Brent van Staden explains what you need to know before becoming a franchisee.
The rationale for business format franchising is that consumers are attracted to franchise businesses more than others, because they have a highly appealing brand and because consumers prefer the consistent presentation, standard and quality of the offering created by the franchise system - often because of successful, centralised marketing. For example, McDonald’s is a household name because of marketing and one can expect a McDonald’s burger to be the same, everywhere.
There is a compelling logic to business format franchising. Ideally, the system should provide a comprehensive business model. This includes the product or service, branding, marketing, business and strategic planning, operational standards, systems and formats, training and quality control, as well as ongoing guidance and supervision.
In these circumstances, anyone should be able to operate the business with little previous experience and the franchisee should benefit from the knowledge and experience of the franchisor. A good franchise should also enable the franchisee to achieve supply and procurement efficiencies it would not get on its own.
From the franchisor’s perspective, the benefit is the ability to expand its business while reducing both the capital it requires and the business risk.
What are the disadvantages?
Franchise relationships are unbalanced. As a result, business format franchisees don’t have much discretion in how they run their business. And when things go wrong, it can be difficult for the franchisee to resist legal steps by the franchisor to terminate the relationship and recoup its losses.
Secondly, franchises usually entail an upfront cost to the franchisee and ongoing royalties, over and above the cost of running the business. Furthermore, franchises are often for fixed periods, limiting the time available for the franchisee to obtain the desired return on its investment. We have seen this problem arise even in some of the blue-chip franchises operating in Australia.
However, most problems arise either when franchisors do not have systems strong enough to deliver on their promises or the franchisees’ expectations, or the financial modelling underpinning the system is flawed because revenue and cost assumptions are wrong and the fees are too high. This problem is more acute in newer franchise systems.
Should you take the plunge?
If you are considering becoming a franchisee, you should read and understand the franchisor’s disclosure document, test the financial model, speak to other franchisees and ensure that the franchise agreement goes no further than necessary to protect the integrity of the franchise system. In other words, professional advice is absolutely indispensable.
Generally speaking, the more mature the franchise system, the lower the risk, but due diligence is still critical to making the right decision. Mature franchises generally demand a higher entry and ongoing cost to the franchisee, which has to be balanced against the advantage of trading under a well-established brand.
Brent van Staden is a commercial lawyer in the Brisbane office of Colin Biggers & Paisley.
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