Happy 2019 esteemed readers, we hope this is the year when you will franchise your brands.
Following an earlier article regarding funding considerations, some queries emerged requiring further clarifications. Deeper insights here are on how to determine the cost of a franchise.
Total investment in franchise acquisition consists of four main elements. First, the franchise fee, also known as initial/upfront fee paid by franchisees to join the franchise system. This covers a portion of brand value, initial training (additional training is charged), support during startup (pre-launch, launch and post-launch activities), legal fees, assistance in site selection, marketing and promotional materials-signage, stationery, website, intranet etc.
Second, the establishment cost-the cost of establishing the outlet, including equipment, furniture, computers, shelving, stock, staffing etc.
This varies depending on size of outlet and type of business. These are not a revenue source for the franchisor and costs of items should be reflected at the actual price to the franchisee.
Third, the working capital, cash needed by franchisees to cover operating costs until revenue generated can cover expenditures. It is important to provide this adequately, otherwise risk hemorrhaging and stalling the business.
Fourth, other cost of items that do not have to be acquired according to franchisor directions. Most franchisors will dictate the quality and source of items needed to run the franchise.
But sometimes some small items can be sourced independently, provide for these as well.
There is no ideal formula to determine the cost at which a franchised business can be acquired and the revenue streams needed to make the franchise option a viable proposition for both franchisor and franchisee.
The methodology used by franchisors, being the owners of the system, to calculate cost and fees often contribute to this problem.
This is because naturally, franchisors are inclined to favor themselves but reality requires a balance to enable franchisees recover their investments quickly and happily make money for the franchisor.
The best option normally is to use the “pilot outlet”, the first owner-operated store, to determine the cost/value of an outlet based on the proven financial viability as well as the efficiency and effectiveness of the system. Additionally, an objective brand valuation can indicate what the market would pay to acquire your franchise.
But a few guidelines are needed to avoid common pitfalls in this approach.
First, the costs and fees should be established based on justifiable levels to ensure profitability for the franchisor and the franchisee, not just to ensure they are competitive with other franchisors.
Second, focus on ensuring adequate revenue to outperform competition, not the need to out-sell competitors-where you invest in bigger outlets than competition. This is very key because should franchisees find the engagement untenable on account of your emphasis to outsell rather than outperform (revenue-wise) competition, they will soon give up.
Third, do not make unrealistically excessive expansion predictions, for example, opening twenty outlets in the first year.
When new to franchising you will make mistakes which you need to correct before your franchise system matures, hence experts recommend a maximum of six outlets in year one. Also, if you underestimate the chances of franchisee failure, you will base your projected future revenues on quick sand.
The writer is a Franchise Consultant helping indigenous East African brands to franchise, multinational franchise brands to settle in East Africa and governments to create a franchise-friendly business environment.
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