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Know the Present Value of a Franchise

A new paradigm for decision making helps franchisors see short-term expenses for their long-term worth.

Mark Siebert

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As a franchise consultant, I’m often surprised by the decisions made by demonstrably intelligent business people. These are often business people who’ve successfully grown businesses based on nothing more than their own ingenuity, talent and sweat – and yet some of their decisions almost defy explanation when it comes to franchising.

In analysing some of those poor decisions over the years, I’ve come to the conclusion they’re often a result of a lack of understanding of a very simple principle: the present value of a franchise.

Hardly a week goes by when I do not witness it: The business owner who pulls the plug on a successful broker programme or advertising source because “it just isn’t profitable” to sell franchises after paying broker fees. The franchise sales director who refuses to commission a franchise sales person because “there is not enough margin in it after paying broker fees” – even though that strategy may result in lower broker closing rates. The hiring of less qualified staff or the failure to use a recruiter in order to save some salary – knowing that diminished sales production may be the result. Pulling the plug on advertising or a trade show because it didn’t work the first time. Saving 20 cents a copy on a franchise marketing brochure by using a sub-standard paper stock, despite the less impressive message it may send to prospects.

Sure, some of these decisions are made based on necessity and short-term budget constraints. But often, it’s simply cost cutting for the sake of it – without looking at the long-term consequences. That’s why we emphasise understanding the present value of a franchise.

Calculating Franchise Value

The concept of net present value (NPV) is borrowed from the world of finance. It means that a rand paid to me today has a greater value than a rand paid in the future. If I receive that rand today, I can earn interest on it. And, of course, there’s the uncertainty of not being paid at some point in the future. The present value of a future payment thus represents the amount that I would accept today in lieu of that rand paid at some point in the future. If, instead of accepting a rand one year from now, I would take 91 cents today, the difference is the ‘discount rate’ that I would apply to that payment. The discount rate represents a combination of the cost of capital (foregone interest) and the uncertainty of that income or income stream.

So what does that have to do with franchising?

Let’s start with a basic premise. A franchise sale is more than a one-time sale. It is, at least from a financial perspective, an annuity that can last for decades. Franchisors will receive fees, royalties, advertising funds, transfer fees, renewal fees, training fees, product margin, rebates and other sources of revenue over the term of each franchise relationship. And those fees – or the promise of those fees – represents a real value to the franchisor today – and will certainly have value to a prospective buyer who’s looking to acquire the franchisor.

So how does one assess this value?

The first step is to understand the estimated life of a franchisee. A franchise, of course, represents a going concern. As long as it’s open (even if it’s sold), it continues to pay royalties and fees. So start by determining the anticipated life of the franchise. If you think your franchise offering will have an average failure rate of 5% in any given year, then you might anticipate the life of a franchise at 20 years (1 divided by ,05). If your historical or anticipated failure rate is higher or lower, modify that number using the same formula.

Next, estimate each franchisee’s average profits. For many, this number increases over the years, so the best means of finding it is to develop a financial model. The model should account for all revenues you anticipate over that franchisee’s life.

Deduct any costs associated with bringing on a new franchisee. Factor in marketing, commissions, and other costs associated with the franchise sale. Also deduct any costs for goods sold to the franchisee. The tricky part comes when allocating expenses and overheads.

Estimating Expenses

There are a number of ways to estimate expenses, and different methods are more relevant for different decisions. For most decision-making purposes, the most relevant way to conduct this analysis is to focus only on those costs directly associated with servicing that franchisee – not allocating overheads that you would incur regardless of whether a sale is made. For example, you might look at the costs of support-related travel as a variable cost. If you have one field rep for every 20 franchisees, allocate one-twentieth of his compensation. You wouldn’t allocate a portion of the CEO’s salary, as the addition of a new franchisee would not impact that expense.

Finally, you’d need to determine the discount rate. The higher the discount rate, the greater your uncertainty of a future stream of revenues. I’ve used a 20% discount rate for the sake of illustration, and this is a conservative number for such an analysis. A 20% discount rate is the equivalent of saying that you’d rather take R4 000 today than wait five years for R10 000. Even when using a relatively high discount rate, the lifetime value of a franchise can be well in excess of R100 000 even after losing R10 000 on the initial sale. This shows that, in the long run, it can pay handsomely to lose money on the franchise fees in return for the stream of income that each franchisee represents.

This analysis doesn’t account for the increase in the terminal value of your franchise company if you were to sell it. (More profits mean a higher selling price.) When we see franchisors reducing or waiving franchise fees to spur franchise sales in today’s more difficult economy, that move may prove to be very wise in the long term when considering the NPV. While few franchisors can afford to lose money on every franchise sale, consider the short-term sacrifice for the potential long-term revenue.

Ask yourself these two questions:

  • Will expenditure on staffing, marketing and training be responsible for one additional franchise sale?
  • Could this expenditure lengthen the anticipated lifetime contribution of a franchisee (by increasing revenues, improving longevity, decreasing expenses). How would it impact the NPV?

