Franchising as a small business growth strategy: a resource-based view of organizational development.
KEYWORDS : business format development; competitive advantage; franchising; growth; intangible assets; UK
Une vision du developpement des organisations basee sur leurs ressources
Ce ne sont pas seulement les franchises qui, pour la plupart, sont des petites entreprises; mais aussi les franchiseurs, surtout pendant les annees de formation de leurs activites de franchisage. Les niveaux eleves de remous et d'abandon, au cours de ces annees de formation, ont abouti a l'instauration d'un profil industriel selon lequel--et ce en tout temps--pratiquement cinquante pour cent des systemes de franchise ont moins de cinq (5) ans et plus de 10 debouches commerciaux. Une question se pose: comment les organisations de franchisage qui reussissent planifient-elles le developpement de leur capital humain pour s'assurer une croissance productive'? Pour completer cette question il faut se demander quel est le role des franchises qui--meme s'ils ne volent pas tout a fait de leurs propres ailes si l'on se refere au vrai sens du terme 'exploitant de petite entreprise'--n'admettent pas plus d'etre consideres comme des employes traditionnels et, jusqu'a un certain point, ambitionnent de participer au processus dont ils font pattie integrante? Cet article preliminaire se fonde sur des informations decoulant d'etudes de cas realisees aupres d'un certain hombre d'entreprises de franchisage 'modeles', pour donner une vision du developpement des organisations basee sur leurs ressources. Il devrait etre d'un interet considerable non seulement pour les universitaires specialises en la matiere, mais aussi pour toute personne qui sc specialise dans l'etude de domaines tels que la gestion strategique, l'innovation et la croissance des actifs incorporels des petites entreprises.
Mots cles: developpement de l'image commerciale; avantage concurrentiel; franchisage; croissance; actifs incorporels; RU
Mots cles: developpement de l'image commerciale; avantage concurrentiel; franchisage; croissance; actifs incorporels; RU
Una vision del desarrollo de las organizaciones segun sus recursos
No solo la mayoria de los franquiciadores sino, ademas, muchos franquiciatarios son pequenos empresarios, especialmente durante los anos de formacion de sus empresas franquiciadas. Las elevadas tasas de turbulencia y bajas vegetativas durante los anios de formacion de las empresas franquiciadas sc traducen en un perfil industrial segun el cual, en cualquier momento, casi la mitad de los sistemas de franquicia tienen menos de cinco anos y menos de 10 salidas comerciales. Se plantea la cuestion de como las organizaciones en regimen de franquicia planifican el desarrollo de su capital humano para lograr un crecimiento vigoroso. Un complemento de esta cuestion es el papel de los franquiciadores, ya que no son totalmente independientes en el sentido estricto del vocablo 'pequeno empresario', ni tampoco se consideran empleados convencionales, y tienen ciertas expectativas de participar en el proceso del cual son una parte integrante. Este articulo preliminar se basa en un estudio de casos practicos de una serie de empresas franquiciadas 'modelo' para dar una vision del desarrollo de las organizaciones segun los recursos. Este articulo sera de mucho interes tanto para los academicos expertos en la materia como para los que estudian las esferas de gestion estrategica, innovacion y crecimiento de los activos intangibles de las pequenas empresas.
Palabras claves: desarrollo de la concesion con condiciones de comercializacion; ventaja competitiva; concesion de franquicia; crecimiento; activos intangibles; RU
Eine auf Ressourcen basierende Sicht organisatorischer Entwicklung
Nicht nur bei vielen der Franchisenehmer selber, sondern auch bei vielen der Franchisegeber, insbesondere in den Anfangsjahren ihres Franchisegeschatts, handelt es sich um Klein- bzw. mittelstandische Unternehmen. Hohe Turbulenz- und Schwundraten in den Anfangsjahren von Franchisegeschaften ergeben ein Industrieprofil, bei dem zu jeder Zeit rund die Hailfte aller Franchisesysteme weniger als funf Jahre alt sind und weniger als 10 Geschafte aufweisen. Es stellt sich deshalb folgende Frage: Wie planen erfolgreiche Franchiseorganisationen ihre Humankapitalentwicklung um ein erfolgreiches Wachstum zu erzielen? Zu dieser Frage kommt die Rolle der Franchisenehmer hinzu, die zwar nicht wie Mittelstandler vollstandig unabhangig sind, sich abet gleichzeitig in keiner Weise als konventionelle Angestellte sehen und dementsprechend gewisse Erwartungen haben, was ihre Mitbestimmung des Prozesses, in dem sie ein wesentlicher Bestandteil sind, anbelangt. Dieser Forschungsbeitrag nutzt Fallbeispiele von einer Reihe ,,beispielhafter' Franchiseunternehmen zur Entwicklung einer auf Ressourcen basierenden Sicht organisatorischer Entwicklung. Der Beitrag durfte von erheblichem Interesse sein und zwar nicht nut fur die Akademiker, die am Gebiet des Franchising interessiert sind, sondern auch for diejenigen, die derartige Themenbereiche wie das strategische Management mittelstandischer Betriebe, Innovation und Wachstum immateriellen Vermogens untersuchen.
