The Wealth-Creating Power of Franchising
- Jan 9, 2004
- Tip 3-1 Risk Management: Ownership and Wealth
- Franchise Risk Profile Template: An Introduction
- Agency Problems and Administrative Efficiency
- Buy a franchise, or launch a standalone?
- How Do Franchisors Determine the Amount of Franchisee Fees and Royalties?
- Size and Risk Management
- Balancing Company and Franchised Outlets
- Resource Constraints
- Franchise Disclosure: An Insight into Individual Franchisor Health and Wealth
- License Agreement: How the Franchise Shares Responsibilities and Wealth
- Key Factors in the Franchise Relationship
- Public Capitalization: An Expanded View of the Franchise Company
Our first two chapters captured and detailed franchising as both an entrepreneurial vehicle and a systematic risk-reduction tool. We clearly established opportunity assessment as the core function of entrepreneurship and then illustrated how franchising must embody this principle. We also defined what a franchise is and how it is best assembled and/or examined using the franchise relationship model (FRM).
Now we discuss several issues that exist in virtually all businesses of scale: administrative efficiency, risk management, and resource constraints. Franchising can overcome such common obstacles. It is an efficient model for significant wealth creation. While making our case that a successful franchise follows from a highly developed franchise service delivery system (SDS), considerable capitalization, and significant growth, we further propose that obtaining public capital as an additional source of funding can be a piece of an overall successful franchise strategy. The most effective way to expand a concept is to launch and grow a small number of company-owned stores, to subsequently sell several franchises, to concurrently obtain public capital to increase the number of company-owned units, and to build an infrastructure for both. Please see TIP 3-1 for key aspects of wealth creation through franchising.
Tip 3-1 Risk Management: Ownership and Wealtha
The average franchisee
owns 1 outlet
has been in business for 9 years
spends 8.5 percent of sales on promotions
has $58,000 in after-tax profit
has made an average investment of $155,000
Five percent of franchisees own 30 or more outlets.
The largest franchisee owns more than 500 outlets.
The average franchisor
owns 13 percent of his or her system outlets
franchises 87 percent of his or her system outlets
has 75 percent of his or her franchisees owning only one outlet
Understanding the Motivations of an Entrepreneur to Become a Franchisor
There may be no better franchise illustration of the glory and costs of rapid growth than Boston Chicken. Boston Chicken opened its first restaurant in 1985. Eight years later, in November 1993, it was a franchisor and floated an initial public offering. Serving healthy food that actually tasted good in a fast, casual setting was a simple but compelling story. Besides, restaurant sales had shown consistent and impressive growth. But Boston Chicken (which later changed its name to Boston Markets) transformed itself into more of a real estate mortgage company than a restaurant franchise. Until the IPO, Boston Chicken had grown by way of individual franchisees who put up substantial amounts of their own money to open new stores. To accelerate expansion to a dizzying pace, the company signed up financed area developers (FADs). These folks put up 20 percent of the required development costs for a market, and the rest provided by loans from Boston Markets.
The capital market appetite for Boston Chicken seemed insatiable. In 1997 the company raised over $400 million in bond offerings and convertible debt. At the same time, those choice FADs were losing increasing amounts of money—$156.5 million in 1997 alone.
Did Boston Chicken grow too fast, or did it lose sight of the business format that made it a success in the first place? It was probably guilty on both counts. The growth strategy is always dependent on the religious devotion to the business model and store-level economics. Success can be turned into dramatic failure when you forget that.
Historically, an entrepreneur launches a successful single outlet. That success often motivates a desire to add new outlets. If the entrepreneur perceives the opportunity as considerable, the human and financial capital requirement is likely to be bigger than the currently available resources. There are many ways to secure capital for new outlet growth, and as we have discussed, franchising has proven to be a significant method. When a franchisor sells a franchise unit, she is securing both the capital and the talent of the franchise partner—the franchisee. The one-time, upfront franchise fee, ongoing royalties, and franchise management system creates a sharing arrangement between the franchisor and franchisee. Once success has been achieved with the initial rollout of a franchised unit, most franchisors begin to think along the lines of, “If we can have 10 units, why not 25; if 25, why not 50; if 50, why not 150?” and so on. This successive growth logic becomes self-fulfilling as more success leads to more success—but only if you run the stores right and make a profit.
Eventually, Boston Chicken filed for Chapter 11 bankruptcy, reemerging only after being purchased by the MacDonald’s Corporation.