Should you franchise?
It has helped the likes of McDonald’s and Pizza Express - could it do the same for you?
For many of you, franchising is probably something you’ve never considered for your own business.
It’s something most entrepreneurs think of as being for risk averse people who seek a lifestyle business rather than a fast-growth one. And it’s surely something we all assume is mainly suited to fast food and drainage repair services.
Most of that is fair. But it ignores the fact that it just might be a great way to grow your own business using other people’s money. The two main factors preventing entrepreneurs growing their businesses faster are capital and the right people. Selling franchises of your own business could solve both those at a stroke. And there are many franchisors now in all sorts of industry sectors. Getting interested?
It gets better, too. Many businesses achieve substantial cost savings when they reach ‘critical mass’. If you could double or triple your sales volume, how much would that boost your gross margin? Selling franchises to others could not only bring you profits from the franchised business, but also boost the profits of your own current business. Better yet, franchisees often make a contribution to marketing, which could boost your brand’s marketing clout considerably and have knockon benefits for your own business.
Your business has to be suitable, though. With retail it’s pretty easy to package up what you do into discreet chunks. For professional services businesses, however, it can be a little trickier. Not every company is compatible. And even if yours is, it takes time to get it right.
Printing.com opened its first store in 1998 but then spent another three years perfecting the formula. “We opened 14 of our own stores to bullet-test the concept,” explains founder Tony Rafferty. “We developed a skillset for how we train, assess the competencies of people that run outlets and how we give corrective training.” The AIM-listed company is now opening tens of franchises a year within UK and Ireland and boasts 137 outlets.
Is your business suitable?
Clearly, you need to be able to divide the business into sellable segments, usually geographic areas. Then, according to Mark Scott, national franchise manager at NatWest, arguably the most franchise-focused of the big four banks, there are three ways to test if your business is suitable. Firstly, your margins should be high enough to guarantee there will be something in it for both parties. Secondly, it should be something that’s relatively easy to teach in around two weeks (hairdressing is a notable exception). And finally, there’s got to be a reason for joining the franchise. Does your business offer something different, unique, not available everywhere?
Consider also what would make your franchisee want to renew their arrangement: it could be that you have negotiated preferred supplier arrangements, whereby a large client guarantees to buy the service you offer, nationwide. NatWest, for example, has a national account with printing network Kall Kwik.
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Sectors that have historically been less successful include internet-based franchises or those requiring rapid expansion, such as an online venture planning to offer localised information on every town or city in the UK. People won’t rely on or use the site if only two territories are up and running. Travel is another that struggles as without high volumes it’s difficult to get discounts. Predictably, the other area to avoid is ‘the latest craze’.
A business needs to be proven, and to have critical mass (or at least offer it to franchisees) before attempting to sell the first franchise. That almost always means the core business needs to be profit-making because it enables franchisees to borrow much of their starting capital – a significant factor in selecting a new franchise.
Established businesses can start franchising quickly, possibly within six months. But while preparation is key you can spend too long planning. “If I were doing it all again I’d probably have established five outlets and taken franchising forward in 2001 instead of 2002,” agrees Rafferty.
The money you can make from franchising is fundamentally made up of the initial licence fee and then ongoing fees for management and marketing. The average licence fee, including training, stationery, equipment, etc is £14,000 to £15,000, though major fast food franchises often go for over £100,000.
However you set the figure (more on that later), bear in mind this shouldn’t be your profit centre. As Andy Pollock, founding partner at accountants Rees Pollock and one of the UK’s leading advisers to franchisors, explains: “On one hand the idea is to recoup as much of the investment as possible, while on the other not burdening the new franchisee with too much debt. That then keeps them motivated to get out of bed every morning. Equally, the franchisee needs to see it as a serious amount of money so they won’t just pack up if it’s not working out. It’s more an art than science.”
He adds that it would be a worry if the up-front charge was too high, suggesting that the franchisor doesn’t have confidence in the longer-term and is in it for a quick buck.