Schlagworter: Geschgiftsformatentwicklung; Wettbewerbsvorteil; Franchising; Wachstum; immaterielles Vermogen; Grossbritannien
Franchising, as an organizational form, continues to increase in importance in the provision of services, jobs and self-employment opportunities (British Franchise Association/NatWest, 2004; PricewaterhouseCoopers, 2004). This has led increasingly to its presence in debates spanning a number of disciplinary fields including management, marketing, economics, sociology, psychology, law and entrepreneurship (Stanworth and Curran, 1999). There have been numerous debates on the issue of franchise definitions (Hoy and Stanworth, 2002) but a broad definition, framed to meet the points commonly raised in debates, has defined franchising as:
A business form essentially consisting of an organisation (the franchisor) with a market-tested business package centred on a product or service, entering into a contractual relationship with franchisees, typically self-financed and owner-managed small firms, operating under the franchisor's trade name to produce and/or market goods or services according to a format specified by the franchisor. (Stanworth and Curran, 1999)
This definition covers most modern varieties of franchising and, in principle, no barriers appear to exist to incorporating quasi-forms. It is essentially ideal-typical in approach. For instance, in practice, market testing can be perfunctory. Franchisee self-financing is often supported significantly by loan finance from banks or other sources, including franchisors. Also, multi-unit franchises and corporate franchisees that are found in some areas such as fast food are clearly not always owned by small firm owner-managers. Finally, it can embrace both arms-length 'product' franchises such as those that characterize petroleum and soft drink distribution, and also 'business format' franchising which involves an entire business format allied to close ongoing relationships between franchisor and franchisee.
If a franchise company is successful, then at some future point, take-over, merger or public quotation is a definite possibility and the issue of business value becomes highly relevant. Far more so than is the case with conventional SMEs, franchise businesses tend to have relatively few of their assets in tangibles and a much larger proportion tied up in intangibles. Increasingly, franchise companies are in fact joining the stock market (Domino's Pizza, Business Post, Punch Taverns, etc.) but are still regarded as sufficiently novel for financial journalists to need to explain their special characteristics to their readerships. For example, a leading investment newsletter, Small Company Sharewatch (January, 2004), in recently recommending Domino's Pizza as an investment, said:
Domino's Pizza operates a franchised system of pizza delivery stores run by independent operators which is enabling it to expand without a commitment to capital. (Small Company Sharewatch, 2004: 7)
The Investor's Chronicle (February, 2004) explained that franchise company profits can result in high dividend distribution:
Continued store expansion and a flat cost base remain the cornerstone of success at Domino's Pizza ... With minimal capital expenditure, and strong cash-generation, (there) is plenty of scope for the group to continue growing its dividend yield. (Investor's Chronicle, 2004: 35)
Another leading investment publication (Shares Magazine, January, 2004) explained:
Domino's is now the UK's top pizza business with around 300 sites, most of which are franchised ... with the franchisee paying an upfront fee of around 50,000 [pounds sterling] and then royalties of some 12% on sales of pizzas. (Shares' Magazine, 2004: 28)
Thus, the point is made that franchised businesses are fundamentally distinct from conventional businesses. In place of conventional levels of shareholder capital and employees, we see self-funded franchisees juxtaposed between franchisor and customers. Franchisees bring to the franchise system not just financial capital, but also a knowledge of geographic locations and labour markets, plus their own managerial labour. That is, they represent an efficiently bundled source of financial, managerial and informational capital. In the development of the franchisor's business format, asset intangibility is a particular feature with its company and product brands, retail formats and managerial technology. The successful construction of these business features can prove very elusive to those seeking to become successful franchisors. This current article seeks to break new ground in an exploratory investigation of the chemistry of successful franchise system development.
High Franchise Failure Rates
While the literature on franchising in both the UK and the USA is replete with industry-generated claims of high success and growth rates, there is now a critical mass of academic literature internationally to demonstrate that failure rates in the sector are in fact very high (Bates, 1998; Lafontaine, 1997; Shane, 1996; Stanworth et al., 2001). Although some franchisors successfully achieve break-even and find the 'promised land', the experiences of many franchisors range from substantial challenges to outright disaster (Hunt, 1977). For instance, research in the USA has yielded the conclusion that:
... a new franchise system brings with it a high probability that the new franchisor will not be around in future years ... Because over half of new franchisors cease to franchise during the first four years, potential franchisees should be very wary of buying into systems that have not yet reached their fourth anniversary. (Shane, 1996)
This same point has been underlined by the research of Lafontaine and Shaw (1996) whose work prompted the observation:
While many firms keep entering into franchising, giving the impression of tremendous growth, many are also exiting, leading to an overall growth rate at best commensurate with that of the [wider] economy ... From the franchisor's viewpoint, the high rate of exits suggest that many firms fail despite franchising, and many others choose to stop franchising after trying it for a few years. Clearly, these firms have found that franchising is not right for them. (Lafontaine and Shaw, 1996)
In the UK the situation is similar. For instance, Price (1996) identified 1658 franchise companies as having been operational between 1984 and 1995 of which only 601 (36%) remained in existence at the end of that period. Stanworth and Purdy tracked entries from the two principal UK franchise directories in 1995 and found that, of an initial 704 separate entries, only 464 (66.3%) survived the following 2 years (Stanworth et al., 2001).
The British Franchise Association (the sector trade association) admits three levels of membership to its ranks. For 'Full' membership, franchise systems are required to have been franchising for 2 years, run a pilot for a year, and have a minimum of 4 franchisees. 'Associate' members (a lower grade of membership) are required to have been franchising for only 1 year, run a pilot of 1 year and have just 1 franchisee. Finally, 'Provisional' members need only be currently developing a franchise system while receiving help from accredited franchise advisers--consultants, solicitors, etc. The fact that less than half of current members qualify for 'Full' membership after the British Franchise Association has been in existence for 25 years (Wise, 2002) may be taken as indicative of the high rates of system failure or withdrawal and turbulence in the sector. The Director-General of the British Franchise Association has recently been reported (Franchise World, 2004) as saying that a sizeable number of companies come into franchising:
... and then give it up within 18 months because they didn't think it was going to be like that, or it is actually going to cost them more to do it properly than they thought. (Franchise World, 2004)
Once a franchisor has generated a basic idea for a franchise (a quick print service, emergency 24-hour drain cleaning service, film development, fast food provision, etc.), a pilot needs to be established by way of developing and testing the product/service itself, operational marketing strategies, staffing procedures, pricing policies, etc. Every small business start-up plan inevitably requires considerable modification during its initial months of operation. The process of franchise system development should then, ideally, continue with the establishment of a second outlet in an alternative location as a test of ability to replicate the initial success with different staff, clientele, premises, lines of supply, etc. There will, inevitably, be a steep learning curve here (Stanworth and Purdy, 1999).
