Franchising and Growth

1
Franchising and Growth

• The Academic Debates

2
Survival and Growth Rates

• Why is a growing franchise system different?
• Investors (franchisee) risk is not limited to
  the value of the initial investment but must
  include opportunity cost of labour
• Many new franchisees already have a history of
  self-employment the benefit is a proven business
  formula.
• How certain is the survival of a new system?
• US and UK data confirm that there are high
  failure rates amongst young franchise systems
• These are at a level typical to small businesses
  in general
• Which undermines the message of low risk and high
  success rates usually communicated
• A broad pattern of survival is that young systems
  are more likely to fail than old, very small are
  more likely to fail than their larger
  counterparts.
• The most powerful influence on survival is
  whether or not they grow within a short period
  after start-up

3
Survival The Franchisor

• The development of a business from a proven
  concept to sale is typically long, expensive and
  risky.
• There are sizeable upfront costs
• 28.6 of 1980 US franchise system start-ups
  survived to 1992 overall of 2,524 firms entering
  the franchise industry 1,941 exited (Lafontaine
  and Shaw (1996). 138 US franchise systems 24.6
  survived 10 years (Shane, 1996)
• UK franchising 1,658 (1984-1995), 601 remained in
  existence (36) at the end of the period (Price,
  1996).
• High entry, impression of growth, high exit.
  Firms choose to stop franchising because the
  system fails or does not fit the firms
  strategies for growth.

4
Survival The Franchisee

• Despite the widely documented view that 92 of
  franchises are still in business at the end of
  five years versus 23 for independent firms
  reports to the US government indicated real
  number of failures was unknown (Franchising in
  the Economy, 1988).
• IFA claims that 96.9 of franchised units reach
  five years (1992)
• Data complied by surveying franchisors, rather
  than the actual franchisee owners
• one of the major selling points of franchising
  over the years has been the statistics on low
  failure rates. These statistics never had a real
  scientific basis Lafontine, 1995.
• Birkland (1997) noted in a PhD thesis on King
  Cleaners franchisees that they regularly
  disappeared 30 discontinued outright and 5.4
  sold the franchise

5
Survival The Franchisee

• Small business formation statistics from the US
  Census Bureau also contradict the IFAs claim. A
  sample of 20,554 (1991) between 1987 1991 34.7
  of the franchisees and 28 of the non-franchised
  young firms had discontinued operations.
• See Bates (2003) for a detailed study
• In summary, franchises closely resemble the
  broader universe of small business start-ups.
• Failure prone young firms tend to be small,
  poorly capitalised, where the owner works
  part-time and the very youngest are the most
  prone to shut.
• Franchisees differ from young small businesses,
  i) better educated owners are not more likely to
  see their firms survive and ii) the ongoing
  characteristic of the system is directly related
  to enhanced likelihood of firm closure.
• Risk preferences may influence franchising
  survival rates. The more risk-adverse choosing
  franchise systems
• Self-employment or business formation is not made
  safer by investing in a franchise
• Franchisees starting out by purchasing a unit
  from a previous owner were riskier than starting
  out from scratch.

6
Franchising Growth Franchise Systems

• The notion that franchising in the US and
  internationally is growing is widespread
• Views are based on i) growth of various groups
  of franchisors who are growing intend to grow ii)
  The increase in new franchise opportunities
• Reports on growth developed ignore exit data
• The exit rates are quite sizeable (Price, 1997)
• In the US looking at every one of the years
  except 1976 the growth in the number of
  franchisors was greater than the growth in the
  number of units
• 1982-1995 the number of business format
  franchisors in the US did grow inline with growth
  in the economy
• No sign of phenomenal growth, at best the growth
  in business format franchising has mirrored the
  US economy and consolidated from 1995-2000
• In the UK franchising went through consolidation
  during the 1990s, growing modestly by 12 between
  1990-1995. When taking inflation into account it
  contracted during this period.

