When to Franchise: Quick vs. Slick
“When to Franchise: Quick vs. Slick”
Mark C. Siebert, CEO of iFranchise Group, the leading consulting firm specializing in franchise development, answers questions about when to franchise.
"Should I franchise now?"
"Should I wait until I’ve opened another unit? Should I add a menu item? A drive-through window?"
"Should I wait until I have additional capital available for my expansion program?"
Obviously, these are not questions that can be answered without precise knowledge of the business in question. There are, however, two basic factors that will lead us to the right answer: personal goals and market readiness.
DRAWING A MAP
Whenever I meet with an entrepreneur, my first step is to determine his or her goals. Where do you want to be in five years? Living on a beach collecting shells? Running a public company? If you are looking to cash out, how much money is "enough" for the time and effort that you have devoted over the years to developing this business? After all, every business is an extension of its owner, and as such, it must reflect the owner’s goals and desires.
Then I try to determine exactly where this business is now. How well defined is the concept? Is it making an adequate return? Does it have adequate financial and human resources? How strong is the management team? Is it ready for expansion? Only then do I look at the question of franchising.
In essence, what we are doing here is drawing our map, the business plan. Most of us wouldn’t get in a car to drive to Florida without a map. Yet, as business people, some of us are getting in a car hoping we can drive to London — not knowing where we started from, where we are going or the sometimes substantial obstacles in our path. Where and when we want to end our journey will dictate our speed, direction and mode of transport.
For example, Entrepreneur A has a small business doing $600,000 in sales and bringing $100,000 to the bottom line. He can start a second unit for an initial investment of about $100,000, and is confident he can duplicate the performance of his first unit. Or, he can invest that capital in a franchise development program now. In either event, he has the capital and is prepared to invest. Both management and concept are in place and ready for expansion. The market appears to be ripe.
Should he franchise now or should he add a unit before franchising? The simple truth is, we are not in a position to answer these questions — not until we know where Entrepreneur A wants to be five years from now. Let’s add some information and see how that changes our perspective. Let’s say that Entrepreneur A is 55 years old and wants to retire at age 60. He would like to sell the business at the end of that time and would like to have annual retirement income of about $150,000.
Now the decision is easy. Entrepreneur A knows that the average small business sells for 6.7 times Earnings Before Interest and Taxes (EBIT) — thus he can estimate that its current value is about $670,000, which is not enough to meet his goal. But with two units earning a combined $200,000, he could sell the business for $1.3 million. After taxes, he could just about swing it. Thus, Entrepreneur A should plan on opening one, perhaps two more units, in the next five years and then sell.
Let’s say, on the other hand, that Entrepreneur B, whose business and capabilities are identical to those of Entrepreneur A, wants to sell his business for $10 million in five years. Using that same information, he knows that he will need to be earning $1.5 million in year five in order to meet his needs. Company-owned expansion simply won’t get the job done. But if he sells franchises at a five percent royalty, he could generate $30,000 in revenue per franchise. And if he could bring one-third of incremental revenues to the bottom line, he would need to sell 150 franchises in five years to meet this goal. Since the average franchiser sells nine franchises in their first year of franchising, 11 in their second, 13 in their third, and 20 per year at maturity, Entrepreneur B will need to franchise aggressively if he has any hopes of meeting this goal.
So should he franchise immediately? It’s still too soon to say.
DETERMINING YOUR DEPARTURE TIME: QUICK VS. SLICK
While at first glance it appears that Entrepreneur B should franchise his business immediately, it is still too early to make this type of a judgment, because we as entrepreneurs are not expanding in a vacuum. Before making a decision to move ahead, we must take a look at the competition to make some kind of determination as to our chances of success.
Essentially, what we are doing here is measuring risk. While Entrepreneur B may want to sell his business for $10 million, he may not want to go this route if he only has a small chance of reaching this goal. Thus, before finalizing a "departure time," we must examine the competitive environment to determine whether we need to reevaluate our goals or whether we are, indeed, ready to begin our journey.
