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Recent years have seen the rapid expansion in Australia of a phenomenon known as franchising. In fact, it is almost impossible to drive down any main street in Australia today without passing a franchised business. Currently it is estimated that the franchise sector accounts for nearly 4% of existing business numbers, and a massive 30% of retail sales volume. Between 1987 and 1994 alone, Australian franchised sales grew from just over $14 billion to a staggering $42.7 billion per annum (according to the Australian Bureau Of Statistics) - and the growth is still continuing. Fuelling this exponential sales growth has been the emergence of over 700 new franchise systems, a huge increase from the 184 opportunities available in 1988.
Today there is no shortage of advertised franchise opportunities. Naturally, with such a differing array of opportunities to choose from, finding the right franchise for you is often a daunting task. You only have to look at the business opportunities section of various newspapers and magazines around Australia to see that supply is far outstripping demand. For you, the potential franchisee, making the right decision in such a climate is imperative - your livelihood depends on it. To make the right choice though, requires you to be fully informed and armed with the tools to help make your decision a successful one.
What is Franchising?
When a business licenses its tradename and operating systems to a third party in exchange for a payment, and exercises some control over the operation of that third party, the business generally is defined as a franchise. In order to understand franchising, it is important to recognize that McDonald's does not "franchise" hamburgers nor does Midas "franchise" mufflers. What they both franchise is a business system-and it is that system that delivers the products or services. It is the entire method of doing business (the name, the product, the decor and the methodology of delivery) that is franchised.
While sophisticated investors are becoming a major force in franchise ownership, it has been the individual, investing in a franchise opportunity, that has fuelled franchising's growth. Franchisees typically express their reason for buying a franchise as a desire to achieve the Great Aussie Dream of financial security and independence.
Franchisor Control
For a franchise system to be successful, the franchisor must control the system, and the franchisee must follow the methods laid down by the system. The principal reason for this control is to safeguard the public's ability to rely on the franchisor's trademark as an indicator of the system's products or services, knowing that these products or services will be delivered consistently from location to location. In simple terms, it's knowing that a Big Mac is a Big Mac, no matter which McDonalds outlet you purchase it from. The public becomes accustomed to a certain level of quality and consistency from brand-name franchises, and it's this brand identification which makes it easier for new franchisees to compete with well-established independent and chain operations. Another reason for the franchisor maintaining control is to protect the franchisees themselves, who are reliant on the franchisor ensuring that other franchisees do not do harm to, or diminish the value of the business.
Considerations when Buying a Franchise
Your decision to purchase a franchise should be based upon two broad understandings:
Franchisors, having survived their mistakes while developing the franchise and operating their prototype locations, can guide their franchisees so they do not make the same mistakes. Upon joining an established franchisor, franchisees receive comprehensive initial training in the operation of the franchise system and in its product, services and methodologies. The franchisee benefits from the operations manual, site selection, store design and continuing system support which would not be available had they started independently. They not only have their franchisor as an experienced partner from whom they can get answers, they also have the network of other franchisees that can provide added assistance in the continuing operation of their business.
In essence, many of the major stumbling blocks which could lead to failure are removed by a good franchisor. These franchisors prepare their franchisees for the business and then continue to support them. A statistic often cited about small-business failure estimates that over 80 percent of independent small businesses fail in the first three to five years. A recent study conducted by Edith Cowan University in Western Australia shows that franchisees are 2.5 times less likely to fail than independent small businesses.
"Failure," as commonly used in franchising, must be carefully understood by the prospective franchisee. Business failure refers to the closing of the location's doors, on a permanent basis. In a franchise system, statistics on failures do not include franchised locations which are repurchased by the franchisor, and continue in operation as a company-owned location, or as a location resold and operated by a new franchisee, at times with a financial return to the original franchisee.
Franchisors will often acquire locations for strategic reasons, which may include a desire to operate more company-owned locations or because a franchisee is not performing to standards. Instead of terminating the relationship through litigation, the repurchase of a franchise may be the most attractive route. On the other hand, franchisees often sell or abandon their businesses because they have not received the rewards they expected, or for other reasons including retirement or the desire to change their life patterns. Therefore, it is important when discussing failure rates with any franchisor that you ask about reacquisitions and transfers. Request the names of those franchisees involved in the transactions and determine for yourself why the businesses were sold.
Critical Decisions
Ensuring that you have enough working capital to sustain you in the start-up period is crucial, and poses a major risk for new businesses. Will the location selected provide the business with sufficient customers? Is the size of the location too large or too small? Is the rent too high? How many employees are required, at what times of the day, and how much should they be paid? Is the equipment selected the best for the operation and is the price for the equipment fair? These and hundreds of other questions must be considered and answered. Well-developed franchisors have experience in starting and operating the business the franchisees are going to operate. They can guide their franchisees as they make these critical decisions. That experience lessens the franchisee's chances of making mistakes, helps them to avoid underestimating their capital needs and, therefore, reduces their risk of failure.
The difference in failure rates between franchises and independent businesses is an impressive factor to consider. Bear in mind though, that independent businesses do not fail solely because of poor-quality products or services. They often fail because they could not anticipate their capital requirements, and do not have the experience or resources to fully analyze the risks they face.
Advantages And Disadvantages
Franchising is not a perfect vehicle and has advantages as well as disadvantages. It is important for new franchisees to recognise that many apparent disadvantages inherent in franchising may, however, also be advantages. One factor that is often seen as a disadvantage is the public's perception of the system as a chain. When they receive great service at one location, they assume they will get great service at all locations. The reverse is also true. You will be judged not only by your performance but also by the performance of all of the other franchisees.