A franchisor’s main revenue is its management or royalty fee, for which the industry average is 8.2% of turnover, according to the British Franchise Association (BFA). Your business clearly benefits as franchisees grow.
Contracting your franchisee to buy from you can generate additional profit. Clearly many fast food franchises need to do this – how else could a McDonald’s franchisee obtain the proprietary Special Sauce needed for Big Macs? Franchisors that don’t sell goods on (for example drain clearance franchises, where there are no goods sold) tend to charge higher management fees.
On top of this franchisees usually pay a marketing fee to help build the brand. Typically 1%, it’s rare to see a marketing fee of more than 2%, says the BFA’s James Eades. Liz Jackson runs telemarketing business Great Guns Marketing, which has nine franchises and is not a BFA member. It charges a franchise royalty of 10%, with 2.5% contributed for marketing the network. She explains that unlike some franchisors the company charges cash received, rather than invoices raised, so as not to put restraints on the franchisees’ cashflow.
Printing.com has two main profit centres – manufacturing from its factory in Manchester and retail through its outlets. A franchise turning over £300,000 will buy £150,000 wholesale from the company’s head office, estimates Rafferty, who says the added income is necessary to support the network. “We pay for the raw materials, labour, the investment in the printing presses, for the massive factory in Manchester and for improving our bespoke IT systems,” he says.
Franchisors can sometimes also negotiate commission from approved suppliers to franchisees. Franchisees can get a better deal than they could alone, and your business can make a little extra, too. Some franchisors charge for training, marketing and other support services, although most successful franchises include it in the initial fee, with ongoing management fees paying for support. “If there’s too much charging it suddenly starts to make interest in buying your franchise diminish,” explains Pollock.
How to get started
Franchisees expect an easy to follow formula. All your systems, processes and training modules need to be in place before you launch the network. Carry out as much research as possible. There are several books on the subject, notably How to Franchise your Business by Dr. Martin Mendelsohn of law firm Eversheds. Talk to other franchisors too. But as soon as you get serious about it, your best route is to speak to a franchise advisor or consultant.
Once satisfied that it’s an option worth pursuing you’ll need to carry out feasibility checks. Great Guns Marketing’s Jackson compiled a database of the number of companies (potential clients) in each target region; which sectors; the average turnover and average employee numbers. “We looked at whether the brand could be sustained and how big each franchise territory needs to be,” she says.
You’ll need to develop a cast-iron franchise manual. In any normal business if you ask three managers about a particular procedure they’ll probably give three different answers. A franchisor can only have one. A good franchise consultant could help you design and build a business manual – a great opportunity to review your processes and procedures – and also recommend grants you could apply for and aid your franchisee recruitment, says Jackson.
What role does the BFA play?
The BFA is the only organisation that positively accredits good franchise practice. Eades claims the term franchise is misused by some. “We look at business format franchises, which stands for good and ethical franchising. It allows the franchisee the right to own the chosen company in a given territory, the rights to its goodwill and the right to sell it at some point. Others are multi-level marketing agreements, where the right to trade under a company’s name is sold, but the new company doesn’t necessarily own the goodwill of customers. They masquerade as a franchise,” says Eades.
Peter Miles, managing director of NXO Plc, a marketing consultancy that launched its first franchise last year and now has three, found that not being a BFA member has proved problematic. “The initial advice we had was ‘don’t bother’. It’s becoming a barrier though.” Consequently, the company is now set to apply.
Joining takes more than just filling in a form, though. “If someone comes to us we check their franchise agreement, that they are profitable and ethical and franchisable in our terms before they can join as members,” explains Eades.
A franchise agreement is the legal document setting out your agreement with franchisees; once your network is established it is not normally negotiable with new franchisees. It’s an important document to get right, to protect your future income stream and your brand. There are specialist lawyers approved by the BFA that you might wish to use to create this.