When examining the market into which you are expanding, look at both major competitors and potential competitors. If you’re going to go head-to-head with entrenched competitors in a mature industry, you will need to get your franchise concept as close to perfect as possible before entering the franchise marketplace. Operations procedures and management techniques should be tight. Store design and marketing materials should be first-rate. Furthermore, before you consider franchising, you need a strong track record. In short, you must be able to offer potential franchisees advantages comparable to those offered by your competitors.
No franchise industry is more mature than fast food hamburgers: Burger King, Wendy’s and the granddaddy of them all, McDonald’s. If you want to compete with industry giants, the concept will need to be extremely "slick." This is not an industry in which a five-unit hamburger chain can compete for franchises — at least not without substantial backing.
At the same time, the market is always big enough for a good competitor. When I worked with Krystal hamburgers on franchising hamburger outlets, I was enthusiastic. The company was already well established in the Southeast, with some 220 restaurants in operation and a tremendous reputation. More important, the operation was well-refined, offering both the consumer and the franchisee something that was truly unique. Consumers loved the little square Krystal hamburgers that had been the company’s signature product for over 50 years. In addition, prospective franchisees liked the idea of a unit that could be built for less than half the cost of its bigger competitors. Krystal was slick. And sure enough, Nation’s Restaurant News named Krystal Hamburgers the country’s fastest growing chain just a couple of years later.
On the other hand, if you have a concept that is new to the market, or has a truly unique niche, you had better be quick. If you elect to roll out your clever new program gradually, playing a conservative hand until everything’s "just right," you may find that by the time you are ready to franchise, instead of being first with your concept, you’re third or fourth — or worse. Lots of people with money and business know-how are looking for bright new ideas that someone else has taken the time and effort to test in the marketplace! While you’re meticulously developing your new fish sandwich, your competitor may be quickly developing an identical franchise concept that will leave you standing in their dust.
One of our clients who failed to take this advice recalled to me years later how they sat across the street from their first unit discussing the details of unit operations with the company that would one day become the first franchiser in the industry. While my client eventually sold over 70 franchises, the company with whom they casually spoke years earlier sold over 500!
When I worked with Discovery Zone providing franchising assistance back in 1990, almost no one had heard of fitness centers for children. I certainly hadn’t. In fact, Discovery Zone had only one store open, and it was just a month old. But Ron Matsch, the entrepreneur who designed Discovery Zone, was worried. People were already taking photos of his units and writing observations in their notebooks. "Every TV station and large newspaper in Kansas City covered our store opening," recalls Matsch. He knew that it wouldn’t be long before another bright entrepreneur tried to duplicate his concept.
Media enthusiasm, plus the conviction that he had created something timely and useful, motivated Ron and his team to begin their franchise program while the business was very much in its infancy. Sure enough, their confidence was justified. Within a few months, a fast-track franchise development program had been completed, and franchises were being sold.
The rest is history. By the end of 1991, franchises were opening at the rate of one a week and revenue for the year was $5 million. No other company, no matter how affluent, could have caught Discovery Zone from a standing start after it began selling franchises. There simply wasn’t time to copy the concept, get stores into operation and put a franchise program together. Within four years, Discovery Zone had gone public and boasted a market value of some $900 million! The market was ripe, and Discovery Zone was quick.
So where’s the dividing line? Five years ago, there were thousands of restaurants featuring rotisserie chicken with homemade side dishes. Most of them probably thought that Kentucky Fried Chicken was their competition. Today most of them are probably kicking themselves every time they drive past a Boston Market.
The ultimate answer to when you should franchise cannot be found in any book. Nor can it be provided by a consultant. The ultimate answer to that question can be found within ourselves. Is the market ready? Is the concept ready? But mostly, are you ready?
About the Writer: Mark C. Siebert is CEO of the iFranchise Group, a leading franchise consulting firm that offers the skills of the nation’s top professionals in franchise strategic planning, operations training and documentation, franchise marketing and sales, advertising fund management, franchise recruitment, and development of Internet-based applications for emerging and established franchise companies worldwide.