Measure the cost of the expenditure vs the impact of the decision. Every franchisor will have a different NPV based on his/her anticipated fees, product sales, expenses, and franchisee longevity (as well as their estimate of an appropriate discount rate) so a good decision for one franchisor may be a bad decision for another.

As this analysis illustrates, franchisors have a much greater need to balance short- and long-term considerations in their decision-making than other businesses. The NPV paradigm coupled with good short-term cash management will bring a long-term perspective that will ultimately improve your decision-making and your long-term profitability.

As a franchise consultant since 1985, Mark Siebert founded the iFranchise Group, a franchise consulting firm, in 1999. During his career, Mark has personally assisted more than 30 Fortune 1000 companies and over 200 startup franchisors. He regularly conducts workshops and seminars on franchising around the world. For more than a decade, Mark also has been actively involved in assisting U.S. franchisors in expanding abroad. In 2001, he co-founded Franchise Investors Inc., an investment firm specializing in franchise companies. He's on the board of directors of the American Association of Franchisees and Dealers and the board of advisors to Connections for Community Ownership, which encourages minority business and job development through franchising.

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Franchisors

3 Core Strategies For Building Successful Franchise Organisations

How to attract potential franchisees to invest in your business.

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The most common questions I hear from franchisors are usually related to growth strategy. In other words, what are the core strategies that differentiate the successful from the mediocre?

Strong leadership determines the overall success of the organisation, but how can this be defined or broken down to actionable strategies? People often ask me how we created a franchise growth strategy that enabled us to grow to 150 units in less than three years. This is the secret sauce! When I coach my franchise executive clients, we begin with three core strategies.

As I described in my book, Franchise Bible 8th Edition, The Upside Down Pyramid strategy sets the pace for everything since it is a core belief. This will get the company moving in the right direction and keep the focus strong as franchise owners are added to the community. The Three Decision Lens Philosophy then kicks in to make sure the company stays on track and makes good solid decisions that will benefit the franchisees and the overall growth of the organisation. Lastly, the Franchise Glue creates a strategy for long-term maintenance that inspires aggressive growth and peak performance.

Related: Selling Your First Franchise? Consider These Key Pointers

The following are the core leadership strategies that I identified in Entrepreneur Magazine’s Franchise Bible 8th Edition.

The Upside Down Pyramid

This strategy is a paradigm shift from the common corporate organizational structure. Typically, you see the leader at the top of the pyramid governing over the team members, which trickles down to the employees and eventually the customers.

Franchising is a very unique business model and is very different from a traditional corporation. The primary difference is that the franchise owners are independent business operators, not employees. The Upside Down Pyramid strategy flips that model on its head by placing the leader(s) at the bottom, bearing the weight of the company infrastructure on their shoulders. Franchise owners then are viewed more like the customer and supported accordingly.

The Three Decision Lens

Every decision a franchisor makes has Legal, Practical and Political implications, so these three factors have to be considered whenever a decision is made. Making good decisions is mission critical to the successful growth of a franchise organisation. Many franchisors have stumbled or even failed because of poor decisions that negatively impacted their franchisees.

The Three Decision Lens Philosophy is tool that enables a franchisor to consider the total impact of their choices before the decision is made.

The Franchise Glue

Franchise Glue is everything a franchisor does that sticks the franchisees to them. Ongoing support and training, buying power, technology tools, innovation, events and other programmes and systems that endear the franchise owners to the brand. These are the reasons that franchise owners stay with the brand and have no problem paying ongoing royalties.

Once these three strategies are implemented and the leadership spoke is in place, we can build the remaining spokes which are marketing, operations, finance and technology to head for the “hockey stick” growth of 100 units and beyond.

Related: 3 Ways You Can Innovate And Improve As A Franchisee

Like any other business strategy, the most important factor is your willingness to buy in and execute. The best game plan in the world is useless if it is not put in to action. Building a healthy and thriving franchise organisation is much like exercise. Long term and consistent exercise programmes generally lead to a healthy person.

I will be posting a series of articles that will break these three strategies down in more detail including real world examples and tips for implementation. This will allow you and your team to focus on one strategy at a time and work on implementation steps. Stay tuned over the next several weeks and try working these strategies in to your franchise business model and see how it impacts your franchise community.

This article was originally posted here on Entrepreneur.com.

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Franchisors

The Secret Sauce To Great Franchise Leadership

The upside down pyramid puts the franchisee at the center of everyone’s effort. Success follows.

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I am often asked to share the secrets of franchise success with my clients and audiences of franchise executives as I travel the country spreading the Franchise Bible strategies.

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The most critical of the three core strategies is what I call the upside down pyramid strategy. This is more than a catch phrase or slogan. It must become a true belief in order for this strategy to affect a franchise organization for the better. Lets start with some basic facts to clarify.

What it is                              

The upside down pyramid is a servant leadership model that makes sure that franchise owners always come first. This must be genuine for all members of your team.

Related: 3 Challenges To Establishing A Franchise System And How To Overcome Them

Franchising is different than any other business model in this way. A franchise organisation simply cannot thrive unless the entire corporate team is on board with this commitment. If it’s not, it would be like a medical team where some members simply did not care about healing the patient. It is a non-negotiable.

