This article appears in the November/December 2013 issue of Business Franchise Australia & New Zealand
Franchisors & Franchisees Beware – Identify Sustainable Points of Difference
When buying a franchise you are committing to a five to ten year venture involving an investment that may cost hundreds of thousands of dollars to buy.
You do so because you are looking for a business that can help you generate a strong income and an asset that can be sold for a premium when you are ready to exit.
So before you get too involved in reviewing marketing material and franchise documents, step back and ask the big questions:
• Why will customers want to keep buying this product or service from you over the longer term?
• How will the customers want to buy the product or service in the future?
• What is likely to happen to margins and profitability over time?
• Can the underlying concept and model be evolved to maintain a competitive advantage?
• Is the franchisor capable of keeping the concept and brand attractive in a changing market?
One of the great advantages of joining a franchise network is you benefit from the innovation, intellectual property and investment of the franchisor. This takes a lot of the risk out of starting up your business and can fast track your profitability and provide you with a support network for running your business.
However, franchising is not a guaranteed pathway to success in all cases. Markets change, technology changes, customer preferences change and also franchises change (or fail to adapt).
Franchising is a way of doing business – it is not the business itself. So like any business purchase it is important to do your due diligence, take professional advice, and form views on critical success factors and long term viability.
Over the years I have worked with many franchisors and start-ups. I love the commitment and enthusiasm of the business owners but their passion or thirst for growth can result in failure to properly address the customer and market fundamentals of their business. So as a buyer you need to be careful and look beyond the marketing pitch.
Alternatively, if you are a franchisor wanting to sell franchises, you should anticipate these issues and address them when developing your franchise or build them in to your strategic planning.
Let’s look at the big 5 questions:
1. Why will customers want to keep buying this product or service from you over the longer term?
This is about the unique selling proposition (USP) – what makes your goods or services more attractive to customers than your competitors’ goods or services? Sometimes the advantage comes through brand strength, other times through product innovation, smart retailing techniques, pricing or service.
The key thing to test here is sustainability of the USP over the longer term. Many products can be a short term success or fad, so what is it that will make your products or services sought after by customers over the five to ten year period?
2. How will customers want to buy the product or service in the future?
This is about distribution channels and customers changing their shopping habits. If you are buying a retail or store based franchise, ask why will customers keep coming to you to buy? Is it your superior location, your interesting fit out, your product range or your reputation for service?
Online shopping will continue to have a major impact as a growing distribution channel for many businesses. From a franchisor perspective it is increasingly important to have a multi-channel distribution strategy, where customers have a choice of channels to buy from you. But if you are a franchisee in such a business your rights may be limited to just your store, so the franchisor can sell goods online or through other means but you can only sell via your physical store.
Where a franchisor operates an online channel as well as a franchised store network, some franchisors recognise that stores play an important role with helping to build the brand or generating leads for online sales. Some franchisees may be rewarded or online sales that originated from their territory or area – this will depend on whether the franchise model includes territories and if the online sales can be accurately attributed to a franchisee or their area.
Given online sales are likely to increase in the future, franchisors and franchisees should look carefully at how the channels fit together and how they can complement each other rather than compete.
3. What is likely to happen to margins and profitability over time?
Most prudent franchisors undertake feasibility testing before launching and selling franchises. A key objective of this is to test the current and future viability of the franchise from both a franchisor and franchisee perspective.
For established businesses looking to add franchise capability this is usually easier than for start-up franchises because they at least have some historical trading data to use as a baseline. However, both scenarios are still trying to forecast the long term outcomes and in fast changing markets this is not an exact science and past performance is not always a good indicator of future performance. In fact, often a start-up franchise, usually seen as more risky due to not having a track record, can be better positioned for the long term because they do not have legacy systems or procedures that tie them to yesterday’s way of doing business. So if they have their strategy, supply lines and technology right, newer franchise systems can often operate a cheaper and more flexible business model, which may aid franchisee profitability.
