One of the things that makes certain businesses more successful than other businesses over long periods of time is the presence of franchise value. A company with franchise value can often sell more measurement units of its products and services, resulting in higher revenue, and generate more net income applicable to common than other businesses in the same sector or industry.
As long as the capital structure is intelligently managed, businesses with high franchise value can more easily survive periods such as the Great Depression of 1929-1933 or the Great Recession of 2007-2009. Though you may not be familiar with the concept, businesses with high franchise value have such distinctive characteristics that by the time you are done reading this article, you will probably be able to name five or ten of them off the top of your head. Before we get into the details, though, let's define franchise value.
What Is the Definition of Franchise Value?
Franchise value does not refer to the traditional franchise business model, but instead is used to describe a company or brand that has such superior popularity it has extraordinary "mindshare" among consumers.
In your own mind, you probably link bleach with Clorox, tissue with Kleenex, soda with Coca-Coca, Pepsi, or Dr. Pepper, soup with Campbell's, coffee with Starbucks or Dunkin Donuts, fast food with McDonald's, and chocolate with Hershey's. Apple, Google, and Tesla all have high franchise value as well.
There is something unique about each of these products that make them stand out from others and that causes people to go out of their way to buy them, even if they cost more than a competitors'
How to Spot Franchise Value in a Business or Brand
The quickest way to determine if a business or brand has high franchise value is to ask yourself a series of questions.
- Am I willing to pay more for the brand (e.g., Hershey's) as opposed to another, cheaper brand (e.g., the generic chocolate bar)?
- If a store didn't have the brand in which I was interested, would I walk across the street to buy the product I wanted due to it being better or me having more trust in it?
- If I started a business in direct competition with this product or service, what are my chances of success? Would I be able to make a dent in its market share or is the product so firmly entrenched it would be difficult to wrestle away even a small portion?
Why Companies with High Franchise Value Make More Money
You may wonder as to the reason the owner of business possessing high franchise value tends to enjoy more prosperity. The reason is simple: if a product or service has strong consumer demand and affinity, the company that manufactures or offers that product can raise prices and earn more money overall.
Alternatively, for alternate business models, it can achieve such economies of scale that it is able to reduce its prices below what competitors can comfortably sustain, still earn hefty profits, and drive others out of business.
The company that does not have franchise value is forced to compete on a price or service basis, which it may not be capable of doing depending upon the specific economics of a sector, industry, or market. For the business without franchise value, this can be a disaster, particularly in an industry with high operating leverage. The major airlines are a good illustration.
Determine Your Investment Results Over the Long Run
Due to the laws of mathematics, the return you realize on an investment is absolutely dependent upon the price you paid. Paying too high a price for any asset in relation to its conservatively estimated intrinsic value moves the investor out of the realm of investment and into speculation.
That said, time and time again history has shown that when an investor has a chance to buy a great business with a tremendous amount of franchise value, he or she may want to seriously consider foregoing the wait for a steep discount and, instead, acquiring it whenever it is trading at or near a fair price.
Owning a company that is capable of producing sustainable high returns on equity is one of the great joys of life. Given a long stretch of compounding, it can be life-changing. I'd go so far as to suggest a good motto, given the reasonable valuation, might be, "When in doubt, invest in the excellent business."