The ideal franchise

By Sarah Stowe | 29 Oct 2015 View comments

YouÍve dreamed and planned and now the time has come to invest in a franchise opportunity. The most fundamental question, of course, is in which franchise system you should invest. With that decision made, the next key consideration is whether to purchase an existing franchise business or establish a new one.

LetÍs look first at some of the considerations in assessing the franchise group as a whole. Many factors will determine whether a franchise system is the right one for you. Answering the following 10 key questions will give you an initial insight into the quality of the operation and whether you are joining a franchisor of choice.

Selecting your franchise opportunity

1. Does it look good?

It is critical that you are the best looking store in your category or, if you are a mobile franchise, the vehicles should be well-presented and serve as mobile billboards for the business. There is no substitute for first impressions.

The best retail sites are seen by more people and, as a result, trade at higher turnover levels. Franchise groups having a strong brand, well-presented stores and a professional approach are generally able to secure the best sites.

Better sites create profile in the market place, tend to generate excellent numbers and are therefore a more attractive proposition _ provided that rents are manageable.

One of the big discriminators is naturally a comparison of return on invested capital. There is little point in a franchise group looking good but being only marginally profitable.

Be sure that the business is maximising the profit that falls to the bottom line in both its company-owned and franchised locations.

Does the business you are considering have a profile in the media? Every franchise group should have a unique selling proposition and a public face to sell it.

Does the franchise group diligently promote every aspect of the business _ customer experiences, expertise in the segment, a particular characteristic of its staff or plans for future national or international expansion?

The advocacy of franchisees is one of the most powerful indicators that this is a franchisor of choice. What makes a franchisee smile? Good returns and a positive working relationship.

You want a franchisor focused on ensuring franchisees are maximising the performance and profitability of their outlets.

Many of the best franchisors are seen in the marketplace through their advertising and promotional activities. Advertising drives retail and service business sales and this flows to the bottom line to produce a more profitable business.

The franchisor of choice has an ongoing and well-developed marketing campaign with constant reminders to the market the organisation is alive and well.

Advertising may be in the form of product sampling, catalogue distribution, local area marketing, event sponsorship, radio or television advertising, or a combination of these.

Franchisors with aspirations for significant growth will generally have a strong and robust relationship with the banks which, in turn, are willing to offer attractive funding packages for franchisees.

Company-operated locations provide a valuable core of cash flow and profitability for the franchisor, which provides stability for the group. Company operations provide a controlled environment for your induction and training which will contribute to your success.

Many of the ideas and innovations in a franchise network come from the franchisees at the customer end of the business. Has the franchisor used this wealth of knowledge and information to improve processes and create more value for the customer?

Leading franchisors are continually articulating the direction and goals of their organisation and the progress of the business in one-on-one discussions. They encourage every stakeholder in their network to consider the opportunity and aspire to be part of the future prosperity of the business.

Established or new?

If youÍve done your homework, ticked each of these items off your list and decided which franchise group you want to join, youÍre now faced with another choice; a new location with exciting potential or an existing location with proven performance. ItÍs important to recognise that there is inherent risk in both of these scenarios _ the risk of any new business venture. While it is generally accepted that higher risk equals higher returns, we know this is not always the case, so careful analysis becomes the key to good decision making.

Firstly, you should take a long, hard look in the mirror and analyse yourself. What is your risk profile? We all have our own unique risk aversion characteristic which drives our behaviour. Someone with low risk aversion tendencies will be more likely to venture into a new location and be prepared to face the consequent start up risk. Someone with high risk aversion tendencies will be more likely to opt for the safer bet of an established location and the certainty of a proven track record.

Understanding your personal risk profile is important in the decision making process. While you may want to push a little beyond your personal comfort zone, how much risk is too much? The uncertainty and associated stress levels associated with a high level of risk may impact negatively on your performance as an owner operator.

Too little risk on the other hand, may result in no adrenalin rush and a quick descent into boredom. Understanding where you sit on this scale and what motivates you will be an important factor in making your choice.

The new location _ starting from scratch

LetÍs assume for a moment that you’re the type of person that can tolerate a reasonable level of risk and as such, youÍre prepared to venture into a new location. What should you look for, what are the questions to ask and how do you arrive at a commercially sound decision?

Some of the benefits of taking on a new location include: no goodwill is payable to a previous franchisee; it is a brand new operation and the local reputation of the business can be established as desired; the landlord may be prepared to make a contribution towards fit out.

Obviously, the balancing factor is that you will not have the certainty of a proved trading history for that particular location.

Do your homework

Much research should be undertaken when considering a new venture. Interestingly, many potential franchisees do not use the options at their disposal. The following are examples of some of the methodologies used to make a factual judgment in relation to the likely success of any given location:

A people traffic count; examining neighbouring business performance; researching previous tenant performance irrespective of the business type; shopping centre reports; ABS data for the territory; bank advice on the industry risk profile and the consequent accreditation rating for the franchise system; industry research, IBIS World, Retail Association, other available sources; competitor study in surrounding locations.