One of the key trends in franchising over recent years has been towards low cost franchises, in particular service or mobile formats where no office or store is required and in turn, less or no staff. These formats run on a very low cost base and when economic conditions are favourable they have the flexibility to scale up rather than to be locked in to a high fixed cost base from day one. The other thing to consider is the pace and strength of future competition and technology impacts. This can drive margins down quickly, so to withstand this your franchise needs to have a USP that provides options other than competing on price.
4. Can the underlying concept and model be evolved to maintain a competitive advantage?
There are two issues here – the franchise concept and the franchise model.
Firstly the concept – even the most successful franchises like McDonald’s need to evolve over time. The introduction of their healthy choice menu and McCafes is a great example. Their market changed, and their customer preferences changed, so they had to adapt the concept whilst remaining true to their core brand values and business objectives. This is common in most industries. Consider one of the tough industries at the moment like video rental. With Foxtel, pirate downloads etc., many thought the days of the video store were gone but what we are seeing play out now are chains like Blockbuster and Video Ezy implementing smarter distribution channels. Their franchise stores can now offer self-serve video kiosks to extend their reach and access customers where the customers shop rather than having to come to the stores. Even in the Financial Services industry, franchise groups like RAMS Home Loans evolved to broaden their product suite with different types of loans and now even deposit taking accounts.
Secondly, the franchise model – I tell many of my franchisor clients that developing a franchise is like building a house. Once you have selected the right neighbourhood and block (your industry and competitors) you then need an architect to design the house to meet your requirements and then after that a builder to construct the house. For franchise systems the needs are the same. You need a professional design for your franchise model and then need it professionally built. People who DIY or don’t use an Architect usually end up with problems and an asset that is worth less than those who went about it properly.
A well designed franchise model together with well-prepared franchise documentation gives the franchisee the ability to deal with future changes instead of being locked in to old world paradigms.
Nothing is worse than watching your competitors adapt and succeed while you are still doing things the old way.
5. Is the franchisor capable of keeping the concept and brand attractive in a changing market?
Even if you have a well-designed franchise and agreements, it can all count for nothing if the franchisor is not tuned in to the market or is not willing or able to reposition the franchise to refresh the USP. Buyers need to carefully interrogate the franchise owners and key decision makers to test their experience, attitude, financial position, leadership, and visionary qualities that are indicators of propensity to lead and run a successful franchise over time.
One of the first things I discreetly test when approached to help a business owner franchise their business is “Are they likely to be a good franchisor? Do they have the rounded set of skills and attributes that go with being an entrepreneur, leader and innovator?” Then I look at the team around them and their financial depth to see if they have the right skills in the business and the financial means to see the program through over the longer term.
A buyer should look for similar elements. Many franchise founders are great small business operators, great sales people or great technicians – all of which are important qualities to underpin the business. However, being a franchisor is much more than that so buyers need to form a view on the franchisor and their team to determine if they are likely to keep growing and protecting the business in the changing market over the next five to ten year period that you intend to be a franchisee with them. Sometimes you may need professional help to extract this information, but it is essential to come away with a positive view because what may start out as an attractive franchise may over time fade or fail, leaving you with declining profitability and a business that is hard to sell. The flipside is you may take on a franchise with a dynamic group that will be a long term serious force in the market and in turn resulting in your franchise being highly successful and valuable.
So remember, look beyond the marketing material and before you jump into reviewing the legal documents get a good understanding of the underlying business USP, the sustainability of that USP, and whether the franchisor is switched on and capable of keeping your franchise ahead of the game in a competitive and changing market.
CEO Consulting specialises in developing, launching and growing franchise systems in Australia and international markets. Services include Strategy, Feasibility, Analysis, Franchise Model Design, Franchise Development, Marketing and Franchisor Support.
Robert is one of Australia’s leading Franchise experts and an authority on Franchise start ups. Formerly the Australian Head of Franchising for both ANZ Bank and Westpac as well as CEO of RAMS Home Loans.
For further information contact Robert Graham, Managing Director at CEO Consulting:
Phone: 1300 764 484