How To Develop A Franchise System: Part 4: What Makes a Successful Franchisee


The franchisor to franchisee relationship is integral to a successful franchise system. As a franchisor, setting up your franchisees for success is a sure way to grow your brand. This video explains what makes a successful franchise so that you can prepare your own franchise system, and explains the upsides and downsides of franchising from both franchisor and franchisee perspectives. 

Learn how to support your franchisees, your supply chain, and deliver to a sustainable market. Consistency is important in delivering an accurate representation of your brand. Successful franchisors know their market, know their community, and understand the environment of their franchisees.

Video Transcript:


Where are we today, fifty years after franchise rules come in and all these regulations? Franchising is an 890 billion dollar economic output in the United States. There's approximately 780,000 to 800,000 franchise establishments, brands. There are 8.9, close to 9 million people work in the franchise industry directly. Compound that with all the suppliers to the industry. 

Franchising is a huge part and a growing part of our economy. Ownership today, we're looking today at about 50 some odd percent of franchisees own more than one, but we still have totaled about 45% of all franchises are single-unit operators, building up to a smaller percentage where people actually own a hundred or two hundred of these locations. Multi-unit franchising is now part of our system. 

What makes for a successful franchise? What you're looking for is the ability to create critical mass. One of the mistakes new franchisors make, is they allow the phone call to tell them where to expand. When you're developing a franchise system successfully, you want to make sure that you can support your franchisees and you can develop critical mass, a number of locations in a market that will allow you to support your franchisees, your supply chain, your marketing to consumers. 

So, ability to build critical mass is important for a successful franchise. Successful franchises certainly have product and concept expertise. They are bringing to a potential franchisee a system for delivering the product and the services; there's an operating system.  Effective marketing goes on when you turn the TV on and you see an advertisement at the Superbowl for a brand that is relatively new, a brand that's probably 15 or 20 years old, it's because that brand as a franchise system had the collective resources from all of the franchisees and the ability to hire marketing people to create that advertising. There's market expertise and the market expertise, surprisingly, comes from the franchisees themselves. So, where a company has to do a lot of research, and we still do a lot of research in franchising, the local franchisee coming into the market knows the community, knows where people are shopping, knows where/when things are happening, and that market expertise is one of the reasons that franchising does so well. The franchisor has the benefit of getting their revenue off the top line generally on the franchise sales, but because we have this community and this collectiveness in franchising, often the operating costs of the franchisee can be lower.

Landlords want to have a brand that attracts people into their centers, and you can leverage that into lower rent with many brands; and you want to have the ability to support your franchisees in a host of different ways and we'll discuss those. 

When you're looking at what makes for a successful franchise, understand that the franchisee is coming to you, and even if they've been an executive at a major corporation, they've never run your business. They may not have ever run a small business. They may be used to calling up their secretary and asking them to make copies, or they've never opened up a bank account. They never understood what a fictitious name filing is, things that are very common in small businesses, they don't know. So, the ability to train that franchisee and their manager and give them the tools to train their own staff is important. 

Franchisees also need to be motivated. If you look at great franchise systems, one of the things you need to notice is that as you walk through the door there's a difference to their culture, how they feel, and that brand promise and that brand recognition is a major portion of what makes franchising, or any chain, successful.

When you're driving by a Starbucks at 60 miles an hour, you do not need to go into the Starbucks to know exactly how it smells, how it feels, and how the staff is going to respond to you. You also know if you're driving down the highway and you're looking for a clean restroom and you have a choice between the local gas station and the McDonald's, or the Burger King, or the Wendy's, that the restrooms in those places is going to be there. You get there because there are standards and you get there because the franchisor motivates the franchisee, not through the contract, but motivates the franchisee because it's in their interest and the brand's interest to meet those standards. So you get a consistent delivery. 

