Franchise Versus Company Operations -- the Franchisor's Dilemma

(Franchise-Chat.com) October 7, 2005 -- By Phil Blain

The question of whether to run a mix of franchised and company-run operations is a question which every franchisor inevitably faces. In most franchise systems, the issue arises in the earliest stages of development. The franchisor has an operating and proven model which he wishes to replicate and grow the business via franchising. Even amongst seasoned franchisors, the issue of how many, if any, company operations to keep remains an issue of strong debate.

In the conventional retail model, this is relatively straightforward as, finances allowing, another outlet can be opened and run under staff before franchising it off. If finances don't allow this, the franchisor is faced with a burning question. Do I franchise my existing model, or do I keep it?

Where the franchisor has several outlets, this is less of a problem as one can be franchised without overly affecting the franchisor's income from the group. In most systems where Franchise Alliance has been involved with their development, the franchisor is forced to keep the "cash cow," best store or territory, purely for financial reasons. This can bring its own problems to the table as it can be interpreted by franchisees that the franchisor is only franchising the less profitable, or even problem outlets, and is keeping the best for themselves. This perception is not conducive to strong franchising and will not be overcome until a franchisee can reach the same level of success, or better, from a new outlet. It is thus well worth considering franchising the best performing outlet and foregoing the income. The supporting rationale behind this being that the particular franchisee will be highly successful and, by validating the system, will be the best resource possible to refer potential franchisees.

The service-style franchisor often finds it more difficult to sell off the originating territory, as it is frequently their sole source of income. They are then faced with selling off new territories against the existing proven model. Whilst the retail franchisor needs to do thorough demographic research, it is even more important for a service franchisor to do so in these situations. Sadly, it is our experience that retail franchisors recognize this need, but service-style franchisors tend not to.

Situations usually dictate the path in the development stages, but what about when a system is more mature and can actively address the issue of how many company operations to run, if any?

Generally, the recognized advantages of having franchisor operations alongside those of franchisees are as follows.

1. The franchisor has the opportunity to trial new products which lessens the risk of inflicting dud products on the franchise system.
2. The franchisor can trial new systems and procedures before introducing them to the system. Scott Meneilly of Body Bronze says, "My feeling is that on one hand company-operated salons can be a distraction, but on the other hand it keeps you understanding the business. Company-operated stores enable us to try out new ideas before releasing them to the network." Diana Williams of Fernwood puts it, "One of the main advantages of having company-owned outlets is to enable us to trial new procedures and systems, which we are always working on to improve the way we do things. Trialing them in our own clubs allows us to make sure that all of the problems are ironed out before we roll it out to the franchisees."
3. The franchisor operations provide a healthy breeding ground for franchisor staff to grow and develop into highly knowledgeable support staff for franchisees.
4. The franchisor has a ready-made school to train new franchisees.
5. The franchisor can keep a source of income from the company operations. Meneilly again, "The company salons also provide us with a great source of income compared to franchise fees alone."
6. The company operations can enable the franchisor to grow assets, which can be franchised with a strong goodwill component attached. But there is always the old reason why franchising is so powerful, and Diana Williams contributes: "While our company-owned clubs are generating healthy profits, generally franchised clubs are far more profitable than company-owned clubs. This has been proven to be the case where we have sold a company-owned club to the existing manager and without any change of management, staff or location we have seen an immediate increase in both the turnover and profitability." Peter Fox, General Manager of Autobarn agrees, "The franchise model is far more profitable for an owner-operator than a corporate store is for the franchisor."
7. The franchisor experiences the same day-to-day problems that the franchisees are experiencing in their franchises. This gives the franchisor the opportunity to fix problems before they fester and damage the system and impact franchisees. Similarly, when a franchisee takes the position "that can't be done," or "that won't work," the franchisor has the capacity to show how and why it can be done and thus can see through franchisee excuses. However, Peter Fox adds, "We have also found that if a corporate store is in any way non compliant with the system, franchisees use this to justify an endless array of excuses as to why they may do things differently or work outside the system, ultimately to its detriment."

Martin Rose, an ex Master for New Zealand Natural Ice Cream, summarizes the above points as follows, "Company stores allow a franchisor the ability to control and profit from a successful concept. They can provide cashflow and a training facility to showcase the business for both the market and other franchisees."

But it's not all rosey in the garden as there are certainly some disadvantages in keeping franchisor operations running alongside franchisees.

1. If the franchisor is not careful, franchisees could complain that the franchisor is in fact competing with its own franchisees.
2. Running franchisor operations ties up capital, which may otherwise be used for system growth and development.
3. The resource demands on a franchisor running their own operations are obviously substantial. Whilst there may be some absorption of these tasks by the franchise support system, there is no doubt that time and money are soaked up by running the franchisor operations alongside that of the franchisees. In reality, this is more like running two systems instead of one.
4. Without question, the worst part of running company operations are the issues that more staff bring to the fore. Many franchisors went into franchising initially to lessen or remove this issue as far as possible. For these people, running company operations may be decidedly unattractive, no matter what the bottom-line contribution may be. Scott Meneilly sums it up, "Staff cause us the majority of our problems on a day-to-day basis, however I think this again is a burden we need to feel because it is a real problem that faces our franchisees every day. How can we give our franchisees advice if we are not gaining any experience in running a salon?"
5. Having too large a company operation network can initiate an "us and them" mentality, which manifests itself at gatherings where all the franchisees sit on one side of the room and all the staff on the other. This is a highly destructive cancer in a system.

Running a system with master franchisees, who are often required to own and run their own operation, can alleviate the franchisor from needing direct experience, but only if the masters are highly communicative and responsive.

Martin Rose comments again, "A combination of having both management resources and capital tied up can often lead to a poor return on investment—most particularly in difficult trading times. Further challenges exist in ensuring staff perform as well as an invested, driven franchisee."

So, what is the right answer?

Well, sadly, there isn't one. There is no formula which provides the magic solution, and every system is faced with differing opportunities and needs with circumstances often dictating the path forward rather than a conscious decision being made. However, Peter Fox has this interesting viewpoint: "It is fine to have one or maybe two corporate stores to operate as a model and/or training store, and these can generally be accommodated within the existing infrastructure with little cost impossed to the franchise model, but if numbers increase over and above these, a strict corporate model with specialist infrastructure is required."

In balance, at Franchise Alliance, we have to say that we believe running at least one company operation can be easily justified and, in our view, the advantages outweigh the drawbacks.

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