BUSI 423 Week 6 Essay 3 Example

Is the Business Ready to Franchise? Replicability, Support Capacity and the Odds of Survival

Introduction

For the owner of a successful small business, franchising can look like the fastest route to growth: other people supply the capital and the labor, and the founder collects fees and royalties. For Grossman and Katz (2017), franchising multiplies a concept that already works, yet the franchisor must also build a second company, one that sells and supports franchises, on top of the original one. Kaufmann and Dant (1999) locate the franchisor's entrepreneurial role in creating a business concept and spreading it through others, a different task from running a single store well. This essay argues that the decision to franchise should rest on four tests: proof of the concept, replicability, franchisee economics and support capacity. It applies them to a composite owner of two profitable cafés and draws on research about why many new franchisors do not survive.

Test One: Is the Concept Proven?

A concept that works in one location may depend on that location, or on the founder's personal effort, rather than on the business model. The strongest evidence is profitability in more than one unit, ideally in different neighborhoods and under managers other than the founder. Our café owner has two stores, both profitable, but the founder works in the original store daily and the second opened only eighteen months ago. That is encouraging but not yet conclusive; a third unit run entirely by a hired manager would show whether the concept travels without the founder.

Test Two: Can It Be Replicated?

Franchising sells a system, so the system must exist on paper and in training, not only in the founder's head. Grossman and Katz (2017) emphasize the operations manual and training program as the core of what franchisees receive. For the café, that means documenting recipes, supplier specifications, opening and closing procedures, hiring standards and the store design, and testing the documentation by training a new manager who has never worked with the founder. If quality slips when the founder steps back, the business is not yet ready to be franchised. The test is demanding because a franchisee will not have the founder's years of experience, will be hiring staff from a different labor market, and will be learning the business while paying for it. Every step the manual leaves to judgment is a step where quality can drift, so the founder should write down not only what to do but why, so that franchisees can make sound decisions in situations the manual does not cover.

Test Three: Do the Unit Economics Work for a Franchisee?

A franchisee must earn a return on an investment that includes the initial fee, build-out and working capital, after paying royalties and advertising contributions. Suppose each café has annual sales of $850,000 and an operating profit, before any royalty, of $127,500, or 15 percent. A royalty of 6 percent and an advertising contribution of 2 percent would take $68,000, leaving $59,500. If the total investment for a franchisee is $450,000, that is a return of about 13 percent before the owner's own salary, which is thin for a business requiring full-time work. A concept that is profitable for its founder can still be a poor franchise, because the founder never paid a royalty. The café owner may need to lower costs in the model, lower the royalty or wait until sales per unit are higher. Each choice has a price: a lower royalty slows the franchisor's ability to fund support, and higher sales may take years to prove.

Test Four: Can the Franchisor Support Its Franchisees?

Franchisees pay royalties in exchange for continuing support: site selection, training, marketing, purchasing and field visits. Providing this requires staff and money before royalties are large enough to pay for them. Research suggests that this is where many new franchisors falter. Shane (1996) studied firms that began franchising in the United States in 1983 and followed their growth and survival over a decade. He found that many new franchisors did not survive, and that franchising helped growth and survival when it reduced the cost of monitoring unit managers, but that the benefits depended on the franchisor's ability to manage a growing system. A franchisor that sells units faster than it can support them risks failing franchisees, and then failing itself.

For the café owner, this test translates into a staffing plan. Supporting the first ten franchisees would likely require at least a training manager and a field consultant, plus the founder's own time, at a cost that ten units' royalties would not cover at first. Kaufmann and Dant (1999) emphasize that the franchisor's entrepreneurial task is building and spreading a system, and in practice that means funding the support organization before it pays for itself. The owner would need capital from savings, a lender or investors to bridge the gap between the first franchise sales and the point where royalties carry the support staff.

The Costs of Becoming a Franchisor

Before selling a single franchise, the café owner would need a franchise agreement and a Franchise Disclosure Document prepared by an attorney, audited financial statements, registration in states that require it, an operations manual, a training program and a budget for franchise sales and marketing. These costs can easily reach six figures before the first royalty arrives. The founder should also expect the first franchisees to need more help than later ones, since early units test the training program and manual in practice; budgeting for frequent field visits in the first two years protects both the early franchisees and the brand's reputation among later buyers. The founder must also be ready for a different job, recruiting, training and coaching franchisees rather than running cafés.

Conclusion

The café owner should not franchise yet. The concept is promising, but it has not been proven without the founder's daily presence, the systems are not fully documented, and the unit economics leave a franchisee too little return after fees. A sound plan would be to open a third company-owned store run by a hired manager, document and test the systems through that opening, improve unit margins and build capital for a support organization. If all four tests are met within two to three years, franchising could then offer a sustainable path to growth, for both the founder and the franchisees.

References

Grossman, R., & Katz, M. J. (2017). Franchise bible: How to buy a franchise or franchise your own business (8th ed.). Entrepreneur Press.

Kaufmann, P. J., & Dant, R. P. (1999). Franchising and the domain of entrepreneurship research. Journal of Business Venturing, 14(1), 5-16. https://doi.org/10.1016/S0883-9026(97)00095-5

Shane, S. A. (1996). Hybrid organizational arrangements and their implications for firm growth and survival: A study of new franchisors. Academy of Management Journal, 39(1), 216-234. https://doi.org/10.2307/256637