Deal or No Deal

• Deal or no deal

Deal or no deal

Turning your business into a franchise system can be an easy growth strategy but it requires planning and commitment.

The worst reason to franchise a business is the misguided notion that creating scale will lead to a more successful business, executive director of franchise consultancy DC Strategy’s Rod Young says.

“Too many companies that are offering franchises in Australia don’t have a proven and profitable business,” he says. “If your business system is not profitable now and you franchise it, what you’re doing is simply cloning an unsuccessful business and no amount of scale will solve that problem.”

While some franchisors are simply misguided on this point, Young says there are plenty with ulterior motives. “We see that there is some opportunism in franchising where people see selling franchises as a way of generating income,” he says.

There are good reasons to consider franchising. It is a low-risk growth strategy and a sophisticated way of raising capital, from franchise entry fees, without giving away equity in the business. Young champions its benefit to human resources, especially in an environment of skills shortages. “It’s a people management strategy,” he says.

“You get motivated individuals into your business. Not enough thought is given to how powerful that is.”

Young says the main objective of franchising should be building the business to a point where it is a saleable entity — that is, building enterprise value — based on its revenue stream.

To build that enterprise value by haphazardly and quickly adding on stores, like a child building a tower with wooden blocks, is not the answer. “If you’re going to move into a franchise model, your objective should be to put the maximum amount of revenue into the market with the minimum number of [franchise) units," he says. Simple maths shows that a $100 million business with 50 units is worth much more to a buyer than a 100-unit business with the same revenue because per-unit operating costs (such as mentoring and administration) are lower while profit margins are higher.

Young's ideal scenario to begin franchising should cover three main concerns. The business should be "proven and profitable", should be established for two to three years and preferably have a second or third outlet. This is to prove that the success of the business is not resting on the shoulders of a charismatic owner. There are exceptions to the rule, Young admits, but these are the criteria he encourages people to tick off before considering franchising.

Young says West Australian-based shoe label in.u needs to be careful as it considers franchising. With its first store opened in Perth's Subiaco in October 2010 and a second to open in suburban Claremont soon, in.u's director, Matthew Steptoe, is embarking on a franchisee recruitment drive. "[To grow] we really need the right kind of committed, focused people and I think franchising is the way to attract those,” Steptoe says. “Looking at what is available to potential franchisees in Australia at the moment, there seems to be a plethora of food and beverage ark coffee-type opportunities but there’s not really a great deal in fashion-focused retail. We see that as an opportunity.”

The company is in the early stages, so the establishment of proof of concept is a concern, Young says. However, the fact that in.u is about to open a second company-owned store will be good learning curve before franchising.

“The second store will teach them a lot about their systems,” he says. Despite being open for less than a year, Steptoe says his previous retail experience would make up for a lack of precedent in the brand’s operations and he will lean on this when deciding store location, shop fit-out and giving franchisees guidance and training.

As well as economic readiness, there are key operational considerations before business owners should think about franchising and most of them concern paperwork.

“Offering franchise opportunities before you develop your strategy, structure, economic and business model, commercial policies, your franchise agreement, your disclosure document and, importantly, your operations and procedures manual, is almost a formula for failure,” Young says, adding that it has not been uncommon for business owners to approach DC Strategy before even registering their business trademarks. “At the core of each franchise agreement is the right to use a trademark or a brand name,” Young says.

Canvassing for franchisees without first having a clear recruitment, screening and selection process in place is not a good idea. Young says business owners often end up giving away too much information in the screening process, an outcome that backfired for Ben Hennock (see “Shiny brand a gift for opposition”, left). “A number of people… actually disclose the core of their intellectual property and that’s not just the brand but how they do business, and we don’t believe that that’s necessary, certainly in the early stage of conversations with a potential franchisee.” Of course, with a poor recruitment process it will be difficult to find the right franchisees but when franchisors complain about them, Young repeats his first law of franchising: “Every franchisor gets the franchisees they deserve.”

“I just remind [the franchisors]: ‘who actually recruited, screened and selected inducted, managed and developed the business plan in the first place’” Young says.

Even for businesses that have ticked all these boxes, there is one common factor they often fail to appreciate. Although franchisees may come from business backgrounds, they need continued training, tools and mentorship. “When a franchisee buys a franchise, there is not a mantle of expertise that somehow falls onto his crown and all of a sudden he becomes an entrepreneur,” Young says. “He’s exactly the same as he was before he arrived at your doorstep – except he’s $350,000 lighter.”

Rod’s Rules

DC Strategy’s Rod Young says that before franchising, businesses should:

• Be profitable
• Be established for two to three years
• Have more than one location

Young’s first law of franchising:

Every franchisor gets the franchisees they deserve
 

DC Strategy is your business growth specialist. For more information in relation to franchising, please contact:

Rod Young 
Executive Director
rod.young@dcstrategy.com
02 8220 8711