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Is Franchising the Way to Go?

by John R. Ingrisano, SBO

Many small-business owners (SBO), and would-be SBOs, wonder if they should go it alone, independently — or jump into the franchise frenzy. It can be a tough call. The right answer has to do with balancing risk and independence.

Dealing With Risk
There's no way to completely eliminate risk from business. It comes with the territory. The key is risk management, based on the rough formula that says: the fewer variables (risks), the greater the probability of success.

That's the principle behind the phenomenal boom in franchising — from auto dealerships (which were among the original franchises) to fast food, print shops,lawn services, accounting, pest control, and more. That's also why, over the last several decades, the franchise form of doing business — now with thousands of franchise companies and better than half a million franchise units in operation — has changed the way small business does business in this country.

Franchising is not new. The first franchises appeared shortly after the Civil War (established by the Singer Sewing Machine Company and other large corporations to distribute their products). The idea took off early in the last century with the rise of auto dealerships. But franchising has truly come of age in the decades after World War II with the boom in retail and service franchises.

The franchise concept is simple. The franchisee or franchise buyer purchases a legal right to sell a good or service from the franchisor. This includes the parent company's trademark and other services. In return, the franchisee agrees to certain restrictions and pays ongoing fees.

That's perhaps why franchises have become the domain of the SBO. In fact, about two-thirds of franchises are organized as single establishment sole proprietorships, with approximately 5 employees per establishment.

Franchises Reduce Risk
The number one advantage of franchising for the business owner is risk reduction. Purchasing a franchise gives franchisees the opportunity to build a business of their own, but not necessarily on their own. They share in the expertise and support of the parent company.

This is especially significant in the start-up, since new businesses, as a group, have the highest failure rate. However, franchises from established companies generally have a lower failure rate than businesses either started from scratch or bought as a going enterprise.

Other Pluses for Franchise Buyers Include

  • Availability of start-up funding and ongoing credit (a key factor, since many banks are reluctant to lend money to start-ups, and many start-up companies fail due to under capitalization).
  • The ability to tap into the established goodwill and logo/name recognition of the franchise.
  • Ongoing professional management support, training, and promotional assistance.
  • Cost savings for supplies and equipment.

Each of the above benefits reduces the risk factor for the franchisee, thereby increasing the probability of building and maintaining a successful, profitable operation.

But There Are Negatives.
Among these are:

  • Start-up costs can be high, from several thousand to several hundred thousand dollars.
  • Loss of independence. As one franchisee explained: "You might feel more like a worker or a junior partner than a boss."
  • Limited, if any, control over product line and pricing.
  • Ongoing revenue-splitting, with the franchise company receiving from 1% to 20% of gross, with the average being 4%.
  • Potentially heavy administrative paperwork, since a high degree of documentation must be provided to the franchisor.

Perhaps the greatest drawback is lack of equity in the business. The franchise contract often includes a buy-back clause that sets the price at the time of the franchise purchase. Under most circumstances, the franchisee does not have the option to sell on the free market the business he or she has built. It is possible that a franchise purchased for several thousand dollars, then built up to a multi-million dollar enterprise, will revert to the parent company upon termination of the agreement for little more than the original purchase price.

Is Franchising For You?
Only you can decide. For many SBOs, the freedom to run your business the way they see fit is crucial. Still, many of these folks do end up nose diving into business failure.

Our Recommendation
If you have the entrepreneurial bug, do your homework. Two good places to start are The International Franchise Association (www.franchise.org), a rah-rah organization promoting franchise growth, and the American Franchise Association (www.franchisee.rg), which serves as the voice of franchise owners. Whatever you do, good luck and good business.


John R. Ingrisano is co-founder of www.SmallBusinessOwner.biz. He is an author, marketing consultant and small-business owner since 1986. He can be reached at jri@smallbusinessowner.biz.

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Is Franchising the Way to Go?

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