Three key documents need to be drawn up prior to franchising the embryonic business. If it is an existing business 'converting' to franchising, the same holds true. First, an 'operating manual', committing detailed instructions to paper for the guidance of franchisees when running an outlet for themselves. Second, a 'franchise contract', stipulating the legal obligations of both franchisor and franchisee and, finally, a 'franchise prospectus' for use in franchisee recruitment. All documents require a considerable input of knowledge and, ideally, external professional help from consultants, solicitors and accountants. Then begins the process of recruiting and training new franchisees, premises selection and subsequent launch of their franchise outlets. These are all processes that are liable to prove time-consuming and expensive, particularly for those with little previous relevant experience to draw upon.
New franchisors will struggle to build up management and administrative control systems internally and also establish and sustain franchisee recruitment channels, lines of supply and links with relevant outside bodies such as trade associations, property agents, accountants, solicitors. Close personal attention will need to be given to each new franchisee, who will, in effect, be taking over part of the role of piloting from the franchisor in the early days. Many franchisees may have human capital (experience, skills, knowledge) that the franchisor lacks.
'Human Capital' will tend to be in critically short supply in the early stages of franchise system development. For instance, our own research (Silvester et al., 1997) indicates that, at the end of their first year of franchise operation, as many as 44% of systems have no more than 2 full-time staff equivalents (FTEs) and 66% have no more than 5. After 2 years of franchise operation, 45% still have 5 (FTE) staff or less. Income generation at this stage from franchise royalties (sometimes termed management fees) will be at best modest since they typically amount to no more than 10% of franchisee turnover. Half of this is usually promised to an advertising budget and, in any case, franchisee financial turnover levels are themselves still modest since they are still getting established.
As an initially anticipated break-even figure of less than 10 franchise outlets typically becomes 20-50 (Silvester et al., 1997), franchisors realize that their days of existence as a small business are likely to be limited if they are to survive. If break-even then involves establishing a minimum of 20 outlets (each with its own workforce) and the franchisor has to directly employ sufficient staff to service this system, a sustainable franchise system in its entirety may well involve in excess of 100 people at break-even point. This puts it into the category of an SME rather than a small business. Thus, franchising can be an avenue for small firm growth but few systems are sustainable until they have passed through the 50 fulltime equivalent workforce size normally regarded as the interface between a small and a medium-sized firm. In short, prior to break-even, they are small businesses carrying the overhead structure needs of a medium-sized firm.
Exemplar UK Franchise Case Studies
Given the now well-documented difficulties inherent in building a successful franchise business, it was decided to study, by means of face-to-face taped interviews, a range of entrepreneurial franchises in the UK. These had all been set up initially as small business ventures. They had passed break-even point (shown by our own previous research to involve typically 5 years of trading, the establishment of 20-50 outlets and the raising of around 0.5m [pounds sterling] financial resources). Also, the individuals who had achieved this success were still with the companies they had founded and were willing to participate in the research. Further, they had achieved break-even point recently enough to be able to clearly remember the events and stages involved. Such organizations are not common in UK franchising and the choice of companies was limited. However, a number of companies were successfully recruited, from a range of sectors. Eight of these cases, in condensed form, are outlined below:
One of the best known of our in-depth case study sample was the high street film developing and printing service, Snappy Snaps, launched in the late 1980s. Its founders, Don Kennedy and Tim MacAndrews, had some time earlier gained vital prior experience of franchising when they had been amongst the early franchisees of the quick-print franchise system, Kall Kwik, and had thus witnessed fast growth in a young franchise system at first hand. They had been very successful and had opened up a total of four Kall Kwik outlets as franchisees.
Don Kennedy had first seen rapid Japanese film development equipment in operation while on holiday in Canada. Prior first-hand experience of franchising, coupled with the franchise potential of this new technology, led the partners towards the decision to pilot a Snappy Snaps franchise, based on a one-hour high street developing and printing service. As early as 1983, they opened their first Snappy Snaps film processing pilot store, harnessing vacant space in one of their Kall Kwik outlets, located in a tourist area of London, for the purpose. They subsequently sold their Kall Kwik outlets in order to concentrate on developing their own dedicated Snappy Snaps franchise system as franchisors in 1987. Given their rapid earlier success as franchisees, and familiarity with franchise system structures and procedures, they felt able to develop their new franchise system themselves, without taking on external consultants or outside partners.
Prior to joining Kall Kwik as franchisees, Don Kennedy had taken a degree in Business Studies before working for McDonald's, while his partner, Tim MacAndrews, had qualified as a chartered accountant. Kennedy said that, when setting up the Snappy Snaps franchise system:
We were experienced enough to know that franchising was a long-term business. There has to be a lot of up-front investment from your own funds--we put in 500,000 [pounds sterling]. Often franchisors try to make fast profits without building any real backup system--franchisees then become disgruntled and the whole thing falls apart. We had seen this first-hand.
Kennedy and MacAndrews sold their 4 Kall Kwik outlets and set up 4 Snappy Snaps pilot operations. Only when all four pilots emerged into profits did they begin franchising. They achieved break-even at 25 outlets. As ex-franchisees themselves, they felt they understood the problems and anxieties encountered by franchisees, and so provided a comprehensive support package including assistance with finding suitable premises, introductions to a major clearing bank, full technical training, corporate image reflected in store layout and design, staff recruitment, marketing, financial and legal assistance, weekly newsletters, regional meetings, focus groups and annual conferences.
