McDonald’s and how you can expand your franchise

Let’s say you currently run a small business and think franchising might be a good way to grow. You don’t really know much about franchising, but you’ve had a few customers ask if your business offers franchises, you’re tired of the challenges of managing staff, and you can see the potential for new outlets or territories. But you just don’t have the capital to take it forward.

Franchising. What a magnificent word. Think franchising, think the McDonald’s franchise and other multinational fast food chains. Imagine your business all around the globe. Appealing, isn’t it?

The reality, however, is remarkably different from the dream path to riches that you think franchising might be. If franchising were easy, everyone would do it. If franchising could be done without financial sacrifice, long hours and managing staff, everyone would do it. If franchising were guaranteed to make you a fortune, then everyone would do it.

The fact that everyone who has an independent small business does not franchise is a reflection of how tough the journey can be. Having said that, the question of whether or not a business can be franchised is relatively easy. Most businesses can be, but whether they should be depends on the three critical factors of profitability, sustainability and leadership.

Critical Factor No.1 – Profitability

A business that is not profitable should not be franchised. Full stop. Franchising will not save an unprofitable business, and the motives of anyone who franchises an unprofitable business are likely to be questionable.

Businesses that deliver consistent strong profits (after the owners have drawn a wage or salary for themselves at the prevailing market rate for the job function they fulfill) may well be capable of franchising. The profitability of the existing business will form the model of each franchise unit to follow. Given that accountants and savvy franchisees will be expecting a minimum return on their investment of 25 per cent to 30 per cent, plus a full return of their invested capital during the first term of the franchise, the original business model may need to be generating net profits of 30 per cent to 40 per cent (or more).

Why the discrepancy between the two profit levels of the current business and the profit target of a future franchisee? Because future franchisees will be required to pay ongoing royalties to the franchisor – either as a fixed fee or a percentage of turnover – and these royalties will not form part of the expenses of the business in its current position.

Furthermore, the decision to franchise, if done properly, will not result in short-term profits. Profits for the franchisor will be achieved in the long-term – usually sometime after three to five years – as the early costs of developing the systems and funding the growth of the business are likely to absorb all profits and still require further capital to meet your increased level of spending. In fact, it is quite possible that the first franchisees of a business may achieve higher profits in the early years than the actual franchisor.

Critical Factor No. 2 – Sustainability

The issue of sustainability can be further divided into two parts: sustainability of the concept, and sustainability of the operations. Business concepts come and go with changes in technology, fashion, regional and national demographics, regulatory environments and consumer tastes.

For example, internet cafes sprang up rapidly in the early days of the internet as these were often the only access points to the World Wide Web, available to private individuals. Then, as the cost of personal computers came down and their penetration throughout Australian households reached record proportions (coupled with the rise in affordable dial-up access) more and more people chose to access the internet from home, rather than cafes.

The cafes, which originally began as internet access centres that also served coffee, rapidly lost mainstream relevance. The change in technology, costs and consumer tastes cut a swathe through the numbers of internet cafes operating in Australia, and the few that survived did so mainly by catering to the niche independent traveler market. To continue to service their new niche market, these centres added long distance call services, discount travel and accommodation bookings, and dropped most or all cafe services.

Assuming that any of these internet cafes have survived to this day, in their original form, they now also face the prospect of competition from established cafe chains (whose customers are primarily interested in the cafe experience), but which are now also offering wireless internet access for their increasingly mobile, laptop computer carrying customers.

The business world is littered with the corpses of unsustainable business concepts, so any business you are thinking of franchising must be able to demonstrate market relevance in the face of changing conditions in ten, 20 or 30 years’ time in order to justify the effort to franchise.

The other element of sustainability – operations – is also critical. Can the business be operated elsewhere by other people without your micro-management? If not, what operating systems or procedures need to be developed to make you, as the business founder, effectively redundant from working at the coalface?

If it is impossible to replicate your operational knowledge and expertise (or other unique personal attributes, which make your business a success), then franchising is not for you. The best way to test the sustainability of operations is to establish additional outlets under management and run them as if they were franchises. While this may initially require you to dig deeper into your own capital resources, it will save you the cost of being sued later by unhappy franchisees with unviable businesses.

Critical Factor No. 3 – Leadership

Business owners who choose to franchise embark on a long and winding path of entrepreneurial development that will extract a financial, time and emotional cost. The two key qualities needed to survive and flourish during this journey are commitment and capability:

Commitment: Franchising is a business methodology where half measures are unacceptable. A decision to franchise a business involves taking on significant responsibilities and obligations to both the business itself, and its franchisees.

This commitment will involve working long hours, engaging with people from all walks of life, leading a team of staff with skill sets altogether different from your own, and being completely focused on building the brand. There is no room for the halfhearted, or those likely to change their mind at the slightest difficulty.

All the successful franchise systems operating in Australia today began with a business leader committed to growing the business. Those leaders often paid a personal cost (even if only in the interim) in terms of lifestyle, discretionary spending, and family time.

Capability: This is the other key element of franchisor leadership, and is equally important. A capable franchise leader will make every attempt to learn everything they can about franchising, and will commit themselves to ongoing personal professional development in order to be the best franchisor they can be.

A capable franchise leader recognises that the business of franchising requires a completely different skill set and approach than what they used previously in the business from which the franchise evolved. In other words, running a franchise network of widget businesses is completely different from just selling widgets.

