21 April 2011

The Franchise Misnomer

In the wake of the largest franchise IPO ever last week (Archos), I was reminded of a topic that I've pondered for quite some time. With franchise chains being the easiest way to get a business jumpstarted, it's no wonder that there are almost 1M locations representing $1T of sales in the US alone. No MBA required, no resume massaging; just a roll-up the sleeves attitude and a propensity to work hard is all you need to sign up. But are franchisees actually entrepreneurs? Do they run their own business or are they merely buying themselves a living?

Let's look at the dynamics of the largest franchisor on the planet, Subway, as an example. Subway makes it easy for new locations: a very small upfront fee ($10k or so), soup to nuts setup and management services, and a straightforward royalty model (take ~12% off the top). This looks great, right? If atmabus wanted to leave the corporate world for business-ownership, this seems to be a low risk option right? Let's look a bit closer of who would actually "own" this business.

Subway controls more aspects of this endeveour than atmabus would. In addition to the branding, Subway mandates your procurement for everything from napkins to lettuce (at a profit for corporate). They dictate how the store should look, how much you need to spend on improvements, and mandate computer and accounting systems. Margins and pricing is controlled at some levels -- most franchises actually lose money on the $5 footlong (but have limited say in what they can do). Sure Atmabus would manage some parts of the operations; but he would not control supply chain, advertising, pricing, and product offerings under this franchise agreement. So what's left?

When you think of entrepreneurship, you think of control and unlimited upside potential. Here you get neither. Given your sales are limited to your foot traffic in a specific geography, the only way to scale is to buy more franchises. Couldn't Subway technically "own" the stores and pay a management fee to operators and accomplish the same thing? This model feels more like a distributor relationship versus a B2B one as advertised by the franchisors. Remember the Coca-Cola bottlers? Look who owns them now.

Certainly new franchisors will command less control and costs than established players like Subway. But ultimately franchise models tilt in favor of the corporations. Incentives are misaligned; the $5 footlong promotion benefits franchisors (Subway sells the ingredients) at the expense of franchisees. Most hotel chains are moving away from ownership to franchise models because their is frankly more profit and less headache for them through the arrangement. As long as their are people willing to live on site and work 7 days a week, they can continue along this path.

Don't get me wrong - there is money to be had for franchisees. Many make a decent living doing them. You just have to do it in a big way since so much of the margin is taken by franchisors. If you get in on the ground floor of a bustling one, you might be able to negotiate a sweet deal. Plus just the mere fact that its considered a "business" gives owners a path to tax benefits associated with ownership. Given the limited control, upside, and autonomy for franchise owners, its hard to consider them entrepreneurial ventures.


  1. In the case of subway, with such low up front costs, I would say they are simply 'buying themselves a living' as you put it with the apparent need to have family members working on staff so they can earn a decent profit. Ironic that with many of these food franchises like subway and dunkin donuts being owned and run by families, you would get great service and with a 'I know you' small business feel (maybe what subway was hoping for). Not true. Subway should have the option to 'buy a smile' from the service staff. I walk into a jimmy john's (not sure if they are franchised or not) but wow, what service and what a great connection they make. Oh and if it sounds like I hand picked the two franchises with predominantly indian ownership, I did. I'm indian myself. But I hate the service and the attitude of many indian owned franchises. Yes, I get it, they're around their family all day long, they work 12 hours a day just to earn a decent profit,a nd have very limited flexibility in how they are allowed to operate. Oh wait that's why they're mostly indian owned. No one else would want to do that. So I guess I deviated quite a bit from the question. My answer is that they are buying themselves a living with the illusion of entreprenuership.

  2. good point. without the immigrant families (and extended ones), many of these franchises would not be able to "sell a living" in the numbers that they do today.

  3. You do realize that Ray Kroc was a franchisee of the McDonalds brothers.

    Most of your assertions about Subway are not reflected in a review of its FDD.

    Many of the small footprint hotels in the US were bought/managed by Indians, mainly Patels, who now run one of the biggest franchisee associations - AAHOA.

  4. Some fair points. But today, large scale franchisors such as MCD or Subway command more control and drive more profits to their coffers. In terms of the hotels, the Patel model only works because of the unique circumstances is not replicable in mass scale (ie. 7 day week hours, numerous family members on payroll, tier 3-4 cities, etc..)

  5. Raki, I disagree that, "the Patel model only works because of the unique circumstances is not replicable in mass scale (ie. 7 day week hours, numerous family members on payroll, tier 3-4 cities, etc..)"

    Many of the Patel's and 2nd generation franchisees have become sophisticated franchise operators.

    There is entrepreneurship in early stage franchise systems; however, I would agree with you that investments into mature franchise systems is the equivalent to buying yourself a job.

  6. I should've clarified my point, my apologies. No question the "Patel" entrepreneurs have become extremely sophisticated and have quite a bit of clout given their collective size.

    I was referring to the difficulty in building a new model comparable to what has been achieved. If an entrepreneur today wanted to build a brand and scale new franchise, they couldn't really look at the "Patel" model given the unique attributes to their rise. My point is that it's harder to do now since the power is tipped to franchisors in the large franchise arena.

  7. Franchise is one of the best way to introduce business products globally using any brand's right and logo to gain profit. Like subway is one of the best example of franchise business.

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