Why Franchisors Fail - and How To Help Them Succeed, Part 3

This is Part 3 of a series on why new and emerging franchise brands fail. In the first two parts, we discussed 8 reasons they fail. The remaining installments will cover what they can do to succeed.

Doing It Right from Day One

During a recent IFA convention, we approached several franchisors in different industries that survived the start-up phase and had growing franchise systems with happy and profitable franchisees. They had all crossed the threshold where they were royalty-sufficient, meaning their existing royalty stream sustained the business. Their business could sustain itself if they failed to recruit another franchisee.

We asked them, "Knowing what you know now, if you wanted to launch your concept right and not be undercapitalized, how much should you have started with?" Their answers were consistently between $1 million and $2 million. Not a single franchisor we know of invested less than $1million. Not one.

We've worked with two franchise brands recently, both started by well-capitalized companies with deep pockets. Both owners had experience in franchising and set out from the beginning to build successful national brands. One, an IT franchise, has just passed the 50-territory mark and has made an almost $8 million investment to get to royalty self-sufficiency. The other, a school franchise, has invested more than $15 million to scale their business to six schools and build out the infrastructure, systems, and support structures needed to scale the business quickly. Franchisees' revenues are up 40% over the past 2 years. The model is hitting its tipping point. They look and act bigger than they are. In other words, they're built for long-term growth, and the company will grow into their excess capacity rather than continually stretching the organization or breaking it down.

When we took on Menchie's as a client with 25 one of the first things CEO Amit Kleinberger did was assemble a roundtable summit with a legal expert, a top PR firm, a top marketing firm, and our firm, which specializes in lead generation and franchise sales. Kleinberger made sure from the jump that Menchie's was set up to win as a franchisor. Four short years later, Menchie's is opening its 400th location, with almost 300 more in development. Menchie's has brought on more than 100 franchisees each year for the past 2 years and is on course to become an iconic national brand.

How should you spend your money?

All sustainable franchise brands have already achieved royalty self-sufficiency. It's the key milestone in a franchisor's history.

The initial capital - from a best-case scenario of $500,000 to a more likely range of $1 million to $2 million - is pure investment, meaning none of it will be used to line the owner's pockets. Expect 75% to be invested in infrastructure, including a larger and more experienced home office staff, better systems, better and plugging any holes in the model. Franchisors, when operating correctly, will quickly employ a team of specialists, including:

  • VP of Operations: This person should be an expert in replicating the business model, accelerating new franchisees through the learning curve and maintaining brand integrity. They will build and manage a team of operational support personnel who will act as business consultants for franchisees to identify areas of breakdown and bring in specialists where needed.
  • VP of Marketing: Someone in this role will provide the expertise in new customer acquisition, increasing customer frequency, increasing average customer transaction revenue, increasing customer retention and loyalty, and creating a brand identity.
  • VP/Director of Franchise Development: This expert will identify your value proposition as a franchise opportunity, craft your franchise sales process, CRM, systems, maintain FTC compliance and recruit, train, and develop successful franchisees.
  • Director of Training: This person will work with the VP of Operations to craft learning systems for new franchisees, which will accelerate them through the learning curve and past breakeven as quickly as possible.
  • CFO: The CFO will create, track, and manage the franchisor's financial plan, secure financing for franchisees' initial capitalization and expansion, reduce the franchisor's tax burden, and manage budgets.
  • Founder/CEO: The leader sets the vision and long-term objectives, sets the culture and corporate values, and acts as a control tower, making sure all internal and franchisee relationships remain workable, and must also marshal the resources necessary to allow these franchisor specialists to execute their "A" game.

Many new systems underestimate how important it is to hire skilled staff early in the process. Many franchisors jerry-rig such things as by promoting a company manager or a family member who has no background in adult principles and who lacks understanding of how professionals from outside their industry learn new business models. The predictable outcome is a system where franchisees struggle rather than power through the learning curve and ramp up slowly.

Additionally, many franchisors hire outsourced franchise sales firms who have no commitment to the long-term of the organization. These firms are paid a large percentage of the franchise fee revenue, and often a percentage of ongoing royalties as well, which further delays the franchisors' ability to achieve royalty-self-sufficiency. Because banks and other potential investors evaluate the worth of the franchisor by the predictability of its recurring revenue streams, these franchisors find out too late that this has wiped out a significant portion of their equity value and creditworthiness the moment the ink was dry on the contract.

We recently spoke to the owners of a QSR chain who signed a 10-year, no-cut deal with no performance guarantees with a franchise brokerage firm. The brokerage firm receives 30% of revenue and a percentage of royalties on franchisees recruited. The brokerage firm has not produced a fraction of what was promised. The chain needs an equity injection to keep going. Investors are balking because the franchise brokerage firm, rather than the franchisor, receives most of the value. This is a chain that might have grown to 200 units, but will most likely bleed out before they open 30.

There are excellent outsourced franchise partners out there, but there are also sharks. Check references. And never pay royalties.

Next time: Investing your first million, getting educated, and launching your concept

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.

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