Franchising Insight

Turning Your Business Into a Franchise Can Pay Off

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In northern Illinois, a 67-year-old former nurse named Seattle Sutton has everything figured out -- except franchising.

Her meal-delivery business is an unqualified success. From a state-of-the-art kitchen the size of a basketball court, her staff prepares three meals a day for close to 3,000 customers in and around Chicago. With revenue of more than $6 million last year, Mrs. Sutton has become something of a celebrity, too. In 30-second TV spots, she wears a white lab coat and speaks in a cheery North Dakota accent: "We serve ya' what ya' should be eating for the rest of your life."

Mrs. Sutton started Seattle Sutton's Healthy Eating in 1985, and had always intended to franchise. Two years ago, she took the plunge, and has since spent about $100,000 hiring franchising experts, filing state registration forms and looking for franchisee candidates to duplicate her business elsewhere.

She has yet to find her first one.

It's not for lack of trying. In April, Mrs. Sutton spent three long days working a booth at the nation's largest franchise expo in Washington, D.C. She spoke to 150 prospective buyers, but to date none are close to coming on board.

The start-up costs -- as much as $800,000 -- have discouraged many. She even addressed that problem. Earlier this year, Mrs. Sutton's franchise salesman offered a less-expensive option, whereby franchisees could have meals trucked in from Mrs. Sutton's kitchen. That, too, didn't work, and Mrs. Sutton recently shelved the idea, fearing it would attract less-committed operators. "What I want," she says firmly, "is all or nothing."

Perhaps she'll find such franchisees. For now, though, Mrs. Sutton's story provides an important lesson for small-business owners: While a recent study found there were about 1,400 registered franchise concepts in the U.S., franchising isn't a slam dunk. Even such successful business owners as Mrs. Sutton can stumble when trying to take their concept to a different level.

Still, with proper strategies and the right concept, an entrepreneur can blanket the nation with a network of franchises inside of 10 years -- using other people's money. The trick, of course, is to find the right concept, and to put it to work smartly. Here are some tips for success:

Build a Successful Model First

"Never franchise [just] a concept," says Rhonda Sanderson, a public-relations consultant in Highland Park, Ill., who for 20 years has helped turn successful businesses into franchise operations. "You have no idea how many people want to do that."

Some concept sellers simply believe that their idea is hot and that they need to move quickly. That's understandable, but it ignores a simple truth: Few franchisee prospects, particularly the smart ones, will sign up for something simply because you promise them it will work.

Make Sure It Makes Money

That's another obvious hurdle, but one that is often barreled through by eager franchisers, convinced that adding more units is the way to overcome a rocky start.

Indeed, building more units to simply build more market presence is hardly a way to generate profits for your whole system. And for your franchisees, that's "a big fat zero, going nowhere," says Susan Kezios, president of the American Franchisee Association, Chicago. In fact, it's often less than zero. Here's the math: One store losing $10,000 equals minus $10,000. Fifty stores losing $10,000 equals minus $500,000.

Experts suggest waiting for at least three consecutive years of profits before starting a franchise. Ask Raymond J. Huntington, who opened his first tutoring center in 1977 in Oradell, N.J. Despite early success, he held off franchising his Huntington Learning Centers Inc., for kindergarten through high-school students, even as a competitor, Sylvan Learning Systems Inc., of Baltimore, began franchising a similar concept. Before launching his own franchise operation, Dr. Huntington built 17 more learning centers himself, perfecting his procedures and training. "Everything else kind of flows from that," he says.

He sold his first franchise in 1985, expanded quickly, and now has 155 franchised learning centers in addition to the 47 centers owned by the Oradell-based corporation. (Dr. Huntington estimates that if he had built the 155 franchised centers himself, it would have cost him about $25 million in today's dollars.)

In franchising, profits must feed two mouths -- yours and the franchisee's. So, be sure the profit margin is there. David Kaufmann, a franchise attorney in New York, says he was always leery of bagel chains -- simply because he grew up in the Bronx near an independent bagel guy named Jerry. Every day, Jerry eked out a living, arriving before dawn and leaving after dark. "And Jerry wasn't walking into a Mercedes," Mr. Kaufmann says. "He was walking into a beat-up Impala."

... But in Tech, Rules Change

Three years can be too long to wait to franchise a concept tied to computer technology-franchising Internet service for example.

Take the case of Quik Internet, an Internet service provider based in Carson City, Nev. Jack Reynolds formed the company in January 1996, just as the Internet was taking off. Two months later, he began searching for franchisees -- placing small ads in several dozen newspapers throughout the nation, stating: "Become an Internet provider."

On the other side of the country, 25-year-old Kylan Koblitz was hanging out in a coffee shop when a friend "told me about this thing called the Internet." The next day, he signed up for an account with the provider America Online Inc., and was hooked. A few months later, Mr. Koblitz picked up the Palm Beach Post and saw one of the ads for Quik. He called Mr. Reynolds, Quik's founder, and within three weeks had signed up. (He paid a franchise fee of $10,000, plus $35,000 in equipment and office expenses. Quik's franchise fee has since gone up to $35,000.)

