Franchisability is Not Enough

by Edward N. Levitt

Well, you have read everything written about franchising, sought the advice of a franchise expert, spoken to your accountant and lawyer, discussed the matter with the bank manager and consulted your brother-in-law (who has eaten in hundreds of franchised restaurants over the years) and you all agree that your own particular business is franchisable. Are you ready to start preparing a franchise program? Absolutely not!

All too often, the decision to franchise is made based upon the fact that the business is franchisable, without any consideration being given to the following questions:

1. What will the impact be on my existing business?
2. How will it change my activities and responsibilities?
3. What financing do I require?
4. Where will I obtain the various skills necessary in planning, implementing and administering a franchise program?
5. What alternatives exist to expansion through franchising and are these alternatives attractive to me?

The early stages of your franchise system will require a considerable amount of your valuable time. Even if you decide to work with franchise professionals, you will be required to be part of the planning process because, after all, you are the original success story everyone is attempting to clone.

You then must come to terms with the fact that you will not always be able to tend to the original business and others will have to take your place. If you cannot find and train the right people, you could seriously reduce your earnings and cash flow. Remember, most franchise systems do not become profitable for the franchisor until a number of units, sometimes as many as ten or more, are up and running smoothly. Consequently, you may have to rely on the original business for some time to support you and provide the working capital necessary for the franchise expansion.

The flagship business may also be jeopardized by the fact that your franchisees are using your trademarks, style of doing business and appearance. Disgruntled customers will direct their wrath at the system as a whole and you may not have a business to go back to, if the franchise expansion fails.

In the Early Stages, the Expenditures are High and the Revenues Low

You must be prepared for the fact that starting a franchise system is a career change. You are not longer going to be a restaurateur, a hardware store owner or a druggist. From then on, you will be a marketing executive, financier, franchise salesman, labor relations specialist, systems analyst, real estate broker, general contractor and buying agent. While some of these activities may be delegated or subcontracted, in the best systems the franchisors have control of or a strong influence over all of these areas.

As with any other business change, budgeting is crucial in a franchise expansion. You will have to plan for the cost of preparing the franchise documentation, creating and registering the necessary trademarks and logos, and producing the franchise sales package, including pro forma financial statements. Further, you may chose to rely on franchise professionals for the planning and/or implementation of some or all of your franchise expansion and these costs must be calculated and provided for in your budget. Finally, you will have to budget for your extra staff requirements and the costs of site selection and procurement and for the sales of your franchises.

Many new franchisors make the mistake of assuming that the front-end franchise fees will cover all of these costs and produce a tidy profit. In fact, in new franchise systems, the front-end franchise fee most often is not high enough to cover the direct costs of establishing a franchised unit; for example, the costs for site selection, lease and franchise negotiations, franchise sales, franchisee evaluation, construction supervision and training.

Another reality that must be faced by the new franchisor is that the first franchisees in a system are often in a position to demand special deals, which may result in lower front-end fees or lower rates of royalties than planned. However, you can look forward to the fact that the head office costs of operating a successful franchise system can be much lower than the costs of operating a similar business network on a chain basis. You just have to be able to survive the early stages, when the expenditures are high and the revenues are low.

As mentioned earlier, there are a number of specialized skills which are necessary in building and operating a successful franchise system. These skills can always be purchased from professionals, consultants or independent contractors of various sorts. However, while it is often cost-effective to rely on such sources at the beginning and at various stages of growth, on an ongoing basis it is far better to develop expertise within your own organization. Therefore, in deciding on whether or not franchising is for you, you should examine your ability to learn the necessary skills yourself or your willingness and ability to attract and manage an organization capable of performing as required.

Budgeting is Crucial in a Franchise Expansion

To fairly evaluate the options available to you other than franchising, you must first examine your reasons for considering franchising in the first place. You may have considered franchising as an alternative method of financing your business expansion, as a means of more rapid expansion than is usually the case in chain operations, as a mechanism to obtain a more dedicated level of management, as a vehicle to exploit markets you might not otherwise have considered, or as an opportunity to generate income with a minimal utilization of your capital and manpower.

As we have seen, there are disadvantages as well as advantages in choosing franchising for your business expansion. Alternatively, you could raise capital through equity or debt issues and you could secure a high level of management dedication by selling or giving equity to your unit managers. Another approach is to enter into a series of joint ventures or partnerships with others for the development of particular units or territories. Finally, you may simply decide that a smaller number of corporate owned units provides you with a sufficient income level and that you do not want the increased complexity of establishing and operating a regional or national franchise network.

If your business is franchisable, if the change of business activity and demands placed upon you by a franchise expansion are exciting challenges, if you have the necessary financial and human resources, and if you have examined the alternatives and found them wanting, then franchising may be for you and you may indeed achieve the coupon clipping nirvana that only a successful franchise network can provide.

Edward N. Levitt is a franchise lawyer and partner with Gowling LaFleur Henderson LLP -- more commonly known as Gowlings -- located in Toronto Canada. Levitt has over 30 years experience practicing franchise law, is a prolific writer, a noted lecturer and is currently General Counsel to the Canadian Franchise Association. Contact Levitt at ned.levitt@gowlings.com.