The owners, as Kall Kwik franchisees, had witnessed the emergence of a franchisee association that they felt was 'born out of contention'. In order to avoid this, Kennedy and MacAndrews had facilitated the formation of such a body themselves as a mechanism for consultation and communications. Two similar franchises had formed as competition but each had subsequently failed:
We knew franchising was a long-term business. The idea of rapid expansion using franchise fees is totally false. You must avoid being greedy and take your profit long term. Franchisees have to make profits before you do.
The partners prefer franchisees that are without prior experience in the operational line of the franchise. Such people, they feel, are more receptive to accepting, rather than challenging, the authority of the franchisor. They claimed that, as franchisors, they resist temptations to hand out 'overstated information' such as overambitious growth and profit projections. The company takes no mark-up on bulk purchases sold to franchisees and operates a cap on franchise fees in order to avoid disincentives to franchisee growth.
Another equally successful, though less visible, franchise system operating away from the high street, is Pirtek. Operating since the late 1980s as an on-site supplier of hydraulic and industrial hose replacement assemblies of cars and commercial machinery, it is highly successful and now operates internationally. Interestingly, once again, the founders--Peter Brennan and Forbes Petrie--had both previously been successful multi-unit franchisees with another franchise system--Prontaprint--before being made directors of the main company board.
Their subsequent recruitment to Pirtek of John Chaplin, former CEO of Dyno-Rod and British Franchise Association Chair, represented a major injection of 'human capital' since Chaplin is regarded as one of the most competent and experienced professional managers in the field.
Rather than face the long haul of developing a completely new franchise concept, Brennan and Petrie visited Australia in search of a concept that was established there but underdeveloped in Europe and America. They shortlisted two different franchises. One was a mobile carvery roast for use at parties, receptions, barbecues, etc., and the other was an on-site vehicle hose replacement service. In the event, they chose the latter. They formed a joint venture with the Australian franchisor, to be run by Brennan and Petrie, operating under the name of Pirtek. After a first year loss of 250,000 [pounds sterling], Pirtek made a profit of 2m [pounds sterling] the following year and has been very successful since. Unusually, for a franchise system, Pirtek subsequently broke-even on just 10 outlets due to high individual outlet sales and good profit margins.
Operating from a London base, the franchisors attract franchisees from a wide range of backgrounds and assist them in raising some of their initial capital requirements. From their background experience, they inform incoming franchisees in new territories to expect to work as an operator in their businesses for some months until turnover levels are sufficient for them to adopt a full-time managerial role. Sales skills and a strong will to succeed are considered crucial traits for success.
Given that Brennan and Petrie both had substantial initial funds available from their sales of Prontaprint outlets, Pirtek UK experience differed from that of most new franchisors in that they did not require any bank funding until year three of their operations when they took out a 100,000 [pounds sterling] overdraft facility. When they required bank funding, they found institutions supportive of their needs. This they attributed to their previous track records and also to being an adequately funded profitable company.
The major threat to a franchise system is insufficient on-going support to franchisees and the potential that raises for conflict between franchisor and franchisee. We don't require franchisees to have prior experience in the operational line of the franchise. Our franchisees come from many walks of life--from banking, sales, marketing--you name it. Because of the substantial cash requirements, they are usually ex-professionals. What we do require is adequate sales skills and a strong will to succeed.
Rosemary Conley Diet and Fitness Clubs
Another example of a successful UK franchise system involves the case of Rosemary Conley Diet and Fitness Clubs, established in the early 1990s. An initial major asset here came in the form of a widely known household brand name--Rosemary Conley--famous for her best-selling books on diet and fitness and also widely exposed via television, radio, newspapers and health magazines.
Neither Rosemary Conley nor her husband and business partner, Mike Remington, had any previous experience of franchising, though they had considerable prior knowledge of the rapidly growing diet and fitness industries and had achieved a good and continuing income stream from their existing activities in the area, sufficient to meet the costs of launching a franchise system based on the notion of localized fitness clubs using the Rosemary Conley name.
In order to overcome the obstacle posed by lack of previous experience of franchising, additional human capital was recruited in the form of Brian Smith. Smith was a former Chairman of the British Franchise Association and Managing Director of the ServiceMaster carpet cleaning franchise (he had previously been a franchisee with that system). At the time of their meeting, he had been working for Ernst and Young accountants as a franchise consultant. Smith took early retirement from Ernst and Young and joined Rosemary Conley, first as a franchise consultant and later as Franchise Director.
Nearly 60,000 [pounds sterling] had been spent on professional advice before Brian Smith joined the business full-time. Smith says:
Rosemary and Mike didn't use bank finance initially because they didn't need it. They invested money they already had, plus a great deal of their own time. Pre-investment in a franchise system takes the form mainly of professional, consultancy, legal and accounting fees.
They launched the system from the grounds of the historic Quorn House in Leicestershire--Rosemary Conley's home and business base--and took cheques for 100,000 [pounds sterling] at its first recruitment seminar. The system operates on the basis of training franchisees in dance and movement for them to operate their own local 'Rosemary Conley' diet and fitness clubs along franchise lines on an agreed fee basis. Training is received by franchisees plus field support from field development managers. Franchisees administer their franchises directly from their homes, thus minimizing overheads.
The venture has been a substantial success. Smith says:
Greed is probably the biggest cause of franchise failure. Many new franchisors refuse to pay for professional advice and few succeed without it. Also, franchisors sometimes fail to re-invest in their business and, instead, funnel their money into life-style.
On the conventional wisdom of avoiding franchisees with prior operational experience in the line of the franchise, Smith said:
I don't agree with this idea as much as I used to. It became an industry conventional wisdom after the early quick printers, particularly Edwin Thirlwell (founder of Prontaprint) was motivated to avoid members of the print unions coming into his franchise. I can understand franchisors getting nervous of franchisees coming in with prior experience in case they want to do things their own way.
