Attention Franchisors and Franchisees: A Successful Franchise Shouldn’t
Require Extraordinary Performance
by Ed Teixeira
In a prior article I presented a number of reasons why some franchisees fail.
One of the reasons for the failure of a particular franchise was that the
franchise program was flawed. The following article attempts to explain how
franchisors and franchisees can address this specific issue.
In the article I wrote several months ago entitled
Franchisees Fail Will Help your Evaluation Process”, my objective was to educate
prospective franchisees and existing franchisors as to how to better relate to
the factors that lead to franchisee failures. This article expands on one of
these factors. An excerpt from that article: “The franchise program is flawed
shows a situation, where the sales and/or gross margin dollars needed to meet
expenses, including paying royalties may be difficult to achieve. It may require
extraordinary performance to be profitable.” This can eliminate franchisees that
do a good job but not an extraordinary job. This situation can be corrected by
The Franchisor: A franchisor should structure their franchise program in such
a way that franchisees can earn a fair return on their investment based upon
good performance. If it’s a start-up franchise program there should be a
proto-type or model operation that the franchise is based on. Then the sales and
gross margin necessary to achieve profitability would flow from this model. The
royalty and ad fund contributions should reflect the aforementioned fact. To
take this a step further; if the business model for the franchise was well
managed and profitable, then the franchisor should understand how much added
expense in the form of royalties and fees the new franchise can absorb.
Unfortunately, in some cases a 5-6% royalty and 2% ad fund contribution is added
on with the expectation that the franchisee can generate additional sales and/or
gross margin to cover this added 7% plus earn a profit.
If the business model earned 20% pre-tax and a new franchisee did just as
well as the founder then their pre-tax income would be 13% after fees.
Franchisors have to take a realistic approach when it comes to the level of
performance their franchisees can be expected to achieve.
The Prospective Franchisee: An individual looking to purchase a new franchise
needs to perform comprehensive due diligence. A critical part of this process
involves constructing a pro-forma income statement that provides a financial
model of the franchise. The inputs for this model will come from the franchisor,
existing franchisees and information contained in the Franchise Disclosure
Document. Developing a pro-forma is a way to determine if the sales and gross
margin results will require reasonable effort. Simply put; does the pro-forma
indicate that the franchisee must achieve a top sales number to reach break-even
and earn a profit? I cannot over state the importance of this activity. Many
prospective franchisees become overly optimistic in their sales projections
which can lead to a shortfall in their future profits.
Both franchisors and prospective franchisees need to recognize whether future
franchisee profits will require extraordinary performance. Franchisees that
follow the franchise program execute correctly and achieve good results should
earn a reasonable return on their investment.
© 2010 FranchiseKnowHow, LLC
Ed Teixeira is the President of FranchiseKnowHow, LLC. He
can be reached at firstname.lastname@example.org