Designing & Developing Your Franchise Offering, Part One

Overview

In MSA’s five-part series on the Threshold Analysis, we discuss how to evaluate whether your business is ready to franchise. This series will look at the approach MSA takes when designing and developing a franchise system for our clients.

At MSA we do this frequently and when we work with clients, the process is relatively seamless. Franchise system design and development is not intended to be a do-it-yourself project, because knowing some of the questions and issues does not give you the experience to understand the alternatives – and why they work or do not work under certain circumstances and approaches. This article series is intended to give you a basic understanding of the design and development process, when it is properly done.

We are fortunate to have among our clients many large, established franchised and non-franchised brands in addition to small emerging concepts. When properly designing a franchise the scale of the franchisor is relatively unimportant, as you are developing a franchise system to create a consistent, sustainable, and replicable approach for supporting franchisees and protecting the brand. Those franchisees are generally going to be small owners. Our approach and focus, whether the franchisor is large or small, is basically the same. Don't be intimidated by the detail and areas that need to be evaluated. Each is important, and most are interrelated in one way or another to various other elements in strategy.

In the Threshold Analysis article series, we address the types of information we feel are necessary from a 30,000-foot vantage point. In this series, we come down to level ground. While the ultimate decisions reached in designing a franchise system will differ for each company and industry, there is a commonality in many of the elements in building the franchising plan.

Designing a proper franchise system is a creative activity and entails developing a strategic plan, which needs to be written and have a logical flow of information. The strategic plan provides management with a road map for the company, with defined tactical actions that achieve the company’s objectives. It needs to include benchmarks that can be measured in real time against accomplishments and predetermined targets or expectations. It should express the unique qualities of the business, challenge long-held assumptions, and most importantly, strategic franchise plans must capture the fire and enthusiasm the owners have in their company.

Strategic plans are rarely completed in a single draft, as assumptions need to be continually challenged. Strategic plans should always be a senior-level management activity, not something left to junior staff or relegated to accountants or lawyers. The design of a franchise system is primarily a business exercise, and the strategy and resultant franchise offering needs to be based on the business decisions included in the plan. Working with an experienced outside business advisor in designing and developing your franchise system is essential for most emerging franchisors.

Designing an effective strategy for any company, including a franchise system, necessitates a deep dive into all aspects of company’s business. When you conduct a proper Threshold Analysis, you obtain a substantial amount of information and begin to view your business in the context of a franchise offering. Moving through the design and development process should be dynamic, with an expectation that the end product will be used as a road map for development of the required legal documents, support structures, marketing materials, manuals, training programs, and other elements necessary for converting your business into a sustainable franchise system.

Your strategic plan needs to be a living document that you frequently review and update when information or assumptions change, or when results do not meet your expectations. The plan also needs to be supported by your entire organization. Achieving that goal requires that you include your entire management team (including your senior officers and board of directors) and members of staff in the planning process.

The design and development of your franchise offering should not rest too heavily on the offering of your direct competitors or what are often described as ‘best practices’. Neither may fit the culture of your the company, and may limit how you view what is required for the proper structure of your franchise offering, as they often create unnecessary restraints on management’s decisions. Your goal in designing your franchise offering should be to create a compelling, sustainable franchise system built on practices that other franchisors will want to emulate and strive to achieve.

Mission & Vision Statements

Mission and Vision Statements can be the most effective tools a franchisor has for clearly defining its Brand Promise and gaining long-term control over the quality and consistency delivered by its franchisees to consumers. The Mission and Vision Statements embody the system’s culture and, over time, become the fabric of the franchise system.

Mission and Vision Statements should be concise. They should accurately reflect the company’s culture, describe the fundamental reason for the company’s existence, establish its scope of activities, and reinforce your commitment to the delivery of consistent quality products and services to the end user customer. The statements should be published, broadly communicated inside and outside the franchise system, and most importantly, celebrated at every opportunity.

When a franchise system’s culture is well developed, documented and communicated, franchisees and franchisors intuitively know how the system is meant to operate. They are able to recognize when their actions are inconsistent with the established culture, and can intuitively and consistently deliver to consumers the system’s Brand Promise. It’s essential that everyone involved in the design of your franchise offering measure the decisions you make against the culture you are trying to achieve, and which you have enunciated in your Mission and Vision Statements.

Business Overlay

After the Mission and Vision Statements, the Business Overlay is the first major section of your franchise plan, and summarizes all that follows. It provides basic information on the background and current operations of the company including its history, key management, business form, geographic reach and number and type of locations, etc. Information generally included in this section includes, but is not limited to:

Overview of System

Description of the business:

• Description of the company’s products and services
• The size of the system and its geographic markets
• The types of locations targeted
• The market dynamics, including why the market is attractive
• How the market is changing and its challenges
• The retail customers
• The retail-level competition
• The targeted classes of franchisees
• The direct and indirect franchise competition for the targeted classes of franchisees
• The company’s competitive advantages and disadvantages at the retail level
• The franchisor’s competitive advantages and disadvantages at the direct and indirect franchisor level

Detailed Company History:

• Date of origination and form of business
• The history of the business, its founders, etc.
• Current ownership and IP holders, etc.
• Current management
• Current organization

Statement of Management:

• Major accomplishments of the business
• Major setbacks
• View on market and competition
• Expected challenges
• Future forecast

Financial Information:

• Current and projected financial and statistical information for the franchisor
• Current and projected unit economics and statistical information by market and type of locations
• Current and projected information on the franchise system at the unit level

Retail Level Operations and Franchisor Support

The goal for most franchisors is to enable its franchisees to consistently and sustainably replicate the system’s Brand Promise regardless of the market or the class of franchisee that owns or manages and operates an individual location. To meet that goal there are some key questions that must be answered:

• What is required for franchisees to operate their local businesses to brand standards?
• What types of support programs are required to support the franchisee?
• What is the organization required to deliver that necessary support?

