Iceberg director on franchising businesses

According to the Iceberg Corporation , there are several critical elements a business must have to be capable of being successfully franchised. Anyone considering franchising their business must examine closely what they might be offering to a potential franchisee who will be paying an upfront fee, often mortgaging their house to do so, and committing themselves to a long term relationship and often an onerous premises lease. Typically with franchises also, the potential franchisee will have had no experience in the particular industry they are looking at; this being of course, one of the strengths of the franchising model that a novice can enter a particular industry with no prior experience.

1. A Justifiable Franchise Fee:

This is distinguished from ongoing royalties and other turnover based franchisor income streams as it relates to the purchase of the right to use the franchisor’s intellectual property and business methods for a specified time frame.

It is important to distinguish this up front cost from ongoing fees as this initial payment is a one off payment for the use of the franchisor’s system and components thereof. Ongoing fees however should be directly quantifiable in terms of the franchisor’s delivery of ongoing services to the business system. This may consist of a wide variety of business activity including system development, training, and improvements to intellectual property, but should always be related to ongoing services supplied by the franchisor and not by default become an ongoing cost of using the franchisor’s intellectual property and business methods.

For a business to be franchised therefore, a potential franchisor must have in place a business method or system that in essence is worth a potential franchisee paying the up front franchise fee to procure. In other words, were a potential franchisee to attempt to create a similar or equal business system or method, could he/she do so with relative ease, or does the business method for sale have sufficient ‘critical mass’ and substance to warrant the, say, $50,000 fee.

Too often, franchising is regarded as a way to quickly recoup monies invested in a project or as a way to make a ‘quick buck’, without an appropriate business method being in place. To sell a franchise is such a circumstance can be tantamount to fraud as often in this circumstance it will be difficult to have sufficient certainty of a future maintainable income stream, which is, in essence, what the franchisee is paying both the up front fee and the ongoing income based royalties for.

2) Justifiable Ongoing Turnover Based or Other Fees:

Franchisors must deliver on an ongoing basis, services to justify an ongoing fee, be it based on a flat weekly fee, or turnover based royalty payments. These services can consist of many forms of business activity but should as far as possible be transparent and capable of being quantified within reason by the franchisee. These services may include:

• Improvements in the method or system

• Marketing and promotional activity (although the management of the marketing fund may be compensated for by the marketing fund itself)

• Brand and global promotion

• Supplier improvements and negotiations

• Ongoing training

• Newsletters and other communications that promote the unity amongst the brand

• Financial analysis, advice and counseling of the franchisee’s performance

• Annual conferences and regional seminars

• Brand expansion.

Having said that, it would be unreasonable for a franchisee to quantify a franchisor’s ongoing payments by a detailed analysis of deliverables in terms of anticipated costs and assumptions about time input etc. A franchisor/franchisee relationship survives in part on mutual respect and understanding. Just as a franchisor must be satisfied that a franchisee is making a ‘fair and reasonable’ effort in operating their franchise, a franchisee must also be satisfied that the franchisor is making a ‘fair and reasonable’ effort in the global operation of the business and that the ongoing fees he/she is paying are justified.

It is, in most circumstances, an impossible situation to justify in absolute terms. A lawn mowing franchise, for instance, may charge a flat weekly fee of $30 per franchisee. With a relatively simple operation like that, the requirement for a lot of ongoing support may be minimal, making the ongoing fee superficially more difficult to justify. However, the franchisor should still be performing many of the above ‘less obvious’ tasks to keep the brand strong and viable.

The other relevant issue here is that typically in franchise chains, there will be a mix of strong operators and some not so strong. A franchisor will therefore often be required to spend a disproportionate amount of time with a weaker franchisee who is actually paying less in ongoing incomes to the franchisor because of that weakness. Other stronger franchisees must accept that their ongoing payments are in part funding the extra support of the weaker franchisee and that this is necessary to keep the brand strong and in turn by default protect their own investment.

