Core Elements in the Franchise Business Model – Part Two

Executive Summary

This paper (one of a series) discusses some of the elements that must be present for a business model to be appropriately adapted for growth through franchising, and focuses specifically on the financial and emotional attractiveness of the concept to potential franchisees.

Major points include the following:

•    For a franchise system to be successful, the concept must be both emotionally and financially attractive to prospective Franchisees.

•    For many prospective franchisees, the emotional part of the equation is at least as important as the financial aspect.

•    Alternative franchise models, which will appeal to distinct target markets, include conversion franchises, start-up franchises, area franchises, area development or sub-franchises, “buy-a-job” franchises and high capital requirement franchises.

•    Franchise sales (and franchise sales management) require different skillsets than the operational and retail marketing skills which a new franchisor may already have.

The Importance of Marketability of the Franchise Concept

Marketability of the concept to be franchised is of critical importance to the success of the strategic decision to franchise, a point well understood by franchising professionals but sometimes ignored by those planning on franchising a business model, which they may have been operating for years.

Typically, new franchisors begin by concentrating on such issues as operational modifications necessary for franchising an existing business model, developing site selection and build-out criteria, writing operational and marketing training manuals, designing franchisee/manager training programs, etc.  

All of those tasks (and many more) are entirely appropriate for the prospective franchisor, but they ignore a core business reality: it’s impossible for a business to be successfully franchised if franchises are not sold.  

And that requirement implies another: the franchise must be attractive to prospective franchisees, and more attractive than competing investment opportunities, whether franchised or not.  So, both the nature of the business being franchised and type of franchise model being used, as well as consideration of the prospective franchisee’s emotional and financial needs, are vital considerations in developing any franchise model.

A Prospective Franchisee’s Financial and Emotional Needs

In designing a franchise model that can be successfully marketed, both conscious/rational and unconscious/emotional needs must be considered and addressed, and can affect the design of the franchise business model.  While prospective franchisees may or may not have thought about their needs, at least in a conscious, analytical way, the prospective franchisor should.

Let’s start with the conscious/rational needs, focusing on financial needs, which may the easier ones to analyze.

In general, most prospective franchisees are interested in making money from their franchise investment and any “sweat equity” involved in building the business.  

That desire relates to two separate metrics: the expected return on their monetary investment (can they do better for the same investment level in some other opportunity, franchised or non-franchised?) and the anticipated cash flow of the business, which the purchaser will use to justify their involvement and support an appropriate lifestyle,

Therefore, prospective franchisors should be mindful that their offering will be tested, in a financial sense, against other available opportunities and the franchisor should have designed a business model (including initial franchise fee, royalty rates and required initial investment) that will meet any such tests.

[Note that significant legal constraints, and potential liabilities for violations, are involved with respect to a franchisor’s ability to make any financial performance representations to a prospective franchisee regarding the business to be franchised, and that the methods commonly used in selling other opportunities will not be legal in the franchising context.  This is an area where advice of experienced franchise legal counsel will be critical.]

Assuming that a prospective franchisee’s financial needs can be met, let’s turn to his or her emotional needs.

Part of those needs relate to the business model itself, and the operational requirements of that business.

For example, operation of a quick serve restaurant can involve long hours, as well as the practicalities of supervising young employees who may be working for minimum wage or close to it.  The financial aspects of the business may make good sense but, for a prospective franchisee who has a white collar, non-retail background, investing in an executive search franchise may more properly suit her emotional needs and her existing skills.  

Similarly, a business requiring the franchisee to personally engage in face-to-face marketing (e.g. printing) may not be appropriate for a shy person.

An often-unstated emotional need of prospective franchisees is simply one of belonging.  Operating a business as an independent may give the operator much more freedom, but one price of that freedom is lack of support, including the feeling of belonging to a large organization, with its own culture and values, and made up of other owners similarly situated.

Individuals with that set of emotional needs can be very good franchisees, but the franchisor must be aware of those needs and be sure that the system he or she designs will meet them.

Different Franchise Models Appeal to Different Markets

Another point, sometimes not appreciated by prospective franchisors, is that franchises can be offered under a variety of structures, and that each structure can appeal to distinct markets.  

We’ve set out below some of these alternative structures, many of which can be combined, and the typical target markets related to each alternative.

•    Start-up Franchises

This model is representative of probably most of the franchises offered today.  

The prospective franchisee has never operated a business of the type in question and will have to be convinced that he or she will actually enjoy operating that business.  Such purchasers may have adequate capital, but also strong emotional needs under the “belonging” heading.

•    Conversion Franchises

Here, the prospective franchisee already owns and operates a business of the type to be franchised and is offered the opportunity to retain ownership of that business but as part of a franchised system and benefit from the related brand identity, as well as possible operational and other efficiencies.

This purchaser may have demonstrated an ability to run the business (or may be purchasing the franchise in an attempt to save it from failure!) and will have to be convinced that the costs involved will be justified by operating under the new model and meeting its operational requirements.  Adequacy of available capital may be an issue with some such franchisees.

•    Single Unit Franchises

This model is also typical of many of the franchises offered today.  

The franchisee is granted the right to operate one (and only one) unit, often at a specified location and with or without express territorial rights.  Typical purchasers usually have limited capital (adequate for opening only one unit) and focus on operational requirements.  Their management skills may be limited and they may need more support than other franchisees.

•    Area Franchises

This type of franchise involves a more extensive set of commitments than some other models, both for the franchisor and the prospective franchisee.  Here, the franchisee typically obtains rights to an area, along with the right (and the obligation) of opening a specified number of units within a defined time period.

The franchisee’s needs are for greater economic rewards than in some other models and may (and probably should) be accompanied by a greater level of risk tolerance.  Also, a higher level of franchisee management skills will generally be required under this model.

•    Area Developer and Subfranchise Franchises

In these models, the franchise may or may not operate a franchised unit, but he or she will take on some or most of the franchisor’s duties within a defined territory, including marketing franchises to other prospects, assisting them in finding locations, training new franchisees, supervising regional marketing efforts, etc.

While the economic rewards can be high with this model, the risk levels and required skills can also be higher than in other structures.

“Buy-a-Job” Franchises

Sometimes inappropriately disparaged, these franchises typically involve the franchisee actively working the business, including perhaps behind the counter, and are hoped to be adequate to pay an appropriate return to justify that level of full-time involvement.  

Capital requirements may not be excessive and any potential increase in the capital value of the business may be a secondary consideration, as is any real plan to open additional units.

High Capital Requirement Franchises

These franchises, of which hotels are a common example, require investments of perhaps millions of dollars, are generally made by sophisticated high net worth individuals or groups, and usually involve a purely economic analysis, with little consideration being given to emotional needs.

Here, the projected return on the investment will be critical and actual management of the unit will be generally delegated to employees.

Franchise Sales Management is a Distinct Skillset

Finally, let’s make a very important, although sometimes ignored, point: franchise sales and franchise sales management are distinct skills, requiring sensitivity to legal requirements, ethical constraints and good salesmanship principles.

Those skills may not be present in the founder of the franchise system. who may have spent much of his or her career in operations, finance or consumer marketing.

If that’s the case, the founder will have to be aware of that lack and be prepared to identify, hire and appropriately compensate personnel who can properly fulfill that function.