All too often, inadequate planning and development of a franchise business structure before offering franchises is reason why newcomers to franchising will fail.
Sometimes, they will just ask their lawyer for input. But while good franchise lawyers are invaluable when it comes to legal issues, they are unlikely to have the business experience, education, or expertise to develop sophisticated cash flow models and the organizational development plans that should accompany them. Instead, they must provide their input based on “what they have seen” in the marketplace. In fact, many franchisors will make the mistake of simply copying the franchise structure of their competitors when entering into the complex world of franchising. The rationale is that “if it worked for them, it should work for me.”
The problems with this approach are threefold.
First, this approach assumes that the new franchisor’s franchise offering should be similar to the offerings of their competitors. Unfortunately, “me too” is not a strategy. Often, it is a recipe for disaster. A new franchisor must distinguish itself from their competitors in order to attract a franchise buyer who has a choice between them and their more established rival. This difference can come in the form of the consumer offer, franchise marketing, franchisee support and training, or franchise structure. And all of these will have implications for the way in which the franchise offer is crafted.
Second, this approach assumes that even if a similar strategy is implemented, that the resources of both organizations are similar. Every organization comes to franchising from a different starting point – with different strengths and weaknesses. Competing with an established franchisor by going head-to-head in an area of their strengths can be a huge mistake.
Third, this approach assumes that a new franchisor’s competitors did it right in the first place. What if they simply made decisions at random? Often, it may take years for a franchisor to realize that an early decision is resulting in diminished profitability.
A mistake of a single percentage point on a franchise royalty can easily cost you millions of dollars. How?
Consider the following example:
A franchisor expects that the average unit revenues of their prospective franchisees will be $500,000 and hopes to sell 100 franchises in the first year. But instead of charging a 6% royalty, they opted for 5%.
It does not seem like a big mistake, when accounting for a single franchisee. It simply means that the franchisor will make $5,000 less in royalty revenues. But in franchising, we are talking about growth on steroids, and this mistake might be multiplied 100 times or more. And, since there are no expenses associated with this $5,000, this mistake comes right off the bottom line.
So do the math:
$5,000 in annual lost royalties multiplied by 100 franchisees = $500,000
Multiplied times a 10 year franchise term (or longer) = $5,000,000
Lost enterprise value assuming 10X earnings multiple at exit = $5,000,000
TOTAL LOSS $10,000,000
And an incorrect royalty is only one of a number of different business decisions that a new franchisor will make early in the process that could impact long-term profitability. Just a few of the many others include:
- Advertising fees
- Technology fees
- Product margins
- Type of franchise offered (individual, area development, area representative, etc.)
- Organizational structure
- Compensation structure
- Geographic growth strategy
- Territorial rights provided to franchisees
- Reservations of rights for the franchisor
In order to best position new franchisors for success, the iFranchise Group will often take a six-step approach to the development of your franchise business plan:
- Initial discovery – we immerse ourselves in your business and organizational structure to better understand how you should position the concept.
- Competitive benchmarking – we then gain a detailed understanding of the business decisions made by your competitors, understand competitive strengths and weaknesses, and how to best position the concept against them.
- Organizational gap analysis – we gain an understanding of your internal capabilities, your needs to fill certain “gaps” when delivering services to your franchisees, and the resources you can call on to do so, in order to plan your organizational development.
- Initial strategy development – we use your goals and your unique strengths and weaknesses to develop a preliminary franchise structure, subject to further financial analysis.
- Financial modeling – we then develop a complex cash flow model (often 16 pages or more) that allows us to test various business decisions for both the franchisee and the franchisor simultaneously.
- Financial sensitivity analysis – we then test various alternative scenarios to determine the impact that each might have on both the franchisee and the franchisor before making the recommendations that will allow you to finalize your business decisions.
By following the steps outlined above, the business structure that we ultimately recommend for our clients is based not only on best-practices in franchising and within the client’s industry, but also on a close examination of our client’s culture, goals, business economics, and the resources available to implement a franchise program.
To learn more about how this business planning process can help provide you with your best chance of success in franchising, contact us. Email us at firstname.lastname@example.org, or call one of our consultants at 708-957-2300. And be sure to request our free video on How to Franchise Your Business – which will go into greater detail on this important topic.