by Simon Lord
last updated 23/09/2019
franchising for beginners
by Simon Lord
last updated 23/09/2019
Franchises have become very much a part of the daily life of most New Zealanders, whether we know it or not. We buy Lotto tickets, groceries and even houses from franchised companies. We have our lawns mown, our carpets cleaned and our cars serviced by franchises. At work, the computers may be supported by a franchised team or the office cleaned by one. We eat out at franchises - not just fast food but Burger Wisconsin, Cobb & Co or Columbus Coffee. And at the end of the day, after we have brushed our teeth with toothpaste bought from a franchised pharmacy, we climb into a franchise-bought bed.
But what is franchising? How does it work? Is buying a franchise a safe way to go into business for yourself, or is it just pyramid selling under a different name? Can you really make money as a franchisee?
In this beginners guide, we’ll answer some of those questions to help those who are considering buying a franchised business for the first time to understand how franchising works.
what is franchising?
The basic principle behind franchising is that someone develops a business format and an operating system which has some advantages over other existing businesses in the market. By franchising, this person (called the franchisor) then replicates or clones his or her business in other geographic areas by granting the right to another (the franchisee) to operate the same business system under the same name. This right is usually granted for a fixed term, not forever.
The franchisor gains income from an initial fee paid by the franchisee to gain access to the franchise brand, training and systems, and from ongoing fees paid by the franchisee which can be calculated in any one of a number of ways: some of the most common are a flat monthly fee, a percentage on sales or a mark-up on product supplied. In return, the franchisor must provide a variety of services to encourage the continuing profitability and growth of the franchisee’s business. The franchisee receives their income from marketing a desirable product or service under a desirable brand name.
This basic approach – which is called business format franchising – has proved to be the most dynamic form of marketing and distribution in the world over the past sixty years or so.
So successful has it been that the term franchise has been loosely applied to other forms of business arrangements – the term is now common in the world of Super Rugby, for example, and movie-goers are familiar with talk of the Lord of the Rings and Harry Potter ‘franchises’. However, it is business format franchising which concerns us here.
how does it work?
Mention the word ‘franchise’ to most people, and one name will spring to their mind – McDonald’s. That’s not too surprising – with about 37,000 restaurants in 120 countries world-wide, McDonald’s is one of the world’s best-known brands (although another franchise, Subway, has even more outlets – almost 45,000).
McDonald’s didn’t invent franchising, but in the 1950’s and 60’s they led the development of franchising as we know it today. Let’s use them, then, as an example of how franchising works.
When you go into a McDonald’s, you’re not going into part of a huge company-owned chain – you’re actually going into a small, local business, even if it looks similar to every other McDonald’s in the country (or the world). That may sound odd but it is absolutely true. Your local McDonald’s is usually owned and operated by a local person who has their own company. That company’s business is running a McDonald’s franchise.
What does this mean? Well, this person - the franchisee - has gone to the McDonald’s Corporation and said ‘I like the look of your restaurants, I believe I could run one profitably, will you please sell me the right to operate a McDonald’s in Helensville?’ or wherever it might be. McDonald’s have taken a look at this man or woman, checked that they are the right sort of person, put them through all sorts of tests, confirmed that they can afford to set up the business, then said ‘Yes, we might consider letting you operate the McDonald’s in your area.’
That person is then trained in all aspects of running a McDonald’s business – not just making hamburgers but developing staff, managing cash-flow, and all the rest of it. If they pass the training, they are then given the chance to go ahead.
what are you paying for?
This is where money comes in. The first thing that the new franchisee will spend their money on is the franchise fee – buying the rights to use the McDonald’s name above the door of their own restaurant and to use the McDonald’s operating system inside for perhaps 20 years.
The second thing that they will spend money on is setting up the restaurant. McDonald’s will organise this, but all the bills will be paid by the franchisee because it will be the franchisee’s business. McDonald’s aren’t going to take the profits from the restaurant - the franchisee is.
