What is the value of non-franchised outlets?

Debate often exists in the franchise sector about the issue of franchised versus company-owned (or non-franchised) outlets.

Among retail and fixed-location service franchise systems, opinion is frequently divided about the benefit and management requirements of a company-owned network within a franchise chain.

A key element in the debate is the greater organisational resources required to manage and support company-owned outlets, particularly where managers of company-owned outlets are not able to fully benefit from the outlet’s financial performance and appreciation in market value in the same manner as a franchisee.

In other words, the profit motivation of franchisees, as well as the desire to make a capital gain on the eventual sale of the business, are motivating factors rarely, if ever available to employed outlet managers.

This is the crux of franchising and on the face of it, operating company-owned outlets would seem to perpetuate the key motivational problems that franchising largely resolves.

Nonetheless, there are compelling arguments for non-franchised outlets, and these are outlined as follows:

To provide a training location

New franchisees need a combination of classroom and in-field training, and company-owned outlets provide the best opportunity to control the in-field training environment. The new franchisee is able to learn the operational details of their franchise in a real business serving real customers, but under the constant supervision and guidance of the franchisor’s training team as well as the store’s employees, some or all of whom may also be involved in the formal training and assessment of the franchisee.

As a training location, any mistakes made by the franchisee in training are generally limited to the company-owned outlet. The franchisor can learn from these mistakes to improve systems and modify the training program to avoid similar problems in future.

By comparison, problems can arise if new franchisees are trained in an existing franchisee’s outlet. The trainee franchisee is no longer under the supervision of the franchisor, and may receive informal training from the existing franchisee that is not consistent with the principles or operations of the network. Any mistakes made by the trainee franchisee could adversely impact the existing franchisee’s business, and give rise to a demand for compensation or otherwise strain the relationship with the franchisor.

Company-owned outlets can also provide opportunities for potential franchisees to gain work experience in the business before progressing their application to the next stage. This may form part of the recruitment process of some systems and be an important method of helping identify quality candidates. The capacity to offer such work experience is limited when relying on busy franchisees to make such places available.

To test new innovations

Company-owned outlets can be useful testing grounds for new innovations. These might include testing new products, services, processes, equipment, marketing campaigns, or even the design and look of the outlet itself. The franchisor is able to better supervise and monitor the impact of such innovations on the performance of the outlet than if the innovation is introduced to a volunteer outlet in the network.

If the franchisor’s innovations don’t work, no harm has been done to the network and to the franchisees’ businesses. If the innovations do work in company-owned stores, the evidence may be compelling enough for the franchisees to adopt the innovation, or to at least agree to further testing in sample franchise locations ahead of possible network-wide adoption.

To act as a Trojan Horse

Company-owned outlets may provide the initial point of presence in a new market or region required to build market awareness and a customer following that can facilitate the opening of franchised outlets in that region thereafter.

In other words, company-owned outlets can act as a Trojan horse to penetrate a market when there is a lack of available or willing franchisees, or the market research is inconclusive about whether or not the concept will be accepted by that market. The non-franchised stores can prove (or disprove) that the concept will work in the new market, and serve as a reference point to potential and future franchisees, and may in time be granted as a franchise itself.

As a franchisor profit centre

Company-owned outlets can make a substantial contribution to a franchisor’s bottom-line if they are well operated and profitable. This profit contribution may be necessary in the early stages of franchising to help the franchisor offset the costs of developing the franchise network, particularly when royalty income is insufficient to meet the network’s support and infrastructure costs. Even after start-up, developing and mature franchisors may continue to operate a growing number of company-owned outlets to generate revenue for other ventures, or to simply maximise profits.

But as noted earlier, the profit and capital gain motivation for franchisees on the successful operation and sale of their businesses is generally not available to the managers of company-owned outlets, and consequently their attention to detail in customer service delivery and cost management may not be as strong as their franchisee counterparts. As a result, company-owned outlets risk underperforming when compared to franchised outlets, or worse still, become a loss centre, not a profit centre, for the franchisor.

High-profile franchise insolvencies in Australia in recent years including electrical goods retailer Kleenmaid, fashion accessory chain Kleins, and auto repair franchise Midas all had a large proportion of company-owned stores which may well have contributed to the losses accrued by those businesses.

Sequential system growth

Company-owned stores can provide new franchisors with viable going-concern businesses that can be granted to new franchisees who would not otherwise be prepared to risk opening a new outlet from scratch. Expanding by opening company-owned outlets, and then granting these to franchise buyers may be a slow and capital-intensive way of growing, but for a start-up franchisor this might be the only way to grow until the brand and its business model is well-enough known that potential franchisees are willing to risk opening new outlets.

By sequentially growing in this way, it also provides the franchisor with an essential opportunity to develop and refine their operating and franchise support systems in a controlled manner.

Not all franchises are suited to company-owned outlets

Generally, the debate about company-owned versus franchised outlets is difficult if not impossible to apply to mobile service franchises due to their labour-intensive and often single owner-operator nature.

For very small businesses where the cost structure and highly technical or personal nature of the service generally precludes the opportunity to employ staff, and in which the services are performed entirely by the owner-operator, company-owned outlets are far less likely to be viable compared to franchised outlets.

Start-up franchisors of mobile service systems may continue to operate an outlet of their own after granting the first handful of franchises, but inevitably find that the demands of servicing a growing network will eventually make it untenable for the franchisor to continue to run their own outlet, and they will need to close or sell it to concentrate on supporting the network.

What is the right ratio of company-owned to franchised outlets?

There is no simple answer to the question of what is the right ratio of company-owned to franchised outlets. It is not uncommon in some mature fast food chains for there to be equal or even greater numbers of company-owned than franchised outlets, and in some of these, active buy-back programs may exist where the franchisor purchases franchised outlets to retain them as company-owned operations. (Most likely for outlets where 100% of the profits is worth much more than the royalty the franchisor would otherwise receive.)

Many systems believe that once the decision is made to franchise, they should exit company-owned outlets altogether, with the exception of one outlet to be preserved for a training and testing location.

While it is important to hold a limited number of company-owned outlets for the reasons outlined in this article, finding the right ratio is a balance that will vary from one system to another according to the situational factors of available capital, management resources, and organisational goals, any of which can change over time. As a result, the level of commitment to, and ratio of company-owned outlets, will vary in any given system as it grows and matures.

Jason Gehrke is a director of the Franchise Advisory Centre and has been involved in franchising for 18 years at franchisee, franchisor and advisor level. He provides consulting services to both franchisors and franchisees, and conducts franchise education programs throughout Australia. He has been awarded for his franchise achievements, and publishes Franchise News & Events, Australia’s only fortnightly electronic news bulletin on franchising issues. In his spare time, Jason is a passionate collector of military antiques.