06/28/2017

Running a Franchise: Pros and Cons

Franchises are popular largely because of their historical success. In the late 1980s the U.S. Chamber of Commerce published a study revealing that 97 per cent of new franchises remained in business after five years. That sounds terrific, especially since 80 per cent of independent businesses fail within five years. But not all franchises are secure investments.

Pros of Franchise Ownership

When considering the franchise option, potential franchisees must understand the attractions and drawbacks of buying a franchise versus starting a retail business from scratch.

There are many reasons to consider franchise ownership, including the success rate, which results partially from the proven business model that the franchisor offers. Success also results from the unique relationship between the franchisor and the franchisee, in which both parties benefit from the success of the franchisee.

To get franchisees off to a good start, most franchisors provide off- and on-site training, location analysis assistance, advertising, and sometimes a protected territory (i.e., no other franchise may open a store within a certain radius of the first store). Some franchisors even provide financing or offer third party financing opportunities.

Cons of Franchise Ownership

There are also several drawbacks to franchise ownership. In addition to having to pay money to the franchisor, the franchisee needs financing for start-up costs, including rent or purchase price of office/retail space, modification of the space according to the guidelines of the franchisor (e.g., paint colours, flooring, lighting, layout), signage, opening inventory, and equipment. For example, a traditional Subway restaurant in the United States creates up-front costs ranging from $114,800 to $258,300, including the $15,000 franchise fee.

The variation in the cost estimates is primarily due to the cost of leasehold improvements, which can range from $59,500 to $134,500.

In addition to incurring the capital costs, the franchisee must adhere to the franchisor’s rules and operating guidelines. In many cases, the franchisee is required to purchase operating materials from the franchisor, especially in fast-food franchises that rely on standardized products across franchises for the success of the brand. The franchisor also might require the franchisee to purchase the equipment needed to offer a new product, such as fryers at a Burger King or beds at a Holiday Inn.

The hours of operation and days of the year that the business is allowed to close also may be dictated by the franchisor.

Finally, sales and profits can be hurt by events outside the control of the franchisee. For example, in 2005, a scam artist reported she had found a severed finger in her Wendy’s chili; in response, franchise sales dropped significantly in the subsequent weeks.

In another case, a Jackson-Hewitt franchisee actually was caught falsifying tax returns to get larger refunds for its clients, which enabled it to collect higher fees.

Whether true or false, such incidents harm the image of the entire franchise system and materially influence consumers’ future purchase decisions.

The Right Process

Buying a franchise can be a dream come true, or it can be a nightmare. The key is buying smart, which requires planning and investigating before signing a contract. Franchising can be a very satisfactory method of starting a business. It also can be extremely rewarding, both personally and financially, and it offers ownership and decision-making privileges not afforded by working for someone else.

The key to making a smart purchase of a franchise is taking the necessary time to research franchise opportunities thoroughly. The five steps outlined below offer a methodical approach to the decision process:

  1. Initial investigation
  2. Formal request for information from franchisors
  3. Interviews
  4. Evaluation of fit
  5. Choice of franchise
Diligence in following these five steps improves the odds that the potential franchisee will transform into a proud owner of a successful franchise that knows the pros and cons of the business model and can easily adapt to it.