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Winter 2006 Franchising for Growth

You’re thinking of franchising your business, and you believe you have a pretty good idea of what franchising is all about. After all, franchises are everywhere—they’re an established facet of American business. And there are plenty of books and seminars and Web sites about franchising, so you know a thing to two. Right?

Ask Mark Siebert. As CEO of The iFranchise Group, Siebert has spent the last 20 years helping companies launch, refine or in some cases revive their franchise operations. He has attended countless franchise trade shows, where he watched a variety of well-intentioned companies launch franchise programs with lots of fanfare but little understanding of what they were getting into. After two decades of seeing new faces come and go, here’s Siebert’s first nugget of advice to business owners thinking about creating and selling their first franchise: Adopt a different mindset.

“A lot of franchisors go into the franchise business thinking that it’s an extension of their existing business—and it’s not,” he says matter-of-factly. “Franchising is a whole new business.” For example, Harry’s Hats: “If I’m in the business of selling hats in malls and I then become a franchisor, I’m no longer in the hat business,” he says. “I’m in the business of selling franchises and servicing franchisees. That’s a whole new business—and a whole new mindset that a lot of franchisors just don’t have.”

All right, now what. Does this mean stop thinking about franchising as a growth mechanism? No: it means think of it as trading your hat-selling business for your new business, the one that sells franchise opportunities to sell hats.

Sticker shock

Let’s be realistic from the get-go: Selling a new franchise isn’t easy. Complicating the issue is trying to sell your new franchise and grow your own retail operations at the same time. Siebert says the typical business owner has a tough time effectively growing company-owned outlets while launching a new franchise program. According to industry averages, the typical franchisor has to generate 100 leads to get three to four franchisees sign on the dotted line. And that can be expensive.

There are six basic methods for finding franchisees, and each one takes time and money. “Advertising costs per lead run between $100 and $250,” he says. “The average franchisor spends $5,151 on advertising for every franchise sold.” Siebert ranks the six methods from most to least expensive as follows: public relations, print advertising, trade shows, direct mail, the Internet, and referrals or walk-ins. “There are ways to optimize each one,” he says, but not every one of them needs to be part of the franchisor’s strategy.

Also provoking sticker shock is the cost of legal documentation for franchising (including state UFOC filings—see the “What’s a UFOC?” sidebar). Legal and filing fees usually run between $20,000 and $40,000, says Siebert. Tote up the various costs of lead-generation, marketing materials and legal documents, and you’ll see that getting into the franchise business can cost $50,000-$100,000. “And if you want to get into it aggressively, it’s going cost you more than that,” he adds.

With so much at stake, it’s no wonder that business owners want to know if their business is “franchisable,” and to what extent, before shelling out thousands of dollars and devoting innumerable hours to launching a full-blown franchise program. To help owners evaluate their franchise potential, Siebert and The iFranchise Group developed the 12 Criteria of Franchisability that help predict the likelihood of success (see sidebar). All 12 factors influence growth through franchising. But when it comes to franchisees’ return on investment, the one factor that trumps the rest, Siebert says, is the strength of the franchise business model.

Again, potential franchisors have to shift their mindset from Harry’s Hats retail operation, which operates under one business model, to Harry’s Hats franchise operation, which would operate under a very different model. As a franchisor, “[you] need to make sure that, financially, the business model works for [both the] franchisee and the franchisor,” says Siebert. The core element is “whether or not [your] franchisees can make an adequate return on their investment plus a return on their time—in other words, a salary if they’re an owner-operator—after deducting a royalty on that business.” Royalties are a percentage of gross sales paid to the franchise company.

Siebert says the franchisee’s return on investment (ROI) should be at least 20 percent by the second or third year of operation. Smaller returns mean unhappy franchisees, and unhappy franchisees can negatively affect your credibility as a franchisor and your ability to sell more franchises and continue growing. If franchisees’ ROI seriously lags, he says, “you’re going to have failed franchisees; you’re not going to be able to sell more franchises; and you might end up in litigation.” The one thing that the franchisor is not going to be doing, he says, is collecting royalties.

Franchise trends

The fact is, not everyone who attempts “going franchise” will be successful. It’s also a fact that not everyone who buys into a franchise will be a successful franchisee. With the negative effects of many failed franchises making headlines in trade and financial publications and even mainstream media, it’s logical that many franchise companies look for buyers with MBAs or at least extensive executive experience. Maria Anton, executive editor at Entrepreneur Magazine, has tracked franchise trends for more than 20 years. Anton notes that many janitorial/cleaning franchises, those that “people consider to be ‘blue-collar’ franchises,” are now looking for franchisees “with business backgrounds—people who can take these businesses and run them as a business and employ people to do the work.”

