Can I franchise my business?

In South Africa, two out of every three ‘franchised’ brands offered as business opportunities do not see month 36 as a continued franchised operation.

Franchising is an effective way of distributing a product or service to consumers and business-to-business markets. However, before embarking on franchising as an expansion strategy, it is necessary to establish whether franchising is a suitable replication format and if the business system, including the brand, is mature enough that a third party may, with relative safety, invest their livelihood. Conclusively answering these questions will require more than spending a few hours on the Internet or reading a book or two on the subject.

All too often, the failure of new franchised businesses has nothing to do with the underlying customer value proposition, but can rather be attributed to the fact that franchising a business demands more patience and capital than the aspirant franchisor anticipated.

Good franchisors are true entrepreneurs at heart and entrepreneurs are not famous for their patience. However, the premature introduction of ‘franchised’ brands to the multitude of eager, and sometimes gullible, would-be franchisees, is a challenge to the reputation of franchising.

CONSCIENTIOUS FRANCHISING
The franchisor’s ability to offer reasonable, safe business opportunities often hinges on their ability to display patience and diligence in preparing their business system for franchising.

Motivation and expectations

Amongst the many reasons prospective franchisees rely on to justify joining a franchise and paying the attendant joining fee and royalties, probably the most important motivation is that they expect to capitalise on the value offered by an established brand.

If a prospective franchisor has only one or two outlets with limited brand exposure, especially in the regions where would-be franchisees want to establish their businesses, the reality is that the franchisees will actually be doing the brand building and most candidate franchisees want the brand they invest in to work for them, not the other way around. While there may be prospective franchisees who appreciate this dynamic and are prepared to be the ‘trailblazers’ for the brand in untapped markets, it is imperative that such candidates have the necessary operating skills to counter the fact that the brand is not known. The franchisor can reward these franchisees for their courage and participation by offering them discounted joining fees and/or royalties.

Most well-known franchised brands established several company-owned operations before franchising their business opportunity. 

How strong is the market?

As franchisor you need to assume and acknowledge the likelihood that your prospective franchisees most probably know nothing about the business or the market they will be operating in. Therefore expecting the franchisee to take a view on the potential of the market they intend on operating in, is not reasonable.

It is up to the franchisor to take ownership and to — through some means of reference, be it research or historical network sales data — demonstrate that the company’s value proposition is strong enough to be successful in a particular location. Even when the would-be franchisee is pressuring the franchisor to approve their proposed location/area, it is important to remember that the franchisee is relying on the franchisor for their judgement call. Including a disclaimer in the franchise agreement or disclosure document that prospective franchisees may conduct their own market research, and that the franchisor will not be liable for incorrect assumptions on the part of the franchisee, is not best practice.

While there is an argument that the franchisee has an obligation to develop their own customer base within the market, especially in service industries, it is a big ask if the brand had no prior market presence. The acid test for the franchisor is to conclude whether a new franchisee, assuming that they adhere to the rules of the business system, can generate sufficient sales in a short enough period to become cash flow positive soon enough. Every month the business trades below breakeven as a result of a lack of sales, the balance sheet and working capital of the business are eroded until it will eventually close down.

THE BLAME GAME
Blaming the franchisee for a lack of sales may cause the franchisor to assert that the franchisee was not the correct jockey for the horse as they have not displayed the trade or customer relation skills required — but whose mistake is that when the franchisor had the privilege and obligation to assess these skills before entering into the franchise agreement?

Franchisees are generally very eager to get into business as soon as possible, but especially so in cases where funding is at hand and/or where the franchisee has already resigned from their job. In such instances it can be very tempting for the franchisor to disregard any red flags.

CASE STUDY
The Sorbet brand is very powerful and sought after today, both in the consumer beauty environment and as a business opportunity. They have closed or relocated very few outlets to date, and for a brand with such a significant footprint, it is a commendable effort from its proprietor, Ian Fuhr, who we had the privilege of working with when the brand started out.

Sorbet’s success can be attributed to the fact that the franchisor would not consider third party investment in a franchise where the brand was not almost a household name, or where the business system was not refined to the extent that only minimal adjustments would be required after full-scale replication commenced.

Before franchising was pursued, Sorbet established more than 20 company-owned stores which required significant cash input from the franchisor. While these company-owned stores proved the viability of the business model, the income they generated also provided the capital to fund the infrastructure required to support a franchise network.

THE SOLUTION
If you, as aspirant franchisor, do not have the financial means or patience to establish a number of company-owned stores before offering franchise opportunities, we suggest the following approach:
While the nature and capital intensity of a business model will influence its strategy, always establish the second company-owned operation (first replication) with your own cash. Involve an investor if you need to, but you have to replicate the business at least once before entertaining further franchise thoughts. Once the second operation trades at a level well above breakeven, then a franchise expansion strategy could be considered, provided that at least the next three operations are co-owned by the franchisor with a shareholding of say 49 percent. The primary argument around this structure is that risk is shared by the franchisor and this structure allows the franchisor to be operationally active in the management of the business. Funders and landlords would also be more comfortable entertaining a ‘new’ brand on this basis. The 51 percent shareholding franchisee would have the right to purchase the 49 percent interest of the franchisor at cost after a minimum period of time or when the business performs better than expected.

While the science behind effective and responsible franchising spans much wider than what is communicated in this article, we have articulated the primary concepts franchisors must consider when introducing a new brand or business model to market.

Need advice about your expansion strategy? Email Kobus Oostuizen to discuss your options.