Considering a Franchise?

What is the difference between a franchisee and a company owned store within a franchise chain? Why might one prefer to be the franchisee or the manager of a company owned store?

A company owned store within a franchise chain is owned and operated by the corporation. A manager, employed by the corporation, runs the store. As an employee of the corporation, the manager is only as independent as the employer allows. This arrangement is most often seen in larger corporations which use retained earnings to open company-owned stores and to purchase existing stores from franchisees.

Owning a franchise gives the entrepreneur an opportunity to experience the rewards of business ownership. The rewards of ownership include self-direction (although somewhat limited by the franchisor) and the potential for high returns. Franchise owners usually have responsibilities which extend beyond managing their location. In fact, many franchisees own and oversee multiple locations.

By contrast, a store manager is employed at the discretion of the employer. Management can be a rewarding career and may provide the ideal career for the right individual. In addition, managing a chain does not put personal capital at risk. Not everyone has the skill set, the desire, or the financial resources to own their own business. Given the differences in individual makeup, it is impossible to say, in general terms, whether management or business ownership is better.

What is typically provided by a franchisor to its franchisees? Why would these be valuable to a nascent entrepreneur? Why is the failure rate lower for franchisees than it is for independent businesses?

The appeal of starting a franchised business comes from ability of an owner to start a business that is ready to go versus the uncertainty and risk of an independent startup.

Franchises offer a number of advantages including a proven business model, support systems, shortened learning curve and recognizable brand. For example, franchisors can help franchisees with financing, advertising and promotion, finding locations, negotiating leases, and managing numerous other day-to-day operational and administrative tasks. There is certainly value to buying a proven business model. Franchisors hold all locations to a consistent standard which is key to promoting consumer confidence. To assure standardization, franchisors offer and often require training and ongoing marketing for its franchise owners in order to maintain consistency and quality and to protect the overall reputation of the corporation. Providing experience and expertise is essential for the success of a nascent entrepreneur who, more often than not, requires the operational and administrative scaffolding that a franchisor can offer. While these franchisor functions are attractive, they need to be weighed against the often substantial price and fine print that comes with the franchise. Franchisees must adhere to a strict agreement detailing how they will operate their franchise as well as the franchise fee schedule which outlines the percentage of their profits, or flat fee, they must pay to the franchisor.

The failure rate is typically lower for franchises than startups due to the established name or brand of the franchise. When opening a franchise, the owner has instant credibility; customers know what to expect which leads to greater confidence in choosing the business. However, franchises still come with some risk – if you open a franchise in the wrong location, or open a store with a new or unknown franchise you could have just as much trouble as any other nonfranchise start-up. In most cases however, the franchisor does not want to see their franchisee fail because it reflects poorly on the overall brand and can be a red flag for potential owners so they will provide training upon initialization and oversight throughout operations as needed. The franchisors really don’t want their franchisees to fail. The old franchise adage holds: “You’re in business for yourself; not by yourself.”

The down side of franchises is that you’re not really an entrepreneur; it may be the next best thing, but you do have a hierarchy that you must answer to and restrictions which can be very confining. Don’t believe me? Ask some of the owners of Cold Stone Creamery franchises. A June 2008 Wall Street Journal article discussed the unusually high number of Cold Stone Creamery franchises that had been closed or put up for sale by their owners. Many of these owners suffered substantial financial losses along with severe emotional distress. The problems facing Cold Stone franchisees are not limited to that organization; they are an all too common experience for franchisees from an array of corporations.

At Cold Stone, the franchisees found that their costs were too high relative to their revenues. Some of the specific problems facing Cold Stone franchisees include: high overhead, a saturated market, and franchisor control. Franchisees complained about the way they were required to operate their businesses. For an example, the franchisor requires franchisees to buy Pepsi products from approved distributors who can be substantially more expensive than alternatives. Cold Stone does not allow franchisees to do their own advertising, and even force franchisees to honor discount coupons mailed out by the corporate office.

While examples like Cold Stone are cause for caution, it would seem to make sense that starting a business through franchising would be the safest track in many instances. It is just important for the owner to do due diligence. Make sure that the franchise you are inspecting is a good fit. Remember that just because a business is a franchise does not mean that you will automatically be successful. If a franchisee does not seek out a business opportunity that matches their interests, skills, budget constraints, and risk tolerance the probability of success diminishes. However, with all other factors being equal, the franchise will lead to quicker results and returns.

Helpful Links about Franchising

http://online.wsj.com/article/SB121321718319265569-search.html

http://franchises.about.com/od/franchisebasics/a/history.htm

http://www.entrepreneur.com/magazine/entrepreneursstartupsmagazine/2009/october/203504.html

http://www.sba.gov/idc/groups/public/documents/sba_homepage/serv_sbp_isfforme.pdf

http://www.entrepreneur.com/franchises/index.html