Why Franchisors Fail - and How To Help Them Succeed

This is Part 1 of a series on why new and emerging franchise brands fail. In the first two parts, we discuss 8 points on why they fail. The following installments will cover what they can do to succeed.

Speak with any number of franchise brands with fewer than 100 franchisees or locations, and a troubling theme will emerge: An alarming number of them have not been able to grow as they expected. Some have stopped growing altogether; others have declined from peak numbers of franchisees or locations. Even more troubling are the large number that have ceased to exist.

Compared with other business models, we find franchisors to be far more transparent with information, more open to giving advice, and more likely to take a personal interest in the success of others.

Why, then, when so many passionate people have committed their lives to improving the condition of both franchising in general and franchisors in particular, do so many new and emerging franchisors struggle or fail?

Are these failures isolated incidents or examples of a franchisor failure epidemic? In 1998, business school professor Scott Shane studied the problem and published his results in an article in MIT's Sloan Management Review (Factors for New Franchise Success). He researched 157 companies in 27 industries that became franchisors between 1981 and 1983. He looked at their progress after 12 years as a franchisor.

Are his findings still valid today?

Franchising is full of success stories where committed franchisors created scalable and profitable businesses that will be around for the long haul, taking many franchisees along for the ride and adding more value to the brand than either party could have created separately.

But why is franchising so successful for some, while so many others struggle?

In this first installment, we present our first two findings of "8 Mistakes That Can Lead to Failure." More important, we will also examine what can be done to help more new franchise systems succeed.

1. Undercapitalization

Most would-be franchisors have the wrong questions in mind when they begin thinking about expanding through franchising. They ask, "How do I launch a franchise system and what does it cost?" The question they should be asking is, "What does it take to sustain the organization on royalties and continuing fees alone?"

An entire industry of franchise attorneys and consultants specialize in packaging and launching franchise systems. They cite amounts in the range of $100,000 to $150,000 to launch a franchise system, including such things as writing an FDD, designing templated training programs, writing operations manuals, upgrading consumer websites, and designing franchise sales processes, tools, and systems. Inexperienced franchisors often take this at face value, assuming from that point forward the business will self-fund through the revenue generated by franchisee fees and, eventually, royalties. Many franchisors fail because they grossly underestimate how much capital it takes to get to royalty self-sufficiency.

Franchisors should plan on investing a best-case scenario of $500,000 to upwards of $2 million to take them from launch through the initial ramp-up to 50 franchisees or units. At that point, most franchisors will have crossed the threshold where royalties and recurring revenue are covering all of their operating costs. Those quoted amounts do not include the money owners or founders pull out of the business. If you plan on living off your system, add that amount to the total needed.

We believe many new franchisors get into a circular situation where they start out with just enough capital to purchase the FDD and operations manual and a small ad budget to start recruiting franchisees, but not enough to sustain themselves through their growth curve. As they recruit franchisees, they either underestimate what's needed or don't have a clear road map for investing back into all the things an emerging franchise system needs: operations staff, developing training systems, and coaching franchisees through the learning curve so that they, too, can become profitable.

2. Poor operations, training and support

Undercapitalization or franchisor inexperience leaves the franchisor with ill-conceived or underdeveloped training and operating systems, and poor or ill-prepared operations and support - leading to breakdowns and low profit margins for franchisees, which in turn creates operational headaches for the franchisor and poor franchisee validation. If the franchisees are not making money and are unhappy, it becomes impossible to attract additional talented franchisees. This pushes the franchisor's dream of "royalty self-sufficiency" further out into the future. Inevitably, the franchisor will find themselves at point No. 3: selling franchises to survive.

Next issue: Points 3 through 8, which will be followed by several installments on "How to do it right."

Joe Mathews is a founding partner of Franchise Performance Group, which specializes in franchisee recruitment, sales, and performance. Thomas Scott, senior consultant at FPG, is a franchise lead generation specialist and an expert in creating franchise websites, blogging, SEO, social media, and PR campaigns to recruit qualified franchisees. This is an excerpt from their recent e-book. Contact FPG at 615-628-8461 or joe@franchiseperformancegroup.com.