And the third thing they will spend money on will be an ongoing fee – sometimes called a royalty – which is paid to the McDonald’s Corporation regularly. This money pays for the continuing right to use the name, and includes an element of profit for the McDonald’s Corporation. It also pays for the research and development costs of new products and equipment and, most importantly, it pays for the field support managers who visit each restaurant regularly and help the franchisee to overcome any problems with staff, equipment, marketing or whatever in order to maximise profitability in that location.
The other important thing that this money is used for is maintaining standards. If you have spent money buying a franchise with the most famous name in the world, you want to make sure that everyone else who is using that name is treating it with as much respect as you do. You don’t want them to have dirty floors or under-filled burgers, because if they get a bad name for the franchise then it’s going to affect your reputation, too.
There will also be an advertising fee – in most franchises, a set percentage of turnover – which is combined with the contributions of all the other franchisees to pay for McDonald’s advertising across a wide range of media.
So the person who buys a McDonald’s franchise ends up in business for themselves but with the advantages of the best-known name in the world, a system for running a restaurant that has been tried and tested in 37,000 other restaurants and a system of support and back-up that should give them every chance of succeeding.
The franchisee makes the profit from all the thousands of burgers, fries and drinks they sell every day, and in return they pay a small percentage to the McDonald’s Corporation. From the sheer size of the operation, it can clearly be a very successful relationship for all concerned. In fact, such is the demand for McDonald’s franchises that a new one opens somewhere in the world every 14.5 hours!
different types of franchise
The important thing about franchising is not that it has been incredibly successful for McDonald’s, but that the franchise model can be applied to almost any industry. The franchise method has proved particularly effective in highly-focused markets such as building (Navigation Homes, Stonewood Homes, Wide Span Sheds), auto services (The Touch-Up Guys, Wheel Magician, Pit Stop), home services (Jim’s Group, V.I.P., Green Acres, Hire-A-Hubby) and business support (Small Business Accounting, Cookright, Fastway Couriers).
Franchising offers several advantages for franchisees, including operational speed and efficiency, buying power and brand strength which enable small local businesses to compete with the big chains. For franchisors, their brand will be represented in each location by a committed franchisee who has invested their own money in their own business – they have ‘skin in the game’, as the saying goes.
But how do you apply the lessons of the fast food industry to something so totally different as, say, lawnmowing? In a restaurant, you deliver a standard product to the customer in a set of totally-controlled circumstances; when you mow a lawn, you deliver a uniquely varied service to the customer in their own environment.
The secret to the success of both lies in the application of an operating system which must have, as we said at the start of this article, some significant advantages over other existing businesses in the market.
why does it work?
Consider the duties of an independent lawnmowing operator. In the course of an average day he or she must answer the phone, visit potential clients, quote on new work, maintain equipment, arrange advertising, organise invoicing, organise the bookings, handle any queries, travel from job to job over a widely-spread area – oh, and mow lawns. Unfortunately, though, it is only for the last duty – mowing lawns – that he or she actually gets paid.
Now consider how a lawnmowing franchise can streamline that system. Phone calls and even quoting are often handled by the franchisor. Equipment is selected by the franchisor and bought at favourable (bulk-buying) rates, and a maintenance schedule set out which has been proven to minimise break-downs. The franchisee is trained in the most time-efficient ways to carry out common activities, rather than having to learn through trial and error. Well-researched advertising is arranged centrally, the budget is increased by the contributions of all the other franchisees and an 0800 service, website and custom-designed apps are provided to increase customer response. Scheduling may be arranged by the franchisor, and invoicing handled centrally or via state-of-the-art systems that link into on-line accounting services to minimise paperwork.
In addition, the impact of all that marketing increases the amount of work available in any one area, enabling the franchisee to focus on more local customers and reduce the amount of time wasted travelling between jobs. The result is that the franchisee can spend more time actually mowing lawns – the money-making bit – than the independent contractor.
In this case, the franchise system has enough significant advantages to work.
Another aspect of franchising, and one which has led to its sometimes being confused with multi-level marketing or pyramid selling, is what is called master franchising.