In fact, many Conley franchisees joining the business are already RSA/NVQ trained in dance and movement. Much of the content of Rosemary Conley's earlier books and videos, etc., was highly relevant to the franchise packages developed.
Harry Ramsden's Restaurants
Another of our case study firms was Harry Ramsden's, the fish and chip restaurant and takeaway. When Harry Ramsden died in 1963, the sole outlet was still the Guiseley restaurant in Yorkshire, which featured in the Guinness Book of Records and was a household name, certainly in the North of England. In the 1980s, the shop was purchased from Associated Fisheries by three businessmen with the express intention of franchising. All three partners had prior franchise experience. John Barnes had been Chief Executive of Kentucky Fried Chicken, Richard Richardson had worked as an executive with an advertising agency where he had responsibility for the KFC account, while Richard Taylor had had senior managerial experience with a large brewery. Richardson stressed the importance of the partners' prior experience of franchising:
It was good to be able to start with a clean sheet for, once a franchise relationship goes wrong, it is difficult to rescue. You need to know what you are doing right from the start as a franchisor. You need to get things right first time round ... For people from large company backgrounds without any former franchise experience, franchising can be a culture shock. As a franchisor, you have to expect to be challenged by franchisees in a way that corporate managers are not used to. They [franchisees] challenge you with new ideas. There are plenty of ideas we would never have followed up on but for our franchisees. They convinced us to let them try new ideas and they worked. Good franchisees always out-perform managers. Bad franchisees do not--they are a constant problem. Franchisees are often entrepreneurs--they think intuitively--most franchisees would not make franchisors because they would be uncomfortable in structured situations.
Prior to franchising, Barnes, Richardson and Taylor had had a sound financial base and there was little pressure to sell franchises quickly to ensure an income stream. Although the original Guiseley restaurant had been in operation for several decades, they soon realized that 'nothing was written down'. The local knowledge and expertise required to run the business had been 'all still in people's heads' and required to be extracted, distilled and presented in manual form in order to service a strategy of expansion via franchising. The Guiseley operation was used as a pilot in developing the training format and operations manuals.
The franchise was expanded initially in the North of England where it was best known and then spread throughout the UK and internationally. Somewhat similar to the previous case (Rosemary Conley Diet and Fitness Clubs), this was a case of an existing strong brand being converted to a franchise format. Added to this was the ability and know-how required to raise money on the stock market (AIM [Alternative Investment Market]) which they did early on, avoiding any subsequent panic reliance on 'boot-strap' finance, or front-end franchisee sales fees. Break-even was achieved within 5 years of operations and with less than 20 outlets in existence. This was put down to cheap stock market capital sources and large outlet sizes (usually requiring franchisee investment in excess of 1m [pounds sterling]).
Rainbow International is another franchise success story. In 1987, a management team from a large UK brewery looking for diversification opportunities, paid 500,000 [pounds sterling] for a master licence from a US carpet care and restoration franchise company (Rainbow International) with rights to develop it in the UK. The experiment was a failure and the wreckage was bought out for a nominal sum by a successful former ServiceMaster multi-outlet franchisee, Melvin Lusty (ServiceMaster is another US-based company also operating in the carpet care and restoration field).
Rainbow International (UK) is now a considerable success thanks to Lusty's expertise and management. He says:
I bought out an ailing franchise system when I took over the Rainbow International UK license and I may look for other ailing franchises to buy out in the future. There are some good franchises based on a sound concept which struggle and fail because the people running them don't understand franchising or come in under-funded. I could buy them out, get good management and proper systems in place and give them financial backing.
It is interesting that, as a former franchisee in a related area, Lusty had run several territories, indicating an ability to proceed beyond the worker-manager role, which is often a feature of a single outlet, and onto managerial team building involving specialization and delegation. However, he feels that the large corporate brewery management team subsequently proved ill-equipped to run a business format franchise system where managers may well have been accustomed to delegating but not to the extent that franchise relationships require.
Lusty passed break-even at around 90 outlets and became Rainbow's most successful Master Licensee worldwide. And in January 2003, the franchise network was acquired as a member of the ISS Group, for an undisclosed sum (Birmingham Post, 2003), but with the goodwill or intangible assets valued at approximately 9.5m [pounds sterling] (107m Danish Kroner; ISS A/S, 2004). Lusty retained a management post in the UK operation and the network presently comprises 130 franchise outlets.
Though he is still reliant upon the American Master Licensee for supplies and specialist cleaning materials, he feels that the flow of organizational expertise is largely operating the other way round now.
Lusty has recently served a two-year period as Chair of the British Franchise Association and is currently finding a stream of independent small business carpet cleaners wishing to convert to becoming franchisees with Rainbow. This 'conversion process' is common to many franchise systems. With Rainbow, one of the appeals is their highly regarded knowledge of the fire, flood and clean-up insurance market with which Lusty negotiates national contracts that he then disperses to individual franchisees.
On the issue of who makes a good franchisee, he says:
Some franchisors want good salesmen as franchisees but we disagree. Salesmen can often win orders but they can't always look after them and retain them. We look for 'growers'. We like to help our franchisees to grow and invest a lot in training and advice. When new franchisees want to take on staff, we recommend in the early days that they take on people 'like themselves' for ease of team working. In the early days, if you have no experience of handling employees, you can struggle and so I advise them to look for clones of themselves so that, at least, they have someone they can get along with. However, as they get bigger, we tend to suggest they recruit people "unlike themselves' in order to round out the team--to get different skills and viewpoints on board. I am following this philosophy myself with the team I lead at Head Office.
Freedom Maintenance Franchise Group
Simon Rigby and Andrew Webster were managers of a Yorkshire Electricity inhouse property maintenance division until April 1996 when, in a management buy-out following privatization, the unionized workforce of 75 maintenance and repair staff were made redundant and the work subcontracted to Freedom Maintenance, a newly formed franchise operation run by Rigby and Webster. Fiftyfive of the 75 staff made the transfer, using their redundancy money to pay their front-end franchise fees. Thereafter, Yorkshire Electricity contracted the work formerly undertaken by electricity maintenance workers to their franchisor, who then allocated it out to their (now) franchisees via a computerized call centre, in exchange for a 10% royalty fee.
