Franchisors can make money off their franchisees in several ways:

1. Upfront Franchise fees
2. Monthly royalties on gross revenue
3. Deposits on equipment
4. Ongoing “hidden” cut on the mark-up of equipment, products, services, extra training and support, and supplies (many use Vistar Corp as a distributor)
5. Advertising, art and signage fees
6. Kickbacks and commissions for real estate deals (from landlords and brokers)
7. Kickbacks from financial lenders (similar to finder’s fees)

Usually the skimming is minimal and is serves the purpose of offsetting lower upfront costs for the franchisee. But, many of these extra “fees” and “commissions” earned by the franchisor are not disclosed and purposely obfuscated during sales process. Too often franchisees do not have enough accurate information to estimate these.

Also, franchisors often do not disclose the total related expenses and costs of a full site build out. They know that once you paid the upfront franchise fee, you will make the extra investments needed to get your building up to par and ready.

Franchisors also make nice profits on the resale of franchises. Franchisees who want out can’t just sell their franchises to their neighbor. Usually there are breakup fees and all sort of other hoops the corporate headquarters will impose on the seller.

Wizbangblog had a contest for funny business name and released the winners. Could these be good franchise names? I think they could be. Here are a some of the funniest ones:

• a florist “Floral And Hardy”
• franchise for “Yassin’s Used Wheelchairs”
• a deli named “Cheeses Of Nazareth”
• a high-tech deli named “CTRL ALT DELI”
• a fried chicken stand in Corpus Christi called “Corpus Crispy”
• a ental lab company called “DK Dental Labs”
• a door-accessory shop called “Knobs And Knockers”

I found this interesting – Wal-Mart Realty. This division of Wal-Mart has buildings for sale, land for lease, and in-store leasing on Wal-Mart and Sam’s Club properties. Wal-Mart and Sam’s Club already have the people traffic that many franchisees require.

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.

Entrepreneur Magazine has an interesting article about whether franchisors are vicariously liable for their franchisees’ actions or incidents happening at their franchisees’ locations. The answer is "maybe but probably not". Naturally, a plaintiff’s attorney whose client slipped and fell in a McDonald’s is going to want to go after the parent company as well as the individual franchisee. Or, a client who feels they were discriminated against will want to sue the corporate headquarters of McDonald’s, not just the franchisee. The plaintiff victim would have to argue that the franchisor’s training and standards of operations contributed to the injury.

For example, if a customer burned themselves using a self-serve coffee station at a Panera Bread, and the coffee pot’s dangerous position was directed by Panera’s operations manual, then an argument can be made that Panera Bread contributed to the burn and is financially liable.

Hat Tip Franchise Law Blog

Here are financial results from a Curves franchise. EBITDA is somewhat higher than I expected assuming these numbers accurately reflect the state of the business. It’s in Sarasota, FL and they project growing from 373 to to 500 members by the end of 2005. It’s large for a Curves, 2900 sq feet, and has the standard 12 workout stations and 12 recovery stations (those bouncy platforms). Let’s look at the numbers provided by the franchisee seller:

If these numbers are accurate, and place is run mostly by the part-time employees, then it’s asking price is only about 2x EBITDA, which sounds cheap. It doesn’t say if the expenses include the owner’s salary, but it’s probably safe to assume that it doesn’t. The owner has several part-time employees, but they must be “really part-time” because this franchisee only has on allocated $56,000 or $4,666 a month for rent, fees, operational expenses and owner’s/manager’s salary.

4-10-2005 Update:

This particular franchisee is earning its first year a 37% return on their $40,000 investment assuming $60,000 is allocated to either the owner’s salary or expenses for a full-time qualified manager. 37% is an excellent return. Keep in mind I’m working from unaudited and anonymous information. And as we saw from our Quiznos example, the devil is in the numbers things are usually more expensive than they appear.

