Why do companies decide to franchise their business?
The most obvious reason is that it allows a company to grow their business without taking all of the financial risk. Instead of investing in a new location and hiring a manager, bearing all the costs of building and growing their new location, the franchisor can give someone else the opportunity to invest and to gain from the new location.
By providing support to the new owner, the franchisor has a good chance of doing well in the new location, and of gaining a profit from the new shop as well as getting added distribution for the company’s products. Getting great products out into new markets is a good way not only to earn more money for the franchisor, but also to benefit from positive word of mouth.
Franchise fees and royalties provide a revenue stream for the franchisor, and are fair payment for the benefits franchisees get from the franchise.Successful franchises are often a more efficient way to grow the company than opening new locations in a chain owned entirely by the parent company.
These descriptions aren’t intended to be romanticized or over-optimistic. Rather, they represent what you want to see in a franchisor. If that’s not what you’re seeing — or you see it only if you keep your rose-colored glasses firmly planted on your nose — then you’re not seeing the kind of franchise business investment you should choose.
If it appears that collecting franchise fees upfront is the main source of income for the franchisor, think twice. You don’t want to see a company getting lots of upfront fees, possibly by placing too many franchise locations in a given area, and then letting the franchises fail. The upfront fees are supposed to be a franchisee’s investment in training and support going forward, as well as a purchase of systems and the use of the company’s name and brand.
Then the franchisees succeed, make money, and share a percentage with the franchisor. If that’s not what happens, the company you’re looking at is not a successful franchise.
High percentages on royalties can be a red flag, too. 5 to 10% of revenues is a typical royalty fee. If the franchisor wants a higher percentage, it should be a reflection of added services. If not, it could be because franchisees don’t earn enough to make 5 to 10% of their revenue a worthwhile profit. That’s not what you want to invest in.
As for products, if the franchisor is primarily using franchising as a distribution model, that product had better be great. If it seems as though the franchisor is franchising because they can’t sell the product through retail, or you can tell that the product is not excellent, then it’s not a good candidate for successful franchising. If it’s a great product with an excellent distribution network and you know you want to be part of it, you’re on the right track.
You’ve probably already thought quite a bit about why you want to be a franchisee. Make sure you take some time to figure out why your franchisor wants to be a franchisor.