7
Entry and Exit

• At best one franchise system in four can be
  judged to be successful over a ten year period,
  around half the sample was judged to have failed
  completely.
• Entry and exit rates of franchisees are
  comparable with little or no growth in the
  general population
• High exit rates imply that many firms try their
  hand at franchising investing and hence losing,
  in most cases significant amounts of resources,
  but then decide to discontinue.
• Many of the departures cease operation, i.e.
  continue in business but dont franchise
• About half fail outright
• Large numbers of franchisees in fact face failed
  franchisors

8
Factors affecting franchisor exit

• Franchise fee linked to survival. The collection
  of higher franchise fees relaxes one of the
  constraints in the early years of growth, namely
  lack of funds.
• Franchisor rankings are not really a useful
  evaluation criteria for franchise survival and
  success
• Number of years of experience of the franchisor
  in the business format prior to launching the
  franchise linked to survivability might depend
  on the economic cycle.
• Franchisors who spend more time developing their
  prototype, operating procedures and documentation
  are more likely to succeed in franchising
• Most of the publicly available observables on
  franchising have little capacity to explain
  future success or failure

9
Franchising and Growth

• In Practice

10
A Model of Franchise Growth

• Similar to small business growth franchise
  systems experience common problems arising at
  similar stages of development
• Which can be defined as a sequence of
  identifiable stages

11
Hatchling

• Hatchling concept development
• decision to start
• ideas hatched and refined
• refines an idea for a product or service and sets
  up in business
• securing customers, delivering product common
  problems to SMEs

12
Nestling

• Nestling business development
• a commitment made to franchising
• testing of a conventional business configuration
  and a franchise format
• may be single or multi-unit businesses
• the business concept should be flourishing
• the concept should be tested in more than one
  location
• We are going to need a fairly good track record,
  so it is important that we get it right so
  potential franchisees can look at us with
  confidence and know that we have got the
  experience and the history to back them up
• development of systems of support
• testing and refining concept
• Development of infrastructure, documentation,
  team
• Can take 0.5 2.5 years depending on investment
• Often needs venture finance
• Nestling concentrates overwhelmingly on
  developing a business configuration and franchise
  format sufficiently
• There were a number of factors that we didnt
  allow for and developing the brand and
  developing the systems takes a huge reinvestment.
  So, everything that we thought we were going to
  make got reinvested in building a franchise of
  quality

13
Fledgling

• Fledgling- Initial Franchisees
• A critical step because the fledgling business
  embarks on the path to independent survival
• Franchisees required for fast growth to rapidly
  reach economies of scale before cash reserves are
  exhausted
• Quality franchisees are required
• Franchise selection processes must be evaluated
  and fine tuned frequently
• Franchise systems support, infrastructure and
  management systems are variously developed as
  limitations are identified
• That race is to get all documentation done and
  all systems in place and, at the same time, to
  get to a level where the franchisees are
  generating enough return to be able to be
  self-sufficient and be able to develop further
• Attracting franchisees for growth waived fees
  incentives employees trade fairs
• Location securing good sites important in the
  fledgling stage establish sites and operations
  before selling franchisees securing leases in
  advance
• Head office development effective franchise
  management team delegating managerial
  responsibilities capacity to support further
  growth.
• The response to franchisees demands was too
  long. We were burning the candle at both ends,
  always tired and almost anti-social. The house
  was getting neglected. But you get all this work
  and you have to service it
• Unforeseen problems unexpected problems can
  inhibit system development, e.g. a marriage
  break-up, local authority by-laws, volcanic
  activity and French nuclear testing

14
Adult stage

• The adult stage Franchise expansion
• Head office with some degree of functional
  organisation well-documented operating
  procedures for most aspects and networks of
  franchisees
• Primary focus strategic managing delicate
  franchisor-franchisee relationships maintaining
  the brand building and maintaining market share
  and reducing internal inefficiencies
• It is important for us never to get tempted to
  do anything that would in anyway upset the
  relationship with our franchisees and put them
  under pressure
• Its a vicious circle because enforcing is not
  easy and, at times, having the franchisee
  understand where the hell it is all at in terms
  of what we are trying to do in the marketplace
  they just cant see the wood from the trees
• The biggest problems we always have are with
  struggling stores. We put an extraordinary
  amount of time into working to support struggling
  store owners

15
Beyond Adulthood

• Logical development beyond adulthood is expansion
  into foreign markets