Franchising

Introduction

We have all heard of the term "franchising", and most of us know people involved in it. After all, it now contributes more than 10 billion to the UK economy, across numerous business sectors. But what is it really all about, and how are some businesses so successful at it, whilst for others it brings disaster? In this article we will be looking at:

The basics - what is a franchise, and how does it operate?

What do you need to know if you are thinking about buying a franchise?

What should you consider if you are thinking about developing your business through franchising?

The basics of franchising

The concept is fairly simple. In a franchise, an established business ("the franchisor") grants someone ("the franchisee") the right to trade under the franchisor's trade mark or trade name.

Most franchising is actually "business format" franchising. This means that the franchisor develops a business concept, including a trade name and operating methods, and they train the franchisee in how to run their business using this concept. The franchisee operates his/her own business under the franchisor's name and under some fairly tight controls and guidance. These are set out in a franchise agreement, and usually an operations manual as well.

At heart, a franchise agreement is essentially a trade mark licence, with a number of operational instructions and controls placed on the franchisee.

In many cases, the franchisee is given an "exclusive" territory in which to operate during the term of the franchise agreement.

In exchange for the right to use the trade name and operating methods, the franchisee normally pays the franchisor:

An up-front fee (usually 5k upwards)

Ongoing payments (referred to as "royalties" or "management service fees") which are usually paid monthly, and tend to be either a fixed percentage of gross sales (generally 5 - 11%), or otherwise a set monthly figure.

The franchisee is sometimes required to make contributions to a central marketing fund operated by the franchisor.

In addition, the franchisee may have to pay to acquire premises, stock, equipment etc.

For franchisors, franchising can therefore be an exceptionally quick route to business growth, with low overheads and low risk. We will look at this in more detail later on in this article. For franchisees, franchising can provide an attractive opportunity to own and operate their own business, but one which has a proven business concept and which provides training and support. Franchising can in some cases also provide a very rare opportunity for genuine work/life balance.

What you need to know if you are thinking about buying a franchise

Sadly however, as with everything in life, it is not always that simple. Although survival rates for franchisee businesses are much higher than for other business start-ups, franchisees all too often fail. Some lose substantial amounts of money, often through no fault of their own.

Below are some of the perils to avoid:

Peril No. 1 - Not doing enough "homework" before handing over your cash

Most franchisors can "talk a good talk". It is their job to convince you that their franchise offering will bring you wealth and success. However, whilst many franchisors are scrupulously honest and professional in their dealings with prospective franchisees, some of them are unfortunately not.

Remember - when you take on a franchise this is a "business to business" agreement. There is no consumer law to protect you, so your legal remedies may be very limited. It is your responsibility to check out what you are being told, and never to take promises and forecasts on face value.

It pays to remember the age-old saying: "If it sounds too good to be true, it probably is"... !

Things to check out before signing up:

Do the figures in the franchisor's projections really add up? Consider asking your accountant to check out the projected figures to see if they are realistic. Ask other franchisees. Do the figures allow a suitable margin for error? For example, it should be possible for you to fall a little short of conservative projections and still make a profit that you can live on.

Research your market. Is there already a proven customer demand for your product/service? Does your territory have the right demographics (disposable incomes, buying trends etc)? Is the market already over-saturated with competing offerings?

Get inside information from other franchisees (and be wary of franchisors who do not want you to speak to their other franchisees).

How long has your franchisor been established? Do they already have a proven track record of success? If they are a new business, this is not necessarily proof of disaster ahead. But being realistic, you are taking on much more risk with a new business than you are with a well-established one.

If you are a member of a networking group, consider discussing the business opportunity with other members, to get their thoughts and feedback. They may give you a more objective view than close friends or family members.

Search on-line for comments or information about your franchisor. Are there lots of happy customers out there, or heaps of complaints?

Is the franchisor a member of the British Franchise Association? Remember that not all franchise systems are necessarily well thought out or well tested. Membership of the British Franchise Association - requiring the signing of a charter for ethical franchising - is a good indicator of an opportunity worthy of consideration, although there is no substitute for properly checking out and researching a franchise.

Peril No. 2 - Taking on a franchise which does not play to your personal strengths

You need to think long and hard about whether taking on a franchise will suit your personality and skills. You may imagine, for example, during a frustrating day at the office, that nothing would be lovelier than leaving the rat-race and running your own cafe. But beware of the "grass is greener over the fence" philosophy. No matter what franchise you take on, it is likely to involve hard work, and this will never be satisfying unless it is something that you are passionate about.

The key traits that franchisors are looking for in their franchisees include:

Enthusiasm for their industry. Will you be a good ambassador for their brand?

Willingness to operate within the confines of the franchisor's operating system. (In other words, franchising will not be right for you if you are a free-sprited entrepreneur who wants to do their own thing.)

Motivation and a strong work-ethic.

In many cases, financial literacy and management skills.

