November 24, 1997Franchise investment can't guarantee instant success
Just 62 percent of franchises started in United States in 1986 remained operating in 1991, SBA study says
Karen M. Lundegaard Special To The Austin Business Journal
As the franchise industry takes the nation by storm, industry experts caution that would-be entrepreneurs are finding themselves tied to franchise agreements they didn't completely understand -- and financial structures more profitable to franchisers.
The franchise industry's strongest leg -- that it's safer to buy into an existing business format than start one from scratch -- is wobbling as new studies question the safety of a franchise investment.
Even though they represent only 23 percent of existing franchises, product franchises such as beer distributorships, soft-drink bottlers and auto dealerships rank among the most difficult to buy and the most profitable -- accounting for 69 percent of the $803 billion posted in franchise sales in 1992, the most current statistics available.
The rest of the franchise industry pie -- $249 billion in sales -- is cut between 429,000 business-format franchises, which sell an entire method of doing business. They include fast-food and restaurant chains, convenience stores and service operations.
A modified dream
Nationally, franchised businesses grew 50 percent between 1984 and 1994, from 444,000 establishments to 663,200, according to the International Franchise Association in Washington, D.C."There's more and more recognition of how successful franchising has been," says Don DeBolt, president of the IFA. "It's created a lot of personal wealth for a lot of people." Several factors are driving franchise growth.
Government and corporate downsizings have left many people with severance payments big enough to launch them in franchise businesses by covering often hefty up-front fees. Also, franchising feeds "that inner urge to have a slice of the American dream and have responsibility for your own destiny" DeBolt says.
He agrees franchisees must play by the rules, but franchisees buy into a system to gain access to rules that established success. "The essence of a successful franchise system is the ability to replicate the exact product or service -- whatever it might be -- with consistent quality," DeBolt says. "Those rules are pretty rigid. That's why you buy a franchise, because someone else has gotten all of the kinks out of it."
Who's testing the concept?
Buying a franchise doesn't guarantee kinks have been worked out. More and more, fledgling companies franchise a concept after just a short time -- a "recipe for failure," says Susan Kezios, president of the Chicago-based American Franchisee Association. "You're supposed to be buying a proven system from someone. It should be proven somewhere," she says.Franchisees generally pay an initial franchising fee and a percentage of sales after that for royalty-- and marketing fees. Costs vary from $500 to $250,000. Those figures often don't include initial capital to get a business up and running.
Capital needs vary from virtually nothing for a home-based business to millions of dollars for a hotel.
DeBolt recommends that potential franchisees consider a relatively new, unproven franchiser as a high risk, and conduct a thorough investigation.
Safety first
How safe is a franchise investment?The International Franchise Association cites a 1991 Arthur Andersen study that found 86 percent of franchise companies that had opened in the previous five years remained in business under the same ownership. Just 3 percent had gone under.
The association contrasts that with a U.S. Small Business Administration survey, which showed 62.2 percent of all new businesses started between 1978 and 1988 dissolved within their first six years in business.
But consider two studies released from the SBA's Office of Advocacy:
Of franchises started in 1986 or 1987, 62 percent were operating in 1991, according to a study by Tim Bates, a professor at Wayne State University in Detroit. That compares to a 68 percent survival rate among independent startups, the study notes.
The other SBA study tested the survival of franchisers. Of 138 franchisers that started franchising in 1983, fewer than 25 percent were franchising 10 years later, according to the study. Systems that survived tended to be more proven, operating more company-owned outlets.