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THE TOP 10 FRANCHISE QUESTIONS

by Simon Lord,
last updated 04/06/2015

Simon Lord provides answers to 10 of the questions most commonly asked about franchising.

 

1 What Is Franchising?

Franchising is a method of marketing and distribution whereby a company (called the franchisor) expands nationally or internationally by granting a person or company (called the franchisee) the right to operate a copy of its business in another geographic area. The right will usually include the ability to use the name, the business system and the know-how of the franchisor, and is granted for a fixed term.

Franchising differs from licensing or agency arrangements in that the bond between franchisee and franchisor is usually an ongoing one with more obligations on both sides.

The franchisor gains his or her income from initial and ongoing fees paid by the franchisee. In return, he or she must provide a variety of services to encourage the continuing profitability and growth of the franchisee's business. The franchisee pays to set up the business in their area (including, for example, property, leasing or equipment costs) and is the owner of their own business. They receive their income from successfully marketing a desirable product or service under a promotable brand name.

2 Is Franchising Reputable?

Franchising has proved to be one of the most dynamic business methods of the past 50 years. It enables companies who have a good product or service to expand faster because they are using the capital, local knowledge and commitment of individuals who are in business for themselves. It gives those who wish to be self-employed the ability to go into business properly trained and equipped, with the security of a well-proven product and system beneath them.

Franchising can be applied to almost any industry: retail, restaurants, courier services, industrial fittings, car repair, education and even massage therapy. It is a reputable part of daily life in New Zealand. Many of our best-known brands are actually franchises: Lotto, Stirling Sports, Robert Harris, Cash Converters, Green Acres, Paper Plus, The $2 Shop and, of course, McDonald's.

Franchising should not be confused with 'pyramid selling' or network marketing.

3 Why Are Franchises more Successful?

Statistics show that the risk of failure for a franchisee is considerably less than that for an independent small business because many of the greatest risk factors have been removed. The following are just some of the advantages a franchisee enjoys:

Product or Service: The franchisor has already proved that the market exists. Franchisees are not 'taking a punt' on a new idea or launching into a declining area.

System: The most efficient way of delivering the product or service has been developed, saving the franchisee from wasting time and money.

Equipment: Franchisees start with the best equipment for the job and only the equipment they need - often specially-designed or developed.

Suppliers: Bulk buying means franchisees benefit from lower prices and better service than independents.

Brand Marketing: The company already has a name which attracts customers. Launch campaigns have proved effective elsewhere, and new campaigns are shared across the whole franchise.

Training: A franchisee can enter a brand new industry and be trained in how to run that specific business to best effect. This applies not just to producing the product but to sales, marketing, staff selection, cashflow management, and so on.

Support: The franchisor keeps a watchful eye on the progress of the business to help the franchisee grow at the right speed and avoid errors.

Research & Development: While the franchisee focuses on customer service, the franchisor works on new products and techniques to ensure franchisees remain competitive.

4 If Franchising Is So Great, Why Do Some People Fail?

No business venture is without risk, and of course franchising has occasional failures within systems or even, rarely, of whole franchise systems.

It is important to recognise that all franchises are not the same, any more than all shops are the same. Even within the same industry, each franchise will be set up differently. It will have different business systems, different cost structures, different support services for franchisees and, above all, different people - both as franchisors and franchisees.

It is important to recognise that all franchises are not the same, any more than all shops are the same. Even within the same industry, each franchise will be set up differently. It will have different business systems, different cost structures, different support services for franchisees and, above all, different people - both as franchisors and franchisees.

If the franchise is properly structured, it is likely to be the individuals who make the difference. Common causes for franchisee failure include: 

  • Being under-capitalised from the start and unable to finance the growth of the business
  • Failing to take adequate legal and financial advice prior to purchase
  • Not following the franchise system but thinking you know better or attempting to take short-cut
  • Taking too much money out of the business too soon
  • Being over-reliant on the franchisor rather than accepting that this is your business
  • Failure to act upon advice or take difficult decisions
  • Lack of shared commitment from life-partners causing friction
  • Lack of shared vision with others in the franchise

Established franchisors with many successful franchisees in their system are likely to recognise one or more of the above traits in low-performing franchisees. Franchisors can also make mistakes, though, and the two most serious ones which inexperienced franchisors can make are:

  • Selecting the wrong location
  • Selecting the wrong franchisee

Either of these can lead to failure, although many franchisors will say that even the site is a less important factor than the person.

Despite the lower risk involved in buying a franchise, a potential franchisee must therefore still remember 'buyer beware'. It pays to shop around, do your research, ask questions and always take expert advice.

5 What Should I Consider Before Buying A Franchise?

Buying a franchise is not the same as changing your job. When you buy a franchise, you are going to be investing more than money. You will also invest your working time, a lot of your personal and family time (at first), and your career in the choice that you make. You need to be making a considered investment for your future.

Some of the questions you might ask yourself are:

  • Can I afford to go into this business without being under-capitalised?
  • Will it provide me with the return I require to give me a worthwhile income as well as a return on the money I have invested?
  • Is the industry one in which I will enjoy working? For example, would I be happy working in a shop/working outdoors/getting up early to bake bread/staying up late to make pizza?
  • Although experience may not be necessary, do I have the ability to learn the skills which I will need to run this business?
  • Is my life partner/family aware of the demands of running the business and prepared to support me or become involved?

