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Franchisors

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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1 Comment

1 Comment

  1. James Campbell-Ker

    May 7, 2012 at 13:10

    What a fantastic article. Well writen and explaned.

    Stocktakers Unlimited.

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Company Posts

Muscle And Grill Is Your Daily Chef. We Provide Fresh, Nutritional Food At Affordable Prices

It isn’t always easy to stay in tune with both body and mind. We do all the prepping for you so that you can keep up your pursuit of greatness.

Muscle and Grill

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Muscle and Grill is a healthy fast food establishment based in South Africa. In the face of modern South Africa, lives spent on the go require a fuel to match their aspirations while maintaining a delicious, fast and fresh service.

As our lives swirl into life’s vast depths of opportunity, our bodies are often the product of poor health habits, while trying to keep on the move to achieve our goals. Muscle and Grill challenges this. We want to be able to support the South Africa of tomorrow by offering the food your body needs to keep reaching new heights – to keep pushing the boundaries of accomplishment with health food convenience.

At Muscle and Grill we’ve got you covered. We provide nutritional fast food that is fresh and affordable. We have your health at heart. You could start your day off with some free-range scrambled eggs or fresh oats – for lunch a mixed bowl of rice, protein and fresh vegetables – or to round off your day, replenish your mind and body with a hearty health-infused burger and all its wholesome goodness. We have not forgotten that home constitutes a hungry family who have all been active, so grab a lean beef pasta salad with some greens on the side to go.

Related: SA Fast Food Franchising On The Rise

It isn’t always easy to stay in tune with both body and mind. We do all the prepping for you so that you can keep up your pursuit of greatness.

About us

It was once said that great ideas are born from ones’ frustrations. That is exactly how Muscle and Grill came about. Having no real on-the-go option to stay healthy, or having the time to prepare to be healthy, became a huge frustration for us. We struggled to find enough hours in the day to keep up with a busy lifestyle and still eat healthy while on the move. Our work came first and our lifestyles suffered.

The vision for Muscle and Grill is to make it possible to stay healthy on the go. We want healthy food to be easily accessible for all walks of life.

Our mission is to provide quality, healthy fast-food. The food we provide is delicious and will keep you coming back for more.

Concept

muscle-and-grill

Muscle and Grill works on an almost self-service basis. The point of sale system is customer operated where you can select what meal you would like to have. Once payment has been processed electronically the kitchen staff will receive the order and prepare it to spec. Muscle and Grill will be a completely cashless business, making it super-efficient for consumers and business owners.

Related: 3 Crucial Considerations For New Multi-unit Franchisees

The concept of Muscle and Grill is partnered with Puré Frooty. Puré Frooty is a self-service smoothie bar which prepares smoothies for you at the touch of a button. You can have a store with or without a machine – the choice is yours. Both concepts look to promote the idea of healthy living on the go.

We’ve looked to compliment our values by looking after that which grounds us. Our packaging and utensils are all eco-friendly, as we believe ‘going-green’ is not just a choice of eating but of the environment too.

So, when you are ready to join the next revolution in the fast food industry contact Muscle and Grill at info@muscleandgrill.co.za or visit the website at www.muscleandgrill.co.za to inquire on our franchise options today. Achieve your goals, stay on the move and look after yourself through Muscle and Grill.

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Company Posts

Nando’s Is Firing Up The East

Carlos Duarte has been part of the Nando’s brand since inception. When his brother Fernando co-founded the flamed grilled chicken brand in 1987, Carlos soon participated in its success and today owns four highly successful franchises in Johannesburg — three in the east and one in the south. Here’s how it all began.

Nedbank

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Vital Stats

  • Player: Carlos Duarte
  • Franchise: Nando’s
  • Position: Franchisee
  • Visit: www.nandos.co.za

What were you doing before becoming a franchisee?

I was in the audio visual technology field, as an employee. Then I joined Nando’s as an assistant manager in the Savoy and Rosettenville corporate stores. Franchising was my first experience of entrepreneurship.

Why did you decide to become a franchisee?

When my brother, Fernando Duarte, launched Nando’s in 1987, I noticed its quick growth and wanted in on the action. Being assistant store manager prepared me for when the opportunity to run my own store came along soon after.

What prompted you to partner with Nando’s?