In line with national trends towards downsizing, outsourcing, own-account self-employment and flexible working patterns, Yorkshire Electricity had, upon privatization, decided to detach itself from a skilled, unionized closed-shop, craft workforce while, at the same time, retaining their crucial services via what amounted to a 'rent-back' arrangement. This left management of the newly franchised workforce in the hands of Simon Rigby and Andrew Webster on the understanding that the now privatized utility, Yorkshire Electricity, would see their bill for services cut by 25% compared to their previous direct labour costs. In order to give both parties to the initial agreement security, an initial contract for five years was guaranteed.
Freedom has grown rapidly by applying its 'conversion' formula to other well-known companies. In essence, the system converts employees into self-employed franchisees in return for a contract for the ex-employees to continue doing their old jobs for a specific period of time. Freedom, for its part, allocates this work to the franchisees in exchange for an ongoing royalty. All invoicing is done by Freedom and franchisees receive a monthly 'pay packet' minus a 10% royalty fee. Rigby says:
The customer wins as it can focus on its core business, yet retain the skills of its former workforce and make considerable savings ... the individual staff win by being able to continue doing the work they were doing previously, but with the added bonus of being given the opportunity to own their own business.
The change in status of a formerly direct labour force to franchisees is one that bears close similarities to similar conversions in milk dairy workforces in recent years. The presence of an existing experienced workforce, redundancy payments convertible into franchise entry fees plus an initial order book are obvious elements in common here. Additionally, Rigby and Webster had previously managed the identical maintenance function with Yorkshire Electricity and had two years prior to privatization to plan their buy-out.
This company was founded by Justian de Frias and his wife Anne. Justian had previously spent 16 years building a sizeable printing and publishing company. While still in his early forties, he had sold this business for a sum sufficient to enable him to retire comfortably for life. His wife Anne had worked as a senior administrator with a large pizza restaurant franchise operation.
In 1989, Justian and Anne decided to jointly form a business using his managerial and printing experience plus her administration and franchising knowledge. Research had revealed an ageing population in need of inexpensive wills. As a result, they produced standardized will-writing computer software under the name of Just Wills Plc, which was unique to the company.
Franchisees, in addition to selling a will-writing service, have the opportunity to introduce clients to a range of additional services, including funeral services, guardianship protection plans and executor and probate services, all of which command additional payments. The company grew rapidly and is now considering expansion abroad.
Franchisees are typically 'white collar' and 'middle class' so as to inspire confidence and reliance in potential customers. However, franchisee recruitment is not always simple. Justian de Frias says:
It is as if the people we interview [as prospective franchisees] have an identical twin. The one who turns up for interview promises to work his socks off, is in excellent health and doesn't mind forsaking holidays for a couple of years whilst his business is getting up and going. The twin that actually signs up for the franchise often turns out to be a pale imitation of his name-sake--he has aches and pains, he needs visits to dentists, he needs holidays, he has problem kids, you name it!
The company has moved away from the notion of simply selling defined geographical territories to franchisees and expecting them to be responsible for sales in those areas. Now the company coordinates the major sales effort directly via agents working on commission. High performing franchisees are also used as local, regional and national salesmen. The company is currently building up a system of Area Directors, drawn from the ranks of outstanding operational franchisees. Area Directors will be sold shares in the company.
Justian and Anne de Frias made an initial investment from their own reserves of 500,000 [pounds sterling] in the first two years of the franchise system's existence. Early loans were typically fully secured overdrafts. Justian says:
Bank rules oblige lending managers to look only at your bottom-line profit figures, rather than your system turnover which may be a better indication of your true potential in the early days when you are building a franchise system.
The ingredients of success here appeared to conform to the patterns observed in other case studies. From the outset, Justian and Anne de Frias brought a considerable amount of private funding and prior managerial experience into a market niche, which they had researched thoroughly. The decision to franchise allowed fairly rapid expansion into a dispersed market where clients required a personal service and where individual orders were unlikely to be large enough to carry conventional company overheads.
Established in 1985, Chemical Express sold its first franchised outlet in 1986. It offers an extensive range of cleaning chemicals and hygiene products, as well as dispensing equipment, required on a daily basis by almost all businesses in every sector of industry and commerce. Today, and known as Chemex International, it is a leading UK franchise company with over 100 outlets in the UK and Master Franchise Licenses in a number of countries abroad.
When Les Gray set up Chemical Express in 1985, he had a sleeping partner who supplied the required funds while Gray set about developing the business. In the mid-1990s, Gray organized a buy-out for 3m [pounds sterling] using investment bank funding. The business reached break-even point after 7 years of trading with 30-40 outlets. He said:
Franchise companies that expand very quickly are prone to failure since they often concentrate on recruiting new franchisees ('boot-strap financing') rather than system development and franchisee backup. You have to understand what your franchisees are going through. They hit 'pain barriers' at different stages in their franchise careers--they may be losing confidence or experiencing isolation. Franchisors have to be aware of this and adopt a supportive leadership style.
On the issue of who makes a good franchisee, Gray said his current top performers came from varied backgrounds. His top five performers were an ex-postman, a sales manager, a buyer, a farmer and a former shipping agent. He said:
Don't think there is a formula that will tell you who will make a good franchisee. We get people from all kinds of backgrounds. Inexperienced sons of successful fathers tend to fail. Sometimes we have had families begging us to set up their son who has failed at everything else. Whenever we have weakened, we have regretted it. The key trait is stickability which is the key to surviving the first 18 months.
Les Gray had previously occupied several senior executive positions in large companies and proved very adept as a franchisor in attracting good quality professional managers around him. Chemical Express was voted 'Franchisor of the Year' in 1996 and was described by the British Franchise Association's Director General Brian Smart, as 'one of the outstanding success stories of British franchising'.
Discussion and Conclusions
The case study firms outlined above are quite exceptional in the field of UK franchising. They are generally recognized in the industry as 'excellent' companies. The eight case study companies featured three former British Franchise Association Chairmen--Brian Smith, John Chaplin and Melvin Lusty--and the companies have been regular winners of sector honours such as 'Franchisor of the Year' and 'Franchisee of the Year' awards. Success on any scale in franchising is relatively novel and certain 'human capital' metrics would appear to characterize the minority who go on to become sector exemplars.
What appears to differentiate franchise success stories, such as the above, from their all-too-common counterparts which pass briefly across the landscape of British franchising before failing, is not simply a sound product or service but also a massive influx of human, financial and intellectual capital.
The Advantage of Multi-partner Franchise System Start-ups
New franchise systems appear to have a higher propensity to succeed when set up by franchisor husband/wife teams or business associates. The advantages here are obvious. Not only does a 'duo' or team start-up tap into multiple sources of financial capital but also two or more sets of human experiences, contact networks and energy sources, as well as offering potential decision-making synergies.
The eight companies profiled were characterized by an unusually high incidence of multi-partner start-ups. Only Melvin Lusty of Rainbow International had operated 'solo'. Two were run by husband/wife teams (Rosemary Conley Diet and Fitness Clubs plus Just Wills Plc). In addition, Snappy Snaps, Harry Ramsden's, Freedom Group, Chemical Express and Pirtek, were each set up by two or more individuals working closely together, except in the case of Chemical Express where the initial finance provider was a sleeping partner.
In virtually all instances among our case study firms, the 'duos' or teams involved were previously known to one another and their relationships had usually endured over time--they were 'tried-and-tested'. Don Kennedy and Tim MacAndrews of Snappy Snaps had already worked together for some years as franchisees in Kall Kwik. The same was the case with Peter Brennan and Forbes Petrie at Pirtek--they had worked together while at Prontaprint. Richard Richardson and John Barnes of Harry Ramsden's had worked together during their association via Kentucky Fried Chicken, while Simon Rigby and Andrew Webster had been managers working together at Yorkshire Electricity prior to privatization. Thus, in almost all of our case firms, we were looking not only at managerial teams but established teams. The rhetoric of franchising typically adopts the term 'tried-and-tested' and, in this case, this is certainly what we had--tried and tested management teams.
The Benefits of Franchise System Piloting
The essence of franchising involves selling use of a 'proven', 'tried-and-tested', business format However, Cox (2002) questioned a sample of 40 UK franchisors and established that only 27 of these had run any kind of pilot prior to offering franchises. Thus, 13 systems had not piloted at all and, of those that had, only 6 had run 2 outlets or more as their pilot operation Those that operated just a single outlet had all picked locations close to the franchisor's head office location, suggesting that administrative convenience had been a major factor in market testing when the ultimate intention have been to run a geographically dispersed network of outlets operating at some distance from head office. Yet Floyd and Fenwick suggest:
... prospective franchisors should test the concept in another location before embarking upon franchising because some concepts are difficult to replicate, and outletspecific factors such as location or great staff may be responsible for the original business's success. (Floyd and Fenwick, 1999: 36)
Thus, many franchise systems, far from being 'tried-and-tested' in their early days, still have much to learn. Cox quotes one such franchisor as saying:
... where do you go for help? We didn't know. We read books on it and had seen how other people had done it. But, if you took a company like ours, we were the head office and there was nowhere to go for advice. It was quite difficult to get detailed information from other franchisors because they were competitors or in similar fields. Basically, it is very difficult to find people in the same field who will give you information ... So the only way to really learn is through experience--learn on your feet. (Cox, 2002: 197)
Looking at our exemplar companies, the issue of piloting had been taken very seriously. In fact, two of the eight exemplar firms already had the assurance of a nationally known brand name--Harry Ramsden's Restaurants and the Rosemary Conley brand. Interestingly, in the case of the former, a single outlet had operated for several decades on the basis of informal internal training--internal knowledge and expertise Much of the knowledge was 'tacit' and required to be made 'explicit' when the brand was franchised. Snappy Snaps had four pilots operating at a profit before franchising and the Freedom Maintenance Franchise Group was a conversion franchise using an existing workforce and customer base. In the case of Pirtek, one of the founders, Peter Brennan, had actually set up and run the very first outlet on his own, operating it as a de facto franchisee.
Advantages of Prior Experience of Franchising
Prior experience of franchising emerged strongly as a key factor amongst our exemplar franchise start-up success stories. Not only did a knowledge of franchise contracts, manuals, prospectuses, recruitment, and training procedures, etc., prove vitally important, but also so did the cultural aspects of franchisee management. These were, in themselves, a highly relevant form of human capital since effective management of franchisees requires a multitude of skills and an organizational culture suited specifically to franchising (Forward and Fulop, 1993). Franchise management inevitably entails different skills to those required to manage employees. For some, this may be a potential source of conflict since the franchisor may be unable to accrue the human capital necessary to manage the rigours of franchisee management and the changing nature of the franchisor-franchisee relationship over time.
In her study, Cox (2002) found franchisors in her sample that had previously operated as franchisees in other franchise systems. This, she claims, appeared to 'minimize time, risk and cost' when it came time to set strategy for their own franchise systems.
