Canada: How Many Franchisees Does It Take For A Franchise Network To Become Profitable For The Franchisor?
Franchise Bulletin

This is in stark contrast to the predictions of many new franchisors who generally expect their franchise business to become profitable with only a few (2 to 5) franchisees.

Does a franchisor really have to have 30 to 75 franchises in operation before the franchise business becomes profitable for it?

If so, this represents a significant (for many, even insurmountable) barrier to entry for any new franchisor.

In our experience, the answer to this question depends on several factors.

Many new franchisors actually underestimate the level of investment required to properly set up, start and manage a franchise network.

They too often stop at the direct investments that are relatively easy to evaluate, such as the costs of setting up franchisee search tools, a website, drafting marketing documentation to recruit new franchisees, designing and drafting legal franchise documents, designing and drafting an operation manual (written or in electronic format) and some franchisee training and follow-up tools.

In practice, these initial costs represent only the tip of the iceberg and are not the most important when starting a franchise network.

Here is a non-exhaustive list of other important investments that must be planned and made by any new franchisor who wishes to succeed in the medium and long term:

1. Research and accurate identification of the success factors of the franchisor's concept, which is an essential prerequisite to the completion of the other steps in preparing and starting a franchise network;
2. Practical testing (usually by the franchisor operating at least two or three units in accordance with the model it wishes to franchise) for a reasonable period of time (often two to three years) of the franchise concept to verify its profitability and to develop the business model, operating procedures and operating standards before offering it to franchisees;
3. The implementation of tools and means to properly protect the distinctive elements of the franchisor's concept, including the registration of trademarks and various other tools to protect and preserve the franchisor's intellectual property rights and other intangible assets, in all countries where the franchisor plans to expand its franchise network in the foreseeable future. This step also includes the verification of the franchisor's ability to develop its network in all the targeted markets with the name, logo, banner and other distinctive elements that it wishes to use for its franchise network, a step that unfortunately sometimes reserves some surprises that may require modifications to the name, logo, trademarks or banner initially planned;
4. The planning and implementation of a corporate and fiscal structure adapted to the objectives and resources of the franchisor and designed to protect its interests as the network develops. It is preferable, and much less complex and costly, to carry out this step before the launching of the franchise network than later;
5. The design, development and implementation of tools to organize and systematize its know-how, its operational model and its various processes and standards so that they are clear and complete, and can be well understood and replicated by franchisees;
6. The design, development and implementation of documented tools, processes and procedures for transmitting its know-how and business model to its franchisees, including proper training tools (in person, at distance or through technology), coaching tools and monitoring and continuous improvement tools;
7. The design, development and implementation of documented franchisee evaluation and selection tools and procedures, the quality of the franchisee selection process being a critical success factor for any franchise network;
8. The design, development and implementation of documented tools and procedures for evaluating and selecting the location of franchised businesses, the quality of each site selected (based on the needs of the franchisor and the success factors of its network) also being, in many sectors of activity, a critical success factor of any franchisee;
9. The design, development and implementation of processes and tools (including various technological tools) to allow for the collection, recording and timely reporting (ideally in real time) of financial and operational data needed to ensure the proper management and monitoring of each franchised business, as well as the timely (and, for the most part, automated) payment of the various amounts payable by franchisees to the franchisor;
10. The development and implementation of processes for the procurement by franchisees of goods and services required for the operation of their franchised businesses;
11. The recruitment, training and implementation of resources (especially human and technological) for the support (on all levels) of each new franchisee in the pre-opening, opening and post-opening phases of her of his franchised business, which resources must be in place and ready to perform their work from the moment of the signing of the first franchise agreement.

Another important investment that is often underestimated relates to the advertising of the franchise network.

The franchise agreement generally provides that this advertising will be paid for out of a joint advertising fund to which each franchisee must contribute, often on the basis of a percentage of the gross revenues of its franchised business.

However, such advertising must be launched and conducted well before the franchisees' contributions to the joint advertising fund are sufficient to cover its costs.

Furthermore, this advertising is important to increase the franchisees' revenues and, therefore, the amount of their contributions to the joint advertising fund.

The franchisor must therefore make a significant initial investment in advertising its franchise network. This investment can, however, be made in the form of advances from the franchisor to the joint advertising fund, which the franchisor can repay later when the franchisees' contributions to the fund allow it without compromising the network's ongoing advertising efforts.

Also, the franchisor must provide for some investment by the franchisor in maintaining its operations and services as a franchisor (including those described above) until such time as the royalties and other contributions received from the franchisees can cover the costs of maintaining those operations.

In this regard, various studies have concluded that the point at which a franchisor's investment in a new franchisee breaks even is, on average, between 18 and 22 months after the franchised business begins operating.

Ultimately, the number of franchises in operation that a franchisor must reach before its franchising business becomes profitable for it depends on the level of investment that the franchisor will have made in that network, which in turn depends on the franchisor's objectives and plans.

Thus, a franchisor who, within a three to five-year horizon, wishes to develop a network of about 20 franchised businesses all located in the same market will adjust his investments accordingly and will generally aim for a break-even point for its franchise activity of about 3 to 8 franchised businesses in operation.

On the other hand, another franchisor wishing to develop a larger network (for example, of more than 100 franchised businesses) or to expand into several provinces or countries will have to make more significant investments in processes, systems, tools and resources. For such a franchisor, it is therefore quite possible that the break-even point for its franchising activity will only be reached after about 30 franchises in operation.

In the end, it is essential for any new franchisor to properly determine its objectives and plan his investments in order to set up a network that is sufficiently structured and equipped to achieve such objectives and plan.

Fasken has all the experience and resources necessary to advise and assist you in all aspects of the start-up, management and expansion of your network, including your relationships with your franchisees, anywhere in the world.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.