Structuring A Franchise System

One of the reasons that franchising has become so popular as a way of doing business is that it is so flexible. With variations, the franchise model has been applied to industries as different as fast food and building, hotels and home services. There is almost no industry, it sometimes seems, that a properly-developed franchise system cannot flourish in.

And yet while the failure rate for franchisees is commendably low compared to that of independent small businesses, the failure rate for franchisors is probably rather higher. Some newly-touted systems never get off the ground while others fail after just a few years.

Why should this be? Well, the reason franchising is so flexible is that it is highly adaptable. The original fast-food model of modern franchising has evolved into a large variety of structures and formats, each designed to suit a particular style of business. This means you need to do your homework. If you just copy something that seems to work for someone else, the chances are that you will pick the wrong structure.

Let's take territories, for example. Every franchisee likes to feel that they have an exclusive territory within which they can market their business knowing they are free of competition from other franchisees within the same company. That seems only fair, doesn't it? And it's certainly a structure that their lawyers and accountants like. But how big should that territory be? What should it be based on - maps, malls or phone book areas, to name just three possibilities? Should it be capable of being divided or sub-franchised? Should there even be a territory at all? For the new franchisor, thinking through all these aspects is crucial to establishing a successful and sustainable business model both for the franchisor and the franchisee. Make the territories too small and the franchisee may never prosper. Make them too large and they may never exploit their territory properly, reducing franchisor income and leaving gaps for the competition to enter. In some cases, where referrals and networking are important ingredients, having a defined territory at all may damage franchisee growth.

Fee structures are another area where things regularly go wrong. Like territories, fees need to be carefully set. Initial franchise fees must be large enough to offset most of the franchisor's costs in establishing a new franchisee (although even this is not fixed in stone) but small enough to be affordable. Ongoing fees or royalties must be large enough to provide the franchisor with the revenue required to fund their ongoing support services, but small enough to ensure that the franchisee can make an acceptable return on their investment. Many new franchisors don't actually know what support they will be required to provide on an ongoing basis. Visiting the first four or five franchisees on a personal basis every few months is one thing: establishing a professional support office for fifty or more franchisees with staff, communications, travel and accommodation bills is a very different matter.

Then there is the issue of how the ongoing fees will be calculated. In some sectors, a flat weekly fee is the norm; in others, a percentage of turnover is more common. There may be a mark-up on products or services provided. Suppliers may pay a commission, or the franchisor may take the head lease on property and sub-lease to the franchisee at a profit. There may be additional fees for, say, national marketing or accounting services. All of these structures and more are in use and all of them are working for someone. But none of them is working for everyone - and that's where the pitfalls lie for franchisors who don't do their homework.

In mentioning just the areas above there are over 250 different combinations of structure and I have only scraped the tip of the iceberg. Structuring a franchise properly takes a great deal of research, care and experience, and the truth is that few business owners - no matter how well they run their existing business - have the breadth of knowledge necessary. Consequently, many new franchises find their early stages are typified by trial, error and luck both good and bad. It should be no surprise, then, that some new franchises fail to take off.

However, get it right and the rewards can be huge. Take care to think things through and to take advice. Talk to existing franchisors, use experienced consultants (and some have broader experience than others) and read widely. Make sure that you develop an approach and structure across all the key areas that works for your business and your franchisees. And remember - one size doesn't fit all.

This article first appeared in NZ Business June 2006 

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