DC Strategy on the franchise versus company store debate

Managing a brand that has both franchised and company-owned stores can be like walking a tightrope, according to DC Strategy .

Some retailers strongly believe the two business models are like oil and water they just don't mix. Proponents of this school of thought argue that when franchisors own and operate stores themselves it presents a conflict of interest the temptation to favour one's own stores with better locations and support is too great. Even if a franchisor remains fair, having a large chain of company owned stores carries with it the risk of perceived bias.

The opposing view is that company-¬owned stores give franchisors invaluable and ongoing insight into the market, which in turn benefits the franchise system.

Phil Blain, principal of the Franchise Alliance consultancy, is one such advocate of the dual approach.

“We believe retailers should always have company owned stores. Firstly, they can be a cash cow, so you're looking after your income.

"You can also use those stores to train franchisees and for the trialling of new product, so you don't inflict a poor product onto a chain of 50 franchisees.

"Most franchisors work very hard to ensure there's no 'us and them' mentality within the system. So the company stores pay all the same fees and appear the same as all the franchised stores."

But Michel's Patisserie joint MD Noel Carroll says retailers should avoid having a finger in each pie.

“We have five company owned stores. I believe you've either got to be in franchising or in company owned stores, I don't think you should have both. Obviously with a chain like ours where there are 350 retail outlets, you're always going to have a situation where you have four or five company stores, but I wouldn't like to see it go any more.

“If you're going to have any more you have to separately manage them and have separate people responsible for them, and I don't think you can be both. You're either in the franchising business or you're in the company owned store business, it has to be one or the other," he emphasises. "It's much harder to manage company-¬owned stores because you are responsible for every single aspect of them rather than just the franchisee being responsible."

Profit point

DC Strategy points out that one of the well-known benefits of franchising is having motivated owner operators on the job. Gloria Jean's Coffees MD Peter Irvine says for this reason, company owned stores are rarely as profitable as franchises anyway they're really only useful as a testing ground.

“We have about 10 company owned stores and our aim is to reduce those. We'll probably retain two because those two are in prisons and can never be franchised, but they're not high volume stores. Our aim and model is not to run company stores.

Michel's has avoided conflict with franchisees by ensuring company stores are not in direct competition with them, Irvine says.

"You need to have a minimum of one company owned store, because you need to understand the dynamics of running a store. The franchisees expect us to have at least one to test equipment and trial new products, and we've been able to train staff who have been part of our operational team, so they see a positive aspect to it.

"But generally companies don't run very good stores because you only have employees rather than owners in there."

The other challenge in running both models is creating different management structures.

"When you set yourself up to manage a franchise system, you're not set up to run a large number of company stores. It's a totally different structure and if you are going to go that way, you need to re do your whole company structure," Irvine says.

Corporate trend

Despite the challenges, many retailers continue to dabble in both models. Recently there has been a trend towards large corporate retailers turning to franchising notably Franklins, Australia Post and Flight Centre . For them, the challenge of setting up a second management structure to incorporate a franchising arm is even more onerous than usual, but presumably worth the time and money. Adrian McFedries, strategic director of business consultancy DC Strategy, has spent the past 12 months developing a franchise system for Flight Centre's Escape Travel chain.

"Part of the new year is about putting the strategy into action. It's been a fairly major exercise to get to that position, from developing the franchise program right through to understanding how this integrates into the broader Flight Centre group."

Founded in 1993, Escape Travel has had many incarnations through its life, but essentially the chain specialises in holiday packages, as opposed to Flight Centre, which is more airfare focused. The brand now has more than 50 outlets across Australia's east coast.

McFedries says the existing Escape Travel outlets will be retained as company owned stores while new locations will be found for franchised operations.

"The move to franchise shouldn't be taken as a vote against the existing model not working it's actually going to complement it.

"Corporates are increasingly looking at franchising as an HR strategy, and also to recognise the growth they wanted to have in regional areas and, in this case, in a second brand.

"An HR strategy because, particularly here in Australia, you've got increasing costs of payroll tax, long service leave, hiring and firing costs that's a huge encumbrance on a lot of businesses. Finding good people is increasingly difficult.

"So when a market is very mature, we're seeing increasing numbers of corporates look to harness the energy of incumbents by giving them a business model that has a bit more choice than just the employee road."

"It's obviously a very specific market. Franchise candidates are in the travel industry in some form or have an interest in it. The ambition is to get the first franchisees well on board inside this first quarter and get the plan up and running."

McFedries says there are no plans for the Flight Centre brand itself to be franchised.

Insolvency impact

As every retailer knows, when it comes to brand reputation, one bad apple can spoil the whole basket.

Company owned stores can pose an added risk to franchisees if they go bust a rare, but entirely possible circumstance. Financial adviser Tim Kilham, a partner at McLean Delmo & Partners , says if a company owned store becomes insolvent, it usually means the whole system is going down the tube.

"One of two things will happen. Franchisees will de brand, or some of the franchisees might buy the rights to the franchise and take ownership of the whole system themselves."

A case in point is Collins Booksellers , whose 23 company owned stores became insolvent last May, owing almost $7.4 million to creditors.

In this instance, the company's 31 franchises remained profitable, but the franchisees were left with bad press and a gaggle of competitors wanting to pick off certain company stores. The franchisees were able to save their brand by forming a new private company, Collins Booksellers Pty Ltd, that bought the franchise agreements, intellectual property, brand names and information technology from the Collins group. The new company soldiered on and now plans to have 50 franchises by the end of 2008.

So what are the lessons here? DC Strategy suggests while there is significant value in running a handful of company stores to keep a finger on the pulse, franchisors who choose to run a large arm of company owned stores clearly need to ensure they structure it properly, run it profitably, and ensure no perception of bias creeps into the franchisee ranks.

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