A participant in the discussion forum brought up a good point whether a “delivery only” local restaurant business was an especially good business model. Steak-Out was the franchise mentioned, which delivers char-broiled steak and chicken dinners, salads, sandwiches….you get the idea. Why do you get the idea? Because the food is similar to the restaurants we all know – Applebee’s, TGI Friday’s, and Chili’s. The difference is Steak-Out is delivery or pickup only, and the others are sit-down AND are starting to contract out delivery to local entrepreneurs.

Having a dinning room exposes your menu to more people. In turn, more people will be familiar with your menu and more likely to think about using you for delivering business lunches or family dinners. The more you are exposed to a product, the more likely your to think of it when the time for the service comes. It’s partly a numbers game, and I’d rather have my customers experience my product in person in my controlled atmosphere then exposing them to my product on a piece of paper, coupon or flyer.
I’m not saying delivery only business are a bad idea, I just wouldn’t want to take the risk when my competitors out-of-the-box are going to be exposed to exponentially more customers. That raises my marketing costs. Pizza is the only food that has carved out room for delivery-only stores. Papa John’s is going from delivery only to delivery + sit down.

A 75-unit Subway franchisee group in South Florida bought the telephone number 888-SUB-TO-GO. Orders are processed via the store’s POS system and then delivered by Subway employees. Can a delivery-only subshop startup and compete with that? I doubt it, and I wouldn’t want to risk my capital trying.

If you are buying a restaurant, you should consider what provisions in the franchise agreement address delivery. If you think delivery may be an important distribution channel for revenue and competition reasons, then only consider businesses that are willing to address the issue before you hand over your franchise fee.

43 Burger King franchisees operating 1,112 restaurants filed for bankruptcy in the past 5 years, almost 15% of all Burger King units. While costs rose for franchisees (utilities, labor and food), total customer flow and average sales per customer did not. The price wars between McDonald’s, Hardee’s/Carl’s, and Wendy’s did not help. Many franchisees are highly leveraged, so a reduction in in cash flows put a serious strain on finding the money to service the debt.

Burger King charges a $50,000 franchise fee for a 20-year agreement. Renewal after 20 years is possible for another $50,000 fee, but only if the store meets the new Burger King operational and design standards, which usually require about $400,000 in upgrades. Additionally, the Burger King franchise agreement prevented multi-unit owners from closing underperforming stores.

One bright side is that Burger King reported the highest same-store sales in 10 years this past year. With so many franchisees in bad shape, speculative business owners can pick up a franchisee on the cheap. Any takers?

Update November 24, 2005:
Though I’m not a fan of NPR, you can listen to the audio of a reporter slam Burger King’s new “King” character marketing. He wrote this critical article.

We the People is a paralegal document preparation service.  People typically use their service for simple legal documents and court filings (name change, non-contested divorce, wills, incorporation).  The company provides customers with forms to fill out with a pen, and the franchisee then sends the form off to a processing center located in the state.  One to seven days later (14 days max), the forms are sent back to the franchisee to give to the customer.  The franchisee may also offer to file the forms with the appropriate court for an additional fee.  The processing center takes a 25% cut of the document charge.  

No legal training is required.  Franchisees are basically a sales and marketing arm for the processing centers.  Franchisees are not allowed to alter any document or provide any service not performed exclusively by the processing center.  

Franchisees are free to set their prices above the mandatory minimum.  For example, restraining orders will run customers $100, a noncontested divorce run $400. (article listing more services and fees)

The company was founded in 1996, purchased by a couple in California, and recently sold to Dollar Financial Corp. (NASDAQ: DLLR) in March, 2005.  Dollar plans to also open the store in conjunction with the Dollar Financial stores (like H&R Blocks).

The experience for customers is somewhat odd if you have previous experience speaking with a lawyer.  We the People employees can’t recommend a form, can’t point you in the right direction, and can’t discuss specific facts about your problem.  All the employees can do is generally describe a form and offer a form booklet to fill out.  Recommending a form or solution is considered engaging in the practice of law, and it can subject the franchisee to fines, jail, or liability for damages resulting from the legal "advice".  When you walk into a We the People, you are simply asked, "What form would you like to fill out?"  

I visited one.  There was one man on the phone trying to explain three different types of divorces.   I was promptly greeted by the other employee asking me which form I wanted to fill out.  I said incorporation and will, and she lept into her sales pitch with a brochure, eager to hand me a paper form to fill out.

The franchisor’s disclosed litigation in the UFOC is staggering.  The company has 13 cases pending and 12 concluded cases that range from unauthorized practice of law to fraud.  Several franchisees have sued the company for fraud and unfair business practices.

