Are you a business owner thinking of expanding your business? You have probably considered the model of franchising. If you look around, it is evident that franchised brands dominate many retail and consumer markets. But why is this the case? What makes the franchise model so appealing to businesses looking to expand? This article outlines the top five reasons why you should franchise your business.
1. Scaling a Brand
People turn to franchising to grow their business because it is a fast and effective way to scale a brand. Integral to the franchising model is the licensing of the franchise brand through a trade mark or symbol and operations manual. The franchisor owns the trade mark or symbol and operations manual, whereas franchisees operate a business under licence for a set period in a way that the franchisor substantially controls, determines or suggests.
The Franchising Code of Conduct includes that the franchisor’s trade mark or symbol is associated with the agreement. Therefore, the franchise business is almost identical to the original business. The franchises will typically include the same branding, signage and products. To the everyday consumer, the difference between a corporate store and a franchise is usually indistinguishable.
A franchise system allows franchisors to scale their business without opening every store themselves, while still maintaining the image and quality of service unique to the brand. Such a process is particularly appealing to those with plans to quickly grow their brand beyond their immediate geographical area. For example, the logistics of trying to open a corporate store interstate can be painful.
Granting a right to an independent business owner to open a franchised store in the same interstate location can be significantly more feasible. Due to this, franchising is a preferable model for brands with aspirations of having a store in every major shopping centre.
Opening a second or third store close to the original location can also be a great way to grow a business. However, it generally becomes difficult (or even practically impossible) to continue scaling through a corporate rollout. This is in part due to the problems regarding access to capital and the risks of a corporate rollout.
2. Access to Capital
For retail businesses, opening an additional store usually demands substantial access to capital and the tie-up of significant funds before that investment pays off to allow further growth. If you were to open another location yourself, it is likely you will need to complete capital intensive tasks. For example, you will need:
- to fit out the premises;
- a bank guarantee for the lease; and
- the cost of the initial inventory or stock to start trading.
It can be difficult for business owners to access the necessary amount of capital to open an additional store, let alone several. Furthermore, the time it takes to secure financing for additional sites can significantly delay and limit the pace at which you scale the brand.
Franchising provides a means by which the need for such capital can be overcome while still scaling the brand and getting it ‘out there’. Instead of taking on these costs yourself, you pass them on to your franchisees who have obtained their own financing. You disclose these costs to franchisees before they enter into a contractual agreement with you and they are then implemented after signing.
The obvious trade off here is that by franchising, you are agreeing to take only a small percentage of profits, whereas, with a corporate rollout, you would be keeping all profits. However, many franchisors have rationalised this as a worthwhile tradeoff because it allows for fast and widespread scaling of their brand. Furthermore, the fees you do receive from initial and ongoing franchise fees provide a franchisor with financial resources that can be invested in head office systems and processes to facilitate rapid scaling.
3. Limiting the Risks of a Corporate Rollout
In addition to overcoming the barrier of accessing capital, franchising partly overcomes some of the significant issues businesses face when they elect to expand internally, for example, through a corporate rollout. Notable obstacles an expanding business faces include:
- site selection;
- staff management; and
- payroll tax.
Selecting sites can be difficult. It can become more challenging as you expand and move away from familiar geographic areas. The reality of retail is that not every location will perform to the standards you expect. There are numerous reasons as to why a site may not work, and some include:
- the proximity of competitors;
- changing populations and demographics in the local area; and
- council developments.
Franchising allows the franchisee, who may have better local knowledge, to select appropriate sites and commit to a lease in a particular location. Franchisees are often in the best position to pick a site as they can choose an area that they are familiar with and know well.
Although both you and the franchisee should carefully review the suitability of the site, it is the franchisee who is ultimately responsible for the success of the location.
Managing staff is a challenge. Dealing with rostering, payroll, entitlements, bookkeeping and disciplinary issues is a difficult task in itself. Expanding your business across more than one location means that managing staff becomes even harder. You have to manage staff and personnel issues in a different store to where you spend most of your time.
However, if you decide to franchise, your franchisees are responsible for managing staff in their store. Franchising allows you to focus on the system as a whole and not get bogged down in day-to-day management considerations. As a franchisor, you still need to ensure your franchisees meet their employer obligations, especially in the wake of recent changes to the Fair Work Act concerning vulnerable workers.
Another obstacle to a corporate expansion in retail is the likelihood of quickly reaching the payroll tax threshold. Payroll tax is a tax on a business’ wages applied when total wages exceed the threshold, currently, $750,000 (annually) taxed at 5.45%. This can be a substantial expense for businesses trying to expand. Most retail businesses will reach the threshold between three to five stores, and some even sooner.
In consideration of this tax, many businesses elect to franchise before reaching the threshold. As franchisees are responsible for paying their employees’ wages, those wages do not count towards that of the franchisor. Therefore, franchisors can avoid the cumbersome expense of payroll tax.
4. Increasing Market Power
Increasing a brand’s market power goes hand in hand with scaling to a significant size. Market power relates to a business’ ability to impact the market in which it operates. Increasing market power is desirable for multiple reasons, including:
- the ability to negotiate better supply, distribution or delivery agreements with suppliers;
- establishing commercial relationships with the large retail complex owners, such as Westfield and Stockland. Large brands will often be invited to enter new developments and offered featured lots in centres; and
- the ability to set market trends and competitive pricing (market leading).
All of the above can generally lead to an increase in profits, not only for the franchisor but the franchisee network generally.
5. Resale Value
When franchising a business, you may be to sell the business at a significantly higher value. Some franchise their business with the end goal of maximising their eventual return when they decide to sell. You can achieve this by investing time, effort and capital in establishing a franchise. Depending on the success of the franchise expansion, the value of the franchisor business can become a large multiple of the value of the business in its pre-franchise stage.
You can also sell the rights to a third party to establish and operate the brand overseas. A licence agreement allows you to do so by permitting a buyer to introduce the brand in an overseas market. Furthermore, it is another way to recognise the value of the brand you have built by upscaling your business through franchising in Australia.
Why should you franchise your business? Franchising is an excellent way to expand your business because it:
- allows you to scale your brand;
- provides you with access to capital;
- limits risks in comparison to an internal corporate rollout; and
- increases market power and the resale value of your business.
If you have any questions, contact LegalVision’s franchise lawyers on 1300 544 755 or fill out the form on this page.
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