Do Business Well

To franchise a business is not all plain sailing, however, it can have disadvantages as well. The moral responsibility every franchisor assumes for the welfare of his franchisees that is implied in the franchise relationship must surely top the list of negatives. An entrepreneur who decides tofranchise his business no longer just puts his own capital at risk, but that of his franchisees as well. Some individuals find this a heavy burden to bear, to the extent that it could limit their willingness to exploit additional opportunities, out of fear that this may expose franchisees to unacceptable risk. Other potential problems arising from franchising are:

•  The high cost of franchising. Franchising is a numbers game; the more franchisees there are in a network the greater is the likelihood that the franchise operation is profitable. This can be explained by the relatively high cost involved in creating a franchise package, a cost that has to be amortised over a large number of franchise sales. Similarly, the infrastructure needed to provide effective franchisee support must be inplace from the very beginning, but will be under-utilised until critical mass

has been reached.

The definition of critical mass, meaning the number of franchisees that makes the franchise operation profitable, varies from industry to industry. As a rough guide, it is widely accepted that a concept is not franchiseable unless its promoter has good reason to believe that within a relatively short period, a minimum of 15 outlets can be established.

It appears that most of South Africa’s franchised networks have managed to surpass the hurdle of “critical mass” a long time ago. Figures contained in The Franchise Factor 1999/2000 reveal that on average, the 478 franchise systems that were active in 2000 operated 49 business units each; and of those, 88.7% were franchised and the balance company-owned.

•  Reduced per-unit profitability. New franchisors will soon discover that the profit potential of a well-managed company-owned store is much higher than the return from a franchised unit can be expected to be. The reason for this is simple: Returns from franchised units are limited to a small percentage of the unit’s turnover in the form of the management services fee, whilst the entire profit generated by a company-owned store will be retained.

This is assuming, of course, that the company-owned store is operated at peak efficiency. We have already seen that this is unlikely to happen unless one of the owners of the business exercises hands-on control. A viable solution, applied with increasing frequency, seems to lie in a mixed approach, whereby company-owned stores are located in close proximity to the company’s head office, thus permitting hands-on control by one of the owners, whilst operations some distance away are franchised. See Figure 6.

• Poor franchisee selection. In a branch operation, managers who fail to meet agreed targets can be disciplined or even dismissed. Given the sizeable investment a franchisee has had to make into his own business, the termination of a franchise agreement on the grounds of poor performance is much more problematic.

Assuming that a franchisee fails to respond to intensive care offered by the franchisor and termination remains the only viable alternative, several aspects including the question of ownership of the business,property lease and loan obligations the franchisee may have entered into, must be taken into account. In practice, the franchisor has one of two alternatives:

M He can step in, assume responsibility for the failing franchisee’s obligations and operate the business as a company-owned unit until a new franchisee can be found;

Or

•  He may elect to waive the trade restraint the franchisee almost certainly has signed and permit him to continue trading under his own name. The latter arrangement would be subject to an undertaking by the franchisee to remove any item likely to maintain the impression in the public’s mind that the business continues to be a member of the network.

Possibly related posts: (automatically generated)
Franchising Disadvantages Part 1

• Relationship Franchise Agreement - Operations Manual
• Selling the Franchise
• Some Franchise Terminology
• Is a franchise the optimal solution? From the prospective franchisor's viewpoint
• Business format franchise
• Franchising Disadvantages Part 2
• From the franchisee's viewpoint
• The Fact of Franchising
• Modern-day Franchising Part 2
• The franchise agreement

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