"It's been phenomenal," Mr. Koblitz says of his own operations, reporting growth in sales of 150% in 1997 and again in 1998. He supplies Internet access and designs Web sites for businesses in Palm Beach County. Now 28 years old, he won't reveal how much he's earning, but says he's "very comfortable" and rents a beach condo with a nice view of the ocean.

Meanwhile, in Nevada, Mr. Reynolds recently signed up his 122nd franchisee. "We certainly couldn't have waited three years," Mr. Reynolds says.

If you must move quickly, experts recommend hiring an accountant. Many fledgling franchise operators have no idea whether they're actually making a profit because they're living off their business, says Rupert Barkoff, a franchising attorney in Atlanta. "If they put cash in the bank at the end of the day, they assume they're profitable," he says. But they may be overlooking certain expenses that still have to be paid.

Don't Prop Up Your Franchisees

Some entrepreneurs figure they can essentially act as their franchisees' bank until things get cooking. Bad move.

Look no further than Boston Chicken Inc., which started franchising in 1993. By design, the company's founders acted as a bank for their franchisees -- raising money from Wall Street to do so. All told, investors and lenders pumped about $1.7 billion into what to them seemed like a great new concept dubbed "home-meal replacement."

Wall Street's money hid the fact that franchisees were losing their shirts -- more than $350 million from 1994 to 1996, according to John Hamburger, publisher of the Restaurant Finance Monitor newsletter. And it also hid basic operational problems at the Golden, Colo., company. By the end of 1997, loans to franchisees had reached about $800 million. Finally, in the fall of 1998, the chain filed for bankruptcy-law protection.

Acting as a bank has other problems. One day you're telling the franchisees we're in this together, the next you're yelling: "Where's my money?" Under the franchising-banking model, you don't maintain corporate control of your units, yet you don't get the plus of having someone else building them. "That's the worst of both worlds," says Carl Jeffers, who helps recruit franchisees for new systems. "Do one or the other."

Open Up the Checkbook

Franchising takes "a boatload of money," says Mr. Kaufmann, the New York attorney. "Going in on the cheap, that's essentially a recipe for disaster."

He puts the boatload at a minimum $125,000. Don DeBolt, president of the International Franchise Association, puts it at $100,000 at the least.

The costs will include attorneys, accountants, publicity agents and training manuals, among other things. Often, you'll have to hire someone to find the franchisees, possibly by working industry trade shows; such in-house headhunters can command more than $100,000 a year, including bonuses and incentives. "They're the ones who pay for themselves," says James McPhee, president of Fantastic Sams, the Anaheim, Calif., hair-salon chain.

The good news: Lenders increasingly have a better opinion of franchising, which over the past decade has shed its snake-oil connotations.

Looking to test the waters for as little as $25,000? Here's how: Build a second unit yourself in a new market, and hire a manager to run it for a year under your immediate supervision. Then turn him into your first franchisee. "I call it the fake franchise," says Mr. Barkoff, the Atlanta franchising attorney.

Fake or not, it's often enough to tell you which way to go. Some consultants will try to convince you that anything can be franchised, boasting such nonsense as a franchisee's chances of success are eight to 10 times better than those of independent operators. These consultants will often offer to write registration forms, prepare brochures, find franchisees and train them -- ignoring, of course, that franchising isn't always the best way to expand. Seattle-based Starbucks Corp. certainly didn't think so, and has built nearly 2,300 shops itself over the past dozen years.

A good rule of thumb: Avoid any consultant if the only way he or she makes money is if you franchise.

More Than One?

As sales increase on the Internet and through catalogs, it's more important than ever to ask whether you really need all that bricks and mortar. Now is probably not the time, for instance, to try to franchise greeting-card shops. Consumers today go to the Web to order cards, make cards and send them.

"This isn't baseball," says Mr. Kaufmann. "If you build it, they won't necessarily come." So you must ask: What will franchisees give me?

Sometimes, quite a bit. In 1996 in Dallas, David Kiger started Worldwide Express Inc., an overnight shipping service. His franchisees became his salesmen, hitting up small companies that don't receive the same attention from Federal Express and United Parcel Service that major corporations receive, Mr. Kiger says.

In three years, he has sold about 90 franchises. And this year, he expects to double 1998 revenue of $38 million. Mr. Kiger says his franchisees -- because they own the outlets -- give him a level of commitment he would never receive from far-flung corporate employees. Worldwide Express's customers, in turn, get better service. "That's the absolute key for us," Mr. Kiger says.

Again and Again

Before a franchisee will buy into your system, the concept has to be repeatable.

