Franchising

What does “fastest-growing franchise” really mean?

SmartCompany /

It’s approaching that time of year again when a national business magazine will publish its list of the fastest-growing franchises in Australia.

 

Over the years, many brands have come and gone from this fastest-growing list, and others have made a consistent appearance year after year.

The list usually refers to growth in overall network turnover, or growth in numbers of outlets, or both.

As interesting as this information might be, what does it really mean for a potential franchisee thinking about joining one of these networks?

Let’s look at a real “fastest-growing” example.

Sold4U, a US-based eBay drop-off store concept exploded into the franchise market several years ago and grew by 100 outlets a year from its inception.

Franchisees were drawn to it on the basis that everyone seemed to be getting rich on eBay, and that there was an opportunity to make money by helping people sell their unwanted goods online, but who did not want to be troubled with the hassle of writing descriptions, taking photos, handling inquiries, calculating postage costs, and so on.

Sold4U’s explosive growth had less to do with the success of its business model and more to do with its aggressive expansion plans. People who had never run a business before were not granted one franchise and required to prove themselves, but instead, were sold three or four franchises at the very outset, thus compounding their problems when not even one outlet could make a profit.

The hysteria around eBay as a way of selling often worthless junk for outrageous prices fuelled demand for these franchises, and stories of eBay trades that began with a red paperclip and resulted in a house, or the face of Jesus on a burnt piece of toast selling for squillions became legend.

Sold4U grew to 100 outlets in its first year, then 200 in its second year.

Growing discontent from existing franchisees who realised that the variable nature of their inventory meant they often lost money on items sold on consignment and struggled to achieve any kind of profit ultimately stalled franchise sales.

Today, Sold4U no longer exists, and no doubt many former franchisees rued their decision to jump on board and get swept up in the hysteria of joining a fast-growing franchise before they missed out.

Growth is expected in any healthy business, but excessive growth should be approached with just as much caution as negative growth. In either case, trumpeting the virtues of a franchise because it is growing quickly overlooks the necessity to consider its profitability and long-term sustainability

So how can “fastest-growing” numbers be translated into something meaningful?

For example, a franchise system may state that it now has twice as many franchisees compared to last year (ie. 100% growth in outlets). The turnover of the entire network last year was X, and a simple assumption would be that network turnover would now be 2X as a result of the doubling of outlets.

This simple assumption however, would most likely be inaccurate unless all new outlets commenced at the same time, and traded for almost a complete year.

So here are a couple of things to consider instead.

By dividing the network turnover last year by the number of outlets last year will give an indicative average turnover per outlet. Repeat the formula for the current year and compare the average turnover per outlet result. Has it gone up or down?

Year A Average turnover per outlet = Network Turnover
                                                           Number of outlets

Year B Average turnover per outlet = Network Turnover
                                                           Number of outlets

However, imperfect this formula might be as a result of new outlets only trading for part of the year in which the turnover is recorded, this imperfection exists in both the last year and the current year, and therefore becomes a constant to benchmark average turnover per outlets from one year to the next.

If we use sample figures, these average outlet turnovers are calculated as follows:

Year A = $46 million = $851,850 average turnover per outlet
               54 outlets

Year B = $52 million = $928,570 average turnover per outlet
               56 outlets

The growth of average annual sales per outlet can then be calculated as:

= Year B average sales – Year A average sales
    Year A average sales

= $928,570 – $851,850
   $851,850

= 9% sales growth per outlet from Year A to Year B.

By linking the formula for average sales per outlet for the two different years, it’s possible to get an insight into the effect of the network growth on sales performance, as follows:

= Network Turnover Year B – Network Turnover Year A
   Number of Outlets Year B – Number of Outlets Year A

If the same sample figures are used as follows:

= Year B turnover of $52 million – Year A turnover of $46 million
   Year B outlets 56 – Year A outlets 54

= $6 million = $3 million per new outlet sales growth.
   2 outlets

In other words, for each overall increase of just one outlet, sales in the network grew by $3 million. This illustrates the potential for markets to grow and increase demand for brands, products and services as they become more available and accepted.

A positive correlation between a net increase in outlets and sales growth of the network is an indicator of a healthy franchise with potential for both franchisee and franchisor.

A negative correlation would be when network sales reduce for each extra outlet added to the network, and may indicate (among other things) a greater focus on franchisee recruitment than on supporting franchisee sales growth, and the risk of new outlets cannibalising sales from existing outlets.

Where a negative correlation exists, this might work to the short-term advantage of the franchisor, but should ring alarm bells for any potential franchisee and indicate real areas of concern that should be considered in-depth before progressing with any investment.

Another factor to consider when evaluating fast-growing franchisors is their capacity to service and support their franchisees. If the number of franchisees in the network has doubled over a 12 month period, but there has not been a commensurate doubling in support personnel or resources provided by the franchisor, new franchisees might find that their support expectations are not met and their start-up phase may be much slower and more difficult than for previous franchisees.

Rapid growth might be worthy of mention in “fastest-growing” lists, but does not indicate that a franchise is well-proven or even viable.

A proper assessment of the franchise offer, its market and long-term prospects is critical in a potential franchisee’s due diligence. Fastest-growing franchise or not, nothing should stand in the way of a potential franchisee undertaking proper research to assess the worthiness of the investment.

To do otherwise could mean a “fastest-growing” opportunity becomes a “fastest-impoverishing” instead.

Jason Gehrke is the director of the Franchise Advisory Centre and has been involved in franchising for nearly 20 years at franchisee, franchisor and advisor level.

He advises both potential and existing franchisors and franchisees, and conducts franchise education programs throughout Australia, and publishes Franchise News & Events, a fortnightly email news bulletin on franchising issues and trends.

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