From their UFOC…

Franchise Fee: $89,500 (ouch!)
Total Investment: $116,000 – $152,000
Exclusive Territory: usually 2 miles (at discretion of Company)
You must be Notary before opening
Supervising Attorney fee (mandatory): $200/month
"We the People" Do it yourself legal books: 50% off retail price
Time to locate a site after signing Agreement: 90 days (if no site selected, franchise fee may be refunded less $10,000)
Time to Commence Business after signing the Agreement:   120 days
Document Processing Fee:  25% of total customer charge
Royalty on any other products or services: 25% of gross sales
Advertising Co-op:  4-6% of gross revenue
Promotional Fund: 2-4% of gross revenue
Independent Advertising:  $2,000 or 8% of gross revenue (whichever is greater)
Franchise renewal fee: $2,500
Current transfer fee (charge to sell the business):  $7,500
Advice from company fee:  $250/day
Square feet (usually in strip mall):  about 1,000 square feet
Included Training:  5 days in Santa Barbara, California
Phonebook ad requirements:  Must maintain a bold listing
Internet sales from your territory:  15% of company’s net profit is paid to franchisee
Personal Guarantees: Franchisees must personally guarantee the entire Franchise Agreement and all payments due to franchisor
Time to cure default under agreement: 10 days or franchise can be terminated
Litigation:  All disputes must be arbitrated in Pennsylvania

If this franchise can throw off about $20,000 in extra cash flow AFTER paying all expenses and salaries (including the franchisee), then this can be worthwhile investment.  Mandatory royalty, advertising, promotional fees total over 18%, plus the 25% commission earned by We the People to process each document.  So there goes 43% off the gross before paying any operating expenses. 

Let’s make this simple.  If the business is open 300 days per year, and sales total $1,600 per day (that’s about 8 $200 sales each day, which to me seems very high), that will generate $320,000 in sales, minus 43% is fees is $137,600 to pay all rent, salaries, other operating expenses, and still earn a return on your $150,000 investment.  No thanks!

Here is an existing franchise for sale in New York, asking price is less than $250,000.  Gross revenue is also $250,000 and they claim $75,000 in profit (sellers discretionary cash), so that is before taking a salary.  Remeber that beside your fair salary, you should be earning a return on your investment of at least 10% ($15,000/year). 

Pros:

• little competition
• easy business to run
• virtually no inventory to manage
• seems to be relaxed on granting franchisee’s site preferences

Cons:

• nasty past litigation by franchisees
• assistance after your intial 5 days of training is charged at $250/day plus expenses
• high fees
• no brand recognition

I’m especially attracted to non-food franchises, but this one I wouldn’t buy!

It looks like the Quiznos franchisees are not standing by in the face of apparent fraud:

The primary allegations of the complaint are that the franchisees were harmed by the company’s "deceptive recruitment practices" and "failure to deal in good faith" when it took franchise fees from the plaintiffs, but refused to approve locations to open Quizno’s stores. In addition, the complaint charged, Quizno’s has refused to return any portion of the franchise fees, even though the plaintiffs paid more than 18 months ago and are now being threatened with termination.

and more general comments…

Commenting on the lawsuit, Susan P. Kezios, President of the American Franchisee Association, said, "This lawsuit is a classic example of a popular franchise chain using its brand name recognition to deceive hard-working Americans into investing their dollars to grow a franchise. Bob-the talking baby in Quizno’s current media campaign-is definitely talking out of both sides of his mouth in this case."

Added Klein: "It is unfortunate that not enough people are aware of the abuse that franchisees often endure at the hand of their franchisors. Too many entrepreneurs automatically assume that buying a franchise is a safe investment. We are confident that we will prevail in our lawsuit, and are eager to finally bring justice to the franchisees who were victimized while also alerting people who are interested in purchasing a Quizno’s franchise to make an educated decision.

I don’t have a comment from Quiznos, but I’d assume they deny the allegations. Still, Quiznos claims to open a new franchise every 16 hours. Have those franchisees all done enough due diligence to uncover these allegations of fraud? I fear they are too eager to hand over the $25,000 franchise fee.

Even if this lawsuit turns out to represents a relatively small percentage of franchisees, I would never buy a franchise from a company who would keep an entire franchise fee after refusing to timely approve site selection. Perhaps Quiznos has a logical explanation, but I find it hard to believe so many franchisees in the same city would have the identical claims of fraud. Our legal system allows freedom to contract even if the terms are unfair, but those contracts are not enforceable if one can prove fraud or unconscionable terms.

So what is the problem?

• management’s ego and greed
• salesmen training and guidelines
• commission/bonus structure

The salemen’s compensation is composed of mostly commission and bonuses on total franchise fees. There is virtually no regard for franchisee’s site selection wished or oversaturating the geographic market. Management is certainly aware of the complications, but do nothing so long as the franchise fees keep rolling in. These circumstances seem obvious to me. What do you think?