3) A Method or System Capable Of Being Taught:

Franchise fees are paid for the right to earn a future maintainable income. Unlike stand alone businesses, whereby a purchaser may buy a business he/she believes they can operate successfully, and over time realise they were wrong in that judgment and have nowhere to turn other than external advisors, a franchise system must ensure that, subject to any pre-qualifications or pre entry criteria the business may have, the business system is capable of being taught successfully to a new franchisee to allow them to earn that sustainable income (subject to the correct and agreed time inputs by the franchisee) they purchased with the up front fee.

The business system must therefore be well supported by genuine operating manuals. These must be comprehensive and detail every aspect of operating the business, almost to the point where someone could ‘walk in off the street’ and operate the business in an emergency. In other words, these manuals must not be, as they often were not too many years ago, not much more than just copies of supplier’s equipment manuals and warranties.

4) Potential Franchisor’s mindset:

Not everyone by far will suit the rigours and potential downsides of the franchise relationship. It is a special kind of relationship that must survive not only on system strength and viability, but on the ability of the franchisor to manage that special relationship of being in business with someone who is self employed with their own business but which is a business of which you own the intellectual property and method of operation. You therefore must exercise appropriate control to protect your intellectual property and system, whilst respecting the self employed status of your franchisee. This may be difficult to achieve if you do not have the right kind of personality or perhaps experience in people management.

The strength of the system at the outset will help the cause, as the more clearly the rules and regulations are defined at the outset, the less the risk of relationship problems further down the track.

Franchisees most often go through Greg Nathan, (The Franchise Relationship Institute) called the “Franchisees Curve of Disenchantment” (now the “E Factor”), where by franchisees at the beginning need the franchisor as they know little or nothing about the business, but after a period of time, often a reasonably short period of time, the franchisee begins to regard the franchisor as disposable as they, the franchisee, now ‘knows the business inside out’. This most often won’t be the case, and that attitude fails to recognise the years of experience and hardship the franchisor has spent developing the business and method.

A franchisor must always take a global view, and whilst maintaining the discipline necessary to protect the business, must rise above the petty mindedness that can occur as part of the political relationship within a franchise.

5) Duplication:

Your business system must be capable of ready duplication. You will need to have the relevant sources in place, albeit shop fitters, sign writers, lawyers, manuals etc to expand at an appropriate pace. This can depend on many factors, including capital, manpower resources, sophistication of the system, trades people, franchisor’s training capacity etc.; the list can be extensive. The difficulty of duplicating quickly and successfully can often be underestimated by franchisors, which can result in a bad start to the new franchisor/franchisee relationship, with their shop not being finished on time delaying the projected opening, stock not turning up on time, down to minor things which may still cause disputes between the parties.

There will always be something that can go wrong, but if you are ready to franchise, these hiccups will be kept to a minimum and you will get off to a good start in your franchising relationship.

6) Future Proof:

Is your business viable in the long term? What market conditions exist currently that make your business profitable, what are the likely trends for the future, and what evidence do you have of those likely trends? Historically there have been many concepts launched as franchises which have been ‘fads’; short term market trends. Whilst there will always be a degree of risk with any concept, a pending franchisor should be able to produce reasonable evidence of the likely future longer term sustainability of the concept.

7) Conclusions:

So, if a potential franchisor believes their business has the above qualities, and you as a potential franchisor have the experience or ability to correctly manage the franchise relationship, their can be significant financial gains to franchising your business. These gains may be realised quickly if the business has all the correct elements in place to commence a franchise programme, and the brand launch is handled in the correct manner. Often an attempt is made to franchise a business before it is ready, and although this happens less so now than in the 80’s and 90’s, it still happens, usually with predictable results.

Take as much time as is necessary to put the correct elements in place, both in terms of legal matters and business systems, then go for it

Read about buying a franchise and running a franchise.