How Profitable Are Franchises

[Bryan James]

How profitable are franchises? They vary from not profitable to extremely profitable. Sort of a broad question...

 

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[Walter Hay]

How profitable are franchises? They vary from not profitable to extremely profitable. Sort of a broad question...

That is a very important question. There are a few factors that help determine profitability.

• Profit margin for the franchisees. The higher the sustainable margin, the higher the royalty % can reasonably be set.
• Effectiveness of the system. If it is easy to follow, the franchisees will be less inclined to resent high royalties.
  
• Possibilities of scale for the franchisees. Provided the territory allotted is capable of supporting substantial and preferably ongoing growth, high royalties will be more tolerable.
  
• Great support is an important factor in justifying high royalties. Initially the franchisor has to handle most support unless he employs support staff. Ultimately the Master Franchisees handle support almost entirely unaided, but the franchisor must support the Master Franchisees.

Walter

 

[Private Witt]

That was relatively easy because the niche that I chose was relevant in all English speaking countries, and once proven in one country it was not difficult to sell in another. In case you do set your idea in motion, I will give you a brief outline of how it worked for me.

In my home country I set up branch operations employing commission sales people. Once that territory was bringing in good profits I advertised it for sale as a going concern and had no difficulty selling the franchise.

When starting in each new country I did informal market surveys, personally visiting a number of prospective end users across the country, with what amounted to a preselling approach. The reception I received showed that the product quality and service problems that I was addressing were widespread.

I already had a fully functioning system, and began advertising the franchises. Back in 1992 when I began international franchising, I was able to sell those greenfield franchise licenses for $30,000, equivalent to close on $55,000 today.

After the second country was established I was able to sell a greenfield Master Franchise for $150,000, and set about selling the initial sub franchises for the new Master Franchisee.

From then on the Master Franchisees were responsible for growth, and their existence made it possible for me to relax because they had to deal with the individual franchisees on a daily basis. I just banked checks.

Walter

Thanks for this info and other posts on this thread!

 

[Walter Hay]

So far I have written from the perspective of a franchisor, but after going right through this thread I can see that there is probably more interest in profitability as a franchisee.

Here is my take on that.

For a start I would agree with those who consider being a franchisee as slowlane, but there are exceptions to that rule. The most common exceptions would be those in which the franchisee is himself or herself a competent business person, combined with the franchise system being inherently profitable, and the franchisor not being afraid of losing control as a result of that person's success.

A Master Franchise is another exception. That can be very fastlane indeed. If the franchisor has built a successful network with happy franchisees, profitable for both franchisor and franchisees, and wants to expand by granting Master Franchises in viable territories, that presents a very attractive scenario for taking on a Master Franchise.

It's true that Control is not complete, but if the Master agreement is worded the right way, the Franchisor could and should remain at arm's length, providing back up help and advice as necessary, but leaving the running of that territory to the Master Franchisee. Check the contract and get your attorney's opinion of the effectiveness of your executive freedom clauses.

From my own experience as a Franchisor I can say with a measure of pride and satisfaction that the franchises I sold were highly profitable, yielding in almost every case a net profit equal to approximately 4X the average annual income of workers in the country where they operated. Product prices were set relevant to each country in order to maintain that level.

Even one franchisee in Australia achieved that level despite living near a beach where he spent a lot of time in business hours surfing.

Having dealt with those exceptions, I would now generalize and say that in my view franchisees are generally only buying a job. Income can be dependent on effort, but there are often limits to how that works.

In short, a franchise would have to be quite exceptional for me to recommend a purchase.

Walter

 

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[ZF Lee]

There is a huge range of businesses that can be franchised, from manufacturing through services, to wholesale and retail.

Franchises in the restaurant and fast food industries are notorious for their oppressive restrictions, but many franchise systems have rules that I consider unreasonable.

When I instructed my attorney to prepare a standard franchise agreement for me, he nearly fell off his chair when I emphasized that I wanted it to be fair to both parties, and if it was weighted in one direction or the other, it was to favor the franchisees.

It turned out to be the shortest franchise agreement he had ever written, but it worked perfectly. I believe the equitable terms prospective buyers found when first viewing the contract was a major factor in making it so easy to sell the franchises.

Over the 22 years that I ran my franchise empire, spread over four countries, I only had a problem with one franchisee, and I had to terminate the agreement due to his failure to pay royalties.

Friends have occasionally asked me to review franchises they were contemplating buying, and in every case I had to tell them that I would not buy one like the one they were considering. Good franchises are hard to find.

I know of some franchises that are designed to fail!

One in particular worked this way: Turnover and profit figures from one successful franchisee were used, but they didn't disclose that the franchisee had received special treatment that made sure he did well.

When one of the numerous franchisees failed, the franchisor happily terminated the agreement and sold that territory to another unsuspecting buyer. Those repeated lump sum fees were what made that franchisor rich.

Being a franchisor is a great way to scale and you can do it rapidly if you have a good system, including good marketing and high profit margins.

If you decide to go down that road, I hope you will learn from my experience that treating your franchisees well pays great dividends.

Walter

Splendid write-up. Rep+
I think this applies to partnerships or cooperations in general.