Developing a Franchise System

by Simon Lord

last updated 04/04/2014

– study spreads new light on performance

by Simon Lord

last updated 04/04/2014

April 2014 - It’s commonly said that a franchised outlet will perform significantly better than a company-owned outlet within the same system, but is it true? A new study from the Franchise Relationships Institute set out to shed some light on the question.

Is the customer experience best delivered through a franchised or company-owned retail outlet? A new study conducted by the well-respected Franchise Relationships Institute (FRI) in Australia has tested the belief that franchised stores perform better than company-operated stores under similar conditions. The research looked at what happens when businesses are converted from company- to franchisee-operated, or franchisee- to company-operated.

‘Most franchisors enthusiastically talk of stores achieving an immediate lift in sales of over 20 percent when they change from being managed by the company to being operated by a franchisee,’ says Greg Nathan, Research Director of FRI. ‘Franchisors and franchise consultants also regularly claim that franchise-operated stores outperform company stores due to the ‘skin in the game’ factor, where franchisees invest their own money in a business and are responsible for its profits or losses. After all, when you’re up against it, the fear of losing your job is probably only one-twentieth of the fear of losing your house.

‘Our hunch, though, was that many of these stories are exaggerated to suit the biases of people who want to push the franchising model,’ he says. ‘So we decided to put the proposition to the test using data on stores that were converted from one model to the other.’ The study included 19 established retail and food retail networks that control over 3,000 franchised and company-owned stores.’

Franchises do perform better

The comparative study showed that franchised units did indeed consistently outperform company-owned units on most measures, especially in revenue growth and expense management. Store performance levels were measured for an equal period before and after conversion, the minimum being 2 years (1 year before, 1 after) and the maximum being 6 years (3 before, 3 after).

The results showed that where a store was converted from company-owned to franchised, revenues increased by between 1 percent (after 1 year) and 6 percent (after 3 years) while cost of goods reduced by 1 percent (after 1 year) to 2 percent (after 3 years).

By comparison, stores converted from franchised to company-owned saw revenues decline by 2 percent (after 1 year) to 4 percent (after 3 years) and cost of goods remain stable or actually increase.

In fact, the difference is greater than these figures suggest. In a number of cases, companies retained ownership of their best-performing or key locations for themselves while franchising smaller or more regional units. The researchers found that, when location is allowed for, franchised units will perform between 5 percent and 15 percent better in revenue creation while showing better management of expenses: wage costs, for example, were around 10 percent lower in franchised units. This combination of higher sales and lower costs has a significant impact upon overall profitability.

It should be borne in mind that where outlets were converted from franchised to company, this may have been because of performance issues – especially in the post-GFC period covered by the study. The researchers went into this in further detail and found that, while performance improved slightly where franchised units were ‘sick’ prior to conversion to company ownership, it actually decreased markedly where franchise units were operating within normal parameters prior to conversion. This confirms the earlier findings.

But company-owned can match franchisees

Although the study found that franchised units are better at increasing revenues and controlling wages, the actual differences in performance are not quite as large as commonly believed. In fact, in some cases where franchised units were compared with well-resourced company stores within the same franchise system over the same time period, no significant differences were found.  The key phrase here is well-resourced. ‘If a business has the metrics in place, and is prepared to invest in good sites and good people, there’s no reason why its company units shouldn’t perform as well as franchised ones,’ says Greg Nathan. ‘It may actually be better at making the hard decisions, hence the results.

‘And the dual model, where companies operate both company-owned and franchised units, can be a very productive one,’ says Greg. ‘In some cases, companies encourage a sort of friendly competition between company units and franchised ones on the key metrics, and it can pay dividends. But it’s also the case that company units can be treated like second-class citizens, with franchisees borrowing staff, stock or equipment on occasions. That can be very demoralising for managers.’

However, if company outlets are to match franchised units in revenue, gross profit and customer satisfaction levels, they require a different – and much more costly – infrastructure. The study details some of the considerations, such as the fact that while one field manager typically supports 20 franchisees, they can only support 5 company-owned units. As field managers are an expensive resource requiring cars, travel, accommodation and IT support, this soon adds up. There is also the need for good incentive programmes and different management styles for company managers from franchisees. From a franchisor’s point of view, then, the reduced HR and operational responsibilities required to manage franchised operations are a considerable attraction.

Learn more

The study has shown that the real truth about the comparative performance of franchised and company units is more complicated than many would suggest. For companies to achieve optimum performance from either model they need to be aware of the different styles and resources required.

The next part of the research will involve a series of best practice sharing forums for franchisor executives in Melbourne, Sydney and Brisbane, and the full report will be available at these events. Get more information here. Greg Nathan will also be speaking at the Franchise Association conference in Queenstown in July.

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