This particular franchisee looks like a good deal. It is earning in its first year a 37% return on their $40,000 investment assuming $60,000 is allocated to either the owner’s salary or expenses for a full-time qualified manager. 37% is an excellent return. Keep in mind I’m working from unaudited and anonymous information. And as we saw from our Quiznos example, the devil is in the numbers things are usually more expensive than they appear.

positives

• national “buzz”
• low opportunity for employee theft
• customers tend to have a positive experience
• realistic possibility of positive cash flow the first year of operations
• a Curves franchise has very flexible real estate requirements
• it is a healthy, socially enriching venture

negatives

• 8% of all the franchisees out there are actively trying to sell their franchise (according to Curvesresales)
• If there is a profit margin, then competitors will quickly move in. Competitors will inevitably have a better business model, better facilities, and construct an improved workout system with better equipment. That will pressure Curves membership rates, retention and recruitment.
• Numerous clubs for sale have low membership levels, under 150 members
• Members may get bored of the same workout routine
• Typical health club equipment needs to be replaced in as little as every 3 years

I’ve changed my mind on Curves and think it is a very worthy and likely worthwhile venture. The modified womens-only workout system with a friendly, personable, and fun atmosphere is a winning formula. And Curves seems to have packaged it right. My biggest concern is obtaining and maintaining a profitable level of members in the face increasing competition.

(See our first post on Curves a few days ago for more background information and pictures)

I enjoyed reading how Blimpie has tinkered with its look in a tough market. I think this quote from the article sums it up best:

“It’s hard to communicate a quality product in a store environment that doesn’t reflect that,” he said. “The quick-casual segment has upped the ante on what consumers can expect.”

You wonder why Blimpie would choose the “look” of cheap yellow booths and floors in the first place. Panera Bread has done a wonderful job of creating a high-quality fast food (or fast casusal as some call it) experience.

The basic strategy which I think many franchisees can learn from is “the logo and interior change will draw customers in, while the food (or product) that hooks them”.

By the way, which logo do you like better? I like their new logo.
New logo –>
Old logo –>

As a follow up to my post on eBay drop offs, eBay is fighting new government regulations and licensing requirements on people selling things though auctions. An interview with eBay’s Director of Government Regulations describes and how they are fighting federal, state and local Internet auctioneering regulations and taxes, like the one passed in Ohio. Ohio passed a law that says if you conduct auction online or over the phone, you need to buy a license from the government. eBay is set up an information site for their members on what’s being done to fight governent regulation on auctioneering. The government is eyeballing online auctions as a new revenue stream for government, so watch out!

I’ve read a little about the 1-800-WATER DAMAGE franchise. The company has 70 locations operating in the United States. Their service offering for homes and businesses services is water damage cleanup. The types of services most often are water extraction; basement, crawl space and structural drying; dehumidifying; removing odors; sanitizing; and disinfecting. They claim technicians respond to customers within 90 minutes. The cash requirements for opening up a new franchise are $46,000 and total about $200,000 total investment. I was not able to find out what other mandatory fees (royalty, advertising, etc.) must be paid to the franchisor.

The company opened a whopping 50 new franchises in a three month period in this $5 billion water restoration industry. Some sing their praises. I cannot give a good analysis of this business beyond the opportunty and what I know about the success of the 1-800 type business.

People have been pounded with 1-800 Flowers, 1-800 Mattress, 1-800 Contacts, 1-800 PetMeds and dozens of other well known 1-800 brands. The 1-800 number identification subconsciously sticks with people. If I was in a situation and had water damage, I wouldn’t know exactly what to do. If I looked in the phone book at 100 listings claiming fast water damage solutions, 1-800-WATER-DAMAGE would catch my eye and I’d probably call it. Why? I don’t know. Perhaps because it sounds national and the company must have been around a while and smart enough to get that number. It is a very smart marketing move to name your business after you phone number for obvious reasons.

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.

I read an interesting article about Battery Plus. Their mainly in Canada but now expanding to the USA. I’ve heard of this franchise before but never really investigated the business. I have bought many after-market batteries for laptops and digital cameras before on eBay and Amazon and from miscellaneous stores I found on PriceGrabber for 75% under retail. It is true everyone uses batteries, and I think the store could work from a concept standpoint (I haven’t seen any financial numbers though). Most people don’t know where to go for batteries besides the limited selection at Best Buy and Circuit City. But, the biggest negatives I see are:

• high advertising costs to overcome the current zero brand recognition
• battery inventory turnover is probably quite low because there are such a wide array of electronics and computing devices
• mall kiosks seem a more appropriate cost effective way to sell these items and they will get free walk-by advertising
• storefronts can’t be dinky closest-like in size and feeling, so lease expenses will likely be higher than needed
• are batteries a commodity?
• Radio Shack seems in a much better position to capture this lucrative market

Stories like the one on QuiznosSucks.com make me sad because they could have been prevented if a franchise lawyer was representing the franchisee during the transaction. QuiznosSucks describes a father’s ordeal with Quiznos and all the “unanticipated” problems with parking, protected territory, equipment installation, leases, misrepresentations, location selection and support. Could those problems have been forseen? Yes, they all most likely would have been avoided or mitigated if a lawyer were representing Mr. Sauls throughout the process.

