Franchising Your Small Business - the Fly Speck Part Nine

Master, Master

As an expansion strategy for your business, you might consider master franchising. This is an arrangement in which you grant a franchisee the right to collect some portion of the up-front franchise fee and ongoing royalties in return for recruiting, training and supporting the franchisees. This can lead to rapid growth acceleration for your franchise. The downside is that you give up the right to determine who gets a new franchise - typically the profitable ones who follow the system rules - in a master franchise system this is not the case. New franchises go to those recruited by the master franchisor.

Pricing

"As a franchisor, you need to consider two basic components to pricing your franchise: the up-front franchise fee and the ongoing royalty rate." - Shane

Franchise Fee

The franchise fee is a one-time payment made by the franchisee to the franchisor when the franchise agreement is executed. The idea of this fee is to compensate the franchisor for the cost of getting the business started. It includes the value of goodwill, franchisee's territory, the cost of identifying and training franchisees, location assistance and the costs of signage and other initial equipment costs.

According to a survey of franchisors made by the IFA, the average initial franchise fee is approximately $32,000.

Average Franchise Fees in Selected Industries

Industry Average Franchise Fees Lodging $ 35,200 Restaurants $ 31,900 Printing and copying $ 27,900 Security and safety systems $ 27,100 Hair care $ 25,200 Employment and personnel services $ 22,700 Auto repair $ 22,600 Business services $ 22,194 Fast food $ 20,800 Laundry and dry cleaning $ 19,000 Real estate $ 14,700 Travel agencies $ 14,000

Royalty Rate

"The second major component of the price of a franchise system is the ongoing royalty paid to franchisors by franchisees. As a franchisor, the royalty is your major source of compensation, often accounting for more than 90 percent of the money that you receive from your franchisees over the live of your franchise agreement. In addition to providing you with your profit, the royalty gives you the incentive to support the franchise system over time. Royalties will be used to support your efforts to build the system, to pay for ongoing training, to help existing franchisees work out the kinks in their operations, to develop the brand name, to develop new products and services, and to monitor your franchisees." - Shane

Franchising Your Small Business - the Fly Speck Part Eight

When the Advertising Kicks In

Keep in mind that when you start out as a franchise you don't necessarily want to collect the advertising fee (some do) since you don't have a need for national franchising when you only have 2 or 3 outlets. You might want to write the fee into the agreement but not require franchisees to pay it until you have reached a sufficient size to undertake national franchising.

Support

One of the important benefits of a franchise system is the support it provides the franchisee - you want to provide the back office systems that alleviates the hassles they would have to deal with that would pull them away from doing business. So keep in mind, if you provide too little or not the right kind then you will not attract the right people. Too much and you serve as a wet nurse and your costs run high. The idea is that central office provides the economies of scale in the right areas - back end office, accounting, legal, systems, etc.

More on Support

"In general, you need to get four categories of support right in your franchise system:

• The training that you provide franshisees to get them ready to operate an outlet in your system
• Ongoing support services, such as centralized data processing and inventory control or communications mechanisms, that you offer to franchisees
• Real estate services (for the vast majority of franchise systems that have physical locations) that offer franchisees to help them to identify the right locations for their businesses
• The assistance that you provide franchisees in obtaining financing for their businesses"

-Shane

Marginal Benefits

The marginal benefits of training decline with the amount of training that you provide (200 hours of training is not likely to make you twice as good a house-cleaning franchise as 100 hours) but the costs of training tend to increase in a linear manner with the number of hours of training, there is generally an optimal amount of training that you need to provide to your franchisees.

Take the Field

"Field operations evaluation is a key tool for making sure that franchisees adhere to the rules of the franchise system. Field audits provide an early warning system to identify the need for corrective action when franchisees deviate from system rules." - Shane

Centralized Services

Centralized services include things such as centralized data processing, central purchasing and inventory control. These services are of major value to the franchisee. The economies of scale that are located here offer a significant advantage to franchisees over if they go it alone.

Site Selection

Some franchisors will provide invaluable assistance in site selection: traffic-pattern studies, preselection, etc. This is a good item to offer franchisees since it gives franshisors a mechanism to manage the flow of financial returns from your franchise system.

Franchising Your Small Business - the Fly Speck Part Seven

You Are Going to Need Controls

Here's the set of mechanisms you need to have in place in order to control franchisee behavior:

1. Detailed contracts
2. Reserved termination rights
3. Supply source controls
4. Exclusive dealing requirements
5. Royalty payment ensurement
6. Excess profit provisions to franchisees

This in a nutshell is what your contracts should accomplish:

"To be successful at franchising, you need to write contracts that carefully document the responsibilities and the commitments of your franchsiees, as well as the consequences of failing to uphold these commitments." - Shane

Termination rights spell out that you can in fact terminate the agreement and take back the outlet if one of the franchisees "fails to uphold system standards or fails to follow the policies and procedures as stated in your franchise agreement." - Shane

Additionally, you want to make sure that you provide a list of approved suppliers for cups, utensils, etc. in the franchise and if a certain supply is proprietary to the system (such as KFCs 11 herbs and spices) you want to make sure the source is designated. If it is not proprietary to the system, it is illegal to designate where a franchisee must order supplies from.

Exclusive dealing means that if for example, you own and operate a Baskin Robbins, you can't sell Cold Stone Creamery ice cream in the shop.

As far as royalty payments, franchisees pay royalties based on gross sales - if you leave an opening some will take it and underreport sales to the franshisor in order to get out of royalty payments. The way to circumvent this is to put controls into place - one custard franchise uses special registers that won't allow sales to be erased - and you can audit franchisees and punish them for inaccurate reporting.

Let Them Have Profit!

Bottom line - if you make the franchise profitable for franchisees, they won't necessarily have a reason to cheat. Thus, provide them with excess profits.

Some Terms

You need to set a time limit - "The average term of a franchise contract is ten years, with an eighty-year renewal." - Shane

Back to the 1980s

You want your franchisee to be invested for the long-haul and you want them to have a longer term stake so they have the opportunity to make their money back for improvements, etc but also keep in mind, you don't want a contract to be obnoxiously long so as to create a problem:

"... having long-term contracts can lead your outlets to look dated and stale. In general, franchise agreements call for upgrading at renewal time ... If your business is one in which decor changes often, your outlets can start to look pretty dated if your system has long-term contracts. You've probably seen this as you've traveled around the country. Some older franchise outlets in longer established chains, such as Dairy Queen look like something out of a 1980s move." - Shane

Advertising

One of the key tenents of franchising is to build the brand name nationally. A local advertising push must also be in place but the job of the franchisor is to build the name recognition on the national level. This is done typically through a fund to which franchisees are required to contribute - typically around 3%. You must have this collective advertising bucket to advertise nationally. Franchisees will not pool this money collectively on their own. Set this fee up in your franchising agreement. Typically this rate is a percentage of gross sales.