Access to a reasonable amount of data will ensure you are making a more informed decision. This must however be balanced with the fact that risk will never totally disappear.

Experience has shown that potential franchisees have missed great opportunities over time due to prolonged dithering and the failure to make a decision in a reasonable time. This is just as frustrating for the franchisor as it is for the franchisee.

If you find yourself in this position, try to focus on the key issues impacting the decision. Try not to be too consumed with the multitude of other issues that can divert attention from the important considerations.

The established location _ a running start or someone elseÍs problem?

In essence, the good and bad of the established location are the reverse of the new or greenfield location. You will take some comfort in the proven trading history so in effect, it is generally perceived as a lower risk option. If the premises are looking a little tired, a refurbishment can restore the appearance, and there is an existing reputation _ which could be good or bad.

Similarly, existing employees could be a positive or a negative and this is discussed in a little more detail below. A key issue to consider is the potential for further growth of the business; is there more growth to be had or has it reached its peak?

So, where do you start?

Numbers, numbers and numbers

There is no substitute in business for having detailed and accurate numbers for the performance of a business. The quality of the numbers is crucial and, frankly, some examples we’ve seen defy belief _ lack of detail and in some cases, any semblance of accuracy.

It is important to cross reference any numbers provided with the previous financial reports, BAS statements, reporting to the franchisor, the franchiseeÍs accountant, and any benchmarking that exists in the network. Businesses that carry a cash component are the most difficult to calculate. If the numbers appear in anyway inconsistent this must be focused on in detail. This is not an area where close is good enough.

In addition to reviewing the financial performance it is important to ensure a detailed budget has been prepared outlining the sources and uses of funds and the cash flow from the business. This should include finance costs and a buffer for any reduction of revenue. The single greatest cause of stress in franchisee businesses is being undercapitalised at the start.

The issues

Given the existing franchisee has operated in the network it is worth speaking with other franchisees to gain a peer perspective. The objective is to understand the performance and any views that may assist in making the decision. Typically, if a franchisee has been a good performer and a decent operator they will be respected by their fellow franchisees. It must be remembered however, that there will be franchisees in a network that may not be inclined to provide a balanced view.

The adage that time never stands still is as true in business as it is elsewhere in life. The present situation will not be the same forever and consequently it is important to consider whether there are any circumstance changes that are likely to impact the performance of the business in the future. Past performance is not necessarily an indication of future performance. There may be a competitor that has signed a lease just across the road, a new DFO about to open, a major anchor tenant leaving, or a change to surrounding parking or road infrastructure. All (or none) of these may be relevant to the performance of the franchise and the decision to purchase.

Should growth be expected in the current franchise? Growth is an expectation in nearly every business. This is no different in a current franchise but there are factors to consider. All businesses and brands go through the cycle of start up, growth, and maturity. Whether decline or reinvigoration is the next step is down to the network and the operator. Any purchase should achieve an acceptable return on the invested capital that will typically require a degree of growth.

The other part of this question is growth in what _ revenue, profit, cost base? The reality is all will grow over time but growth in profit is the most important measure. Revenue can fall but improvements in gross margin, productivity or cost management may deliver an improved profit result.

When assessing a franchise system the growth opportunities must be considered in the context of industry and group direction. A new franchise system may have questions of sustainability or may be defining a completely new specialty. A mature system may be on the verge of a slow down or at threat from a younger, more dynamic competitor. Stepping back from the business to analyse the industry and key players will assist in making an assessment of the likely growth trajectory.

What about employees _ should they stay or should they go? There are three key issues to resolve as to whether you should keep existing employees after an acquisition is complete. Do they have the skills to match your expectations of the role? Is there any strong impact on performance if they leave? Is there a cultural and personal fit with the new owners?

Individually none of these provides an answer; it is the combination of factors that matters. For instance, you could have a strong operator to whom customers are particularly aligned and whose departure may negatively affect store performance. However, the same employee could have no interest in the new ownership structure and consequently not only fail to deliver the previous results but impact the future results because of the cultural or personal disconnect with the new owners.

A decision needs to be made very early as focusing on developing your new business is challenging enough without having to worry about whether or not your people are aligned with your direction. There is no substitute for a direct conversation with the existing team and seeking some input from the franchisor or outgoing franchisee.

Another interesting consideration is whether you should keep former franchisor staff if you are purchasing a company operation that is to be converted to a franchise. Some key advantages in that they know the business, how head office operates and have relationships with other head office team members could be to your benefit. But potential disadvantages to consider could be a greater concern for the head office perspective rather than yours, a lack of motivation to work under your constant supervision or the perception that a career path progression has been removed as they are no longer part of company operations. Again a candid conversation is a great first step to understanding these issues and the appropriate actions.

In summary, your personal risk profile is the principal determinant of whether you should invest in a new and exciting location or a proven and profitable one. In either case they key is to be conscious of the risks and benefits inherent in both scenarios and ensure that your decision is supported be the relevant data.n

Rod Young is the executive director at DC Strategy: