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The dangers of do-it-yourself: franchising can be a great way to grow your business--but, asks Simon Lord, how do you set up for success?

Recently, a research student contacted me to gather data on a thorny subject franchisor failure rates. It's a thorny subject because, although franchise people often say that the failure rate for franchisees is commendably low compared to that of independent small businesses, the failure rate for franchisors is considerably higher. When I went back through a ten-year-old database I was struck by just how many of the names were no longer with us--or, at least, no longer franchising.

All of these companies started franchising with high hopes and good intentions. Most were based on successful businesses, or concepts that had succeeded elsewhere. Yet many never actually got off the ground, while others fell apart after just a few years.

Why should this be? Well, experience suggests there are two prime reasons.

The first is that common cause of many business failures: under-capitalisation. The process of franchising is more expensive and takes longer to produce a positive revenue stream than many hopefuls expect. The second reason is that franchising requires careful development to create an effective business model that can be profitable for all concerned. Too many would-be franchisors don't realise this and, rather than involving an expert, try to do it themselves without the necessary knowledge.

Here're three critical areas new franchises must get right before appointing their first franchisee:

1. Territories.

Every franchisee likes to feel that they have an exclusive territory within which they can market their business knowing they are free of competition from other franchisees within the same company. But how big should that territory be? What should it be based on--Maps? Malls? Phone book areas? Should it be capable of being divided or sub-franchised? Should there even be a territory at all? For the new franchisor, thinking through all these aspects is crucial to establishing a successful and sustainable business model both for the franchisor and the franchisee. Make the territories too small and the franchisee may never prosper. Make them too large and they may never exploit their territory properly, reducing franchisor income and leaving gaps for the competition. In some cases, where referrals and networking are important ingredients, having a defined territory at all may damage franchisee growth.

2. Fee levels.

Like territories, fees need to be carefully set. Initial franchise fees must be large enough to offset most of the franchisor's costs in establishing a new franchisee (although even this is variable) but small enough to be affordable. Ongoing fees or royalties must be large enough to provide the franchisor with the revenue required to fund their ongoing support services, but small enough to ensure that the franchisee can make an acceptable return on their investment.

Many new franchisors don't actually know what support they will be required to provide on an ongoing basis. Visiting the first four or five franchisees on a personal basis every few months is one thing; establishing a professional support office for 50 or more franchisees with staff, communications, travel and accommodation bills is a very different matter.

3. Fee structures.

Another key ingredient is how the ongoing fees will be calculated. In some sectors, a flat weekly fee is the norm; in others, a percentage of turnover is more common. There may be a mark-up on products or services provided. Suppliers may pay a commission, or the franchisor may take the head lease on property and sublease to the franchisee at a profit. There may be additional fees for, say, national marketing or accounting services. All of these structures and more are in use, and all of them are working for someone. But none of them is working for everyone, and that's where the pitfalls lie for franchisors.

Just in these three areas alone, the options above already offer over 150 different combinations of structure.

Building a viable, sustainable franchise takes a great deal of research, care and experience, and the truth is that few business owners have the breadth of knowledge necessary. It should be no surprise, then, that many--perhaps most --of those who attempt 'do-it-yourself' franchising don't succeed.

If you have a good business and want to expand via franchising, start by talking to an experienced consultant who really understands all the possible variations and can help determine which might be applicable.

It might seem expensive--but nothing is more expensive than getting it wrong.

Simon Lord is publisher of Franchise New Zealand magazine and website. A free copy of the magazine is available from
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Title Annotation:FRANCHISE FILE
Author:Lord, Simon
Publication:NZ Business
Date:Aug 1, 2014
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