Buying into the franchise business

There are 310 franchised businesses here, with an estimated combined turnover of more than €2.5 billion employing 27,000 staff, writes Frank Dillon

THE IRISH Franchising Association is in celebratory mood this week. Last night there was a gala dinner and an awards function marking its 25th anniversary, while a two-day exhibition starting today in the RDS in Dublin will highlight the opportunities in this business sector.

Franchising undoubtedly represents a lucrative business opportunity for some. According to the association, which recently surveyed the market here, there are 310 franchised businesses in Ireland, with an estimated combined turnover of more than €2.5 billion and employing 27,000 staff.

The association's chairman, John Green, who holds the master franchise for Chem-Dry in Ireland, says the sector is buoyant. He predicts turnover growth of 22 per cent next year within this sector - impressive figures in the midst of a recession.

"Franchise businesses have a 10-year survival rate of over 90 per cent whereas 60 per cent of stand-alone businesses fail within their first few years," Green says. "That gives a good barometer of the success of the sector.

"The great advantage of franchising is that you are buying into a proven concept with all of the major problems ironed out. You have independence of running your own business with the support of the franchisor as well."

However, franchising also has its downsides and anyone considering investing in one needs to be aware of the potential pitfalls associated with this form of business.

The franchising industry was born in the US in the 1850s. Sewing machine manufacturer Isaac Singer is credited with developing one of the first successful models as a way of extending his business without enormous capital investment. Modern franchising took off in the 1950s, centred around the fast-food industry. The McDonald's restaurant chain remains one of the most enduring franchise concepts to this day.

McDonald's has a proven retail formula, a well-honed operating manual, is easily replicated and is backed by major brand investment. Not all franchises live up to this standard, however.

Solicitor Bill Holohan has seen both sides of the franchising coin and describes the concept as "a velvet handcuff where the steel can bite". While many of Holohan's clients have run successful franchises, some have run into difficulties. "In a franchise, you typically contract to pay a percentage of the turnover. Where the business is profitable that is fine, but when there is no profit, you still have to pay the franchisor."

Holohan says that a typical mistake franchisees make is in selecting unsuitable businesses for the local market. About 40 per cent of franchise concepts here are imported from the US, with about 30 per cent coming from the UK.

"Some concepts work fine in the US or on the Continent and the franchisors can point to impressive figures," he says. "They don't always work well in Ireland for reasons of taste or culture. Frozen yoghurt is a good case in point."

Even well-established franchises are not without their problems. O'Brien's sandwich bars has been a good example of an indigenous franchise concept that has been successfully exported. However, founder Brody Sweeney, who recently returned to head up the group following the departure of its chief executive, admits that it is a "very challenging time" for the business, given the downturn.

The company has also been involved in a number of legal disputes with its franchisees. Sweeney says that the level of these cases is normal given the scale of the business. "The vast majority of our franchisees are happy and are getting on with the business."

Holohan says some retail franchise concepts are coming unstuck because of a combination of rising overheads and shrinking turnover. Exiting a franchise agreement early can be difficult and costly, something potential franchisees need to bear in mind. However, he adds, where goodwill exists on both sides, it is possible to work out a compromise in some cases.

"Ultimately, the franchisor doesn't want a failure on their hands as it reflects badly on the brand so they will often work to facilitate flipping the franchise to another operator," Holohan says.

The concept often appeals to those who don't have previous experience in running a business. The expertise and support of the franchisor can be useful but ultimately franchisees need to stand on their own two feet, advises accountant Imelda Prendergast of OSK.

She says that franchisees need to prepare a detailed business plan and advises them to plan cashflow for the first two years. They should also consider a monthly direct debit arrangement with Revenue to avoid building up tax arrears.

They also need to establish how royalty payments will be paid to the master franchisor. "It is generally either a fixed monthly fee or a percentage of turnover. Both have their advantages and disadvantages, depending on how sales are going," Prendergast adds.

Having an established exit policy from the outset is vital, she agrees.

"The franchisee will need to be very clear on what support will be available from the master franchisor in the event that the business does not do as well as hoped.

"For example, will the franchisee have to continue to pay the monthly royalty even if sales are falling? You also need to establish what penalty would arise on termination."

Mark Fielding of ISME says franchising can be a good model. The advantages outweigh the negatives overall but it does not suit the temperaments of all entrepreneurs, he says. "In the nature of the franchise, conformity is vital. This can act as a barrier to innovation in the business which some will find frustrating."

Despite the potential pitfalls, many franchise operations continue to enjoy success.

Ed Murphy, one of the winners of this year's Irish Franchising Association Awards, has had a long association with franchising and currently holds the master franchise for Home Instead, a service that provides home-based care workers for the sick and elderly.

Typical clients use the service for a few hours a day to assist with cleaning, cooking, shopping etc and for many it is a viable alternative to nursing home care. Murphy imported the concept from the US in 2005 and has built 14 franchises throughout Ireland, with plans to extend this to 20. The combined group has turnover of more than €15 million with more than 900 carers on the books.

Murphy says a Home Instead franchise typically increases turnover from about €500,000 in its first year to €2 million in about three years, with operating margins of 10-15 per cent.

He says there is a general trend towards service-based franchise concepts today, given changes in society such as dual-working couples. In many cases, franchising is taking over roles traditionally performed by family members such as cleaning and caring.

His advice to anyone considering a franchise is to do thorough due diligence before signing up to anything. "It is incredibly important to query the projections of the franchisor. You also need to visit other franchisees in the chain. If the franchisor discourages you from doing this, that's a clear signal that you need to run a mile away."

Franchisees also need to assess whether there is a sustainable business model behind the franchise. The acid test of a good franchise opportunity is whether it is capable of development and employing others. "If it isn't, you're just buying a job. People need to be wary of paying out money for a 'man and a van'-type enterprise."

Brody Sweeney also advises caution from the outset. "Get involved with a proven concept, don't be someone else's guinea pig and don't assume that the franchisor has all the answers."