Let's look at the statistics.
According to the Small Business Administration (SBA), in a study of SBA backed small business loans determining failure rates, they concluded,”There is not much difference in SBA loan guarantee failure rates between franchise and non-franchised businesses. In lay terms, slightly less than 6 of every 100 SBA loans for non-franchised businesses go into a work-out with the bank/SBA, compared to about 6 ½ of every 100 SBA loans for franchised businesses.” They concluded that franchise and independent businesses have a similar success rate, judging from the default rates of SBA backed loans.
I thought franchising was supposed to be a safer bet?
It is,….except when it isn't.
In my opinion, success and failure in franchising has to do with some of these contributing factors:
A proven business model. The founder of the franchise may be able to make it work, but how many franchisees have been successful over a sustained period of time?
Start up costs. Franchising involves additional fees above and beyond regular startup costs. Franchises fees, mandatory marketing funds and ongoing royalties are just a few added expenses that independent business don't have.
Experience. Sometimes individuals with no prior experience or aptitude for business are drawn into franchising as it's seen as safe bet. They rely too heavily on the franchise system to make up for their shortcomings. With independent businesses, it's sink or swim.
Franchising can still be a great investment. There are hundreds of proven systems out there and many franchisees are doing very well with their businesses. The thing is, how do you decide what's a good bet and what's a fad? You don't want to go spending your life savings on something that's a novelty.
Put the concept to the test:
How long has it been in existence? A new franchise system isn't necessarily a bad bet, it just hasn't been fully tested as a business model yet. You also don't know if the business is cashing in on a current trend or fad that will fall out of favor in a few years. An example are cereal food franchises, where you go to a physical location to eat cereal at all times of the day. People have paid hundreds of thousands of dollars to open up cereal franchises. It was a novelty trend a few years back that has now lost it's flavor.
How many units are operating? The founder of the company may be able to make the business model work, but have franchisees done the same? Don't be the Guinea pig (that's exactly what you are) the franchisor uses to work out the bugs in the business model, with your life savings.
What is the failure rate? Just looking at the net gain/loss of units is not enough. The franchise may have had a net gain of 25 units over the course of the year. What you didn't know is that they actually opened 125 units in the year, while another 100 units went out of business. That may be a serious red flag.
Can it be easily replicated without great time and expense? Many franchise concepts can be replicated, the question is, can a single person replicate it without great time and expense. Usually the franchise has grown to a point where a single person alone cannot replicate it, making it valuable In franchising your not only buying into the product, you're also buying into the system. If I asked you if you could create a better McDonald's hamburger, you'd probably say yes (with ease). That's the product. If I asked you (I already know the answer) if you could create a better operational system than McDonald's, you'd say no. There aren't many companies on earth than can come close to their operational efficiencies. Make sure you're buying into a rock solid product or a rock solid operational system. Hopefully both.
Can you see this concept being popular 10 years from now? This is more of a judgement call. What seems cool today may be lame tomorrow. Is this something people will always need (think healthcare and children's services) or is it a “nice to have”, but can easily be cut out by consumers if need be. While there are plenty of opportunities in disposable income markets, they are usually the first to go in a recession, as we've all seen in recent years.
Tried and true or just a fad? It's hard to say, unless you look back into the past, then it's pretty easy to spot the fads. Check out this infographic by Entrepreneur magazine that points out some up and coming trends, as well as some that have fizzled out.