Choosing the Right Franchise

Franchise Turnover Rates

turnoverWe’ve explained turnover rates before. However, a new article on the franchise industry asks whether the industry as a whole has a turnover rate problem… and suggests that there are some franchisors that are skewing the numbers.

A franchise’s turnover rate is the percentage of franchise locations that close in any given year. We found that about half the franchises in the data we checked had turnover rates of 10% or less. FranchiseGrade.com’s Franchise Industry Report looked at franchise numbers from 2010 to 2013 through a survey of 1,695 franchisors.

Here are the numbers they found:

  • 135,289 new locations opened
  • 58,104 went out of business
  • 40,113 ended their franchise relationship
  • 11,997 did not renew
  • 8,431 were reacquired by the franchisor

Note that this is not saying that 58,104 of the new locations went out of business, but that during the three years 135,289 locations opened and 58,104 went out of business. In 2010, there were 408,108 franchise locations operating and in 2013 there were 423,624 — a nearly 4% increase in the total number of franchises. All in all, however, while 135,289 new locations opened during that time, 118,654 closed — about a 28% turnover rate, on average.

That seems like a big discrepancy. However, the 10% was not the mean, but the median. If you cast your mind back to math class, you’ll remember that the mean involves adding up all the figures and dividing by the total number of data points. If one franchise has a 100% turnover rate and one has a 0% turnover rate, the mean will be 50%, even though half the franchises considered have no turnovers at all.

So what does the 28% average turnover mean for prospective franchisees?

The first thing a prospective franchisee should know about turnover rates is that the turnover rate for a franchise must be shared in the Franchise Disclosure Document. It’s Item 20. We suggested in our earlier article that a turnover rate of more than 10% might be cause for concern, or at least an indicator that you should ask questions about what caused the closures. Does knowing that the average turnover rate in the survey mentioned above is 28% change that?

The survey included a few franchises with very high turnover rates. Quiznos, for example, had a 475% turnover rate. This and a few other very high turnover rates brought the overall average up.

An article in the Wall Street Journal confirms this. WSJ reported on default rates on loans for franchise start ups. The Quiznos default rate is nearly 30%, while Little Caesar’s is less than 2%. The variations among the franchises is large, so the mean may not be a good indicator.

If you’re thinking about a Quiznos franchise, then, you should look closely at the reasons for such high defaults and turnovers. They might be reasons that won’t apply to you or your location, but it’s something to think about.

However, it’s also important to keep these numbers in perspective. None of these numbers tells you your chances of success after three years, because they are not looking at success rates, just turnover rates. They don’t distinguish between businesses that closed in dismal failure after a year and those that were successful for 30 years before the owners happily retired.

Census data shows that fewer than half of all new businesses survive for five years. At the three year mark, it’s only about 60%. Franchises have better numbers on average, but any business can close. Look at turnover rates, but don’t obsess about them.

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