I joined Nando’s in 1991 as a joint venture partner. At the time, Nando’s hadn’t yet franchised its operations, and the JV partnership meant the brand owned 51% of the business, while I owned 49%. My first franchise store was in Edenglen in 2001.

Related: (Watch) Why Nando’s Is Clucking Its Way To The Top

Describe some of the challenges of running not one, but four franchise locations

At the Edenglen store, we initially battled with sales and getting feet into the store. To be honest, I think the area was overtraded at the time, so it wasn’t the best location. Since acquiring the store in Lambton, Germiston, another in Greenstone and a third in Comaro, I’ve learnt to be cleverer in how I do things — and how I handle some of the same challenges — and learn every day from the brand itself.

Name some of the benefits you’ve experienced as a Nando’s franchisee

Nando’s is 31 years old this year. We’re in 30-odd countries worldwide with thousands of stores across the globe. As franchisees, we leverage off the dynamism of an operational business that’s known for its marketing — customers talk about our ads and they love our food.

What kind of support do you receive from Nando’s as a multi-unit franchisee?

Besides the popular marketing campaigns that attract customers, Nando’s has an extensive training manual along with a skills development training consultant who comes to the store for two days to help staff understand and implement it. The training is really effective — it has to be as this industry involves a very high turnover of staff and new skills need to be taught often.

Why is it important for a franchisee to have a good banking partner?

As a franchisee, your bank should understand your business — from operating costs, to overdraft needs and revamping expenses — so it has cash available for loans that can be approved quickly, with minimal hassle. On the technical side, a reliable mPOS device is imperative, especially for us, because 30% of our sales volumes are from home and office deliveries. It’s a fundamental method of payment every bank should provide its customers of a similar nature.


What advice do you have for budding franchisees on seeking out a good franchise brand and banking partner for their business?

  • Do your research to ensure you’re partnering with a brand that is established, well-known and expect to pay a fair price for that franchise.
  • Be aware of how the franchise brand is perceived in the market and what location opportunities are available to you as a franchisee.
  • Choose a banking facility that always has the funds available to grow your business.
  • Ensure the bank understands the brand’s business model and where you’re falling short.

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Franchisors

Make Your Business A Good Neighbour

Take your business from invisible and struggling to a thriving neighbourhood landmark.

Richard Mukheibir

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Is your business invisible to your customers? You may have fewer customers than you would like because your business does not seem relevant to those in your neighbourhood. This is an even bigger mistake than not being able to reach beyond your direct trading area.

To appeal to people – customers – you should also present your business as a group of people who help other people. This can be helping supply them with goods they need to buy, helping provide them with loans or simply being a reassuring and consistent presence in your neighbourhood.

As our Local Area Marketing Manager, Juan Botha, tells Cash Converters’ franchisees, this is about blending and fitting in like a neighbour. It is about give and take. And all of that adds up to community engagement.

Related: Effective Ways To Bring Customers To Your Door

Here are six of his top tips:

  1. Introduce the family: Cultivate a friendly, welcoming atmosphere in your shop or office. Introduce new staff to regular customers. Make sure that new customers can get to know staff through your in-store welcome boards and name badges.
  2. Find your partners: Identify the gatekeepers in your community and create partnerships with them. Think about approaching sports clubs, schools, church groups, sewing circles and book clubs.
  3. Snatch some selfies: If you have local celebrities as customers, take a selfie and post it on your social media: “Guess who came to say hello today . . .” Build relationships with local heroes and you will be able to call on them to host your in-house fun day or charity drive.
  4. Give back to business: Be involved in local business chambers and groupings as more than a participant. Show you are a good business neighbour by facilitating speed networking, hosting a speaker or sponsoring a sound system or catering for the next meeting.
  5. Adopt a cause: Identify a local charity and rally support for it.
  6. Help the community: Launch or participate in a community project – anything from an area clean-up or helping repaint school classrooms to planting trees or a community vegetable garden.

Building relationships helps you build your business’s reputation. That is because you can make people start to feel a certain way about your business and influence them positively towards you. Then, when they need something that you supply, you will be top of mind.

That neighbourhood warmth creates a sense of ownership. These prospective customers will already know how you can benefit their lives and so are more likely to become your regular customers.

They will be acting on the fact that people remember you for the experience you give them. As top American writer Maya Angelou said, their memories will be shaped by how you make them feel – not how or what you make them think. Relationships may be intangible but they can bring real value to your business.

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