Franchising has a very high success rate and is an excellent way to get into business.
NatWest Bank conducts an annual survey that reports that over 90% of franchised businesses are still operating successfully after five years, compared to a shockingly low 10% for non-franchised ones. Nevertheless, it is vital to make the right choice because, out of about 900 business format franchises in the UK, there are some that it’s best to avoid.
Franchise problems and disputes can be costly, stressful and time-consuming, so it’s best to do everything possible to avoid them in the first place. But without an understanding of how the franchise industry operates, where does an aspiring franchisee start? What checks can be made, and what questions should be asked? Who should be consulted, and to whom should the right questions be put? Thankfully, there are several things that can be done at the start of the process when deciding which franchise to join.
Some of the checks can be carried out at the initial meeting with the franchisor simply by asking the right questions, while others are best done by research. The prospective franchisee should bear in mind that the selection process is a two-way affair, and at the first meeting, the franchisor will also be assessing the suitability of the franchisee. For that reason, questions that could suggest a pre-judged lack of trust should be avoided, and the information obtained instead by research.
Let’s start with an undeniable truth: a successful business must be profitable. Other objectives, such as providing a lifestyle, may also be desirable, but the number one issue is, without doubt, profitability. So how can an aspiring franchisee check how profitable the franchise is likely to be?
The franchisor should be able to show this with financial projections. If the franchise is in the early stages of recruiting franchisees, the projections will probably be based on the financial performance of one or more pilot branches. With established franchises, they should be based on the actual results that have been achieved by the existing franchisees.
This is where the oft-quoted phrase ‘the devil is in the detail’ becomes relevant. Was the pilot branch subsidised? Have all the operating costs, including salaries, been deducted? In established franchises, there will almost certainly be a few high-flying franchisees and some who are underperforming. The prospective franchisee should therefore ask what the projections are based on. If there have been any failures, have their figures been included? If any franchisees have joined within the last year, have their performance figures been annualised? If so, were their trading months in a seasonably favourable period? Could any of these factors distort the projections?
Most financial reporting is on the basis of EBITDA (earnings before interest, tax, depreciation and amortisation). However, this method shows the most favourable situation rather than the actual reality. So, check the small print to see if EBITDA is being used in the projections. If a loan will be used to fund the business, the interest should be considered, as should a sum for the depreciation of equipment. Will any upgrades of software be needed? Only after all these costs have been deducted can the true profitability of the franchise be understood. Lastly, it should be possible to depreciate the initial cost of buying into the franchise over the course of the initial term.
Directly linked to profitability is the suitability of the proposed franchise territory. Is it capable of producing the projected profit? Factors affecting this will include the size and demographics of the population or target market.
Another consideration should be the geographical size of the proposed territory because the operating costs in a sparsely populated part of the country will be very different from those in an urban area. Conversely, travelling times in congested cities can seriously reduce productivity.
Other factors such as regional differences in rent and salaries need to be taken into account. Another ‘devil in the detail’ is the profit margin that has been used in the projections, and it is important to check that it is likely to continue. Some of the factors involved, such as competitor activity, hikes in VAT, import tariffs and excise duty on fuel, will be outside the control of the franchisor, but others are not.
Uniform pricing is a growing tendency for national companies, as many franchises are. For example, it plays a major role in the marketing strategies of those in the convenience food sector. If the franchise under consideration sets the prices, are they suitable for the proposed territory? A competent franchisor will be able to show that this has been considered.
Another area where there has been much controversy over the years has been in franchises where the selling is carried out by the franchisor and the service is provided by the franchisees. An obvious example of this is the commercial cleaning sector, which has seen many instances of franchisee failures due to underpricing by the franchisor. This industry is now under even more pressure due to the parlous state of the retail sector in high streets and shopping centres. Also, the under-utilisation of offices because of the growing tendency to work from home.
Franchising in a post-pandemic business landscape will continue to be the safest way to start a new business, but there will be casualties. It is therefore even more important to select the right sector and, within it, the right franchise.