Once you have selected some possible options, you will need to check out the franchises concerned. Franchise New Zealand has a free list of 250 questions to ask to help you do this.

6 What Is An Exclusive Territory?

A territory is a specific area which is granted to a franchisee in which they can operate their business. If it is exclusive, it means that no other franchisee from the same system can market in the defined territory, and also that the franchisor cannot set up any of its own outlets within the same territory. It is usually but not always geographical, and should be clearly defined and marked in the franchise agreement prior to signing by both parties.

Territories may sometimes be split or subdivided if a franchisee is operating at maximum capacity and the franchisor feels that the local market is not achieving its full potential. Where this happens, having an exclusive territory means that the local franchisee must be involved in the process and will often receive some income from the re-sale of part of their original territory.

It should be noted that not all territories are totally exclusive nor do they have fixed geographical boundaries. A retail franchise, for example, may have only one store in a particular mall but they cannot define where its customers will come from.

7 How Can I Be Sure The Franchisor Is Telling The Truth?

Although franchise disputes are relatively rare (involving only around 1% of all franchised outlets), most of those which make it to court involve pre-contractual negotiations. In other words, on what basis was the franchise sold?

Although misleading potential purchasers or misrepresenting the facts is subject to penalties under the Fair Trading Act, this does not guarantee that a franchisor is telling the truth any more than it would guarantee, say, the word of a real estate agent. All it can do is provide penalties and redress in the event of wrong-doing.

However, a good franchisor will take care to ensure that you are given all the factual and detailed information on which to base your purchase decision. This should include a Disclosure Document which contains details of the franchisor company and its principals, the nature of the franchise, all payments required, what they are for and when they become due, and so on. Members of the Franchise Association are required to give potential purchasers a copy of this document at least 14 days prior to the signing of a franchise agreement.

Franchisors are cautious about making projections or estimates as to the profitability of any particular new outlet, but any potential purchaser will obviously need an indication of the level of sales, costs and potential return before making a decision. It is important to realise than any figures given do not constitute a guarantee, but the franchisor must have reasonable grounds for making the assumptions included in the figures and must disclose those assumptions - for example, why he believes that this new outlet at x will have a similar trading pattern to the established outlet at y. All information provided should be checked out by the franchisee and his or her legal and financial advisors.

Potential franchisees should also conduct their own market research, asking other franchisees in the system or even operators of other businesses in the area for information against which the franchisor's figures can be measured.

8 How Much Money Will I Need?

Because franchises vary across many different industries, investment requirements differ greatly. Some franchises are available from under $10,000, others involve specialist equipment, premises and stock and have high working capital requirements meaning that you may need over $500,000. A look through the Directory section in the back of this magazine will give you a clear indication of what is available.

Banks will often fund small business propositions on a 50:50 basis, where the franchisee provides one half of the total from their own cash resources while the bank finances the other half. For an established franchise system, the bank may consider financing up to 60-70%.

Most franchises involve the payment of a regular management fee or royalty to the franchisor. This is sometimes a flat fee, but is more usually expressed as a percentage of turnover and will vary according to the services provided. The payment of this fee must be factored into all cashflow and profit projections.

9 Are There Any Drawbacks?

Franchising does not suit everyone. It does involve taking a risk, not having the security of a regular income, and being responsible for your own business. Do not rely upon the franchisor to make you successful. The franchisor will help, but basically franchisees are given the tools - the product, the system and the brand - to enable them to get on with the job. Success is up to the individual.

Equally, franchising does not suit the independently-minded. In exchange for the security, training, support and purchasing power of the franchise, you must be prepared to give up some independence. You will not be able to sell whatever products you want if they are not appropriate to the franchise format. You may have to operate certain ways or open certain hours. If you are not prepared to accept these restrictions, a franchise is not for you.

The ideal franchisee has been described not as an entrepreneur but an 'intrepreneur' - someone who is prepared to work within the boundaries of a system but who has the dynamism to exploit that system in their own area for maximum benefit.

10 What Are The Major Growth Areas?

Retail is the largest sector within franchising in New Zealand at the moment, but a category called 'Personal & Other Services' is a close second. This category includes home services such as lawnmowing and home cleaning - numerically, the sector which accounts for the greatest number of franchisees.

New franchises are being developed all the time in every sector. However, a look at trends overseas suggests that education and health are growing in popularity as consumers start to regard these as essential areas of expenditure rather than relying on the state. Leisure industries are increasingly popular, while technology is another major growth area although the speed of change means intending franchisees need to choose carefully.

Franchises have traditionally done well by offering products or providing services which are better, faster, or (especially) more convenient than traditional methods of doing things. Home car tuning is one prime example. The increasing number of two-income families has increased enormously the market for services such as lawnmowing and home cleaning.

Trade services is one area which is fast developing in New Zealand. Laser Electrical have twice won the Franchise System of the Year title and are now moving into plumbing, while Green Acres offers a painting franchise. Such services target another major customer need - reliability. A survey in the UK suggested that the average worker wastes two whole days a year waiting for repair and delivery men. Where there's a problem, there's a franchise opportunity, and that makes one thing certain - franchising will continue to grow.

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