Another trend Anton has noticed is the increase in the number of franchise programs on the market today. “The industry is huge,” she says. “It’s always interesting when you hear of a new franchise, and you think, ‘Wow, they’re franchising that?’” (She recently learned of a “hemorrhoid-removal clinic” franchise, for example.) According to the International Franchise Association, there were 767,483 franchised businesses in the US in 2001 (the latest data available). Four years ago, these businesses had an economic output of $624 billion. No question that the numbers are even larger today.

Siebert and Anton agree that the growth of franchises often reflects trends in the larger business world. “Usually an industry becomes hot in general… and then franchises follow forth right after that,” Anton says. “Children’s businesses are very, very hot, whether it’s learning or enrichment or fitness,” she says, and senior-care franchises “have shown a lot of growth in the last few years.” (Here come those boomers again.)

Weight-loss and fitness centers are among the fastest-growing franchises today, Anton says. Curves International (Waco, TX) was the fastest-growing franchise in the US, according to Entrepreneur’s 2005 Franchise 500. Curves and companies like it “came out a few years back, and now there are maybe 15 or 20 franchises in [the women's fitness] category.”

Like Siebert, Anton has seen many promising franchise ideas fall by the wayside, often due to poor planning or a lack of insight into what makes a product sell in a certain market. “Someone could say, ‘Oh, you make such a great craft, you should franchise it!’” she says. “But then you don’t really… research it to see that maybe it’s [a craft that's] popular in North Carolina but people in California think it’s awful.” One key question franchisors sometimes fail to ask: Can this business be duplicated in a variety of geographic areas? Is there a “universal,” nationwide need or taste for what your franchise will offer? Because if not, expanding your existing retail operation may be the way to go.

Rule breaker

Adaptability, market trends, ROI ratios—all of these are important, Siebert says. And so is following the “rules,” the basics. But he readily acknowledges that “there are franchises that have broken just about every rule and have been successful” anyway.

Candy Bouquet International, Inc. (Little Rock, AK) is one of those companies. Candy Bouquet makes candies and accessories that are turned into colorful, yummy bouquets of candy instead of flowers. When she launched the Candy Bouquet franchise, Margaret McEntire decided to break the generally accepted rule about hiring a franchise attorney to draft the franchise agreement and UFOC. Instead, McEntire wrote her own documentation and sent the materials to each of the 50 states for approval. Each state sent back corrections, which she made and then resubmitted the paperwork.

When all was said and done, she not only had her franchises set up properly, but she had a franchise agreement that “was written in everyday language— language that a middle-aged housewife or woman could read—and that’s the person we’re targeting,” she says. And that may be one large reason that the response from potential franchisees was phenomenal. “They said, ‘Wow, we can read this! This is easy!” McEntire says. The agreement was “simple,” she says. And so was the structure: “No royalty, [just] a flat association fee. [Franchisees] were coming out of the woodwork.”

The Candy Bouquet association fee is a set monthly amount the franchisee pays in lieu of royalties. The lowest association fee is $50 a month for a fairly small territory: a town of 5,000 or fewer people. McEntire declines to reveal what the upper range might be. “I’ve got a franchisee in Japan who just e-mailed me 15 minutes ago and wants to buy all of Japan. I’ve got several people nibbling on buying all of China, and those franchise fees are quite a bit more… I’ve got several who own entire countries… [and] an Arab sheik who owns all of Saudi Arabia.”

Candy’s Bouquet’s franchise fee is also based on the territory’s population: the larger the population, the larger the fee. For example, a territory of 5,000 or fewer costs $3,600; one with 200,000-250,000 people is $29,000; and it goes up from there. McEntire credits her low initial franchise fee and the simple association-fee system with much of her success. The flat-fee structure makes the fees much simpler to collect each month, compared to royalties that fluctuate based on gross sales. (And—interesting to know—potential franchisees warned her years ago that “collecting royalties encourages us to cheat!”)

