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Franchise Opportunity:W​ho gets the bigger slice of the pie?




Have you ever thought about becoming a franchisee or franchisor? Does the work involved in starting or growing your own venture overwhelm you to the point that the startup never starts? In a recent trip to the International Franchise Expo in New York City I made some interesting discoveries.


The Relationship


According the American Bar Association a franchise is a contractual relationship between the franchisor and the franchisee where by the franchisee has the opportunity to distribute or serve a specific product, or follow a business model owned by the franchisor, using their trademark, trade secrets, or brand. There are two perspectives to consider. The franchisor's opportunity is to quickly scale the operation without having to raise capital to fund each location or tie up cash with inventory for the channel of distribution. Secondly, the franchisee recognizes value in the unique way the venture functions and that he or she does not have to possess the skill set to develop the startup from scratch. Who has the advantage?


Caveat Emptor- Let the Franchisee be aware.


A person who wants to explore the prospect of becoming a franchisee should first examine the uniqueness of the franchise. This uniqueness should be or have the potential to become a recognizable brand. A franchisee must be fully aware of the conditions of operational agreement detailed in the franchise disclosure documents (FDD).


You may know the story of the business relationship between the founders of McDonalds restaurant, Dick and Mac McDonald. Adversarial relationshipslike that of Ray Kroc and the McDonalds brothers, as illustrated in the motion picture The Founder, are not sustainable. The"Speedee Service System" revolutionized the restaurant and Kroc noticed the uniqueness of how quickly customers were being served at the original San Bernardino location. Historically the McDonalds brothers were the Franchisors granting the master franchise license to Ray Kroc. Unfortunately, the relationship between the franchisor and franchise was not ideal in that situation.

Prospective franchisees who do not have a net worth of $ 2.2 million to open a franchise like McDonalds have other options. Franchisees should seek opportunities that can be acquired within their means of acceptable loss should the franchise fail. When evaluating the risk versus the reward in an opportunity the preliminary discovery should focus on the agreement or FDD conditions that the franchisor stipulates. States such as Wisconsin publish the FDDs that operate within their state. A prospective franchisee should aware of the conditions before setting the first meeting with the franchisor.


Is it really a proven model?


Harold Kestenbaum PC , who took part of a panel discussion at the 2018 IFE conference in New York, warned that 30% of franchisors have only sold 1-4 agreements in the first three years. Therefore, an assessment of the scale is critical. Kestenbaum made the suggestion that prospective franchisees should look at franchise opportunities that have at least 100 units. This might prove that the business model works as it is a critical metric of success.


Its important to look at the franchise's track record. Concepts that have not scaled quickly may indicate a lack of capital. If a franchise is not well funded there might be a disconnect between what the franchisee expects and the operational support that the franchisor can provide. Kestenbaum stated that startups like Sbarros Pizza sold the first franchises to family members, who then shared the story of their success, which in provided evidence that the franchise quickly. One could assume that there was a sufficient amount of support in starting those first units.


It is unique?


Interestingly enough the number of new pizza franchise opportunities are still on the rise, from low carb to wood burning, quick to healthy, and pan pizza to thin crust. Let’s face it, its pizza, not rocket science. So why would anyone pay $35k for the startup fee; in addition to 5-6% royalties, approved vendor agreements, defined lease contingencies, and percentage of gross receipts for advertising fees? After all it is just pizza. A franchisee should recognize that they are not entering an agreement to just sell pizza. The value is not in the pie, it’s in the brand equity.


When the franchisee finds value in the brand it must have a “proven” system of meeting the customers expectation. While investigating the various options I found two very different startups. Skinny Pizza is unique because of its health focus. The dough is a pre-prepared flatbread that is then topped and prepared in just a few minutes. Urban Bricks prepares fresh dough and bakes the pizza in Neapolitan brick ovens for two minutes, offered with an unlimited number of toppings.


Several aspects need to be considered by the franchisee. How important is health when considering entering into a franchise agreement for a pizza franchise? How quickly do customers need to be served? I posted a Facebook poll on June 1st in which I asked if the crust really mattered to the consumer. I did not quantify the question with concerns of healthfulness. Because both franchises had a claim of quick service that factor was not part of this poll. 10% of respondents preferred the pre-made dough, 90% preferred the fresh dough. Time will tell as to which of these franchises will become more successful in this saturated market. It appears that crust matters to those who responded to the poll.


Building upon the fast-healthy dining market trend was the number of franchises specifically focusing on Açai bowls. I chatted with several founders who explained the business model. One claimed that he supported the Jiu-Jitsu Açai lifestyle connection. When I inquired what that looked like he could not able to articulate his claim regarding and connect that to a sustainable business model. Be careful of trends that use buzz words about the aspiration value of their brand but fail to illustrate the trend will last. After reviewing the prospectus, the opportunity was not exactly curb-jumping, high growth, or a sustainable business model. After all, $14 for a bowl of frozen Acai berry “sorbet” with fresh fruit is a bit hard to swallow, particularly in that the uniqueness of the product is easily replicable, even now it is offered at Costco for $5. Be careful of fad-based franchises, they fade as will your investment.


Is my idea a “franchise-able” business?


Perhaps, if you can provide evidence of at least 5 units that you currently own and that the business model is sustainable and that the market is growing. Franchises that have corporately owns locations are easier to market to prospective franchisees. A budding franchisor should invest time and resources into a feasibility study. The following are some of the costs associated in the development of a basic franchise.

$ 25,000 plus– development of an operational manual, how the venture functions.

$ 30,000 plus- Legal fees, hiring an attorney that specializes in franchise contract development

$ 15,000 plus- Website development

$ 20,000 plus- Brand design and trademark protection

$ 10,000 plus – Audited financial statements for the past five years

$ 150,000 plus – Franchisee acquisition cost for 10 units

So before you invest $150,000 plus in the development of your franchise concept here are some questions you should ask.

1. Is the business model repeatable? Can you train someone to deliver exactly what you do well?

2. Will customers in areas outside of your region see value in the brand?

3. Can you protect your business model with a patent, copyright, trademark, or trade secret?

4. Are you willing to protect what you have built?

If you answer yes to all four of these then maybe others will find value in your concept in order to return a share of the profit back to you.

Resources

1. International Franchise Expo

2. Wisconsin FDD

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