“We spent £100,000 developing our franchise agreement,” says Tony Rafferty. “The franchise lawyer was at my wedding, which gives you some idea of how important they were.” Law firm Eversheds offers free seminars for potential franchisors; for more info visit www.eversheds.com/seminar/seminar.asp
How much does it cost to launch?
The average set-up cost is £100,000, made up of manuals, a pilot, consultants and lawyers’ fees. Clearly you’ll need to sell enough franchises to recoup that and a little extra. You’ll want to take this into account in your initial fee for franchisees. But you’ll have to invest the cash first, and then hope to sell the franchises – so there’s some risk involved.
Setting your franchise fee
The price you can justify depends heavily on your brand and the potential income franchisees can make. A potential franchisee will usually look at several opportunities and will want to know exactly what they’re purchasing. Work out a realistic value for the brand, tools and support.
You’ll almost certainly also need to offer a lower licence fee to early franchisees than you plan to charge once the network’s established. As your brand grows it may be possible to increase prices – what you can’t do is cut them, as existing franchisees would rightly feel stung.
The initial franchise fee goes towards the cost of recruitment (average of £5,000 to £6,000); training; stock and equipment; launch marketing. Look at what comparable businesses are charging and listen to your advisers. You’ll have to convince the banks of why your price is reasonable.
How should I set territories?
McDonald’s started with TV regions. Once they’d filled up it added more. Sensible franchisors will plan their development and not take any old franchise all over the place. If you’re based in Birmingham and launch franchises in Glasgow and Exeter, for example, depending on your business, you could find it pretty difficult to manage. You’ll probably have to grant a larger territory to early franchisees as they’ll be taking a larger risk by going with a less proven model.
How to recruit franchisees
You should use your own website, and try other media, such as the small but specialist franchise magazines or websites like our sister publication, www.startups.co.uk, which attracts hundreds of thousands of people a year wanting to set up a business. The Daily Mail and Daily Express have regular franchise sections. NXO’s Miles found the company got most response from adverts in the Sunday Times; it is likely that some media will suit certain types of franchise better than others, depending on target audience. Some franchisors find exhibitions good for attracting new franchisees. The BFA’s Eades warns that using headhunters to recruit is not something it advises as it involves persuading somebody to become a franchisee, leaving you open to accusations of misrepresenting your brand to sell licences.
Most businesses are started up in the last quarter of the year, and franchising is no different. The National Franchise Exhibition for the year has just passed, but if this is part of your long-term growth strategy then plan for next year’s. “A lot of franchisors don’t understand how long it takes to recruit franchisees. The average is seven months – and within that there will be delays on locating and securing properties,” says NatWest’s Scott. “From the initial contact to setting up is three months minimum.”
It’s better to recruit someone without prior knowledge of your industry sector, so they don’t try to do it their way. The most successful franchises are those that follow the formula to the letter. “You must believe they can operate the system not just consider them because they’ve got a cheque book,” says Pollock.
To get the right people, Printing.com’s Rafferty invested heavily, spending £250,000 marketing the opportunity and had the biggest stand at the National Franchise Exhibition. “We got 10 territories out of it, so effectively spent £25,000 for each one.” Clearly higher than average, your spend will be based on how much you plan to charge franchisees and how much you can make once established.
Managing a franchisee network
Franchising is in some ways not the easiest way to manage a business. Franchisees won’t necessarily do as you expect. While this might not break the franchise agreement, it’s not particularly easy to sack them the way you could an underperforming employee. There have been several examples of very public spats – not particularly good for a brand.
Scott compares the franchisee/franchisor relationship to a marriage, rather than an employer/employee relationship. Be reasonable and fair and keep abreast of the latest industry developments. It’s imperative not to rest on your laurels.
