At its core, franchising is one of many methods by which businesses expand. The term “franchise” is just another word for “permission.” A franchisor grants permission to others to make use of the franchisor’s intellectual property and “system,” which the franchisor has developed for operating the underlying business. Franchisees are simply people who make the decision that they want to operate their own business using that intellectual property and system rather than trying to start their own business. For this right, they are prepared to pay various fees to the franchisor and take on numerous obligations in how the business can be run. The particulars of what is being granted and the rights and obligations are typically contained in a series of contracts between the franchisor and the franchisee. As franchising as a business model is regulated in many jurisdictions, including in six of Canada’s provinces, legislation also exists which overlays the buying and selling of franchises and in their operation.
Most franchisors share common goals. However, their rates and degree of success vary greatly. This article will examine the top 10 characteristics of successful franchisors operating in the hospitality space from a career spanning 40 years working with hundreds of franchise systems. Approximately half of all franchise systems operate in these industries.
1. Their systems sell products and services the public wants.
Franchisors in the hospitality industries typically started life as unit restaurants or hotels/motels which successfully sold products and services to an appreciative customer base. Others — both because they liked the offerings and the financial model they believed existed for the operation of the underlying business — became interested in replicating the success of the founders in those businesses. It is the number-1 characteristic of successful franchisors that they make the best decisions to keep their offerings desirable in the marketplace. Customers of their brands must continue to embrace the value proposition of the offerings. As a corollary, successful systems’ franchisees identify with, are proud of and support the brand, products and services as much as their franchisors. A recent announcement by a large restaurant franchisor of the closing of hundreds of units can be mostly attributable to the failure of the system in this key area.
2. They are instrumental in creating a profit pool large enough to support their businesses and the businesses of their franchisees and they share equitably in the profits.
A non-franchised business calculates its profits simply. It deducts its expenses from its revenues. For a franchised business, those expenses include various line items involving payments which are made directly or indirectly to their franchisors and entities related to the franchisors. For the franchisors, the revenues they generate must create profit levels that allow them to cover their expenses in running their businesses as franchisors and provide an expected rate of return to the franchisees. As one envelope, all of the revenues generated by the system have various offsetting expenses. Successful franchisors find ways to maximize the revenues from the offerings within their systems, minimize the expenses for both the franchisees and themselves and create profit structures or a sharing of these profits for both parties, which justify the investment that both make, and continue to make, in the systems. A simple example is that franchisors in the hospitality area have always enjoyed significant purchasing power. They acquire inputs used by their systems at reduced costs. They usually earn rebates from these purchases. Franchisors’ abilities to reduce costs and earn rebates through this purchasing power become reflected in how they operate their systems. Do they pass on the savings and revenues? If so, how? The handling of this one aspect of franchising can be critical to a system’s success.
3. They recognize the key attributes of successful franchisees, and they seek out franchisees who either have these attributes or can be successfully trained to have those attributes.
All franchisees are not created equal. A franchisee who is good for one system may be a total failure in another. Franchisors know what it takes to be a successful franchisee in their systems, and they recruit accordingly, often utilizing an array of technological tools to identify desirable franchisees. In these industries, franchisees must be willing and able to make a lengthy commitment and have shown aptitude for working long hours, following systems, managing people, loving guest service and having enough resources to endure challenging times.
4. They have franchise agreements that permit them to exercise control over the overall system and the individual units, but they exercise their rights and enforce their agreements fairly, with understanding and significant support befitting the investment and commitment made by the franchisees.
The fact franchise agreements seem very one-sided in favour of the franchisor is completely understandable. A franchisor must be able to operate a cohesive system. However, ultimately, franchisors are dealing with people who invested in them. Breaches by franchisees can and do occur regularly. A franchisee runs out of eggs and instead of asking the franchisor what to do, it buys a few across the road. Yes, that should never happen. Yes, that is a breach. How the franchisor handles that situation knowing a court or arbitrator is unlikely to let the franchisor terminate the franchise becomes a critical component to success.
5. They utilize compliance personnel and tools as a means of providing support and guidance.
They “police” their systems to ensure compliance for the benefit of the system as a whole and not as a means to eliminate franchisees for purposes of churning. As a follow up to the last characteristic, franchisees benefit by having franchisors that are diligent in maintaining the system across the franchised network. Modern technology tools and strategies exist for monitoring and addressing compliance. Successful hospitality franchisors invest in these systems and use them appropriately.
6. They ensure that their franchisees understand, and are comfortable, with the differences over what aspects of the system are controlled by which party and how the allocation of these controls and the overall system works reasonably on behalf of both.
Franchisors and franchisees perform different functions in good systems. Franchisors that succeed have drilled these differences into their would-be and existing franchisees. Franchisees then understand and appreciate why they can’t purchase staple items off standard. They understand that franchisors control the concept. They look for proper ways to contribute but understand which rights they bought and which they didn’t buy. Good franchisors realize that restaurant franchisees, in particular, will figure out how they could make more money if they were allowed to, usually at their expense. They are transparent generally as to what each side’s profit silos are and how they co-relate. They and their franchisees understand that franchisors can make errors in the exercise of their business judgment and that it is their right to do so. Despite this right, they appreciate the impact of their bad decisions on the franchise system, and they find ways to mitigate the impact of bad decisions upon the franchisees.
7. They understand and plan for the different stages of system growth.
Franchising is an organic journey from establishment, to early days, to growth, to maturity, to exit. Successful franchisors understand from the beginning how each of these stages differ, how their own capital requirements differ, how their organizational structures will change, and they are in a constant state of planning for the next stage, to ensure they occur as seamlessly as possible.
8. They design systems that work at the unit level as well as the multi-unit level.
They generate investment opportunities within their systems so franchisees prefer to invest within their own franchise systems than elsewhere. Yet, they understand the difference between what it takes to be a successful multi-unit operator from having unit success. Their systems are designed from the beginning with this in mind. Similarly, and relatedly, they have succession strategies both internally and for their franchisees.
9. They establish systems for engaging their franchisees to obtain all appropriate input from those who are customer-facing and who made investments into the systems.
That can be done by establishing councils or franchisee associations, or working groups involving franchisees. There are different ways for franchisors to obtain good input from this valuable resource while maintaining their clear role in controlling their systems.
10. They understand they are operating in a regulated industry, and they care to become experts in the laws affecting their businesses.
For that, they retain counsel with all the requisite legal and business experience to be by their side in every aspect of their businesses — from trademarking, to structuring, to franchise sales, to performance, to handling issues and dispute, to capital needs, to guiding system changes to succession.
Franchising in the hospitality space is long-established. Experienced franchise counsel has likely seen it all and thinks about aspects of the future of the business and the industries on a daily basis. That experience can be invaluable in helping franchisors exceed in their business goals.
By Allan D. J. Dick is a partner in Sotos LLP (sotosllp.com), Canada’s largest, most experienced law firm serving businesses participating in franchise industries locally, nationally and globally. Allan can be reached at [email protected] or by cell at 416-805-8989.