Peril No. 3 - Missing an opportunity to negotiate

For most franchisors, franchisee recruitment is their single biggest challenge. Competition amongst franchisors to find franchisees is often fierce. This is particularly so in the early stages of a franchise offering. If you are one of the franchisor's first 5 prospective franchisees, you may have more scope to negotiate on fees than you think. Some franchisors will never negotiate, but others will, so it is worth giving it a try.

Peril No. 4 - Not taking advice

It is tempting to save costs by not getting legal advice. Unfortunately, this can turn out to be a false economy. Most BFA affiliated lawyers will review and advise you on your proposed franchise agreement for an agreed fixed fee. Even though many franchisors will not negotiate over the terms of their franchise agreement, a BFA affiliated lawyer will be able (i) to explain to you exactly what the implications of your franchise agreement are for you; and (ii) to alert you if anything in your agreement is non-standard, or unworkable.

When you buy a franchise, you are taking on some significant commitments and liabilities, and these usually include obligations and restrictions which continue after your franchise comes to an end. Consulting an expert lawyer will give you peace of mind.

What to consider if you are thinking about developing your business through franchising

The variety of businesses involved in the franchise industry is astounding. While the most obvious examples are the high street variety, such as fashion retail stores, fast food restaurants and print/copy centres, there are a huge number of service concepts offering franchises too, such as business coaches, automotive aftercare providers, networking organisations, children's activities, snack machine distributors and travel agencies.

An increasing number of new businesses plan their development from the beginning with an eye to the potential for franchising in the long term. So often it pays to take advice at an early stage.

Franchising can be a very attractive route for growth for many businesses. It has a number of features in its favour:

Franchising often enables businesses to quickly establish a national presence within a few years, achieving a rate of network growth which would be inconceivable through company funded development.

The resources you will need to contribute to the opening of a franchised outlet are far less than if you were opening a company-owned store - the franchisee will fund assets such as the premises lease and fit-out, recruits and trains the staff and implements the local marketing campaign. This enables you to develop a compact management base focused on assisting multiple franchisees to launch their business simultaneously, rather than methodically opening branch after branch, and sourcing new startup capital for each.

By taking the franchise route you can cut overheads. If you do it right, then you have fewer staffing and administration issues, and can focus more time on developing the business. By speeding up expansion, your business network achieves higher economies of scale earlier, stronger brand awareness, is much sooner able to challenge for national contracts and, in the case of a fledgling market, is in a much better position to capture early market leadership and establish a dominant position over its competitors.

As the capital outlay is generally lower, your business risks are often reduced.

Franchising can facilitate growth overseas which might otherwise be impossible, particularly if you recruit franchisees in local markets who have contacts and market knowledge that you may not have.

But franchising does not suit every business, and some businesses come unstuck by jumping into franchising too quickly. Here are some working examples of how things can go wrong:

Peril No. 1 - Being too hasty to launch

To get the best for your business, you need to have an eye to the long-term. Franchising might be a great route for future growth, but now may not yet be the best time to embark on it. Essentially, when you launch into franchising, you are selling a brand and a business concept. As a rough rule of thumb, the longer your business has been operating, the more value you build, and the higher the price the franchisor can ask for a franchise.

Issues to consider are:

Business owners are mainly attracted to franchising because it offers access to an established business model which has been properly tested and proven by the franchisor. If you are coming to the franchise market with a business idea that hasn't chalked up a year of operations and satisfactory financial performance, then you may well find it difficult to compete against other franchisors on franchisee recruitment.

If you launch before you have time to try and test your operating methods, there is a risk that your franchisees will run into trouble and look to you to pick up the pieces. And you might be as "at sea" as they are about how to fix things.

Have you registered your trade mark and had proper advice about protecting your intellectual property? It is never wise to embark on franchising before you have done this. As your network grows to national status, building brand credibility and positive customer goodwill, the importance of your brand protection will grow as local competitors challenge your franchisees.

Peril No.2 - recruiting "anything with a pulse", or "anyone with a cheque-book"

For most franchisors, finding and recruiting franchisees is their single biggest challenge. There are far more franchise offerings available on the market than there are prospective franchisees who want to buy them. This means that competition is strong and franchisees can afford to pick and choose. Although you may start off with fine intentions about only taking on people who are exactly right, there is an inevitable pressure to get recruits in so that you start earning fees. Even one badly performing franchisee can absorb a hugely disproportionate amount of management time, and a number of badly performing franchisees can damage your brand and even bring your business to its knees.

Peril No. 3 - Not getting the right advice

Lawyers and consultants who are affiliated with the British Franchise Association are experts in the franchise industry, and their BFA membership means that they are required to operate within a framework of ethical standards. If you are thinking of developing a franchise business, it is a good investment to talk to experts who you can trust.

However, it pays to shop around. Some advisers provide better value for money than others. Some advisers will tie you in to a deal where you pay one big lump sum for a variety of services. Others will tailor-make their services for you, so that you only pay for the services that you actually want or need. And it is best of all if you can speak to someone who can help you to evaluate franchising against other potential routes to growth. In some cases, for example, a licensing or agency arrangement may suit your business much better. So if your adviser has no expertise in these fields, it might make sense to find someone else.