You also want to make certain that the product is the same. Do you ever notice when you walk into a McDonald's the french fries taste the same, whether you're in Pittsburgh or Los Angeles or in Paris, France. The reason for that is that McDonald's and brands like McDonald's are careful about their supply chain. They know where they're buying it from, they know exactly how they're gonna cook it. They use the right equipment to deal with it, sources of supply are amazingly important. 

You'll also notice from company to company that brands will vary. So if I want to get vinegar on my french fries, I know I'm gonna have to go to Rhode Island to get that, and there's nothing wrong with the fact that one state over in Massachusetts, I can't get vinegar on my french fries. I also want to know that if I want to get some jalapenos on my pizza I'm likely to be going down closer to the Mexican border, and there's nothing wrong with Domino's doing that.

Your brand needs to breathe, and it can in a franchise system. So it's not that the franchise system is exactly the same from market to market. That would be idiotic. You have standards, but the standards flow based upon the consumer, and the franchisor can execute that. And the franchisee makes their additional money by attracting customers to the brand because it's allowed to breathe. 

Franchising creates opportunities for entrepreneurs. We have built a middle class since the 1940s and 50s because of franchising. Franchising builds equity. It builds wealth, it gives consumers worldwide access to branded products they wouldn't have. If you look at franchising internationally, in markets like Nairobi, Kenya, you're able to get Kentucky Fried Chicken. You're able to go to a Marriott, to a Hilton Hotel, to an Intercontinental Hotel, and the same exact standards - delivered in a different way, because the KFC Nairobi is different than the KFC here - but the quality of the product is consistent whether it's Nairobi or New York City.

It creates local jobs, it creates stability, it establishes and has built the middle class. If you look at the growth of the market around the Apollo Theater in New York - 25 years ago, that would have been considered an inner-city depressed market. You go by the Apollo Theater today and you see a host of brands. You see franchise brands, you see non-franchise brands, but they all started because branded locations allowed products to come to a community to create local, sustainable jobs, and out of that flow to middle-class. Franchising and brands have an awful lot to do with building the economy.

The capital for that expansion of a franchise system is coming from the franchisee going to their bank, getting an SBA loan, borrowing from their parents, borrowing from their friends, but that capital for expansion comes from the franchisees - different than a company owned. If I want to grow my business in a company owned, and there's nothing wrong with company-owned growth, Starbucks is a great company, company-owned mainly, but I have to either go to the bank and borrow that money, or I have to go out and sell some shares, and I have to reduce my equity in my business. I don't have that with a franchise setting. My franchisees are able to penetrate the market and build critical mass for me, and because of the heightened brand awareness of my brand, not only is my brand and my business worth more because I have more locations out there, but so is the value of the franchisee’s business. 

So if you're looking at a business, and one business's franchisee, one business independently owned and operated, not franchise-related; both have the same bottom line revenue, both have the similar investment in the business,  I will get additional multiples off of the franchisee’s business when I go to sell it simply because of the brand value to it. So my franchisee will, even though they don't own the marks which I license to them, they get basically transactional use of my marks when they go to sell the business. 

All of my responsibility for hiring and firing and day-to-day management is owned by the franchisee. Some people look at it and say, “Well that's a weakness. I can't control the day-to-day.” Sitting in New York City or sitting in Los Angeles and trying to control the day-to-day of a location in Des Moines, Iowa is nearly impossible. Companies do, but they don't do it as well as franchising because the local franchisee and their management team, they're the ones that control the day-to-day. They know they can send somebody home when it's slow. They know they can call somebody in when it's busy. So the franchisee provides the expertise. They know the market, they know the schools, they know all the charities, and they provide the drive that makes franchising successful. 

The key benefits for the franchise are obvious. Capital without equity dilution, faster market penetration, market expertise of my franchisees, their driving interest in their own success. They don't want to fail because they're on the hook for the money. They don't want to fail because they're on the hook for their own pride. They're part of a community and they are going to be successful. A whole different motivation than employees. 

