The tough questions many franchisors don’t want to answer!

June 12, 2013

Will both you and the franchisor be focused day in and day out on the same goals and objectives? It is absolutely critical to understand the answer to this question above and beyond any other single question you can ask. There are many great franchise opportunities out there today in a wide variety of industries. I have worked with some of the best and most successful brands in the country and I can tell you from first hand experience that there are two very different approaches to growing a franchise brand. Franchise companies that have stood the test of time and have a great brand reputation are always an attractive investment, but often have very little development opportunity left unless you want to go to some outlying secondary or tertiary market. In other cases their franchise business opportunity has changed dramatically from their early days. A close friend and past business partner of mine was a very early McDonald’s franchisee. He and his brother had built a large, highly successful group of McDonald’s restaurants within close proximity to one another over the years. They owned the land, the buildings, the billboards and everything else around their businesses. This allowed them to build great value in their company and a terrific lifestyle and legacy for their their families. As most people know today, while certainly an iconic brand and a household name with great management and a stellar reputation, the franchise development opportunity with McDonald’s today is very different. They typically now own the land and the building and lease it back to the operator; they tell you where and when you will be allowed to operate one of their stores; and they pretty much control all of the lucrative profit centers. While they still attract lots of great operators and provide terrific opportunities to people all over the world, their franchise business model has changed significantly over the 30+years as one would expect.

I recently joined a Massage Envy around my house and have had great experiences using their services while traveling around the country. The last time I thought deeply about this industry was when David Stein and I ran a franchise consulting and marketing company and worked with over 32 franchisors nationwide. At the time the massage niche was booming and we met with a number of different high growth franchisors in the segment. It was hard to tell who the winner was going to be at the end of the day since there seemed to be very little point of difference in the services they offered. Fast forward 5+ years and Massage Envy now seems to own the market. They have almost 850 stores around the country and a stellar reputation. Two significant factors seemed to work in their favor in building a great national brand. First, they had a head start and were first in the niche, and it’s hard to beat a front runner that never stumbles. Secondly, they pretty much invented the model of low cost, high quality, membership driven massage centers, and they executed their business model consistently well. They stayed focused on building and running great businesses and ignored the competition. They knew who they were and simply out executed everyone else. Despite the economic downturn, they have built a great brand and a great business for long haul.

Another interesting business I have been exposed to over the years is the hair salon industry. Several years back I looked closely at buying an upscale men’s hair salon, membership driven brand based in Florida. For a relatively modest membership fee, men  could come in and get a haircut, a shave, and enjoy a relaxing upscale treatment. It was an interesting model, similar to the massage industry, and business was booming. I took a deep dive into the men’s hair salon industry, and looked at all of the macro economic factors and competitors that could effect their business model. Since it was targeted toward upper income men it was deemed somewhat of a luxury item. I decided it was vulnerable to economic changes, and decided not to invest. That was around 2006, and we all know what happened to the economy a couple of years later. Unfortunately that company didn’t survive the meltdown we all experienced. I’m glad I did my homework and asked the tough questions despite my excitement and interest in the brand. At the same time, the low cost hair salon niche has continued to grow with large, multi-unit operators. Another friend of mine is currently looking at investing substantial capital into that business. While single unit ownership in that industry does not provide the returns he looks for, he has substantial cash available to invest in multi-unit ownership and the appropriate management infrastructure, and can be reasonably assured of a consistent return on his investment in this type of recession proof business.

What are the key questions to ask a franchisor before you get involved to help give you the real answers to these tough questions.? Are there any tell tale signs that can give you a quick read on just how strong their business really is versus the sales pitch they might be presenting. Here are some great test questions that will give you the facts you need to know:

  • Are they focused on helping you grow your business in profitable ways, or primarily in generating fees to themselves? Do they sell any products, equipment and/or trade marked items to their franchisees, or do they only make all of their revenue through a straight royalty paid from revenues? Some franchise companies make as much or more selling and marking up their products and supplies as they do in royalties. This can put the franchisees and the franchisor at odds with one another when margins are tight. While operating a buying group can be a very powerful force to help franchisors lower operating costs, you may have to dig deep in this area to follow the money trail.
  • How much of the marketing fund is made up of vendor marketing rebates? These rebates can usually either be netted out on the invoice saving thereby lowering your cost of goods sold, or they can be passed along to the franchisor to offset the expenditures and overhead within the marketing department. As a franchisee do you get a financial statement showing all of the revenues and expenditures from the fund. For instance, at Hurricane Grill & Wings our franchisees receive a rebate directly from Coca Cola based on their actual usage or sales of the product. That check is cut directly to the franchisee from Coke so that we can assure our owners that they are receiving all of the benefits of the program. We actively renegotiate separately with all of our manufacturers, vendors, suppliers, and distributors each year, and have been hugely successful in driving down our costs over the years. As we grow the brand nationally we are seeing tremendous leverage through our supply line management program.
  • Are protected trade areas provided and are they reasonable in protecting your investment? Depending on the real estate evaluation of your particular site, you want to make sure to protect sufficient population densities around your location from infringement or canalization by other units.
  • How aggressively are they opening and operating company owned units? If the business really provides a strong ROI and sufficient net profits in real dollar terms to make the effort worth while, then you would expect to see the franchisor continue to open and operate additional new units each year.
  • Are the current franchisees adding additional units? Nobody knows more about the ins and outs of the franchise than the existing franchisees, so seeing them expand at an aggressive pace is a good sign of a healthy brand. Conversely the famous “one and done” development program is a sign of potential problems within the system.

These are just some of the basic questions I would ask in determining the long term prospects for a brand. There are lots of other issues and places to look, including those that your accountant and attorney can guide you through. Additionally, I have not touched on any of the personal preferences, lifestyle choices, personality and skill matching, financial resources and reward expectations, or a myriad of other factors that will play into your decision.