The Right Stuff About Buying a Franchise – Lesson 2: Will You Make Money?

In late 2007, I purchased an existing franchise bookstore whose revenues had dropped by about 30 percent during the previous four years.  The owner and his wife were genuine sellers, having already relocated to another part of the state where they were to care for a seriously-ill relative.

I was confident that I could restore its glory.  After all, I had doubled the membership, revenues, and staff numbers of a real estate industry association just before buying the bookstore.  I knew how to revitalize a business.  Surely I could do the same for the bookstore, right?

Well, yes, or at least a qualified yes.  Revenues are now approaching their former highs as a result of some very long hours and the implementation of some innovative marketing strategies.  Yet, for all this, I haven’t realized significant profits to show for this effort and these outcomes.

Why not?  Because, in the case of books, and probably for a heap of other products, the economics of the business model work against the creation of lucrative outcomes.  I was reminded of this by an insightful quote in the wonderful book, The Guernsey Literary and Potato Peel Pie Society by Mary Ann Shaffer,

“I love seeing the bookshops and meeting the booksellers—booksellers really are a special breed. No one in their right mind would take up working in a bookstore for the wages, and no one in their right mind would want to own one—the margin of profit is too small. So, it has to be a love of readers and reading that makes them do it—along with first goes at the new books.”

So, it’s a tough business.  But we each have to work at a place we find interesting, feel enthusiasm for, and is within our span of knowledge and expertise, don’t we?  For me, this had to be the world of books, particularly since I can’t fix or repair anything, am a dolt and a luddite when it comes to anything technical, and have had a love affair with books since my childhood.  Added to that, I self-selected into a lower-risk, lower-returns industry by buying a bookstore rather than something newer and more glamorous.

Nonetheless, it seems to me that the vast majority of franchise business models are designed with the primary expectation that it is the franchisor who will benefit most.  They pass most of the potential risks on to the franchisees, require the franchisees to undertake almost all of the “grunt” work of the business, and are not especially accountable to their franchisees except in an indirect, relatively weak manner.

Yes, they are required to monitor the health of their franchise networks, provide opportunities for franchisees to get together, and create marketing and logistics support for their franchisees, but these are arguably less onerous, less risky, and less committed tasks than those demanded of franchisees.

If it’s prosperity you seek, there are a few options you should consider.  Otherwise, you will find yourself in the very large pile of mom-and-pop franchise owners who have bought themselves jobs but do not achieve the returns deserved from their labors.

First, you can get in early and buy a franchise in an industry or niche in its early to late growth phase rather than one in its late maturity like the book business.  McDonald’s in the 1970s, Subway in the 1990, and fruit juices, salads, and sushi bars during this decade are all examples of this phenomena.  Cast your creative minds toward the growth curves of the new wave of franchises.  Perhaps there are businesses available that help people better manage the finances they have (or don’t have) that will be in real demand as the economy contracts.  The fitness and health sectors are likely to continue to grow at impressive rates, while services for our aging baby boomer generation will undoubtedly mushroom during the years ahead.  The earlier you are in, the more that you can take advantage of the above-average margins earned by those facing fewer direct competitors in the short to medium term, and the more that you can establish yourself and take advantage of further opportunities to purchase additional franchise stores or territories before the rest of the world learns about the money to be made there.  Of course, there is a higher level of risk here, but higher rewards usually follow if the risks pay off.

Second, you can snap up existing franchises with low-ball offers that may be accepted, with a little luck, by those desperate to sell.  In this way, you won’t find yourself taking years to pay back the goodwill that may or may not have been in the business you have just purchased.  I definitely paid too much goodwill for my store, adding years of additional work to pay it down.  In contrast, I know of one colleague who has recently added a second franchise to his existing store.  His timing was great for both stores, and he paid little more than the value of the inventory he was acquiring.  For him, there is a much greater potential upside than there is for me.  Live and learn, right?  

Third, you can scout around to see if there are any franchisors offering more of a win-win deal than those who cream off a flat rate of your revenues.  In my view, a truly abundance-focused franchisor would take less of your hard-earned cash as you scale up, and then a higher percentage as you move beyond your break-even to increase your overall margins.  I’m not sure if such franchisors exist, but if I was just starting out I would certainly check this out.  If you have already decided on your industry, I would also closely examine, from every angle, the slice of your money taken by all of the existing franchisors in the industry before settling on any one.  Don’t forget, 8 or 10 percent of your gross revenues may not seem like a lot, but when it is considered next to your bottom-line, you quickly realize that every dollar given to them is one that you won’t keep.  It is a dollar you can’t use for local promotions, a dollar you can’t use to pay yourself a higher salary, and a dollar unavailable to pay down your business loan.  You will never see that dollar again.  Consider this fact very, very carefully and understand its serious implications for your business and your lifestyle before buying your franchise.

Finally, you can always take on some extra work outside your franchise or establish another business to help bring in some extra cash.  This is not without its potential problems, however.  Any time spent elsewhere may take your eyes off your most important asset, your core business, and thus compromise your most critical business outcomes.  In addition, your franchisor may not look at your outside work in a benevolent way.  Check the franchise agreement carefully and, if in doubt, discuss it with someone you trust in the franchisor’s organization before moving outside the business.

If you are going to go the extra mile to make your new franchise a success, think very carefully about your expectations for the bottom-line.  If they are unrealistic and inconsistent with the likely profit flows from your business, you may quickly jeopardize your own morale and that of your people, sending the business into a downward spiral.  With some solid homework, however, you will enter and run the business with a healthier business philosophy and with more realistic expectations for its results.