They're resilient, they basically want to make sure that not only they succeed, but you succeed. For the franchisor, it's real simple. While the franchisee has to worry about the bottom line, the franchisor is always generally getting their money from the top line. It reduces the overall risk, but if the franchisee isn't sustainable, if they're not making a return on investment, if they're not able to pay down their debt, if they're not able to think about investing in other locations, eventually you as a franchisor will not be successful. 

So you always focus as a franchisor on your franchisees’ bottom line. It's easy to sell a franchise. What's important is sustainability; consistent, sustainable replication. Sustainability is the key word in franchising. 

What's the benefits for franchising? Why would I want to get into it? There are certain people who should never, ever become franchisees. If you are a true entrepreneur, if you need to set your own course to make your sailing, if you want to play with the fact that you don't like the burger to be medium well, you want it to be well done, if you want to change the sauces - open up your own business. 

In a franchise setting, you are no more than a formula entrepreneur. You are going to take somebody else's system and brand and hopefully do it better. You're gonna smile more, you're gonna make sure the customers come back to you, but you're not truly an entrepreneur. You have a relationship with a recognized brand that provides immediate consumer credibility. You're opening up a new store, but you're not opening up a new brand. When you're working with a brand that is well-known, customers, they're gonna come to you. 

You're gonna get this disclosure document. It's a relatively thick document, it’s an ugly document, it has lots of legalese in it, but in that document they're going to tell you as a franchisee approximately not only what your capital costs are to develop the location, but how much working capital you're going to need. Businesses fail, small businesses fail, not because their products are no good, not because the service is no good, most small business people work really hard to give you a great product and service, they fail because of the unknown. 

Franchisors are delivering to franchisees, if they're doing it well, the fact that the franchisee does not have to replicate the mistakes that almost put the franchisor out when they were first starting. Franchisors are delivering to the franchisee knowledge about products and services and operating systems so they can launch to the consumer. A great franchisor who owns a great franchise system is providing leadership and support.

If you think of a knowledgeable business person visiting your location either by phone or in person, who's going to sit down and talk to you only about your brand and how it relates to all of the other brands in the system, all the other units in that system, that's the type of support you'll get from a good franchisor. Don't think that all franchisors are good, but the great franchisors always make sure they support their brand well. There’s collective marketing, there’s collective purchasing, and great franchise systems look to reduce the operating cost for the franchisees so that the franchisees’ bottom line is improved. 

Why do they do that? It's because it's really easy to sell a franchise when the potential franchisee calls up and speaks to a current franchisee and the current franchisee says “great group, got into trouble, they helped me,” “great group, all they're focused on is my bottom line,” “great group, when they're talking about expanding products and services or equipment, or the facility, they talk to me about return on investment.” That's what you want to see in a franchise system, that’s when you're developing a franchise system right, what you're looking for the keyword of sustainability.

There's some downsides. Biggest downside for a franchisor; it's not the same as running your company-owned store. Just because you know how to make a hamburger, just because you know how to greet a guest, just because you know how to drive a car, or clean a car, or change its oil, franchising is a whole different business. You have to learn the craft of being a franchisor. You can be going into new markets, you may know your product in your current market - but getting to the new market means that you have to listen to your franchisee, you have to go to the market. You have to understand that the consumers may be different than you're used to, that your marketing to those consumers may not be exactly the same. Franchising takes some risk and part of the risk is you have to give up a little bit of your ego and say, “I don't know, let me learn.” 

That's why franchising is great. It can take away your focus - if you are only focused on franchising you may miss the opportunities to license, or to go into mass gathering; again, franchising is only a method of distribution, don't get too trapped in it as your only method. Franchising Can be Slower - how is that possible, since I just said it's a quicker way to get to market? Well, I have to find the first franchisee; when I have a pipeline of franchisees it will be faster, but before I become a franchisor I have to develop a strategy, I have to develop legal documents; in some states I have to register them, a six-month process. I have to invest in all those pieces, I have websites that need to be developed; then I go out and I go find my franchisee. Well, it's gonna take me a while, so I build a pipeline, and that pipeline starts and I can promise you that even with great brands it's going to be about 120 days before that first franchisee comes in. And then you slowly build a franchise network -  it doesn't get born whole.

