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The Franchise Alternative
by Elena Fawkner
ANY new business involves risk. The proportion of new
businesses that fail within their first two years of operation is much higher than those that succeed. Whether
you can afford the risk of your business failing depends on your own individual circumstances.
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If you are continuing in full-time paid employment and your business is something
you start in your spare time for a little extra cash to see how it goes before quitting your job, then you are more
likely to be able to afford the risk of that business ultimately not succeeding. But what if you've lost your
job, taken a package, and are looking for a business in which to invest the proceeds of your package? All of a
sudden the risk of your new business failing looms very large indeed.
One way of reducing that risk is to consider buying a franchised business.
What is a Franchise?
Simply put, franchising involves the owner of the business
which is being franchised ("the franchisor") granting to the person who wants to offer the products and services of the
franchisor ("the franchisee") rights to use its trademarks, business names, associated intellectual property, know-how,
business systems, training systems and operating manuals in exchange for monetary payment in the form of an initial
franchise fee/purchase price and/or ongoing royalty payments which are typically calculated as a percentage of the
franchisee's turnover.
Advantages of a Franchise
-> Proven system
The franchisor has already done the work of establishing a system for the business being offered for franchise. This
system provides you, the franchisee, with a roadmap to follow, hopefully to success. The franchisor has already
tested and refined all aspects of the business and has created a "business success formula" for the franchisee to
follow. This means that you are spared the trial and error of working out what works and what doesn't and are therefore
freed to focus on "working the system", hopefully generating profits within a short period of time.
-> Avoid many start-up problems
Starting a business from the ground up requires a lot of time and effort just getting the basics in place. These
include major undertakings such as developing a reputation in the market place, obtaining finance to fund the new
venture and overcoming competitive threats, as well as the more mundane such as what business licenses to obtain and
what insurance cover to purchase. The franchisor will have already done a lot of this work. For example, the
franchisor will already have developed a reputation for the business in the market place, will have identified competitive
threats and opportunities incorporating ways of meeting them within the franchise system and will usually have already
established relationships with service providers such as financiers.
-> Existing name and reputation
As stated above, you do not need to invest significant time and effort into getting your business known in the
marketplace as the franchisor will already have done this for the benefit of the group as a whole.
-> Support when needed
You are not on your own when things go wrong. Got a business problem? Contact your franchisor for assistance.
The franchisor will have employed many different specialists within its organization who are there just to assist
franchisees successfully operate their businesses. In my 12 years of experience in franchising, the most successful
franchisees are those who are not afraid to ask for help when needed.
-> Group buying power
Depending on the size of the franchise network, the group should benefit from being able to negotiate favorable buying
prices because of their ability to generate volume sales for the supplier.
-> Group advertising
By contributing advertising fees into a group fund, individual franchisees are able to benefit from much greater
advertising exposure than they could afford if each franchisee had to market their business on an individual
basis.
-> Greater knowledge base
The franchisor is likely to have invested in market research for the benefit of the group as a whole. This
means the group has a much greater knowledge of their market(s) than does the local
"independent" competitor. The results of this market research can be put to good use
in the group's advertising and marketing programs.
Disadvantages of a Franchise
-> Restrictions on autonomy
Because you are buying the rights to participate in a proven "system", the franchisor will be concerned that all
franchisees adhere to the system and not operate outside it. After all, if franchisees are free to adhere to the system or
not as they see fit, there is no point in buying into a franchise at all. For this reason, for the benefit of the
system as a whole, franchisors will generally impose strict controls on things such as the quality and types of
products and services that you may offer for sale, the types of local advertising you may undertake, methods of dealing with
customers, ethical conduct and the like.
-> Pay initial franchise fee and purchase price
There may be an initial investment ranging from a few hundred to tens of thousands of dollars to buy into a
franchise.
-> Pay ongoing royalties
In addition to the initial franchise fee and purchase price, most franchisors will also charge an ongoing royalty for the
rights to use the franchised system. These royalties are usually calculated as a
percentage of turnover but various other fee structures exist.
-> Restrictions on ability to sell business
Some franchise agreements can restrict quite severely your rights to sell your business to another franchisee. They may
impose strict criteria for proposed purchasers and you may find it difficult to find buyers who meet this criteria.
-> May not be able to realize value for business on termination
Some franchise agreements state that upon the expiration or termination of the franchise agreement, the goodwill of the
business reverts to the franchisor. This means you may have operated and developed a business over many years and yet,
when the franchise agreement expires, you effectively walk away from the business with no further financial
compensation. Under this type of arrangement you must understand going in that you are expected to derive your financial return during
the term of the franchise agreement by way of annual profits, not by way of a capital gain at the end of the franchise term.
What to Look For in a Franchise
-> An established franchise system with a good reputation.
-> Comprehensive training systems for both your own
management team and other employees.
-> A relatively harmonious relationship between franchisor
and franchisees. Some friction from time to time is inevitable in any long-term business relationship but a
constant atmosphere of hostility, mistrust and long-running disputes can be a warning sign of an unstable system.
-> Ethical business practices both by franchisor and
existing franchisees.
-> An inclusive "partnership" approach on the part of both
franchisor and franchisees. This does not mean that the franchisor should not impose controls on the system but you
should look for a spirit of goodwill and cooperation, willingness to listen to others' ideas and a climate of open
communication at all levels throughout the organization.
-> Exclusive territories - although not crucial, exclusivity
of territory (where the franchisor grants you a limited but exclusive territory which is yours alone) can in some cases
be a relevant factor to the competitiveness of the business. It would be fair to say that it does not benefit the
franchise system if franchisees are forced to compete with each other for limited business.
These are just a few of the major factors you should take into consideration when deciding whether a franchise
is for you. Although franchising minimizes the risks of business failure, it cannot not eliminate them entirely and
any decision to proceed with a franchised business should only be made after obtaining thorough advice from both your
lawyer and your accountant.
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Copyright
© 2004 by Elena Fawkner
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