How to Analyze a Franchise System Before You Invest

Published on November 18, 2016

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Far too many entrepreneurs do not spend enough time analyzing a franchise offering before making the leap.  While different types of franchises should be evaluated based upon the kind of business they are in before they are bought, here are some common factors to all types of franchises that need to be considered.

Market size/density

How many potential customers can you draw from your local market size versus the cost of the franchise fee? The point is that paying a franchise based upon a percent of sales is only workable if you have a large enough local population density.  Franchise fees can be deceptive.  I have worked with a client, for example,  that owned a franchise from a national franchiser and was paying the same 7% of sales franchise/advertising fee in a town of 7,550 as in city like Chicago with a  population of 2.7 million. The logic of the franchiser is that their franchise payment is proportional to their sales and is therefore equitable.  Most franchisees pay the same percent of sales and not the same dollar amount for their franchise. Sound logical, right?

What is missing from this logic is that in most franchise businesses, you need critical market mass or a minimum amount of sales to break even and make a good profit.  The point is that it is much harder to make a profit with only $300 thousand in sales from a population with 7,550 people and paying say a 7% of sales franchise fee than it is to make a profit from a population of 2.7 million people with the same 7% franchise fee.  And yeah, sure there will be plenty of other of the same or similar franchises in a large metro area, and no you cannot serve the entire population of that large area.  The point is that the available local market in a high density city will generate much more sales to be able to pay a franchise fee with a high percentage of sales. Paying a franchise based upon a percent of sales is only workable if you have a large enough local population density base unless you are principally an on line and or a mail order business.

It is critical to determine if the associated franchise fees are justified for your market.  After considering the mass or size of your market:

Competitive analysis

If you are going to be in direct competition with a strong national brand business, whether it is a franchise or not, what is your franchise’s competitive edge, that is, what can you do better that will cause customers to do business with you rather than the competition? The truth is, most entrepreneurs do not do this analysis!

  1. The competitive brand franchise business in this small town of 7,550 did about 50 more times national advertising than the franchiser did for the client I worked with.
  2. If the competitive brand franchiser is going to significantly out spend your franchiser on advertising, or has a superior brand preference advantage, do you have the marketing, social networking and selling skills to offset these disadvantages?

Next, ask the franchiser to furnish the names, phone numbers and locations of all of their franchisees.  Ask the franchiser for the sales for each franchisee by market location.  If they furnish them, match the sales to markets of a similar size to yours.  Call franchisees in similar size markets and find out how successful they are.

  1. Make sure that if location and traffic are important, you understand their location situation, e.g. a fast food location off of an interstate highway exit.
  2. Secondly, make sure you understand their competitive situation.  If you are going to be the only game in town, it makes a big difference.

How can a potential franchisee assess the value of a national brand name?

There are several ways to do this.

  • How profitable is the franchiser, if they are publicly held, this information is readily available.
  • How long has the franchiser been in business?  Are they solidly established as leading national brand or are they a start-up?
  • How many dollars does the franchiser spend on national advertising a year?  How does this compare to their competitors?
  • How much salesdo franchises in similar sized markets generate and how profitable are they?
  • What is the franchise failure rate for franchises in markets your size?

We will talk about the next steps in the following article.

 


About the Author: Jeff Lefler
As the CEO of FranchiseGrade.com, Jeff understands that there is no Silver Bullet or sure-fire, simple way to pick a guaranteed franchise system winner. However, by using a little science and a lot of hard work, Jeff and the team at FranchiseGrade.com have developed a sophisticated research, analysis and comparison model to help potential investors and existing Franchisees assess a realistic value for any franchise system relative to others. It's called a Franchise Grade. With over fifteen years of small business experience and ten working in franchising as a multi-unit Franchisee, consultant and Franchisee Association President, Jeff has a good understanding of the level of hard work, dedication and commitment that drives a successful franchise system. As part of his ongoing involvement with the industry, Jeff also served as a Member of the Strategic Committee of the International Association of Franchisees and Dealers. Get in touch with Jeff to see how your system measures up.
How to analyze a franchise system before you invest

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