So franchising will be slower, but once it comes in, then it comes in well. Franchisees are independent owners; when I walk into my company-business and I say to my employees, we're gonna do this, they say certainly. I say the same thing to a franchisee, they ask the wonderful question of, “Why?” and that why is not because they're pushing back, it's because they're independent business owners, and often the “why” stops you from making mistakes; whereas with  a company-owned employee, you don't have to justify anything to them, they have to listen to you, you write their paycheck. Franchisees are really bright - they know their market; they not exactly in alignment with the franchisor because they're thinking of the location of their business, while the franchisor is thinking of the global chain; but the question “why” is a very important question for them to ask, and it's a very important question for you to be able to answer. If you can't answer the “why” question, then take a step back and don't bring that product to market or don't bring that service to market until you can answer the “why” question.

If you're a jealous type of person, then giving up that location on 42nd and Fifth Avenue which is making a lot of money on the bottom line is going to drive you totally crazy, but if you can embrace the fact that the franchisee took the risk, if you can relish the fact that the franchisee is successful, if you can relish the fact that you have a lot of franchisees that are successful in high-performing locations, that will make you a great franchisor. If, on the other hand, you're going to be jealous about every opportunity that you didn't open, then you should have gone and opened them yourself. The problem is you didn't; franchisees took the risk, and you're still getting your revenue from that location and it's building your brand.

One of the major downsides of franchising, for a franchisor, is when they get into the mode of selling a franchise, rather than selecting a franchisee. You can sell anything. When you sell a product, you have made the sale,  the customer goes away. When you sell a franchise you're not really selling the franchise, you're selecting a franchisee - and they're not buying your franchise, they're investing in their own assets and licensing your brand. But if you have the wrong franchisee, they can tie up a territory if they're a multi-unit franchisee, or they can actually damage the brand. If you think about that today, we live in a world of the Internet where there is no such thing as localization anymore - what happens in Europe can affect the brand in the U.S., what happens in California can affect the brand in New York, so selecting the wrong franchisee just simply because they're going to give you a check is one of the major downsides. I can tell you that turning away that check is very difficult for a new franchisor, but it's essential that they do it. 

What's the downside for the franchisee? They're not independent; a franchisee is a formula entrepreneur. They cannot make decisions about what products and services they're going to offer; they will offer what the franchise system tells them to offer, because you want consistency, of course the brand, consistent sustainable Replication. When a customer comes in and they've shopped that brand at another location or in another market, they're expecting the same.

You are dependent as a franchisee on the franchisor and the other franchisees. If a customer comes in and they didn't like the product or service at another franchisee’s location, that will impact you. You're very dependent on the other franchisees. You have a risk determination; you've made a major investment in your business and yet because you've done something wrong, because you violated the terms of the contract, because you have not met your commitment to the brand, the franchisor can terminate you based upon the terms of the contract. 

You also have a lot of restrictions. You can't sell wherever you want, you can sell only within the territory provided to you by the franchisor - if they've actually provided you with the territory and not just the four walls of your business. The product and service offering is not yours; how you advertise, who you advertise to, the minimum amount you're going to spend on advertising, all of those are downsides to an entrepreneurial franchisee. You also have to look at your ability to sell the business; even though you have a ready buyer and want to leave the business, the franchisor may have rights of first refusal. The franchisor may actually be able to come in and say you're selling the business for too much money, because in their judgment the new franchisee will not be able to sustain that type of debt, and the franchisor may come in and tell you to reduce the price. It doesn't happen often, but it does happen, and you have to look at your contract as a franchisee to understand what your contractual restrictions are. Do not assume that your contract can't be changed; do not assume that your contract is fungible. With all the different franchise systems, it's important that you read what the contract says.

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