You’ll need to appoint someone at your office as the main contact person for franchisees. When your network is large enough, you might want to appoint a business development manager to hand-hold and give regular advice to franchisees. Additionally, provide a helpline via phone, email and chat room that enables the franchisee to talk to you or your appointed network manager. You might want to make it easy for franchisees to communicate with each other, for example with conferences, conference calls, or possibly a protected website they can access. Your franchisees will be entrepreneurs themselves, and you might well find you learn some really valuable tips from them, improving your core business.
Manage them as you would an employee, however, recording details in writing, with every breach recorded. You’ll need to go through a ‘disciplinary’ process if you’re not happy with them, as you would with a member of your staff. On an ongoing basis you’ll need to audit your franchises to ensure they’re complying. You might want to use mystery shoppers. You will certainly want to protect your brand, for your own sake and the other franchisees.
Keep good track of franchisee sales and performance – you’ll need to in order to be able to invoice them your management fees. At the very least get them to send annual returns and file their VAT returns to you quarterly. Try to track it on a monthly basis. Compare what they put in ‘sales’ to the VAT man to what they told you were the sales, just to check that they’re not under-declaring their sales to you.
Work with your franchisees on forecasting, getting them into the discipline of doing forecasts regularly. Review these carefully – they’ll be key to your own forecasts; if you buy in stock in expectation of high sales to franchisees which then don’t materialise, it could cost you serious money. And especially early on, you’ll probably know their potential more than they will. If they don’t hit forecasts there could be a management problem or conceivably they’re putting money in their pocket and not telling you, warns Pollock.
Be warned that anything you say to one will get out to the others – the ‘jungle drums’ will start beating, says Pollock. Equally, a good, happy profitable franchisee will tell others.
Reasons not to franchise
Franchising can help grow your business quickly, so why do some businesses later reverse the process? Luke Johnson is well known for buying back all the franchises that Pizza Express had sold, for example – at not insignificant cost. Ultimately, a business which has limited market potential is reducing its profit potential by franchising.
The reason franchisees will pay money to buy a franchise is to make more money than a manager working for the same business unit would make – the difference effectively being the profit that franchisors forego. This is by far the main reason not to franchise. It boils down to ambition and timeframes – if you’re happy taking your time to grow, and are keen on realising your full ultimate profit potential, then franchising is probably not right for you. But if you’d rather grow faster, and are willing to give up some potential ultimate profit, franchising might be just what your business needs.
Some businesses might also find that poor franchisees could give a brand a sufficiently poor name that they seriously reduce the revenues at company-owned outlets. This should be more of a theoretical risk though, since your franchise agreement should enable you to force franchisees out relatively swiftly if they don’t meet the standards you set.
The other serious potential disadvantage is distraction. Franchising could take your eye off the ball with your core business. Franchisees will be very demanding of your business’ time, especially early on, and they’ll need good answers if they’re to get their franchise working.
As with most things in business, franchising will suit some extremely well, and others not at all. The key is to make sure you know which category your business is in.
CASE STUDY: NXL PLC
Peter Miles, MD of Prestonbased strategic marketing network NXO Plc, explains how the company moved into franchising:
?We embarked on the plan two and a half years? ago and now have three franchises in Birmingham, London, Liverpool.
Founder Philip Dyer considered various options. He visited other companies and benchmarked what they?d done.
I was then hired to head up the company?s franchise operation. Over six months I checked the competition and the market, carrying out a feasibility study. Overall, we spent ?200,000 on deciding whether it was worth doing. It was important to be sure the service sector was suitable as most associate franchising with Domino?s and McDonald?s.
We raised private investment specifically for the network, via the management team and private investors. It took the best part of a year to put together a prospectus and package, including process manual.
Agreements were made with HSBC and NatWest. RBS also has a great regional structure ? the North West guy knows all the regional managers whereas other banks have a central office. We set a figure of ?30,000 for licences, although agreed preferential deals for the first five.
The nature of our services means we need to recruit senior marketing people from blue chips. In the next four years we plan to have 50 or more across the UK. We expect to be profitable in the next financial year and then it should sustain itself.?