Therefore, when evaluating a franchise, make certain that the franchisor has the right in the agreement to enforce the system's standards and has strongly exercised those rights. You need assurance that performance standards will be enforced and enforced uniformly.
Limitations on territorial rights may restrict your market and income, but they allow other franchisees to contribute, as you will, to the system's advertising fund and provide the critical mass needed for the system to compete effectively against the competition. The possibility of being terminated for failure to follow the system, and the franchisor's right to approve the people to whom you may want to sell your business, protects you from other franchisees who may not perform as well as you and to whom your success is tied. Therefore, some of the restrictions placed on a franchisee can also constitute an advantage for the franchisee.
A prospective franchisee needs to have realistic financial expectations. Having unrealistic expectations is the greatest potential disadvantage of starting any new business, not just a franchise. Advantages and disadvantages of franchising will be further discussed in the following chapter.
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Evaluation - Industry and Self
Select an industry that meets your personal needs and likes. If working twelve-hour days, seven days a week is not your idea of fun, make certain the franchise industry you select offers better hours. If you need a certain income each year to support your family, make sure that the other franchisees in the system you select enjoy that level of return. Your answers will come from two main sources: personal meetings with the franchisor, and your contact with other franchisees already operating in the system.
Begin your examination of the offerings in the industry that meets your needs. The obvious choice may be the well-established company with hundreds of franchisees, but keep in mind that many of the newer business opportunities have entered the market with innovations that older systems may find impossible to incorporate. Also, older systems may be less flexible should you want to negotiate any terms of the franchise agreement. Newer systems may be more willing to negotiate.
Again, this may be a double-edged sword. Franchising's strength is in its consistency. Should the franchisor be willing to negotiate with you on significant issues, they are likely to do so with others. Be wary of franchisors offering concessions which seem "too good to be true". This may be an indication of cashflow problems within the system. Even if this isn't the reason, bear in mind that another term for flexibility is inconsistency, and inconsistency is not what you or the public wants from a franchise system.
Contact each franchisor in the industry and obtain their information package. Read it carefully and write down your questions about the companies. Remember, a glossy brochure and a great franchise salesman are not good reasons to select any company.
Try to understand the philosophy of the company and identify their customers. Compare their services and their fees with those of others in the same industry. Lower fees should be the least important reason to select one company over another. If one franchisor charges high fees but provides the best services, the high fees are a bargain. If the fees are low and the services are inconsistent or leave you to operate independently, why buy the franchise in the first place? Once you have received and reviewed the information about the companies you contacted, select those which meet your criteria and arrange to meet the management and staff. Allow the franchisor to introduce you to the system, the services and the key personnel. Ask questions when you visit the headquarters and do not accept superficial answers. Remember, the franchisor is likely to have a very polished interview process and has been through this many times before. This is likely to be your first time.
Be Prepared
Come prepared, with your questions written down. Do not hesitate to ask them. Do not be reluctant to probe for further information. Buying your franchise is likely to be one of the most important personal business decisions you will ever make, so you must base this decision on a firm foundation of information.
Disclosure Documents
At your first meeting with the franchisor you might receive a copy of the franchise disclosure documents. The disclosure documents should provide you with a wealth of information on the franchisor and the system. Areas covered by the disclosure documents should include: the management and key staff's experience in managing the franchised business; its litigation and bankruptcy history; the cost of opening a franchise, initial and continuing fees. The documents should include an explanation of the relationship and responsibilities of the franchisor and franchisee, together with financial information on the franchisor. They also should provide information on the number of franchises opened and closed and, most importantly, a list of franchisees.
Regardless of how much you want to invest in the franchise, after meeting with the franchisor, you should always review the offering circular with an experienced franchise lawyer or consultant and your accountant. Good franchisors understand that this is a very important decision you will make. They should not pressure you to buy their franchise until you are satisfied that the franchise is right for you. Be wary of franchisors who pressure you to "sign up" before you are ready. Once you have made the decision to go ahead and buy a particular franchise, the Franchising Code Of Conduct requires a cooling-off period of a minimum of 7 days from the date you are given the franchise agreement. Use this time wisely and seek outside counsel and advice.
Talk To Other Franchisees
Call as many franchisees as you feel necessary before buying a franchise. Also, visit as many of the franchisees as possible. Just because a franchisee is unhappy in the system, it is not always a solid indication that the entire system is bad. In every franchise system, there may be at least one, or maybe several, unhappy franchisees. See if their dissatisfaction is a widespread concern.
It is critical that you base your financial assumptions on many sources: the information available from the franchisor, information obtained through your discussions with existing franchisees, information from articles about the franchisor and the industry, and your visits and observations at the franchised locations.
A Final Piece of Advice
A final piece of advice in selecting your franchise is to suppress your emotions. Never buy a franchise based upon the sizzle of the brochure or the salesmanship of the franchisor. Base your decision on the quality of the investment and on the available facts. Make certain before you invest in a franchise that it will benefit you both personally and financially.
The above is an extract from EBC's Buying a Franchise guide and software package - a publication written specifically to protect the interests of prospective franchisees. EBC has spent hundreds of hours independently researching, collating and publishing what is arguably Australia's most comprehensive guide to buying a franchise. The guide will take you step by step through the selection process, showing you how to evaluate yourself and the franchise, provide you with checklists and all the important questions to ask when doing your research, reveal common traps to watch out for and how to protect your interests, and guide you in compiling and writing a professional business plan to help win over the bank.
Now, it is up to you to select from the multitude of opportunities available. Purchasing a franchise is an exciting decision to make. Take your time, complete your examination, ask thorough questions,
do not be intimidated... and select carefully.
This information is provided by the Entrepreneur Business Centre. For small business products and services, visit
www.ebc.com.au.
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