independent business owners, who are franchisees.  The franchisor grants the franchisees a license to use its established trademark and proven business system over the term of their relationship.  Franchisees who embrace the franchised concept and are successful at it may wish to leverage their success by purchasing additional franchises.  This can benefit everyone involved:  the franchisor can grow its franchise system, and the franchisee can grow its economic base through multi-unit franchise ownership.  

Whether, When, and How Much to Grow?  

In considering whether, when, and how much a franchisee is able to grow, Ken emphasized that there is no single recipe for success.  Many factors must be taken into account.  For example, some franchise concepts are more easily replicated than others.  Franchise systems that rely heavily on their trademarks to attract customers, such as quick service restaurants, may be relatively easy to grow.  Franchise systems that rely heavily on their service to attract customers, such as automotive repair shops, may be harder to grow.  Why is this so?  Customers who have a good experience in one McDonalds are likely to return to any other McDonalds in the franchise system expecting a comparable experience from that brand.  On the other hand, customers who have a good experience in one Meineke Car Care Center are more likely to want to return to that same Meineke Car Care Center, based on expertise and trust generated over the course of their direct relationship.  The differences in these two franchise models will impact the franchisee’s ability to develop and operate multiple units.  

Franchisees’ potential for growth also may be affected by their ability to replicate the staff operating their units.  Service based franchises may find it more challenging to replicate the staffing they need – particularly when the concept involves an expertise that is hard to find.  A home cleaning franchise may be easier to replicate than an art restoration franchise because the universe of people who have (or can learn) home cleaning skills is greater than the universe of people who have (or can learn) art restoration skills.   

The customer base required to support each unit of franchise system also affects franchisees’ potential for growth.  One type of franchise concept may require only a small customer base to support each unit, while another may require a larger population base to support each unit.  These and other factors must be taken into account when thinking about expansion.  

Different Skills for Single-Unit, Multi-Unit Ownership  

The participants discussed at length the question of what franchisors look for in determining whether a franchisee is ready to expand, and how many units a franchisee can effectively develop and operate.  The consensus of the group was that the skills required to own and operate one franchised unit are different than those required to operate multiple units.  To own and operate multiple units, franchisees must master more than the basic skills they acquired in initial training; they also must be able to develop an infrastructure  to leverage the economies of scale that are intrinsic in multi-unit ownership.  Examples of infrastructural considerations include multi-unit staffing, inventory or product sourcing and distribution, and back-office management.   

Franchisees that move from single-unit to multi-unit ownership must be able to hire and train personnel who can replicate the successful relationship that they forged with their customers in their individual franchises.  Because the skill set required to operate multiple units differs markedly from the skill set required for single-unit ownership, not all single-unit franchisees are suited for acquiring multiple units.  

Participants voiced different opinions as to whether money or aptitude should be the most important factor to consider when deciding whether to grant multi-unit ownership rights to a single-unit franchisee.  One point of view was that no amount of money could overcome a franchisee’s limited aptitude for multi-unit ownership.  Another view was that money trumps aptitude because finding “angel investors” is harder than finding franchisees with the skill set needed for multi-unit ownership.  A candidate with financial means can almost always be paired with one who has the requisite skills but lacks the requisite means.

Area Development Versus Single-Unit Sales

Participants also discussed the pros and cons of growing through the sale of area development rights versus growing through the sale of single units to multiple franchisees.  Franchisors found the area development route appealing, for several reasons.  Franchisors often receive a development fee in exchange for a grant of exclusivity to develop a specific area.  And area development presumably promises predictable, sustained growth through one franchisee.  But this approach is not risk free.  For example, area developers may find that they cannot meet their development schedules, or that they cannot develop the necessary infrastructure to operate their several units.  Key ingredients that participants identified for success in growing through area development were being able to use good economies of scale and having the right people in place to leverage the particular concept. 

Franchisors that want to grow through their existing base of franchisees need to offer special multi-unit training, participants agreed.  To succeed with multi-unit ownership, franchisees must develop skills in managing multiple employment groups, managing bulk inventory, and using advertising that is market-driven, rather than unit-driven.  In addition, because multiple locations demand larger infrastructures, they generate a host of issues that might not arise in a single-unit setting. As an example, a multi-unit franchisee may find that its infrastructure satisfies the threshold to place it in the web of the new Affordable Care Act. 

A number of participants were from franchise systems that have exported their concepts to other countries.  They explained that international expansion presents a unique set of challenges.  For example, the ability to find sources of supplies can make or break the case for international expansion, because for many franchise systems, the ability to offer efficient product pricing and a reliable distribution system is a chief competitive advantage.  A franchisor cannot assume that the template for successful growth at home will apply when expanding into other countries.  Still, if the franchise system has developed a cult following or an iconic brand, that may make the concept easier to leverage internationally, notwithstanding any obstacles to international expansion.    

Finally, Ken emphasized that any discussion about growth must focus on the relationship between the franchisor and the franchisees as defined in the franchise contract.  The franchisor is motivated to design its franchise system to enhance its profit potential.  But the franchisor must keep in mind that most every revenue source for the franchisor translates to an expense for the franchisees, in terms of royalties and other fees paid to support the system’s infrastructure.  The key is to achieve the right balance, so that the system can be profitable for both franchisor and franchisees, and franchisees can monetize their investment at the end of the relationship.  For a franchise system to grow successfully, both franchisor and franchisees must be able to make a profit, he concluded.

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.

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