I’ve been thinking about the soup franchise idea more after the Soup Nazi article I posted. While I don’t think the Soup Nazi franchise is the one to buy (store size and look is bad, management is poor), I think the soup franchise concept does have real potential. The only soup franchise I know of that almost entirely focused on soup is ZOUP! Fresh Soup Company with a $25K franchise fee. The carryout business seems extra compelling too. Soup franchises can serve fast (how fast can you laddle soup?) and the changing menu of soups recipes can be infinite. Zoup, for example, has 12 soups daily. I think a soup focused franchise with a Panera Bread look and feel will be the next QSR boom.

Al Yeganeh, the Soup Nazi character from the Seinfeld T.V show is franchising his soup restuarant. They’ve signed 123 deals so far, and they’re aiming for over 1,000 units.  The franchise fee is reported to be $30,000 with royalty and advertising fees totalling 6%.

Special kiosks sold by the company and storefront locations will bear Yeganeh’s “The Original Soup Man” logo with his photo. For $10, customers will get eight ounces of soup _ from seafood bisque and chili to cold and exotic soups _ plus bread, a beverage, fresh fruit and a small chocolate.

Can this work? I’ve seen a few soup focused franchises coming online lately (Zoup,San Francisco Soup Co.), but I’m skeptical of this small-scale soup franchise. They are making the soup in New Jersey where it will be frozen and shipping to franchisees. I’d feel much more comfortable franchising a nice soup and sandwich cafe, or sandwich cafe known for their soups like Panera Bread, Pickerman’s Soup & Sandwich Shop, Obee’s Soup Salad Subs, or Schlotzky’s.

Strangely, as Professor Bainbridge points out, franchisees are prohibited to use the words “Soup Nazi” or “Seinfeld”.

I wouldn’t buy it!

I don’t get Entrepreneur Magazine sometimes. According to an article in the Las Vegas Business Press, Entrepreneur Magazine named a personal concierge service called “My Girl Friday” as one of the “hottest new franchises” in 2005. The first franchise was launched in 2005! How can a personal franchise business with one franchise in the personal concierge industry (seems I’ve been hearing its the hottest thing for the past 10 years) be named the “hottest” with ONE franchise?

The article’s author showcases her lack of business knowledge in this paragraph:

Hagenmaier projects that the Las Vegas operation of My Girl Friday will grow from one person to having from five to ten employees in the next 18 months. The company hires independent contractors, which mostly appeals to people willing to work flexible hours. Brommenschenkel explains that college students and retired workers make ideal independent contractors, because of their flexible schedules.

By definition independent contractors are not employees. It’s a small issue but that stood out to me.

Here’s more of the business description:

Services cost clients anywhere from $30 to $60 an hour, depending on the chore…My Girl Friday offers a full menu of services including traditional concierge services, personal chefs, errand running, pet care, party planning and assisting with business tasks.

She sounds like a personal assistant. So people will hire this woman as both a personal chef or party planner in Las Vegas? I suppose it is possible.

In my opinion, there are not many errands worth $60/hour. Most things for a minimal fee can be delivered and arranged quickly from a web site or one minute telephone call (travel, food delivery, dry cleaning, courier, pet sitter or walker). This business will be fighting technology and streamlined personal services offered directly from the service supplier (remember what happened to travel agents?). This is not a market I see growing or easy to establish a sustainable level of customers. Building a customer base that you serve on a daily or weekly basis will be exceedingly difficult. My Girl Friday franchises cost anywhere from $47,000 to $86,000, including the franchise fee.

Those looking to buy a franchise should read this article at the Denver Post. It tells the story of a semi-famous author who wanted to get into the smoothie business by buying a Juice Stop franchise (now defunct).

The moral of the story?
When deciding whether to buy a franchise, your diligent independent research is essential. While some franchises have help people achieve their own version of success, too often people are destroyed emotionally and financial. The prospective franchisee should ignore the saleman’s pitch, and make the decision to buy based on one’s own research and facts.

Those with moderate financial success are accustomed to investing many thousands in stock or real estate without a lot of indepent research. If it looks good and seems like a fair price, we buy it.

An investment in a franchise, however, shifts much of the burden of earning a return on you and the integrity of your franchisor. The upfront independent research must include background checks on the franchisor’s management and interviews with existing franchisees. Hell, pay some franchisees to see and photocopy their financial results. That will give you a model of some realistic financials. It’s that important.

The article ends by describing how the franchisors of Juice Stop filed bankruptcy, and several years later the same people started another juice bar franchise called Squeeze. I know it most people improve after making mistakes, but I don’t trust those guys. It’s one thing to fail, but your true character is exposed when you lie and ignore your franchisees on the way down.

This story should keep you on your skeptical toes when investigating franchise opportunities.

Vending seems like a stable, low overhead, recession proof business, right? Not for Tom’s Foods and their franchisees. They filed bankruptcy last month.