Candy Bouquet has two company-owned locations, both in Arkansas, and more than 750 franchise locations in 50 states and 45 countries. More than 40 percent of the franchisees operate more than one location, and five to ten percent operate mall carts or kiosks, some of them seasonal. Looking back, McEntire says when she first came up with the idea, she could see this “as something that could be all over the world—it had to be. I knew it had to be franchised from Day One… I’m certainly not the first person who tried [the concept], but I think I was the one who perfected it.”

Serving up support

Bite-size ice cream—cool! In 1988, Curt Jones perfected the technique of freezing tiny balls of ice cream cryogenically, and Dippin’ Dots was born. Jones then began offering people the chance to be Dippin’ Dots, Inc. dealers, serving up Dots from kiosks that could be located just about anywhere—malls, fairs, theme parks and more. It wasn’t until 2000 that the company began offering franchises through Dippin’ Dots Franchising, Inc., or DDF.

Charles Nelson, who served up Dippin’ Dots from his own retail location from 1995 to 2001, now serves as DDF’s director of operations. He explains why the company switched from dealers to franchisees. “Dealers were individuals to” he says. But according to various laws and regulations, he says, the value of the dealer’s business enterprise when sold was limited to the equipment value and nothing more. Plus, the dealers were pretty much on their own—little if any marketing support, for example.

“On the other hand, today a Dippin’ Dots franchisee has the franchise agreement, a stronger brand, a support system, equipment and intangibles such as good will, which by law can be totaled into the sales price of the business,” says Nelson. So this way, franchisees “have the opportunity to build value—equity—in their businesses as they work toward their financial or retirement goals. That’s a major benefit.” And it’s one reason the company now has more than 600 franchised locations operated by 172 franchisees. “We have locations in over 40 states, with our franchisees doing fairs, festivals and special events in all 50 states,” he says.

Nelson and the rest of the DDF team tackle a variety of tasks every day. Some of these tasks support franchisees directly; others help the overall franchise program run smoothly. Under the heading of “franchise development,” the company provides guidance to franchisees from initial screening through the award of the franchise. “Property development” involves building relationships with developers, identifying available properties, matching properties with franchisees, and reviewing leases. And engineering is another constant endeavor, providing franchisees with eye-catching kiosks, store-layout designs, and more.

Then there’s the area of franchisee training and compliance. Franchisees get their initial training in management and operations at HQ in Paducah, KY, and start-up training on-site when they open. Field consultants give Grand Opening assistance, and ongoing field support during regular visits. The DDF team also creates consistent, effective corporate communications to build brand awareness in the marketplace, provide franchisees with POS and other marketing tools, and protect the company’s trademarks and other rights and properties.

The DDF team also furnishes business-development information to help franchisees identify and take advantage of new expansion opportunities. And all of this is in addition to a recent $7.5 million Dippin’ Dots, Inc. plant expansion, greatly increasing the company’s Dippin’-Dot-making capacity.

“Next to the brand, support is what a prospective franchisee should be seeking,” Nelson says. Strong support is one reason a majority of Dippin’ Dots franchisees are multi-unit owners “or on their way,” he says. In addition to the relative ease of opening multiple locations, two of the factors that attract and retain Dippin’ Dots franchisees are the product’s popularity, and the low cost of entry. The initial fee for a Dippin’ Dots franchise is $12,500. Royalties are four percent of gross sales, and advertising fees are .5 percent of gross sales.

To find franchisees, “we do use trade shows, targeted ads and some industry publications, [but] our Web site by far generates the majority of leads,” Nelson says. “We have gone away from most of the online franchise lead-generators,” sites that list opportunities from a variety of franchise companies.

Switching hats

So: should you continue retailing Harry’s hats, or make the switch to Harry’s Hats, the franchise? Running your own retail locations certainly has its plusses. But so does taking it to the franchise level. And here’s one more key benefit of franchising vs. operating multiple company-owned stores or carts: Franchisees tend to generate higher sales and profits than retail location managers, Nelson says. Because franchisees have an ownership interest in the business, they provide “far better oversight” than employee managers do. “We really strongly encourage active participation by owner-operators,” he says. “Anybody in the franchise business will probably validate the fact that the performance of an active, involved owner operator will exceed that of a passive operator.”

Only you can decide which hat to wear. But if widespread expansion and growth are your primary goal, and if the answers add up and prospects look bright, going from retailer to franchisor may get you there faster—and more profitably.


Nancy Tanker

Nancy Tanker is the former managing editor of Specialty Retail Report. She has covered the specialty retail industry for nearly 15 years for a variety of publications and can be reached at srrtanker@mchsi.com.

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