FRANCHISE ECONOMICS

One of the most fundamental principles in franchising is also one of the simplest: franchisees invest significant capital into a business, and they expect a reasonable opportunity to make a return on that investment.

Most franchisors instinctively understand this. After all, if franchisees cannot build profitable businesses, the franchise system itself cannot thrive.

However, developments in Australia are prompting a renewed focus on this issue, not just as a matter of best practice, but as a matter of regulatory expectation. That development provides an interesting lens through which New Zealand franchisors might reflect on their own practices.

Start at the beginning

The question of franchisee return on investment does not begin once a franchise system is operating. It begins much earlier – when a company first considers franchising.

In my experience, responsible franchising starts with first franchising responsibly, and that means undertaking a comprehensive franchising feasibility study before launching a franchise programme.

A feasibility study examines the business model from multiple perspectives. Importantly, it assesses whether the underlying unit-level economics are strong enough to support both a viable franchisee business and a viable franchisor business.

This includes thinking carefully about matters such as:

• the level of investment required from franchisees
• expected sales levels and margins
• territory structure and market opportunity
• the timeframe for recovering the initial investment
• the long-term profitability of the business model

If these fundamentals are not addressed properly at the outset, problems often emerge later in the life of the franchise system.

For this reason, responsible franchising has always required a focus on the economic viability of the franchisee business. However, not all franchises exhibit this focus.

Leadership priorities

In my own work with franchising companies, one of the areas I always emphasise is the importance of maintaining a leadership focus on franchisee profit and returns. It is best practice number one! This means understanding not just franchisee sales performance, but the total financial picture - including income, costs, profit, cash flow, and return on investment. Without that understanding, it is difficult for a franchisor to know whether the franchise system is truly sustainable.

Franchisees typically invest a substantial proportion of their personal capital into a single business. In the majority of cases, it represents a highly concentrated investment decision.

That reality creates a natural expectation that franchisors will understand and actively support the development of franchisee returns over time.

In many ways, this focus sits at the heart of what is now often referred to internationally as Responsible Franchising, which is a concept that emphasises alignment between franchisors and franchisees and a shared commitment to strong unit-level economics.

For most franchisors, these ideas are not new. What is changing, however, is how explicitly they may need to be demonstrated – depending on where a franchise is located.

Australia’s regulatory shift

Australia already operates under one of the world’s most comprehensive franchise regulatory regimes through its Franchising Code of Conduct.

Recent developments following the Treasury review have strengthened expectations around franchise economics. In particular, the Code now requires franchisors to structure and manage their franchise systems so that new franchisees have a reasonable opportunity to make a return on their investment. As some commentators have noted, the Code effectively places the burden on the franchisor to form a view about franchisee return on investment.

That requirement does not mean franchisors must guarantee franchisee success. But it does mean they must think carefully about the economics of their franchise offer and be able to explain the reasoning behind key decisions. For example:

• Why is the territory structured the way it is?
• What level of sales is realistically achievable?
• How long should it reasonably take for a franchisee to recover their investment?

These are questions good franchisors have always asked. The difference now is that the regulatory environment increasingly requires those answers to be considered more formally.

The role of franchise system management

Beyond the initial feasibility work, strong franchise system management plays an important role in supporting franchisee returns over time – and many of the best practices associated with effective franchise systems ultimately support this objective.

Regular access to franchisee financial information

Franchisors need to understand how franchisees are performing financially. Access to comparable financial data enables franchisors to monitor performance, identify issues early, and provide more targeted support.

Benchmarking franchisee performance

Benchmarking allows franchisors and franchisees to understand how different businesses within the network are performing and where improvements may be possible. When used effectively, benchmarking can be a powerful tool for improving franchisee profitability.

Franchisee business planning

Encouraging franchisees to operate with structured business plans also helps maintain a focus on financial performance and long-term investment outcomes. Business planning creates a framework for discussing goals, performance, required investment or re-investment, and improvement opportunities.  

Field manager understanding

Field managers also play an important role in supporting franchisee returns. Increasingly, the role of the field manager is evolving beyond operational compliance and sales coaching toward acting as a business consultant to franchisees. This requires a practical understanding of franchisee financial performance, including the key drivers of revenue, costs, margins and cash flow within the business model.

When field managers are confident discussing financial performance and unit economics with franchisees, they are far better placed to identify improvement opportunities and help franchisees strengthen the profitability of their businesses.

Collectively, these practices help franchisors better understand and support the economic health of their franchise systems.

Lessons for New Zealand franchisors

New Zealand currently operates within a comparatively light regulatory environment for franchising. The sector is largely governed through general commercial law and supported by the voluntary standards of the Franchise Association of New Zealand.

That environment has served the industry well. However, developments in markets such as Australia provide useful insight into the direction in which expectations may evolve internationally.

Australia’s emphasis on franchisee return on investment is, in many respects, simply reinforcing a principle that has always sat at the centre of successful franchising.

Strong franchise systems are built on strong franchise economics. Franchisors who carefully assess the feasibility of their business model before franchising, and who maintain a clear focus on franchisee profit and returns over time, are not only practising responsible franchising, they are also building stronger, more sustainable franchise systems for the long-term.