For many companies, creating a franchise (or licensing) program is a sensible way to achieve rapid, profitable growth without giving up any control or ownership. Going from a single location to dozens in a couple years, and hundreds within a decade is possible and well-documented because franchise owner-investors put up all investment capital, shoulder all risk and assume all day-to-day operating responsibilities. It's expansion, using OPM - Other People's Money.
Also, the franchise company gets paid handsomely for teaching others the methods of how to operate its business. First, there’s the up-front “membership” or franchise fee of $30,000 to $50,000 paid for the right to use the brand name and operating methods. In addition, there are continuing royalties of 5% to 10% of gross sales for ongoing advice and consultation. That's where successful franchise companies make their real revenue - on the continuing royalty percentage of gross, which is an ever increasing amount. When I owned my franchise and started the business, my first weekly royalty check to the franchisor was $72. By the time I sold a year later, I was writing them a check of $1,000 every week. Multiply that by franchise networks that just have hundreds of franchisees and you get the picture.
In essence, a franchise development program allows a company to get out of the trenches and become highly-paid generals overseeing their soldiers. Long-term options are also attractive. Build an empire and relax, or let the franchise company be acquired by an increasing number of large, international companies that are looking for small, but growing U.S. franchise companies to take to the next level. According to the International Franchise Association, 900 new companies have franchised in the last three years.
What About Recessionary Times?
Even in a recessionary economy, the franchise industry continues to be resilient and dynamic. The companies selling the franchises generally do well in a recession as demand for their business model grows. Laid off employees opt to get in business for themselves via a franchise, instead of seeking another job and having to deal with more scowling bosses.
WHY COMPANY-OWNED CHAINS SWITCH TO FRANCHISING
Other companies who have not considered or analyzed the company-owned vs. franchised option use their own internal resources to develop, open and run multiple locations. If the company-owned network survives, the principals ultimately realize they are immersed in an ever-growing management and administrative headache that consumes time and money without limit.
While some of their star company-owned units operate profitably and keep the chain's collective head above water, others barely break even or post a loss. Compounding the problem, growth in these company-owned chains is slow, expensive and time consuming. This allows competitors to seize the best locations and market share. One founder of a company-owned chain that ultimately switched to franchising summarized the situation:
"When I went from one company-owned location to two, my problems didn't double, they tripled. When we went from two to three, they quadrupled. It was downhill ever since – a geometric progression nightmare."
After the switch from company-owned to franchising, the company sold off all but its top-performing company-owned units as "turnkey" franchises. The financial drain stopped and substantial new cash was infused. In selling the turnkey franchises, the company received both an upfront franchise fee (under the franchise agreement) and a sale of assets purchase price (under the contract of sale for the assets, goodwill, etc. of the established stores). Under new ownership, even the locations with marginal financial performance turned around and became profitable.
The binding nature of the financial commitment made by owners, who often put all of their assets on the line (homes, retirement savings, investments, etc.) explains this result. They will do whatever it takes, working long hours seven days a week, employing family members, etc. to make the business succeed. This level of commitment is not found with paid managers.
Another company, the Mrs. Fields Cookie chain, started in 1977. Pursuing a company-owned growth strategy, the chain grew to hundreds of locations but almost went bankrupt in the process. In 1990, after tweaking and making adjustments, the company switched to a franchise model. The allowed former company-owned locations to be sold off as “turnkey” franchises to independent operators. The new owners assume day-to-day operating expenses and responsibilities like management, human resources, payroll, rent, inventory, etc.
The selling company is not only relieved from these financial burdens, it receives income from a variety of sources. First, it receives an initial franchise fee plus ongoing royalty payments. Second, because there’s the sale of an ongoing business, the franchise owner pays the value of the furniture, fixtures and equipment, plus an "established business" goodwill factor. Besides boosting its income, the franchise parent company benefits from new administrative economies of scale – large numbers of franchised locations require relatively few franchise personnel for training and support.
In 1963, Colonel Sanders managed 600 franchised locations from an office built in the back of his home, employing 17 full and part-time employees. In 2000, Carl's Jr. had a management team of 19 individuals managing its 669 quick service restaurants.
FRANCHISING VS. LICENSING A BUSINESS (Franchise vs. License) - Making Sound Strategic Decisions
Another topic that merits consideration is whether to use a license agreement as opposed to a franchise agreement. This is not a decision to rush or make summarily as there are significant, long-term legal repercussions that can come back to haunt the company for decades.
I consulted in a litigation matter where a "licensing attorney" prepared a dealer license agreement and ignored the FTC Franchise Rule disclosure requirements. The dealers became disgruntled and hired a litigation attorney who sued for the offer and sale of illegal, disguised franchises. It cost the company $750,000 to go to trial in federal court. Other companies that get sued for selling illegal franchises disguised as "licenses" end up with liability in the millions.
For a discussion of some of the legal and business implications of the franchise vs. license decision, read our illuminating franchise articles Franchising vs. Licensing A Business (Franchise vs. License) and Franchise Business Opportunity Expansion Options