Looking at our own sample of franchise case firms, nearly half (three out of eight) were founded by ex-franchisees (this was the case with Pirtek, Snappy Snaps and Rainbow). In each case, however, they had been multi-unit owners, which had ensured that they had had to replicate their initial single-outlet successes and manage outlets at arms length. Thus, in some respects, they had already operated as area-manager franchisees with the value this implies for subsequently running their own franchise systems in their entirety. Others had worked as managers linked to franchise-styled operations (this was the case with Harry Ramsden's and Just Wills). Rosemary Conley had brought in a former franchise company chief executive officer (CEO) and British Franchise Association Chair--Brian Smith. The remaining two franchise operations (Chemical Express and the Freedom Group) both had formidable prior relevant management experience.
In the introduction to this article we presented quotations from three leading shares investment magazines (Investors Chronicle, Shares Magazine and Small Company Sharewatch) reporting on financial year-end results from a well-known franchise operation, Domino's Pizza, early in 2004. The financial journalists involved were all very congratulatory concerning Domino's recent results and sought to explain why a 20% increase in turnover levels had facilitated a 50% increase in profits and a 70% increase in dividends (figures are approximate but accurate). The explanations of why such a high dividend increase stemmed from a much smaller increase in turnover was always couched in terms of 'low commitment to capital', 'minimal capital expenditure', 'strong cash generation', 'franchisees paying an upfront fee of around 50,000 [pounds sterling] and then royalties of some 12% on sales of pizzas', etc. The point emphasized here was that a mature franchise system can be income generating without experiencing many of the bills for rents, staff and loan interest which tend to drain away the profits of conventional businesses.
Indeed, the situation reported in these investment publications is essentially accurate for a mature and successful franchise system way past its break-even point. However, this model of business success first has to be constructed and this involves a process that can take many years and initially absorb large sums of money. Our own earlier research (Silvester et al., 1997: 4) has demonstrated that early-stage franchisors tend to see franchise system break-even being achieved with up to 10 outlets up and running (51%) or, at the very most, 20 outlets up and running (64%). For systems that had survived for between 6-10 years, the breakeven figure was usually cited at 21-50 outlets (38%) or more (see Figure 1).
[FIGURE 1 OMITTED]
Looking at the experiences of our case study firms, this had indeed been the case. Snappy Snaps experienced break-even at around 25 outlets and after an internal investment of 500,000. [pounds sterling] Just Wills invested a similar amount. Rainbow International broke even at approaching 100 outlets, while Pirtek and Harry Ramsden's broke even on 10-20 outlets. However, these were both high investment and high turnover franchises. In both cases, financial requirements were high. Pirtek lost 250,000 [pounds sterling] in its first year and Harry Ramsden's management had to raise capital on the stock market. Don Kennedy (Snappy Snaps) said that, ' ... the idea of rapid expansion using franchise fees is totally false'. Les Gray (Chemical Express) said that franchise systems often fail because franchisors relied upon franchisees to provide money to build the system ('boot-strap' financing) rather than arranging their own independent financial provision. Melvin Lusty (Rainbow International) had remarked that 'some good franchises, based on a sound concept, struggle and fail because the people running them don't understand franchising and come in under-funded'. Finally, Brian Smith (Rosemary Conley Diet and Fitness Clubs) said that, ' ... greed is probably the biggest cause of franchise failure. Many refuse to pay for professional advice and few succeed without it'.
Thus, the picture that emerges here is that the enviable situation in which our case study firms and also Domino's Pizza found themselves, was only achieved after investment of several years of human and financial capital. One advantage our franchisors had was the simple knowledge that this was the case. For others, the false vision of simply setting up a small firm and then selling 'off the board', 20 licenses at 50,000 [pounds sterling] to become a 'millionaire this time next year' can be very alluring and ultimately fatal.
This article has attempted to identify the key importance of human and intellectual capital in franchising, not only as a means of assimilating intangible metrics alongside traditional measures of company strength, but also as a useful tool for strategy formulation. However, it should be noted that traditional accountancy conventions do not fully value a company: profits, rather than human assets, are the basis of evaluation. It is not asserted that our analysis is totally comprehensive but, rather, an exploratory analysis helping towards a better understanding of franchising as a small business growth strategy (Stanworth and Curran, 1999) and, hopefully, a catalyst and platform for further debate.
The authors wish to thank the referees both for their kind comments of encouragement and for their insightful suggestions for improvements.
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JOHN STANWORTH has academic qualifications in Metallurgy, Industrial Engineering, Management and Sociology. In 1981 he was awarded the first UK Chair in the field of Small Business, and between 1979 and 1989 was Director of the London Enterprise Programme. In the late 1980s, he was co-founder and became Director of the Future of Work Research Group (embracing the International Franchise Research Centre) at the University of Westminster (UK). He has over 100 publications to his name, including involvement in 15 books and around 40 learned journal articles, plus 50 TV and radio interviews. Please address correspondence to: International Franchise Research Centre, University of Westminster, 35 Marylebone Road, London NWI 5LS, UK.
CELIA STANWORTH is a Reader in the Future of Work at the Greenwich University Business School. Her current research interests are gender and the labour market, and human resource management amongst knowledge workers. She has published work on a range of topics relating to working patterns such as teleworking, and part-time and agency workers.
ANNA WATSON is based at the School of Management, University of Surrey, specializing in Retailing. Research interests include franchising, e-strategies in the retail sector, and retail environmental policies.
DAVID PURDY is a Research Fellow, International Franchise Research Centre, University of Westminster, investigating the development of franchising worldwide. He has assisted with the management of private and public sector funded research projects, with sponsors including Lloyds TSB, the Royal Bank of Scotland and Business Link London Central. He has co-authored various articles and book chapters on franchising with Professor Stanworth, commencing in the late 1980s.
SIMON HEALEAS is based at Westminster Business School, University of Westminster, and specializes in finance and accounting. His main research interest concerns the intellectual capital dimension of company evaluation.
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|Author:||Stanworth, John; Stanworth, Celia; Watson, Anna; Purdy, David; Healeas, Simon|
|Publication:||International Small Business Journal|
|Date:||Dec 1, 2004|
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