Master franchising is used where the franchisor, for reasons of geographical or operational efficiency, appoints an individual or company to carry out many of the tasks of the franchisor in another area. This ensures that they get the benefit of local knowledge without having to create a long management structure to support franchisees, thereby increasing efficiency and reducing costs.
For example, an Australian company seeking to expand its business into New Zealand might sell a master franchise locally. In the case of café chain The Coffee Club, the Australian franchisor appointed Brad Jacobs and Andy Lucas as master franchisees for New Zealand. Brad and Andy have responsibility for recruiting franchisees in this country and providing initial and ongoing training, support and advice to the franchisees. Under this system, The Coffee Club has opened 62 outlets here in just over 10 years and franchisees have benefitted from locally-based support and understanding of the market.
With master franchising, franchisees pay their initial fee and ongoing royalties to the master franchisee, who in turn pays a proportion of these fees to the franchisor.
The master franchise approach is also used within countries, particularly with home services franchises where the duties of local advertising, quoting, training and support are commonly carried out by a master franchisee who has their own regional territory. When you consider that a home services franchise commonly has 100-200 franchisees (Green Acres has over 600), it is easy to see why this is necessary.
However, there are several important differences between master franchising and any form of multi-level marketing. First, there is no ongoing chain of commissions: there is a franchisor, a master franchisee and the ultimate franchisee – no more. The role of the franchisee is to deliver the product or service successfully and profitably, not to recruit additional franchisees.
In addition, the franchisee will often have a defined territory or location, and no other franchisee will be permitted to operate within that territory. This ensures that both the master franchisee and the franchisor depend for their income upon assisting the franchisee to be as successful as possible, rather than upon appointing as many franchisees as possible in the hopes that one will be successful.
franchising in New Zealand
Franchising has existed in some form or another in New Zealand since at least the 1960’s, Some of those early franchise names still ring a bell, notably the newly revitalised Mr Whippy ice cream vans, the Wimpy hamburger bars and even the newly resurgent restaurant chain Cobb & Co.
The mid-1970’s saw the arrival of McDonald’s and other fast food brands, and New Zealand entrepreneurs followed. Companies such as Stirling Sports and Rodney Wayne led local franchise development in the 1980s, while many other systems were imported, often from Australia where franchising was really taking off. While some succeeded, others proved to be either unsuited to the New Zealand market or under-developed – something which prospective franchisees still need to consider when looking at a new franchise. As always, using franchise-experienced legal and financial advisors is vital.
But it was in the 1990s that franchising really took off here, led by the home services sector. This was the era when Green Acres went from one-man-band to household name, and others were quick to follow. They found a ready market among New Zealanders: being your own boss is a dream for many, but getting started on your own is both tough and risky. Buying a ready-made business format, where there is a proven system to follow plus training and support on an ongoing basis, appealed to a lot of people. That’s still the case today, with many recent immigrants to New Zealand also appreciating the same benefits.
is it safe?
Today, with over 480 franchise brands and 20,000 franchised units, New Zealand has more franchises and franchisees per capita than any other country in the world. Those franchises employ over 100,000 Kiwis. And franchising is also a major contributor to our economy – with a turnover of between $20 billion and $30 billion, franchising accounts for some 11 percent of New Zealand’s GDP.
Despite this success, though, many people still don’t understand what franchising is or how it works. There are still plenty of misconceptions out there, and the fact that franchise brands are so well-known means that if something does go wrong – whether it’s something dodgy in the fried chicken or an individual franchisee going out of business – it tends to hit the headlines.
Generally, however, franchising is regarded as a much less risky way to go into business for yourself than trying to go it alone. That’s not to say that franchisees can’t fail sometimes – they can and do. But if you’re looking at buying a business, a good franchise system offers plenty of advantages.
The important thing is to choose one which suits your skills, your interests, your needs and your pocket, and then to check out the franchise thoroughly with the help of your advisors (you can find lots of help on how to do all this on our website at www.franchise.co.nz – see page 52). Remember, franchising has worked for many thousands of New Zealanders of all ages and all backgrounds. Could it work for you?
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