October 22, 2014

Where Do Franchisors Make Their Money?

I have a challenge for you, if you’re up to it. Are you ready?

I want you to ignore every pre-conceived notion you have about franchising for a few minutes. Pretend that it’s your first time learning about the franchise model. Be at one with the newness of it. Deal?

franchise burgers

Let’s say that you’re the owner of a dog-training business. Your business has been growing steadily since you started it, 4 years ago. You’ve hired more people every year, and you’re thinking of expanding, especially since an ideal commercial space recently opened up in an industrial park two suburbs over.

In your mind, now’s the time to do this, as small business loan rates are at historic lows.

You’re Just Warming Up

What you’d really like to do is turn your dog-training business into a franchise business. That way, you can continue expanding your business by using other people’s money. (OPM)

On the surface, it certainly sounds like a great plan. You’d invest the money needed to franchise your business, and once you started to sell franchises, you’d be able to recoup your money. This money would come from at least two places; franchise fees and ongoing royalties.

Developing A Franchise

If you’re going to set-up your business as a franchise, your first moves need to be right. My late father taught me something very valuable about franchise development, and it has to do with money. He said that the biggest mistake people make who want to franchise their businesses is doing it on the cheap.

A perfect example of this is someone that only uses an attorney when developing their franchise concept. There is so much more to franchise development than the legal requirements needed to franchise.  But for some reason, most of the people I talk to are laser-focused on legalities.

Legal fees to setup a franchise run about $15,000 or so, and someone could get away with spending under $20,000 to get a franchise up and running. But, it won’t be a very successful one. That’s because there are so many more things involved in franchise development.

Things such as:

  • Creating a business plan
  • Writing an operations manual
  • Developing a marketing plan
  • Website development
  • Technology implementation
  • Training program development
  • Franchisee recruitment
  • Franchisee support system setup

The bottom line:  if you’re planning on turning your business into a franchise, you really need to work with a franchise development firm that can help you do everything from A-Z. Otherwise, you’ll be lucky to sell 1-2 franchises, if any at all.

A word of warning:  make sure that you thoroughly vet any franchise development company that you’re thinking of hiring. Ask for lots of references. You may find that some of them are a little too eager to turn your independent business into a franchise business.

The Other Reason That You Want To Franchise Your Business

The picture that you have in your mind of what it would be like to be the CEO of a 250-unit franchise chain is a pretty compelling one. Your visual may even include a 5,000 square foot beachfront home in Maui.

Because as you see it, 250 franchise units paying you monthly royalties of approximately $2000 each = $500,000, which translates into $6 million a year in royalties alone. And, don’t forget the upfront franchisee fees that you’ll receive every time you sell a new franchise.

Of course, there are a lot of ongoing expenses that you’ll have to cover as a franchisor, but you’d still do very well.

Every prospective franchisor that I’ve ever talked to wants to sell 100-200 franchises, so they can make a lot of money. The simple math that I just showed you proves that it is possible to do.

What a great business model; you come up with a concept, invest some money up-front to develop it into a franchise, use OPM to grow it, and then have the people that invested in it pay you royalties every month for the opportunity to use your business system. So, as a franchisor, you’re making money from the franchisees.

No You’re Not

According to Lonnie Helgerson, a franchise development executive who just wrote a book called, “Five Pennies, Ten Rules to Successfully Build a Franchise Mega-Brand And Maximize System Profits,” franchisors profits don’t come from the franchisees.

From Helgerson’s book:

“I often tell my staff members that as a franchisor, we do not make our money when a royalty check is received. We and our franchisees earn it when the point of sale system rings up a sale for a customer and our job is to help our franchisees ring up lots and lots of sales. Losing sight of this leads to fewer sales, frustrated franchisees, and over time will become a significant branding problem.”

At the beginning of this post, I asked you to pretend that you were just starting to learn about the franchise business model. I also encouraged you to give up any pre-conceived notions that you had about franchising. Can you see why?

Lonnie is 100% correct. If, (as a franchisor) you’re not offering a great product or service that will enable your franchisees to ring their registers…a lot, you won’t be successful. And, your franchisees won’t be either.

So, before you even think about turning your business into a franchise, make sure that what you’re offering is outstanding.

Or, your business could end up going to the dogs.

Question Photo via Shutterstock

6 Comments ▼

Joel Libava - Franchise Expert


Joel Libava Joel Libava is the Franchise Expert for Small Business Trends. Joel, The Franchise King®, equips today’s prospective franchise owners with time-tested, proven techniques designed to increase odds of success. He does this through one-on-one coaching, and gobs of useful content that can be found on places like Small Business Trends, SBA.Gov, and his award-winning franchise blog, The Franchise King Blog . He’s been featured in Entrepreneur® magazine, and is frequently called upon by national media outlets and publications for his no-spin insights into the world of franchising.

6 Reactions

  1. I like your concept as well as Lonnie Helgerson’s concept of ringing the cash register of franchisees to make your franchise successful. So, why are companies like Danaher allowed to sell fraudulent opportunities and utilize advertising and popular tv shows as well as the NHRA to keep frisking franchisees of their money? How come an organization like Vetfran allows franchisors to participate in their program who show no history of sustaining franchisees in their franchise?

    • Hi Todd,

      Thanks for commenting.

      Here’s the thing; we all have choices. The IFA-and VetFran can choose who they let in their programs. And, potential franchisees can choose where they want to invest their hard-earned money.

      It all comes down to research. That’s what I teach to would-be franchise owners, and if done properly, great franchise research can save prevent a lot of headaches in the future.

      As for the company you mentioned, I’ve never heard of them, and I wouldn’t be comfortable discussing them in this comment thread, anyway.

      The Franchise King®

  2. Joel, I think Lonnie Helgerson’s point about ringing up sales is good but it is only half the story. The sales need to be PROFITABLE sales.

    I have represented both franchisors and franchisees and I can tell you that since the royalties are based on gross sales rather than net profits, a short-term thinking franchisor is only concerned with ringing up sales, any sales. In the long run, that thinking can lead to bad decisions on promotions and pricing that can lead franchisees to either leave the system or, worse, go out of business.

    A forward-thinking franchisor is thinking less about maximizing its own immediate royalty stream and more about building viable franchisees who will provide a steady stream of royalties for a long, long time.

    • Thanks, David,

      Long-term thinking always works best…in the long run.

      But, sometimes, franchisees need to get out of their own way.

      For example, when several Burger King franchisees sued BK for forcing them to sell $1 dollar cheeseburgers at a loss.

      Loss-leaders are used in a variety of businesses-successfully, I might add.

      Grocery stores sell 24-packs of Coke or Pepsi for a loss all the time. That’s because only 3 feet away are shelves and shelves of Dorito’s chips, which sell for $4, and are huge profit-makers.

      Burger King franchisees may have to bite the bullet once in awhile for a promotion, but their customers are buying other things at the same time.

      How much profit do you think is contained in a $2.99 fountain drink?

      The Franchise King®

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