Tom’s Foods Inc. has reported a lender has filed a motion in the New York Supreme Court seeking $60 million plus interest that Tom’s owes it…..

The company has changed hands three times in the past 21 years and hasn’t turned a profit in more than a decade, posting a loss of $3.3 million in 2003 on revenue of $196 million. Tom’s today sells more than 300 snack food products in 43 states. It operates manufacturing plants in California, Florida, Tennessee, Texas and Georgia, including three in Columbus. It employs 1,650 people.

You can look in the back of Entrepreneurship Magazine and see dozens of ads for snack food and candy vending franchises (remember the 6-foot gumball machine?).

Maybe their franchise infrastructure and training have contributed to the problem. Check this out in the FAQ:

5. Am I required to attend any training programs?
No. Tom’s has no requirements that you attend training programs…

No training is required for franchisees? Maybe they give franchisees a magic truck that overcomes any lack of training.

As a follow up to our previous article regarding Quiznos and the importance of legal representation, the QuiznosSucks.com owner posted his (claimed) financial results from owning a Quiznos franchise:

Topic: How much a Quiznos earns
Posted by: XXXXXXX
Date/Time: in 2005

I am a Quiznos franchisee. Here is a breakdown of how much a franchisee can potentially earn — or not earn.

The figures are not necessarily BAD, I guess I just wish someone gave me these hard figured BEFORE I bought one.

If a store earns $40,000 / month:
7% Royalty	$ 2,800
1% Local Advertising	$ 400
3% national advertising	$ 1,200
20% Labor	$ 8,000
29% Food	$ 11,600
3% Paper	$ 1,200
.3% Accounting/Payroll	$ 300
10% Rent/CAM	$ 4,000
2.75% Insurance / Misc.	$ 1,100
5% repay SBA loan	$ 2,000
4.5% misc bills (utilities, etc)	$ 1,800
.5% Spoilage	$ 200
1% Supplies	$ 400
1% Promo Food	$ 400
1% Comp Food	$ 400
2.9% Credit Card Fee	$ 1,160
.4% Coupons	$ 160
.5% Food Waste	$ 200

No one has any control over %. They are fixed and that is that. So if a store is lucky enough to earn $480,000 annual, the owner can expect to walk away with a profit of 9.4% = $45,120 [edit by Ryan Knoll: I believe this should be 7.15% = $34,320 based on the numbers provided]. No one is going get rich off of that. Of course if an owner can get cheaper rent, and increase sales, it will be of great benefit.

The average store seems to be about 1,500 – 1800 sq ft. and the going rate is $17.50 – $30.00 sq ft + $5.50 – $8.00 CAM.

That looks reasonable to me and should be considered by anyone buying an existing or new franchise. People often forget the expense of promos and coupons, credit card fees, insurance, and payroll expenses. The pretty picture the franchise sales rep paints for you often is the “best case” scenario.

Well, you might think, “That’s a 18% return on my investment of $250,000! I’ll take it!”. That’s not an accurate reflection of your actual return. Those results assume you are working at the franchise full-time and do not include your or your manager’s salary. So, if you think your year’s effort is fairly compensated at $45,000, then your real return on your investment is ZERO (actually it’s negative because you could be making 4-5% in bonds).

General Nutrition Centers ("GNC") forged the path for franchised health supplement stores. It was a nice run but I believe it is near the end of the road for GNC. The industry is saturated with newer, flashier and larger stores like the Vitamin Shoppe and Vitamin World.

For example, in Chicago in the Lincoln Park area at the corner of Diversey Pkwy and Clark Ave, a beautiful large Vitamin Shoppe opened up across the street from the tiny, more expensive GNC. Also, Sherwyn’s, a large health food store, opened up within a block of the GNC. The every evolving competition is slowly finding the formula that will eventually beat out GNC’s small competitive advantages.

This article (from 2003) explains how GNC sales dropped 10% in 2003, which led Royal Numico, a leading Dutch baby food maker, to sell GNC to private equity firm Apollo Advisors. It looks like the sale didn’t help, 4th quarter sales droped 12% from the same quarter last year.

Will GNC’s new smoothies help stop the bleeding? I doubt it.

Does a $25,000 franchise fee for a Geeks on Call franchise seem too high for a home-based computer repair service? I understand that the brand name can be quite valuable once a minimal level of brand identity is recogized by the public, but at that price I would expect noticeable market brand recognition to already exist. Additionally, the royalty of 11% of gross revenue seems steep as well.

If I wanted to get into this type of business, I’d start “Computer Nerds on Call”. I would then take the $25,000 franchise fee and ongoing 11% royalty that would have gone to the franchisor and spend it on additional radio advertising instead.

Or, I’d weigh the differences with Friendly Computers who smartly has tiered their royalties at 3% your first year, 4% your second year, and 5% thereafter.