Why Do Companies Franchise?
Franchising is perhaps the most powerful recipe for scalability in all the business world. For most entrepreneurs, however, when they first launch a new company, the prospect of franchising their business may seem like a far-off and largely irrelevant concept. After all, as a new business owner, it can be difficult enough just keeping up with the day-to-day administrative and operational grind of the business, let alone thinking about how to develop, refine and replicate a model on a national (or even international) scale. Indeed, as the popular book The E-Myth describes: Business leaders get so caught up in mastering their daily operations that they become unable to dedicate adequate time to growing their business to its true potential.
The most successful entrepreneurs, however, eventually come to recognize that achieving long-term success requires that they step back and put in place the right systems, processes, and people to expand their company beyond what any one individual -- no matter how motivated and sleep deprived -- could possibly manage on his or her own. Once a business owner sees what's possible when employees take on operational responsibilities that free management to actually manage instead of act like their own employee, he or she quickly understands the enormous power that scalability means for a business.
And it's typically soon after the lessons of business scalability are internalized that many business owners begin to develop franchise opportunities as a powerful method for expanding their enterprise. In short, to franchise a business is the ultimate form of scaling a company. It's the most leveraged and most powerful form of scaling an operation ever developed. Of course, developing a successful franchise system isn't as simple as training sales people or employees to succeed within a single organizations: the skill and mindset needed to train a franchisee to operate an entire organization on his or her own requires another level of skill and patience.
The beauty of franchising is that it allows businesses that are typically not
scalable to become scalable. The restaurant industry is a great example. With
the operational and financial commitments that come with each new location,
restaurant owners tend to get sucked in deeper and deeper into the operating
requirements of running each new unit. Restaurant
franchises have overcome this challenge, however, by leveraging
standardized business systems and putting owner operators in place to manage
the day-to-day operations of each unit, thereby converting the restaurant
model into a nationally (and even internationally) scalable business.
But why all this focus on scalability and local management? In a nutshell, scalable businesses typically yield faster growth and higher profitability and therefore command greater valuations when the companies are sold. This is why technology companies (with their scalable platforms) and pharmaceutical businesses (with their amazing royalty / licensing revenue streams) often garner such high valuations (think Groupon S-1 filing and the recent IPO of professional social networking website LinkedIn). In franchise mergers and acquisitions, a similar force is at work, as franchise systems are typically valued at 8-10 times EBITDA (Earnings Before Interest, Taxes, Depreciation and Amortization)which, when compared to a company in the 3-5 times range, puts a significant premium on their scaled systems. The reasoning behind this is that new revenue and the ability to grow quickly is much larger through an independently owned distribution model, where the power of the franchise systems and the franchisee network can be combined to drive efficient, lean operations and bully suppliers into offering lower raw material costs, while local owners (franchisees) can tend to the particular needs of their own business. Local operators who have their own capital invested manage locations more profitably (e.g., McDonald's franchisees average 20% higher profitability than company-owned locations). Franchisees also provide investment capital needed to open new locations while keeping the debt structure of the franchisor leaner and more manageable.
Franchising is a duplication of an existing business model; it doesn't fix broken businesses or solve flaws in operating systems. For any business owner wondering how to franchise their business, it's important to be realistic about your operations and recognize that franchising will replicate both the positive aspects and the problems of any particular business model. However, if you have the right model in place and the market makes sense, franchising can be one of the most powerful expansion models on the planet.
Christopher Conner is the founder and president of Franchise Marketing Systems, which is a full service franchise development and franchise marketing firm. The organization works with businesses to launch new franchise systems and sell franchises for existing franchisors, and has sold over 200 franchises for clients. The company is based in Atlanta but has offices in Los Angeles, Chicago, Boston, Nashville and Phoenix. For more information on the organization, visit www.FranchiseMarketingSystems.com
What is the Franchise Disclosure Document (FDD)?
Franchisors, operating within 15 states, are required by law to submit a FDD to franchisees before they sign any agreement or any monetary exchange takes place. The Federal Trade Commission supervises these transactions and it lies within their jurisdiction to ensure that the franchisor in certain states provides the possible franchisee with certain information beforehand so as to ensure some manner of security to the franchisee. Due to some unethical behavior in the 1960s and 1970s, franchisors used their influential market position to hide certain information and franchisees unknowingly fell prey to these franchisors and went into harmful relations. To ensure that the franchisees knowingly enter into an agreement, the Federal Trade Commission made it mandatory for franchisors to submit a UFOC, later FDD, which is basically a document with certain information regarding the operations of the franchise.
Capital Formation Strategies For the Growing Franchise
One of the most difficult tasks faced by the leadership team of a growing franchisor is the development and maintenance of an optimal capital structure and access to the resources that the franchisor will need to stay strong and maintain its growth plans. Access to affordable debt and equity capital continues to be a problem for the growing franchisor even though franchising has matured as a viable method of business growth.
Franchise Fridays for May 20, 2011: Top Franchise and Small Business News of the Week
The owners have not yet commented on the issue.