Decisions need to be made for each class of franchisee. Regardless of who operates the location, unit-level delivery to customers needs to consistently meet Brand Standards. Each class of franchisee will have its own dynamics and support requirements, and your costs for delivering the necessary support may be dramatically different by class. In addition, franchisors need to be able to provide support to franchisees during the different periods in the franchise relationship – recruitment, implementation, start-up and early development, continuing operations, and successor periods. Making decisions on the types and levels of support required by class and during each period are important in understanding how the franchise offering should be structured:

• The operational and service requirements at the local level
• The obligations of the franchisee by class
• The support requirements by class of franchisee
• The back-of-house support organization required by each class of franchisee
• The resources that can be leveraged for the franchise system and what resources need to be modified or created
• The support obligations to be included in the franchise offering by class of franchisee

It is fairly standard for franchisors to modify their franchise offering for conversion franchisees and multi-unit operators. Typical modifications for conversion franchisees often include a lower initial franchise fee, a step-up for royalties based on the franchisee’s existing base of business, and modifications to the location design and IT standards. Over time, the conversion franchisee’s royalties will adjust to system standards, as will its physical location and IT requirements.

For most multi-unit franchisees, franchisors will generally charge a multi-unit development fee/deposit, which is applied on a pro rata basis as each franchise is opened under the development agreement. The fee/deposit is paid by the developer for the reservation of development rights included in their development agreement. Should the developer fail to meet their development obligations, the franchisor may be entitled to retail the unamortized development fee. Generally the other material terms of the franchise offering, including continuing royalties, are the same for multi-unit developers and single-unit franchisees.

Franchisors recognize the benefits that a multi-unit developer bring to the system, which is the reason that developers have become the principal target for development. In addition to a lower per-unit capture cost and the potential for a more certain rate of new unit development by the multi-unit developer, franchisors are able to deal with one franchisee, who is generally more sophisticated, better capitalized, and frequently more experienced in franchising than single-unit operators. The dynamics of the franchisor multi-unit developer relationship also has its potential stresses, as multi-unit franchisees understand their financial advantage to franchisors, have committed to a greater overall initial and continuing investment, generally have additional costs for general management and back-of-house office support, and their experience with other franchise systems gives them a ready basis of comparison.

While investor multi-unit franchisees may primarily measure the success of their investment based on its return, strategic franchisees also look to how well they can leverage the back-of-house resources they already have in place to support their other franchises.

Franchisors are looking today to leverage the advantages inherent in the multi-unit developer relationship by modifying the terms of their offerings for developers, by requiring the franchisee to internalize and share in some of the unit support obligations typically provided to single-unit franchisees and reduce the franchisor’s per-unit cost of support. The goal is to provide the multi-unit operator with an incentive to develop a strong internal back-of-house support capability (based on specified requirements), enhance their capabilities and unit performance, and accelerate location development in exchange for a lower royalty rate than incurred by single-unit franchisees, among other benefits. In doing so the franchisor can enhance its marketability to multi-unit developers, improve its continuing relationship with its franchisees, and also lower its multi-unit franchisee support costs, including but not limited to: site section and development, initial and continuing management and training, and leveraging the developer’s back-of-house and general management resources to expand the franchisor field staff’s span of control.

Organizational Structure

Corporate Organization

Franchisors typically are able to operate with a smaller corporate and field organization than found in vertically integrated companies. Companies eliminate the requirement to manage branded locations on a day-to-day basis when they franchise.

Because franchisors don't have a direct management role at the location level, their field organization can take on the role of consulting – providing the franchisee’s management with business advice and other assistance, and also ensuring that they are operating to system standards. In most vertically-integrated companies, the ratio of general manager to retail-level location is often one to five or one to eight. With a consulting and compliance role, franchise consultants have a greater span of control and may often be able to work with 25 or more single-unit franchised locations. While the number of franchisees may diminish, the number of franchised locations will increase, and the span of control for field consultants working with multi-unit franchisees can dramatically rise.

Headquarters, overall corporate staffing, and other costs will also be lower for franchisors. In addition to a reduction in headcount, franchisors can achieve significant savings in capital requirements; interest; financial; marketing; legal; compliance; and other administrative areas, as much of those obligations are transferred to the franchisees.

Local Management

Franchisees are responsible for their local management and staff costs. This is a major shift from more traditional expansion strategies where retail-level personnel work for the company. With local ownership comes local reward and local risk, and the motivation for excellence this creates can often be measured in the financial and operational results found in locally owned and managed businesses.

It is important to determine the organization you want to recommend for your franchisees, as this will impact your support costs including training and field staff.

If you are going to modify the terms of your franchise offering by class, and are expecting the franchisee to have sufficient persons with the necessary skill sets on board to allow you to do that, you should include that local requirement in your strategy.

In Part Two of this series about developing a strategic plan for your franchise system, we will cover franchisee selection criteria and marketing strategy.