In part 1 and part 2 of the series “How much income can a franchise make me?”, we covered such topics as realistic expectation of earnings, how to assess your return on investment, financing options, which assets franchisors will allow you to use to finance the business and why franchisors are cautious about providing financial projections, among other items.
In this third and final part of the series, we will discuss the difference in performance between company-operated units and franchised units, as well as what you can learn from current franchisees, when to contact them and what you can ask them.
Franchised vs franchisor-operated units
When trying to find out how much income a franchise can make you, don’t look to franchisor-operated units for answers. Most franchisors only have franchised units except for one or two units that they own and operate themselves. These are usually run by employees and are used principally to train new franchisees, test new products and services prior to introducing them to the entire franchise system, and to stay up-to-date with the marketplace at the street level.
There is anecdotal evidence that franchised units typically outperform units owned and operated by the franchisor by around 20 per cent in terms of annual revenue. In situations where a company-owned unit has been converted to being operated by a franchisee, some franchisors claim they have seen a revenue increase of 20 per cent over the first few months alone. Further, along with increased revenue, there is often a reduction in operating expenses.
The difference in performance is generally attributed to the fact that franchisees have a greater level of motivation than employees who manage the units on behalf of the franchisor. It is based on the assumption that the franchised units are operated directly by the actual franchisee, not managed passively by employees.
In some franchises, particularly retail and food service, the additional revenue can be attributed to higher average sales. Most businesses don’t make their money on the “first sale” to a customer, but rather they make it on the second or third sale. For example, movie theatres typically don’t generate their profit from the sale of tickets – they make it on the popcorn and the soft drinks. I am sure that most of you have eaten in a restaurant where the waiter presented you with the bill for your meal a few moments after they brought your entrée. You may have wanted a dessert, coffee or another glass of wine. These are the second and third sales that account for higher average sales, and this is what franchisees generally do better than company managers. Some studies indicate that as little as a 1% increase in an average selling price will typically have a 10 per cent positive impact on operating profit.
Contacting current franchisees
Most franchisors ask you to refrain from contacting any of their franchisees until you have been through their qualification process. This is done for a couple of reasons. First, their franchisees are busy, so they want to respect their time, and second, they don’t want unqualified prospects contacting their franchisees (especially those prospects that are unsuitable). As part of their Disclosure Document the franchisor must provide the contact information for current franchisees, and franchisees that have left the system (i.e. terminated, cancelled or re-acquired).
Most franchisees will be reluctant to discuss their financial performance, although some may be willing to share some information in this regard. Regardless, their individual financial information may be of little or no value, as financial performance will vary substantially from location to location, and from franchise to franchise, and in large part on the franchisee’s ability to manage the business.
The most important thing to find out is if the franchisor provides the training and support they promised. In franchising, “People bet on jockeys, not horses!” In other words, you need to place a lot of trust in the individual who is at the head of the franchise company. Obviously, the service or product is important, but a good franchise system must have a strong leader than can adapt the franchise system to any changes in the marketplace, has a vision for the company, and can communicate clearly with their franchisees.