The next nine steps

So if you’re still reading and keen on franchising your business, the next thing you need to do is to read widely about franchising, attend some seminars and workshops on the subject, speak with franchisors who have already ‘been there, done that’ and find yourself a consultant.

1. Choosing a consultant

If you go to a franchise consultant and tell them you want to franchise your business, their first question to you should be: ‘Why?’ Many people who think that franchising is a great way to grow their business might, in fact, be better off considering some other method of expansion. In marketing terms, franchising is but one method of distribution (one of the four Ps of marketing) and there may be other methods of distribution that will generate more consistent and higher profits in a shorter time, and at a lower capital cost, than franchising.

A good consultant will explore these alternatives to franchising – both to test the suitability of the business, as well as to determine the commitment of the business owner. A consultant must be a specialist in franchising with a track record demonstrating experience as both a franchisor and an advisor with a high level of recognition in the sector. They must also hold formal business qualifications.

Consultants can be found via the Franchise Council of Australia’s online member directory.

2. Conducting a feasibility study

A feasibility study should be done on the business, and include at least the following:

• Overall market demand for the business’s product or services;

• Realistic market share to be achieved;

• Size and qualities of a market territory/unit operation;

• Total number of outlets/territories achievable in the national market;

• Expected average outlet/territory sales;

• Key competitor analysis; and

• Supply/distribution methodology.

This will then form the basis of further analysis. If the overall market for the business’ products or services is such that only a handful of outlets or territories are required, then franchising is not likely to generate sufficient royalties for the franchisor to justify the effort – in which case, an alternative distribution strategy should be considered.

3. Getting the lawyers involved

Many business operators who think about franchising their business will first speak with their lawyer – often in the mistaken belief that, to franchise, all they need is to have a franchise agreement. This is certainly not the case and while there is no dispute that lawyers have a critical role to play in helping start-up franchisors, they should not be the first port of call. Any legal documents need to reflect a sound business model, and only appropriately qualified and experienced franchise consultants can make the best recommendation as to the right business model for your franchise. Note: This is the business model that is tested and, if found to be correct, is embodied in the franchise legal documentation.

The same selection criteria you apply to find a franchise consultant should also be used to find a suitable franchise lawyer. Franchising has its own set of specific regulations – the Franchising Code of Conduct – and only a specialist lawyer is really capable of ensuring you meet your obligations under the Code.

The Code is available from the Australian Competition and Consumer Commission (ACCC)’s website.

4. Protecting your IP

While you will be relying on your franchise consultant to assess your options for franchising, in the meantime you can at least keep your lawyers busy by ensuring that all your intellectual property is protected. Even if you decide not to franchise, this will be a worthwhile investment to protect the future resale value of your business. This involves registering your logo as a trademark, registering business names and domain names, and patenting any special processes that have been developed by your business.

5. Getting the best from your consultant

To get the best from your consultant, integrate them as much as possible into your management team early in the process, while maintaining their arms length involvement in the business. Do not rely too heavily on the consultant to do everything for you – to simply present you with a completed franchising package. While it may be tempting for a busy business operator, the reality is that you will need to have ownership of the process and must be building your knowledge base along the way. By simply outsourcing everything, you are abrogating your responsibility as a future franchisor and compromising your chances of future success.

6. Documenting your operations

The know-how required to operate your business must be able to be transferred to new operators in a scalable manner – ie. without relying on you, the business founder, to demonstrate every single aspect of the business every time. To do this, you will need a training program based on an extensive set of operating procedures for all elements of the business – not just at the frontline, but for back office operations as well. Putting all this into an operations manual may seem like a daunting, but necessary task. Even if you don’t end up franchising, the operations manual will be useful to ensure consistency across the business.

7. Setting royalties

There are two main methods of setting ongoing royalties – fixed fee or percentage of turnover. Variations exist within these, and need to be assessed by your consultant to ensure that the royalty paid is not so high that franchisees cannot make money, and is sufficient to both cover the costs of servicing the franchisees, as well as generating profits for the franchisor. Royalties should be applied in your test franchise and modified in order to get the balance right.

8. Establishing a test franchise

If your business currently operates from just one location or in just one territory, open at least two other outlets or territories and operate them as if they were franchises (including paying you franchise fees). This will test the concept’s ability to be duplicated, as well as the operating systems you have developed, and the management skills required to support multiple operations. It will also confirm or deny the profitability of the business model, and quickly identify improvements that need to be made in order to go forward with franchising.

9. So you think you’re ready to start recruiting franchisees?

Well you might think you’re ready, but chances are you’re not. There’s very little need to race into the market – first entry advantage is often lost to smarter, more considered competitors who don’t rush (remember the hare and the tortoise?).

After coming this far, put your franchise plans for world domination on hold for a few months, while the system operates ‘normally’ after its rapid development. Give things time for the bugs to show (and be fixed) before moving forward. While you might think this will cost you money now, it will cost you even more money later to fix problems across an entire network that were not evident in your early testing phase.

Then price your franchise package, develop a franchisee profile, and start your franchise growth. Sounds easy right? Wrong. Keep reading about Franchise Council of Australia is a not for profit membership organisation that is the peak body representing the franchising sector in Australia.