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11/23/2003

Are franchise fees worth it?

By Damon Carson
Special to the Times-Call

In the October 5, 2003, business section of the Longmont Times-Call, editor Tony Kindelspire wrote two excellent stories examining the franchising opportunities that exist and some of the merits entering business via this avenue.

His particular slant was on the positive side of becoming a franchisee. Certainly this list is long. If you hook up with the right company, you immediately have a template to run a business.

This template — a business name, logo, marketing material, inventory list, suggested pricing, store layout, equipment mix, etc. — can be invaluable. All these are crucial elements to success.

The reality is each of the previously listed activities involves a great deal of time and effort to create independently.

Unfortunately, mistakes in any of these areas can be expensive. Errors of any type in business are expensive. College tuitions often pale in comparison.

Let’s look at a couple of issues that should be analyzed in the due diligence phase before enlisting with a franchiser.

First, does the franchise attract more customers. Let’s imagine a restaurant for example. If you were selling hamburgers at an interstate exit, a McDonald’s sign probably would generate more traffic than “Your Name Burgers” would. Mr. Out-of-Stater, when stopping off for a bite to eat, has no clue the quality of “Your Name Burgers.” That is not true of McDonald’s. He will likely choose a known over an unknown. In that case, the franchise fee is probably of great value.

If you were on Main Street, on the other hand, catering to the local traffic, it might take a bit longer to develop a loyal following but once achieved, you’re not paying a national franchise a part of your revenue stream.

Another angle on franchises is to start a franchise that does not exist in your area.

As with the burger stand example, if you import the hypothetical Connecticut Confections to Colorado, will that name generate any traffic ... probably not. Then starting a Connecticut Confections becomes more like a start-from-scratch opportunity. There might be an advantage to Connecticut Confections in Colorado, though. If their recipes for making confections are outstanding in nature, then becoming a franchisee might be worth the fee to start your business as Connecticut Confections instead of “Your Name Candies,” not because of name recognition, but because of an outstanding product — in this case a proprietary recipe.

Being a financially successful long-term franchisee, like any business, has more to do with giving customers great service, treating employees fairly and managing your pennies than it does with some advantageous start.

If you have what it takes to be a successful operator, you will flourish whether you are a franchisee or an independent. With that fact in mind, the real question becomes will you be more profitable — not will you be profitable — as a franchisee or as an independent?

Let’s use the burger stand as an example. Say you could open up your establishment and generate a projected $100,000 in sales as Your Name Burger. We need also to make two more assumptions. First, we’ll assume that Your Name Burger would operate at a 10 percent profit margin.

In other words, after all the bills were paid, Your Name Burger would have an estimated $10,000 left in the bank. Our second assumption would be if our burger stand was part of a national franchise we would have to pay 5 percent of revenue, or $5,000 in this case, for that right.

Now we must determine if that $5,000 franchise fee is a good value. We’ll keep this simplistic but are hopeful we get the point across nonetheless. Operating at a 10 percent profit margin, it would cost us $4,500 to pay this $5,000 fee. That’s because at a 10 percent margin we must spend $.90 to generate $1 in revenue.

We then must determine how much additional sales we must generate to break even on the $5,000 fee. If we divide $5,000 by our 10 percent profit margin we realize that we must generate $50,000 in additional sales to break even on the franchise fee.

We’ve already established that we can generate $100,000 in sales without a national name, and expense, driving our traffic. So, on a 5 percent franchise fee we must generate an additional $50,000 in sales to break even.

If as a national burger chain, we can’t generate a minimum of $150,000 in sales an owner would be financially better off to open a Your Name Burger. This math and thought process is lost on most prospective franchisees. The financial value of a franchise must be determined if you are to realize the full monetary reward of your investment.

Some franchise fees are absolutely worth the money and others are not. Though you might desire sod, the biggest return on your investment may, in fact, be seed.

Damon Carson is a Longmont business owner and small business investor who can be contacted at damontracicarson@yahoo.com.