What it is not

This strategy is not a hand-holding philosophy that rewards lazy or non-compliant franchisees. One of the exciting outcomes from this system is seeing the franchise owners step up and go above and beyond the call of duty when they feel truly appreciated, valued and respected by the franchisor. I have seen amazing things happen from franchise communities that felt connected and part of the bigger picture.

The challenge

Many franchise organisation executives have a lot of experience as traditional employers so they tend to try to “manage” their franchise owners as though they are employees. In most cases this is the beginning of the most common problem that I call the traditional pyramid model with the boss on top.

The key to remember at this point is the reality that the franchise owners are not employees of the company. In fact, the exact opposite is actually the case. The franchisees invested their hard earned money into the franchise company and pay an ongoing royalty as well. This means that they are the customers of the franchisor and the franchisor should value them as such.

How do you implement this strategy?

I have seen the good, the bad and the ugly in the franchise world. I can usually sense the company culture pretty quickly when I am among the franchise executive and support team. It is no surprise that the most successful franchise brands have a pretty solid grasp on this strategy. Here are some tips to get you started:

  • Train: Introduce this strategy to your executive and support team and give them the opportunity to ask questions and learn. Remember that this may be a bit of a paradigm shift for some, so they may need time to get it down.
  • Reinforce: Use ongoing reminders during your meetings, training sessions and conferences to keep the ball rolling. Your system must be based on things that you and your team will do consistently for a long period of time. A short burst of change followed by a return to the former status quo doesn’t work, so make sure you can commit and stick with it.
  • Insist on buy-in: Everyone on your executive, training and support teams must buy in to this commitment for it to work. You have heard that one bad apple spoils the whole bunch. This is very true within a franchise organisation. You may have to replace team members if they refuse to genuinely commit.

Related: Col’ Cacchio: A Passion For Pizza

Leadership tip

You have also heard the saying that the fish starts to rot at the head. The common denominator that I see in failing franchise organisations is almost always due to poor leadership. I often say that a decent business model with great leadership will usually thrive and a great business model with lousy leadership will usually fail.

Don’t feel bad if you are not the best leader for your business. I have seen business founders step aside and hire in leadership experts to run with their creation. Knowing that someone else is a better leader than you for your franchise organisation is a sign of great discernment and wisdom. If you are not sure just ask your franchise owners to give you a grade as the leader. I asked a franchise CEO recently if he would get an A from his franchisees and he said, “Probably not.” I advised him to get back to work and make sure that he can earn that A.

This article was originally posted here on Entrepreneur.com.

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Franchisors

Get Your Franchise Running Smoothly – Even When You’re Not There

Does the thought of taking time off from your franchise outlet make you nervous? Then you have to learn to run your business instead of letting it run you.

Diana Albertyn

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“A sign of a successful business is one that can operate without your physical presence 24/7,” says Brad Sugars, start-up expert, author and founder of ActionCOACH. While your franchise systems and operations are designed to run smoothly and consistently, is your staff trained to be productive in your absence?

“Franchises are already by nature systematised operations, so it boils down to how you as a business owner hire and train people to get the necessary jobs done,” says Sugars.

If you know a sick day will cause havoc in your store, an assessment of how you’re running your business is needed. Are you really running a successful franchise if things fall about without your supervision? Take a step back and consider the following steps to manage your franchise without it controlling your life. Pretty soon you could book that vacation.

Determine your role in the franchise

Are you managing the franchise, taking orders, doing admin and handling every other aspect of the business? Then you’re not hiring the right people, because those roles should be filled by people who can be left to carry them out unsupervised.

Related: How To Write An Operations Manual For Your Franchise

“And if you don’t have the right people for the job then it might be time to start hiring, so you can free up your franchise’s most valuable resource – you,” says Pieter Scholtz, co-Master Licensee for ActionCOACH in Southern Africa.

“You need to get an idea of how you can hire people to take repetitive or administrative tasks away from you. Ask yourself: ‘Do I really need to be doing this?’” says Sugars. Your business cannot run optimally if you’re the single most-knowledgeable and capable person there.

Lead with clarity

You have long-term goals for your business, perhaps even acquiring more locations and running multiple units. While growth is good, you need to share the load and ensure everyone employed in your business is working towards the same goals, otherwise, it’ll be difficult to get there. Sugars suggests asking yourself the following:

  • How will you make your vision a reality?
  • What makes you different from other franchisees and business owners?
  • What kind of team do you want to recruit and create?
  • How does all of this deliver value to your customer?

Conveying your vision can help ensure employees know how to get to the end-goal faster and more efficiently.

Related: 3 Steps To Ensure Your Franchisees Flourish Your Support System

Plan for long-term cash flow

Loyal customers ensure a constant flow of cash through the franchise and this requires exceptional service and the building of strong relationships. “Target your top-spending customers and establish a good relationship with them for long-term cash flow,” Sugars suggests.

Although the broader campaigns are covered by the marketing fee you’re paying to your franchisor, it’s wise to focus on your local’s tastes and suggestions when looking to deliver an experience worth returning for.

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