Franchising has long been a popular growth strategy, especially with small companies short of the capital required to finance their own expansion. Money aside, a well-run franchise program also offers the advantages of an efficient distribution network, with fewer levels of management than a centralized company, and it relies on a work force of business owners who have a built-in incentive to succeed. With the right kind of support, they can help a business to grow at a breath-taking pace.
For all these reasons, many more firms are trying to expand via the franchise route. What they are finding is that it can be a treacherous journey, particularly in the early stages, thanks to changes in the franchise-business landscape.
For one thing, it's increasingly expensive to launch a franchise program, in part because of government regulations that force franchisors to retain high-priced consultants and lawyers for guidance during the start-up phase. Then there's the problem of finding qualified franchisees with the capital and expertise to run a business. Even if you get your franchise program up and running, there are no guarantees of success. While statistics on franchisor failure are sketchy, experts agree that the number is growing. Some franchisors fall victim to the increasing competition with deep-pocketed big companies, which have been moving aggressively into the franchise business. If they don't sink the start-up, internal disputes may do it in. Nothing will destroy a franchisor faster than lawsuits by franchisees, which are more common now than ever before.
While the problems vary from case to case, most of them can be traced back to the franchisor's failure to provide adequate support. A successful franchise operation requires, above all, a broad-based support system for franchisees, including training, sales promotion, and computer systems. Without it, the franchise is doomed. Franchisees will soon start to flounder. Eventually, they will fail, or break away, or go to court, or all three.
In order to provide that kind of support, you need more than a good idea for a business, something that many would-be franchisors fail to realize. "It's surprising how quickly someone who's worked hard to build a company will go into franchising," says Lewis Rudnick, a Chicago franchise attorney. "What many people don't understand is that franchising changes the basic nature of a business -- how you spend your time, the control you have." Unless you're prepared to treat franchisees as partners in a joint enterprise, franchising may be a big mistake.
It may also be a mistake if your business is not ready to be franchised. Experienced franchise experts use a checklist to determine a concept's readiness. First, a franchise must be a well-tested business with no major unsolved operating problems. Second, a franchisor should have sufficient financial resources for funding beyond the start-up stage. Third comes management depth. But perhaps most important is the economic viability of the overall plan, the business's potential to provide a sufficient return to both franchisor and franchisee. Too often, would-be franchisors look at only one side of the equation, viewing franchisees as a captive market for overpriced products and services. That attitude invites disaster. Unless both parties stand to benefit, neither will succeed.
It is essential to get sound advice at this preliminary stage of the process. A competent specialist will tell you if your concept or company is not ready for franchising; an incompetent one won't. Unfortunately, there are many of the latter around these days. The franchise boom has created a growth industry of franchise consultants. They are not accredited, monitored by government agencies, or held to a professional code of ethics. As a result, their work and their qualifications vary widely, as do their fees.
Consultants offer services ranging from simple marketing advice to a complete set of the legal documents, selling brochures, and operations manuals needed to launch a franchise. Some claim to be able to provide the full menu for as little as $20,000. Others charge as much as $250,000 for similar fare. The only way to evaluate the different offerings is to ask the consultants for names of previous clients and then do some investigating.
The same holds true for franchise attorneys. Lawyers have assumed a broader role since 1979, when the Federal Trade Commission ruled that franchisors must produce an offering circular with a financial history and offer information for prospective franchisees. You probably shouldn't use your regular attorney to prepare the necessary documents: franchise law is a hybrid specialty, involving trademarks, contracts, and registration in 14 states. As convenient as it may be to use a lawyer who understands your business, it's critical to have one who knows the nuances of franchise law. Incomplete state registration papers can delay the franchise sales process. Even more dangerous is a flawed franchise agreement, which may not be discovered until conflicts erupt with franchisees.
As with consultants, however, you can't judge a franchise attorney by his fees. One experienced franchise lawyer in Phoenix charges $20,000 to prepare a franchise offering circular and a franchise agreement. A Washington, D.C., law firm does the same work for $80,000. The burden is on the franchisor to find out what the fees cover.