This ultimately may be Seattle Sutton's problem; her business is tightly interwoven with her personality. The irony, of course, is that's just what makes it such a success.

Her Ottawa, Ill., food business boasts a carefully assembled network of distributors, which now stands at 51. But franchising has been a tough sell. Franchisee candidates essentially have been asked to fork over as much as $800,000 to determine whether the concept can be duplicated. And Mrs. Sutton herself is pretty picky, knowing the wrong franchisee could damage her reputation. "That would bother me a lot, " she says. "This is my baby."

Keep It Simple

With replication comes training. Ask yourself if you could teach a stranger all your tricks during a three- to six-week training course. And could that franchisee return home and teach his staff?

A word of caution is in order from James Khadem, an Iranian immigrant who in 1985 co-founded Chick's Natural, a rotisserie-chicken restaurant in San Diego. Customers flocked there. Mr. Khadem and his partner, Abbas Anvar, opened another nearby Chick's Natural in 1987. Their secret: Soak the birds for two days in a special marinade of herbs and juices.

In 1988 and 1989, they started franchising, and quickly flopped. "This isn't french fries, where you put them in, five minutes, they're done," Mr. Khadem explains today. "You have to watch the chicken all the time. It gets dry, it's no good."

Tensions flared between the founders and their nine franchisees. Three of the franchisees sued, claiming Messrs. Khadem and Anvar led them to believe their expenses would be less. The franchisees' attorney, Robert Purvin, says the restaurant founders were "honest people" who simply underestimated the clone-ability of their restaurant.

"Purvin is right," says Mr. Khadem, adding that he settled the lawsuits, but had to cough up $90,000 in legal bills. "Franchising is good for the big companies," he concludes. "They have a lot of money to spend with attorneys."

Don't Lure the Big Boys

It's all right to enter a crowded field -- if you have something truly unique that can't be easily mimicked.

When Dave Thomas started franchising Wendy's hamburgers in 1973, most folks thought the nation already had enough burgers. But his hook -- fresh ground beef -- was such a departure that neither McDonald's nor Burger King changed its established, frozen-patty delivery system. Needless to say, Wendy's is still very much around.

By contrast, when Rally's and Checkers burst forth in the late 1980s, they pinned their hopes on 99-cent burgers. With little effort, McDonald's, Burger King and Wendy's simply rolled out a series of 99-cent offerings, says Don Boroian, whose Francorp Inc., Olympia Fields, Ill., helps companies build franchise systems. "Today, Rally's and Checkers are a nonfactor," he adds.

The two chains, which are in the process of merging, boast a total of 934 restaurants nationwide. But their flat growth is a far cry from the exponential growth before the "99-cent-burger price wars" of 1993, says Joe Stein, a former top executive for both companies, who calls the price wars "the most significant" factor in the chains' slowdown.

Location, Location ...

Not all concepts can go everywhere. So don't try to sell franchises everywhere.

Southland Corp., the Dallas-based franchisers of 7-Eleven convenience stores, learned its lesson about Manhattan when it opened stores there in the late 1970s. Customers couldn't get the same fresh food that was widely available from numerous corner delis, so by July 1982, Southland wound up closing all five of its Manhattan stores.

Now, because the chain is emphasizing freshly made items such as bagels, salads and sandwiches -- and fine-tuning distribution channels for its stores in Brooklyn, Queens, Staten Island and the Bronx -- the chain says the it could try Manhattan again.

Southland has stores from coast to coast, of course, but stays out of certain geographical pockets -- mainly areas that are too rural -- where it cannot concentrate its distribution network. "If someone wants to open a store in Mississippi, we'll say thanks but no thanks," says Margaret Chabris, a company spokeswoman.

Look in the Mirror

Not everyone makes a good franchiser.

Those who are too entrepreneurial may not be able to share success and growth with others. "Your scope has to be broad enough to see running a company, not just a muffler shop," says Mr. Boroian, the franchising consultant outside Chicago.

On the other hand, you've got to be a bit of a showman -- such that you can inspire dozens of others to invest in your vision.

Finally, you should realize that you won't be able to please everyone in your system. "You have to listen and be totally accessible for your franchisees," says Ms. Sanderson, the public-relations consultant. "They need to feel like they're talking to their cousin, but know it's the cousin who makes all the decisions for the family.

Careful at First

If the initial franchisees are happy, they'll tell future prospects they're happy. If they're unhappy, they'll also relay that -- usually a lot more loudly.

So when you find a top candidate, be willing to offer big concessions -- something beyond just knocking 10% off the franchise fee. Mr. Kaufmann, the New York attorney, sometimes advises clients to cut the fees in half for the early signees. In extreme cases, when franchisers want successful independent businesses to join their franchise systems, Mr. Kaufmann has even recommended paying the top performers to come on board.

"If you're careful," Mr. Kaufmann says, "your first 10 franchisees will sell your next 90 units."


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