Threshold Analysis: Are You Ready to Franchise?

Part One: Minimum Benchmarks for Considering Franchising

Franchise
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While you may have an operating business with a long history and experienced management team when you begin the process of becoming a franchisor you need to first recognize that you are starting down the road of developing a new business — a franchise system. As a franchisor, you will be licensing your brand and your operating system to your franchisees, providing the initial and continuing support, managing and evolving your brand to keep the system competitive and sustainable, and continuing to grow the number of locations.

Your goal is to ensure that your franchise system has the ability to consistently and sustainably replicate your Brand Standards from location to location.

The design, development, and management of any downstream distribution strategy will require a degree of skill and creativity, as the success of every franchise system rests on the ability of the franchisor to maintain a beneficial relationship with its franchisees. But, there is an added dimension of complexity over other expansion strategies. The franchisor is in the business of setting and enforcing its Brand Standards, but it is the franchisees who execute the delivery system at the local level, and it is the franchisees who independently control the day-to-day management and operation of their businesses.

Managing a franchise system requires more than just having the expertise required to operate the underlying business that is being licensed.

Franchisors assume the added responsibility of being innovative and competitively evolving the underlying concept while growing their system. When they establish and enforce Brand Standards, they do so not just for the local consumers of the brand’s products and services but also for the protection of all of the system’s franchisees, the system’s suppliers, and the protection of the franchisor’s intellectual property.

This necessitates that a franchisor has an understanding of both their brand and their core competencies. It requires that they be willing and able to ethically manage the franchise system; anticipate events and market opportunities; to organize activities; and, to effectively communicate the system’s direction throughout the channel.

In directing the course of a branded system that is executed by others, franchisors need to be sensitive to the needs of the overall system. How they manage their responsibilities will have an impact on the underlying operational and financial performance of each of their franchisees. Franchisors select the prospective franchisees they allow to join the system, and franchisors are the ones principally but not exclusively responsible for providing their franchisees with the tools required by them to execute consistently to Brand Standards.

Before beginning an examination of whether or not your company can become a successful franchisor, you must first understand the dynamics of franchising. Taking the time to understand how other franchisors manage their systems will give you a foundation upon which to make important business judgments. Reading articles and books focused on the business aspects of franchising, in addition to obtaining a basic understanding of franchise law, will be essential.

Once those preliminaries are in place, when coupled with a well-structured design and development plan, competent management can execute a successful franchise strategy able to meet their goals and expectations. But, this will be true only if the concept they are franchising is franchisable.

Are You Ready to Consider Franchising?

There really is no issue of franchisability from a strictly legal viewpoint. There is no requirement under the law that the franchisor has ever opened and operated the type of location that is being franchised. Even if they have operated prototype locations, there are no requirements on the number of locations they have operated or whether the prototypes have been open for any minimum period of time. There is not even a requirement that any of the prototype locations have ever been profitable.

All the law requires is a franchise agreement and a disclosure document. But meeting the legal requirements is insufficient to actually be a franchisor.

It is always surprising when even large, well-established, international companies begin the process at the end — the development of the legal agreements. Presented with a lengthy questionnaire by their legal counsel, they are asked to provide information necessary to prepare franchise agreements and disclosure documents. The problem, though, is that the questions are often their only guide to how their franchise system should be structured. Without the benefit of evaluating business alternatives, conducting research, and fully exploring the strategic considerations, the franchise system ends up operating as a legal vehicle for expansion rather than what it truly should be, a business structure for expansion. Experienced franchisors understand that while the law is an element of franchising, it truly is a minor portion of the way franchisors manage their business, make decisions on its direction, or how they interact with their franchisees. Bottom line — almost anything can be franchised, and unfortunately, many companies that should never offer franchises — frequently do.

Conducting a proper Threshold Analysis before making the decision to start any franchise system is the prudent first business step, and should occur before you invest in the design of your franchise system; before you have your legal counsel prepare the necessary disclosure documents and legal agreements; and, before you invest in developing your franchise recruitment material.

But even before you invest in conducting a Threshold Analysis to determine if you should franchise, here is a simple test to first determine if your business is not ready to franchise. If:

  • The business you want to franchise is only a concept and has not yet commenced operations;
  • You have an operating location but it only has limited operating history;
  • Your operating locations, regardless of how long they have been open, have not consistently been profitable at the unit level; and
  • You have not consistently achieved a reasonable return on investment at the unit level; then,
  • …you are not ready to franchise your business.

The minimum benchmark for whether you are ready to even consider franchising should be that you have operated your business for a sufficient period of time to fully understand its dynamics; that the business is profitable; and, that its profitability is sufficient to provide a return on investment.

Your franchisees will be relying on your experience in operating the business, and if that experience is negligible, all that you are really offering potential franchisees is a “theoretic opportunity” and the opportunity to be your guinea pigs. When the system is not ready for franchise expansion, the risk of failure for both the franchisor and its future franchisees is quite high.

In The Threshold Analysis, Part Two, examine in depth how to identify the criteria to use in determining your franchisability, and start to describe the major Threshold Analysis buckets MSA typically uses.