Franchising can be a very successful distribution strategy to expand a proven, successful business.
Business owners considering going the franchise route should remember that it is not ethical or practical to franchise an idea or a business that has not been run successfully and proven to be profitable and showing a good R.O.I.
Once this has been achieved and you decide you want to grow or expand nationally using a franchise model, you should investigate if your business is franchisable.
Critical success factors to consider
To assess the viability of franchising your existing business, you need to consider several critical success factors. Eric Parker, Partner and Consultant at Franchising Plus, offers these ten questions that must be answered satisfactorily before franchising commences:
Q Does the business operate in a large and growing market?
Market demand must be sufficient to sustain a franchised network, or even more than one franchise, since competition either has or will inevitably enter the marketplace. A large market will also contribute to promising margins, making it an attractive business opportunity for potential franchisees. The market must also provide room for growth, for the benefit of the franchisee and franchisor. The franchisee must be able to grow his/her business in the existing market. Because the profitability of franchising relies on a multiplier effect, the franchisor needs to grow the franchise network in order to be profitable.
Q Is the growth in the market sustainable?
The market must have the potential to grow for a long period of time, since the franchisee usually signs a long-term contract and the franchisor has to build a solid infrastructure to support the franchised network. This means that fads are not franchisable, since their growth is not sustainable over the long term. It is therefore important that the concept must be tried and tested for a reasonable period of time. This should prove its feasibility over the long term.
Q Are the margins sufficient to cover the proposed management services fees?
One of the elements that forms part of franchising and indeed describes franchising (in part) is that franchisees are required to pay money to the franchisor both at the beginning of the relationship as well as on an ongoing basis. Usually, the ongoing payments are referred to as a royalty payment or a management service fee and a monthly advertising and marketing payment. The royalty fee is generally determined as 10% of the GP margin expressed as a percentage of turnover. For example, if the GP is 30%, the royalty will amount to 3% of turnover. Gross Profits should be large enough to sustain the royalty. This royalty must be set at an acceptable level once the ideal model has been established and financials determined.
Financial models must be evaluated and analysed. Franchisors must ensure that the franchisee makes enough money to receive a return on the initial investment, as well as be able to pay the monthly fees. It must also be remembered that if a franchisee has to gear himself in order to pay the initial franchise fee and set up costs, franchisors must ensure that these costs can also be paid and still provide the franchisee with an income.
Q Can the product demand a price premium?
Consumers must be willing to pay a price premium for the product, in return for added values such as exceptional service, after sale service, knowledgeable advice etc. Product categories that are caught in price wars do not franchise well. In these instances, there is very little loyalty to the product and margins remain under pressure. A franchisee cannot be expected to prosper in such conditions.
Q Do you have access to sufficient capital?
The first few phases of franchising are capital intensive. It is imperative that the franchisor is financially stable in order to survive the initial period. Moreover, the franchisor must be able to afford franchising in a professional manner. This includes investing in technology and professional assistance. This must be taken into account when franchising is considered as an expansion mechanism.
Q Does the potential exist to establish a memorable brand?
Well-known brands like McDonalds and KFC are among the best franchises in the world. A well-known and easily recognisable brand can move into franchising relatively easily. The criteria for building a brand include uniqueness and the ability to cultivate loyalty amongst consumers. A good brand is easily recognisable and pronounced, so that consumers will remember it easily. This is what branding is all about: occupying the number one spot in a consumer’s mind to ensure repeat sales. Another important consideration is whether or not the brand name can be protected. Intellectual property must be registered as soon as possible and must be difficult to copy.
Q Is there a substantial barrier to entry?
Uniqueness is one of the prerequisites for a franchisable concept. A concept that is easily copied will experience extreme difficulty in gaining the competitive advantage required for success in the marketplace. Although some categories are competitive by nature, the barrier to entry may be raised by offering advantages to the consumer that other brands can’t or won’t. An example in this field is the tyre fitment centres, which are highly price competitive. By adding services such as extended hours, email, internet, photocopying and faxing facilities as well as offering a broader product range, an operator in this category will be able to differentiate himself from possible future players in the market. It is up to the franchisor however to constantly work at innovation and technological advancements that would always set his operators up to ensure that they are “ahead of the pack”.
Q Will the development costs permit a satisfactory return on investment?
The franchisor and the franchisee must both be able to receive a return on investment. The franchisor will incur costs and will invest capital to develop a franchise network with the required infrastructure. The returns he receives must justify this. A franchisee needs a reasonable return on investment; otherwise it would make more sense to pursue another business opportunity. Once again, this question can only be satisfactorily answered once the ideal operation has been established, all products and services have been tested and the financial performance of the operation can be analysed for viability and profitability.
Q Is it possible to grow a franchise culture in the company?
It is important that the potential exists to create a franchise culture in the group. A franchise culture is open and learning orientated. It must be flexible and supportive by nature. When an organisation chooses to go the franchise route, it must be committed to creating a win-win situation. In other words, the franchisor and the franchisee depend on each other for their success. A professional franchisor has a long-term commitment to the success of the concept. This includes having a vision for the future of the concept and a strategy for continued success. The franchisor must practice the highest business ethics, especially since the franchisees trust him with their investment.
The challenge to any organisation during a franchise rollout is the ability to deal with change. A franchise culture should be instilled in the people that will be involved in the franchise, right from the beginning of the franchising process. A “Franchise Champion” will need to be identified as soon as possible and should be trained during the franchising process. Franchising will require a long term commitment from management to support franchisees.
Q Is the business concept teachable and easy to replicate?
The mark of a good franchise system is whether or not the business can be easily replicated and then taught to new operators. In order for a country development plan to be accurately developed, we must determine the replicability of the business concept. In other words, how easy will it be to set up new operations and roll out new outlets?
Further, the business system must be developed in such a way as to ensure that it is relatively easy to pass on the necessary skills and know-how for managing the retail business. Having said this, we must be able to document all business and operational issues into a comprehensive operations and procedures manual. This manual then forms the base or “blueprint” of the business and all franchisees will be required to operate along these rules, standards and guidelines.
If you have ticked all the boxes and decided that your business is indeed franchisable, you must get franchise ready. You need a franchise development plan including:
Country development plan:
This is a development plan where you prioritise the geographical areas for expansion so that growth happens in a clustered, sustainable manner.
A franchise package consisting of:
- Operations manual – this is the blueprint for running the business and the standards that franchisees have to maintain in their outlets.
- Franchise agreement – This has to be CPA compliant.
- Franchise disclosure document – This is a CPA requirement and similar to a prospectus.
- Franchisee recruitment and selection package – Design your recruitment documents and process and ensure that it’s CPA compliant.
- Franchise support – Franchising is a long term relationship and franchisees need support on an ongoing basis.
- Franchisee training.
- Marketing plan – The franchisor must design a national marketing strategy and provide franchisees with guidelines for local marketing campaigns. These guidelines and corporate identity standards must be included in the operations manual.
- Procurement/Distribution – Franchisees will expect to share in collective buying power, the franchisor should negotiate on behalf of the whole group.
- Systems and Controls – Standardised systems such as point-of-sale and backoffice systems will help the franchisor to monitor franchisee performance in order to assist when needed.
Eric Parker is a Partner and Consultant at professional franchise specialists, Franchising Plus. Eric is also a past Chairman of the Franchise Association of Southern Africa (FASA) and served on its Board of Directors for many years.