Franchising … Risk & Return

Franchising … Risk & Return

Franchising is now across most industry sectors and buying a franchise is often dfranchiseescribed as buying a ‘business in a box’. You are basically buying someone else’s business or brand together with all their systems, processes and marketing collateral. It sounds like a recipe for success but before you invest in a franchise you need to do your homework. In the due diligence process you might find the systems and training the franchisor offer are inadequate, the location is unsuitable or there is no real marketing plan behind the business. You might also find that the market is saturated and as an example, in the last 18 months we have seen a flood of frozen yoghurt shops come and go.

We are not suggesting for one moment that buying a franchise isn’t a great potential investment. However, given most franchises appeal to first time business owners, this serves as a warning and you need to be selective about your investment. A franchise study from 2008 suggests that:

  • Only 81% of franchisees are profitable
  • 58% of franchisees generate a profit of less than $50,000 per annum
  • 3% of franchisees generate a loss of more than $50,000.

According to a report on food franchising by Franchise Business Review, 51.5 percent of food franchises earn a profit of less than $50,000 a year; roughly 7 percent exceed $250,000 with the average profit for all restaurants coming in at $82,033. That sounds reasonable but when you factor in the initial franchise fee of between $500k and $1m for a restaurant it represents a relatively small return on investment.

On a positive note, the Franchising Australia 2014 report suggests 72 percent of franchisors report that franchisees have recorded increases in revenue over the 2013/2014 financial year. In addition, over two thirds of franchisors believe franchisees have recorded profit growth over the last financial year and over 80 percent of franchisors expect franchisees to record revenue and profit increases in 2014/2015.

THE TRAPS

 While some franchisors market their franchise as a ‘turnkey’ operation, running a business requires energy, passion, persistence and commitment. There is no substitute for hard work and if the business was just a profit making machine surely the owner would set up more sites and just employ the staff?

The number one question that a prospective franchisee wants to know is, “How much will I earn?” It’s a fundamental  part of the buying equation and some franchisors now offer income guarantees, particularly in the service franchises. Given these types of franchises generally attract first-time business owners moving from a salaried employment position the income guarantee can be very appealing. Guarantees are often stated as ‘$1000 a week for the first ten weeks’ to reassure the franchisee and reduce the perceived investment risk.

Other franchisors are offering prospective franchisees a guaranteed income of say $50,000 per annum. This provides the franchisee with a degree of income stability for the first year of trading and can help the franchisee secure finance. While income guarantees might provide short term peace of mind for new franchisees, they expire and buyers need to look beyond income guarantees when evaluating a franchise. What if the operator is not suited to the type of work or has no marketing or people skills?

Generally speaking, most people looking to buy a franchise will look at least two different franchises before making a decision. You need to look at the total package including the price, training, equipment, marketing materials, ongoing fees and income guarantees. Don’t make the decision based on one aspect of the offering and make sure you understand the terms and conditions of the franchise agreement.

 

Buying any business doesn’t guarantee financial success and franchises are not immune from risk. Before you invest in a franchise or consider franchising your business we urge you to consult with us.

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