A recent survey suggests that 70 percent of Americans do not know what a franchise is. This is why there is so much confusion surrounding the industry. Hearsay, rumors, and assumptions run rampant regarding the franchise industry and business ownership. I will clarify some of the misnomers here.
Some people claim that the franchising model doesn’t work. I’ve heard folks equate franchising to a pyramid scheme. Before you think that, consider the following facts reported by the International Franchise Association, www.Franchise.org:
- Franchised businesses contributed $670 billion of economic output into the U.S. economy in 2020 and still represented 3% of the total nominal Gross Domestic Product (GDP).
- With significant government assistance, nearly all of the economic damage created by the COVID-19 pandemic could be erased in 2021. Specifically, franchising is projected to open more than 26,000 locations, add nearly 800,000 new jobs, and contribute $477 billion to the U.S. GDP.
- Overall franchising contribution to the economy is forecast to grow by 7% in 2021, reaching pre-pandemic levels of economic output by the end of the year.
Some people have become wealthy with franchise ownership. But, understand the facts. Plenty of people fail in franchises. Blame can be placed on many factors—undercapitalization, lousy location, insufficient support from the franchisor, a bad franchise agreement that doesn’t allow the franchisee to make money, inadequate unit management. The list goes on. However, if you consider each of these issues, almost all of them relate to a weak franchise company. Even if a franchisee is undercapitalized, that falls on the franchise company. The company should not have awarded the person a franchise license in the first place.
The fact is there are no rules, regulations, or laws that dictate which businesses can be franchised and which ones cannot. So, when you are investigating franchises, it’s a crapshoot if you don’t know what you’re looking for in a superior business model. Anyone can say that their company is a franchise and start selling franchises. Of course, the company needs to produce a Franchise Disclosure Document to sell franchises in the United States, but that does not guarantee that the franchise owners are reputable, that they will give you support, or that the concept even makes money. Buyers beware. This was the case with Super Suppers, the second franchise I purchased. The company was a culinary school, not a franchisor experienced with supporting franchise units around the country.
As a Franchise Consultant, I do not represent just any company. The entity must meet certain criteria. When franchise companies come to us to represent them, my company turns down more franchise companies than we accept into our inventory because not all concepts are the best of the best. The companies we work with, by default, are looking to recruit the very best franchise partners and have a long-term, successful relationship. That is why they pay my company to pre-screen people.
In most cases, a franchise has exclusive territory. If it’s a store location, there is a specific mileage around that store that is exclusive. The franchise company is not permitted, by contract, to not put another unit in that exclusive territory and sometimes near the border of the territory. If the franchise is home-based or office-based, the exclusive territory is zip code-based.
Many folks feel that minimum royalty payments are a scam.
Now, the goal for the franchise company and the franchise owner is to make money. Based on the royalty system, that is how the franchisor makes money. If they happen to have a franchisee dud in a territory, they are stuck with making low to no royalty money on that territory. In most cases, the franchise agreement is ten years in length. Some are dropping it to 5 years because ten years is a long time making no money in a location. So, the minimum royalty is a way to motivate the franchise owner to get off their butt and build the business.
Currently, the average royalty across franchising is 7 percent of gross, top-line sales.
Territory
Talking about territory, some may think that territory is restrictive. I think it’s a double-edged sword. Having an exclusive territory is helpful because it prevents your business from being cannibalized by other franchise owners. However, a good franchise knows how to delegate and sell its territories. Actually, great franchises have the whole country mapped out according to demographics.
Once a franchise has a track record of a few years of operations, 25 units up and running, they can upload the data and demographics of their typical customers to a marketing and data company such as Buxton. A company like Buxton has data on just about every household in America. It’s scary, but a good data company can tell you within a couple of brands what kind of beer you drink, make and model of your car, your income, how many of each gender live in your house, if you have a dog or a pet and the data goes on and on. When you talk to a franchise that you narrow down to and give them your zip code, that can tell you immediately if the concept is likely to work in your area based on real data. To me, this is amazing.
When you talk to a franchise company, they tell you that your exclusive area will be only one mile; naturally, you will want 10 miles. Still, they know, as a very rudimentary example, that you need 100,000 households to be successful. It’s not a random guess. Depending on the product or service, they know as a business that 1 to 2 percent of the residents in your territory will use your product or service. That small percentage multiplied by the average ticket price will get you to a certain gross sales number. Based on that, you will be able to pay business expenses and be left with a profit. If the franchise company has their act together, The numbers should clearly work.
Franchising can really generate wealth. I’ll be the first to tell you it’s not a free lunch. You have to work. The only free lunch is in a mousetrap.
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