The value in service franchises

By Sarah Stowe | 29 Oct 2015 View comments

Service franchises operate on different entry cost models, from free entry and a high level of royalties, to a high entry cost with lower royalties, or a medium entry cost and a flat weekly or monthly payment.

Regardless of the model, the franchisee can over a period of time estimate the payments to be made to the franchisor.

Business models also differ in various service businesses with large areas often set out with very strict boundaries. Financial institutions such as ANZ, Mortgage Choice, Aussie and CBA all have similar models, with leads allocated to the right franchisee based on the area.

Often lower cost entry systems are more flexible around their territories, or they have very well defined territories, and a more open policy in that only a certain number have ever been sold, and the franchisee can exclusively work their own patch, and then still work across any unallocated territory. But would the franchisees actually have enough work to survive if all the territories are sold out?

Many of the multi-disciplinary franchise systems like Jim’s and VIP tend to follow this model.

Service franchises in the indoor segment include house cleaning, ironing, oven cleaning, portrait photography, befriending the elderly and more.

Outdoor service franchises include pool cleaning, dog walking and washing, building and renovating, antennas, roofing, paving, kerbing, gardening and landscaping, and junk removal among others.

The demand for these types of household services depends on the economic status of the area. SEIFA (Socio Economic Index For Areas) is an Australian Bureau of Statistics product, and provides a score for every area in Australia, centring on an average score of 1,000. 

High SEIFA areas are typically ones where the housing price is high; most people are in employment, and in most cases in professional or other well-paid jobs. These areas include the northern suburbs of Sydney, Melbourne’s inner east and Perth around the Swan River. 

Lower SEIFA areas would be both Melbourne and Sydney’s western suburbs in general.

The demand for household services is definitely stronger in higher socio economic areas, according to research and experience.

Smart franchise systems try and adapt the size of the territory so that each territory gives a similar amount of opportunity for a franchisee. For instance, if the market is split up into territories each consisting of 40,000 households, one would much prefer to have the service franchise for pool cleaning, gardening, or dog washing around Camberwell, Toorak, Double Bay, Hunters Hill or Claremont (WA), than around St Marys, Cabramatta, Sunshine or Broadmeadows. Some franchise systems wonder why some of their franchises are keenly sought after, while others seem to have no interest at all. Inevitably, they have split their territories very poorly.

A franchise operation would do well to first understand what makes for a good customer for that particular business segment. This can be done by creating a picture of who the ideal customer is, or if the business already exists, plot the customers, and look for areas of high concentration of customers. By studying the demographics of the post codes of high penetration, one can deduce if the service franchise works best in high vs. low income, areas of older vs. younger people, areas high with families, or whether ethnicity may have some effect on the business.

Once the drivers that are good for the business are identified, a score can be calculated for each post code. For example, if one household was likely to spend $10 on the service on average, then a household in a high demographic area may spend $15 per household, and a household in a lower demographic area may spend $5 per household. If each post code was equivalent in the number of households, say 10,000, then the higher area would offer $150,000 of potential sales, while the lower socio economic area would only offer $50,000 of potential sales.

If this calculation is done across the total market such as all of Melbourne, one could conclude that the total market offers 1,200,000 households at an average of $10 per household, or $12,000,000.

A good franchise system may conclude it wants 30 franchises across Melbourne, with each franchise having $400,000 of potential.

To balance the potential so each territory is similar, it may take 29,000 households in a high socio economic area to come up with $400,000 of potential and 50,000 households in a lower socio economic area to give the same amount of opportunity for the franchisee.

This type of calculation can be done for any market, and rather than trying to adjust the franchise fee for a higher potential area, compared to a lower potential area, we believe it’s better to keep the franchise fee constant, and adjust the area’s size, so each franchise area is considered to offer similar opportunity.

There is no rule to set the cost of entry or royalties for a franchise system; one could simply follow a couple of models.

If the system has some definite, exclusive IP, then there is an argument for a higher entry fee, as it probably has higher money earning potential. This would apply to exclusive products, very well priced and in strong demand, where the franchisor would be able to ask for more potential franchisees to come on board. Often these products may be some form of vertical marketing where the franchisor is also the exclusive supplier of the goods.

On the other hand, if it involves a very well organised house cleaning or lawn mowing franchise system, it would always be competing against an individual who feels they could do it themselves. This simply values the franchise as the value of gaining them work and a name they can use. Jim’s and VIP are some of the names that come to mind for having good customer recognition. This does keep the entry cost down for a franchisee, and creates more franchisee turnover as there is less to lose if they leave the franchise system.

Our experience is that outdoor service businesses definitely have more opportunity in higher socio economic areas than lower ones; however a good franchisor will balance the territories they create so that each area gives a similar amount of opportunity for the franchisee.