The story illustrated the importance of having a knowledgeable lawyer looking out for your best interests during the ENTIRE franchise purchase (not just look over a lease). Lawyers have an ethical obligation to look out for you, and if they don’t, it is easy to sue them for damages and they can loose their license to practice law. “Consultants”, on the other hand, will provide you little legal recourse against either the consultant themselves or the franchisor.

Part of the expense of buying a franchise must include competent legal representation working for YOU (not the franchise). Don’t sign or pay anything without consulting with hiring franchise lawyer. I find it amazing that people will mortgage their house, commit their life savings to their dreams, and yet try to save a few bucks by not having a lawyer represent them every step of the way. There is reason sophisticated business folks have lawyers negotiate and handle business transactions.

Problems are going to happen in the franchise relationship. Some will stem from the Franchise Agreement but won’t rear its head for a few years (like the franchise changing their mind and opening up another one down the street from you). Franchisors will say something you rely on and interepret as a promise, but in reality it is not enforceable even if its in writing.

It’s worth repeating again -> if you are going to buy a franchise, you need legal represenation to look out for you best interests. Just read Mr. Sauls story at QuiznosSucks if you think buying a simple franchise like a sandwich shop should be problem free.

Some franchisees are suing, but you usually can avoid entering into bad relationships with more due diligence on the front end.

Ace Hardware evolves to stay competitive

We all know the competitive pressures The Home Depot and Lowes bring to the market. I see Ace Hardware as the Walgreens or CVS in the face of Wal-Mart or Kroger. I believe Ace Hardware renovating and re-engineering its stores is a smart and necessary move. Will the independent franchisees will come on board so all stores will have a similar layout and selection? I’ve read most those owners who are near retirement age don’t see the payoff for them of making the $150,000 investment, and their Franchise Agreement does not force them to upgrade.

I’ll write more on this another day

There are tons of eBay drop off stores popping up such as Orbit Drop, QuikDrop, and AuctionDrop’s relationship with The UPS Store . Many of them are franchises. None of the franchises have a household brand name, so the value of the franchise is in the training. Orbit Drop, for example, receives a fee of 35% of the selling price up to $501, then the percentage reduces free lessens as the sale price increases.

Is the franchise brand, training and support worth the $15,000 franchise few and 6% royalty? Probably not for someone with mild business savvy who has experience selling on eBay. $5,000 franchise fee + 3% royalty would be my limit, which is enough to pay for a good consultant to help you set up and maintain your business systems. Most high volume eBay sellers are already familiar with eBay and the eye-popping 3rd party eBay selling tools. If you are going to open your own store (besides regitering a state and federal trademark for you store’s name), go visit and learn from similar franchises in your area. Spend that $15,000 on your store and marketing.

I think the idea is good, and I was wondering when someone would start these. But, I question at this early stage in the industry whether the ongoing franchise fees of 5-6% will kill the margins need to be worthwhile. Look at other consignment and used reseller franchises such as Winmark’s Play It Again Sports to use eBay as another sales channel.

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April 7, 2005 UPDATE: Imagine this Sold is opening up their fist Canadina franchise. The franchise is fee is on the high side from what we’ve seen with others – $20,000 and for additional stores, $10,000 each. The royalty is 6% of net profit (all shipping & handling profits are excluded from net profits for royalty purposes). There is also a mandatory 4% “art work” fee which they claim is used to maintain signage designs (you still have to pay for all advertising media buys). The typical investment to open a store is between $120,000 and $180,000. That’s a lot of eBay sales ($6000,000 in sales would be needed to cover the high-end investment if you retain 30% of total sales as a selling fee).