Probably the best people to turn to for referrals are experienced and successful franchisors in your area. You would, in fact, be wise to get them involved as investors or board members, too. When Tom Reichman bought Seattle-based Scandia Down Inc. in 1980, he convinced Frank Carney, the founder of Pizza Hut Inc., to invest in the company and serve on its board. Reichman now meets quarterly with Carney and other board members, who also have experience in franchising. "They are my best source of information," says Reichman.
Aside from good advice, a franchisor needs capital to fund a franchise expansion. It takes a minimum of $250,000 to pay for the preparation of legal documents and sales brochures, and to finance the barest of marketing efforts. Some new franchisors figure they'll cover these start-up expenses by selling franchises. "Bootstrapping rarely works," says attorney Rudnick. "If you don't have the money that it takes to franchise a business today, don't do it." Jiffy Lube International Inc., a Baltimore-based franchisor of quick oil change shops, spent more than $4 million on franchise system development and personnel from 1979 to 1983, during which time the company sold only 96 franchises. Yet today, Jiffy Lube has annual revenues of over $90 million and leads its industry with more than 400 stores. "Many of the costs associated with franchising are at the front end -- marketing a franchise, adding personnel, and developing a mew market," notes Arnold Janofsky, a Jiffy Lube vice-president.
Indeed, you can get into serious trouble attempting to build a franchise operation with inadequate capital. MicroAge Computer Stores Inc. tried and failed. The company, based in Tempe, Ariz., spent more than $500,000 launching its franchise program in 1980. President Jeffrey D. McKeever estimated that the company would sell 100 franchises in the first two years to cover the mounting overhead expenses. Instead, it opened just 30 stores. MicroAge eventually entered, and survived, a Chapter 11 filing. But McKeever does not advice anyone to try it his way. "You are risking your company if you don't plan to run a significant negative cash flow at the start," he says.
The cash is especially important because most start-ups need to add management. In a typical franchise operation, you should have experienced managers with responsibility for selling new franchises; for overseeing the marketing of products or services; and for helping franchisees to establish and maintain their units.
You may be able to fill some management slots by recruiting from within. At Huntington Learning Centers Inc., a 19-unit franchisor of remedial education centers, based on Oradell, N.J., co-founder Ray Huntington promoted the manager of a company-owned center to train the first franchisees, and hired a franchise sales manager. Then, with only a few franchise contracts in hand, he added a real estate site coordinator and an advertising director. "The people didn't have must to do at first," says Huntington. "But they were ready to do their jobs as the company grew."
A strong management team is also an important selling point with potential franchisees, and -- in that phase of the process -- you need all the help you can get. The competition for qualified franchisees is fierce. Finding them can be expensive and time-consuming. In his first year of franchising, Gregory P. Muzzillo, president of Cleveland-based ProForma Inc., has spent $40,000 marketing the business, a franchisor of business forms and office supplies, and has so far sold four franchises. Others do worse. Without adequate capital to sustain them, they take on franchisees who are not qualified to run a business, and wind up losing their companies.
Yet too much success can be just as dangerous for a start-up franchise as too little. If you expand too quickly, you run the risk of stretching your resources too thin. Corners are cut. Legal requirements are overlooked. Franchisees don't get the support services they've been promised, are paying royalties for, expect, and demand. The entire system breaks down.
Of course, controlling growth is not easy. Most companies, after all, get into franchising because they want to expand rapidly. When the opportunity for growth presents itself, it can be hard to say no. "In a regular business," says Ray Huntington, "you can grow in a relatively sensible fashion. In franchising, you grow when you find someone who's qualified to buy a franchise. You don't want to turn that person away and say, 'Come back when I'm ready."
The only way to avoid this dilemma is to proceed cautiously, adhering to a strict development timetable. Many start-ups limit their first franchises to neighboring states, for example, because distant franchises are more expensive to support and more difficult to monitor. "[Going slow] may not suit the pace of a hurry-up entrepreneur, but it's essential that the start be conservative," says Norman Axelrad, a former executive at McDonald's Corp., who now works as a franchise consultant in Chicago.
So, in the final analysis, franchising a business isn't all that different from starting one. The pitfalls are certainly the same: If you expand too fast, with too little money, you'll fail.