Burn the Business Plan

by Carl J Schramm

  At the time, Taco Bell was developing a national market. Carlucci told me, “Growing up in Boston, I never ate a taco; I don’t think I had ever seen one before.” He approached Taco Bell proposing a statewide territory license for Maryland. Instead, Taco Bell offered him one location close to Annapolis. After building and running it successfully, he got the chance to own several more. Carlucci remembers being turned down by one banker who said, “I think this franchise won’t survive; tacos give me gas.”

  Today, Carlucci owns seventy restaurants in seven states and the District of Columbia. He employs 1,400 people. When I asked Carlucci about his secret to success, he responded instantly, “I used the idea that Taco Bell had invented.” He went on, “I could see the idea worked. I became an entrepreneur because Glen Bell had a great idea. He invented the idea of Taco Bell, I was one of hundreds he invited to follow him.”

  The story of Carlucci is not unique. Many entrepreneurs build scale businesses by owning many franchises. In fact, the majority of McDonald’s owners operate more than one franchise. C. Howard Wilkins Jr. provides another example. Six years after graduating from Yale, he bought a Pizza Hut franchise, a concept recently invented by two students at Wichita State University in his hometown in Kansas. Within two years, he had acquired sixteen stores in Kentucky. A few years later, he sold his stores to the franchisor, becoming Pizza Hut’s Vice President for International Operations. In 1970, he started Pizza Corporation of America, operating 270 Pizza Huts as well as other franchises in the U.S. and around the world, and a property development corporation to support his expansion. Later in his career, he served as America’s ambassador to the Netherlands, where he was famed for spreading the story of how important entrepreneurs are to America’s economy.

  Entrepreneurial Synergy

  New franchises account for nearly forty percent of all new business started each year. Success among strong franchises such as Jimmy John’s sandwiches, Sport Clips Haircuts, and Auntie Anne’s pretzels is very high. Nearly everyone who owns one of the two hundred strongest franchised brands succeeds: Five-year survival rates are over ninety-five percent.

  Curiously, very few university business schools teach even one course about franchising. College students can major in entrepreneurship without ever considering a franchise. This situation reflects the view of most business professors, who do not think of franchisees as real entrepreneurs. As we have seen, their definition, heavily influenced by venture investors, focuses principally on innovator–entrepreneurs, originators of the idea for their own startups. To many professors, it seems building a business with someone else’s concept disqualifies franchisees as real entrepreneurs.

  When I asked Carlucci about this he told me that every franchise owner sees himself as an entrepreneur. “We all start businesses. The only difference is we become part of building out someone else’s idea. I’ve had to make every one of my businesses successful. Like many entrepreneurs, I had someone else’s money at stake. I call that taking risk. While my venture capital came from banks, I was playing with someone else’s money. I was up to my eyelids in debt. If I didn’t make my first Taco Bell work, I would have been bankrupt. I had to solve all the unexpected problems every entrepreneur faces. In my case, I had to learn about cooking, construction, become an expert on wastewater management in parking lots, and the complexities of keeping a semiskilled, minimum-wage workforce motivated. I solved bigger problems, too. I diversified my franchise base, operating hotels, and other restaurant brands. Eventually, I bought a bank to make expansion easier.”

  Successful franchisors, the originators of the idea around which the franchise is built, understand that they must create entrepreneurs like themselves if they are to be successful. They knit together networks of entrepreneurs to reach scale. Without recruiting local entrepreneurs who own their outlets and operate as independent businesses, household brands such as Holiday Inns, KFC, Dairy Queen, Domino’s Pizza, Jamba Juice, Mathnasium, Subway, Visiting Angels, and Wendy’s would never have succeeded in reaching national or global markets.

  Kroc saw his success and that of his franchisees as a co-dependent outcome. “My belief was that I had to help the individual operator succeed in every way I could. His success would ensure my success.” Kroc encouraged his operators to be innovative. A McDonald’s franchisee in Washington sponsored a local television show that developed the character of Ronald McDonald. A Pittsburgh operator, experimenting with how to satisfy customers looking for bigger hamburgers, created the Big Mac. The Filet-O-Fish was invented by a Cincinnati owner in the 1960s for Catholic customers who, before Church rules changed, didn’t eat meat on Fridays.

  Successful Franchises

  Success among the franchisees of already strong brands is more likely for a variety of reasons. Entrepreneurs who become franchisees—generally called “operators” in the franchise world—are older and more experienced than other entrepreneurs. The average age of a franchise buyer is forty-six; only about ten percent of new operators are under thirty-five, and nearly ten percent are over sixty-five. Overwhelmingly, franchise buyers have significant employment or business histories, and most have built up savings and other assets.

  To purchase a strong brand, however, having sufficient financial means is not enough. Most established franchisors screen applicants very carefully; in addition to in-depth and detailed financial background checks, their due diligence may include interviews with friends, neighbors, and family members, and some require that applicants undergo psychological testing. Obviously, these franchisors need to feel confident about an applicant’s level of commitment and fit within their business model, and to know whether the applicant will be a worthy representative of the brand that the franchisor works so hard to maintain and improve. Successful franchising companies pride themselves on their careful selection processes and how successful their operators become.

  Long-established franchisors work hard to perfect and innovate their product and service offerings and their business formulas. For example, every franchisor specifies, often with excruciating particularity, the size and appearance of the brand’s building. With very few exceptions, and no exceptions within the top two hundred franchisors in the U.S., those companies supply assistance to an operator in negotiating for location and with building contractors, require often intensive initial and ongoing training for franchisees and their managers and supervisors, and strictly control supply chains for everything from equipment to the size of napkins or the design of the dining room chairs. To ensure that a Big Mac tastes the same in Seattle and Savannah, McDonald’s operators and their key employees are required to attend “Hamburger U,” and must purchase their “Special Sauce” from an approved supplier.

  A number of successful franchise operations reflect their founders’ intentional creation of business models that can be successfully and uniformly replicated. Snap-On Tools, Panera Bread, Aaron Rents, Servpro, and 7-Eleven began this way. Richard Melman started his first restaurant when he was twenty-nine. In the next twenty years, he opened ten more. In 1991, he decided that he wanted to build a restaurant that, if successful, could become a franchise model. He experimented with an old-fashioned bakery–coffee shop in downtown Chicago’s business district. Today, there are two hundred Corner Bakery locations, many in busy airports.

  Much like Melman, Phil Romano started a dozen single-location restaurants after college. It wasn’t until he was forty that he hit upon the idea of Fuddruckers, now a national chain featuring premium hamburgers, and then went on to create Romano’s Macaroni Grill, a two hundred location franchise. Romano told me that he believes his real talent is sensing customer trends, what people will want next. “Because the restaurant market is so dynamic, you have to be anticipating changing consumer tastes.” In 2014, Romano created an experimental all-restaurant mall in suburban Dallas, where he invites aspiring entrepreneurs to test their concepts as potential franchises that he might develop.

  How Do You Decide If a Franch
ise Is Your Right First Business?

  Perhaps, like Bob Carlucci, you aren’t so sure that you can devise an innovation good enough to become a great company. So, as a first step into the entrepreneurial world, you decide to consider a franchised business, becoming an operator for an existing brand. How should you go about finding the right opportunity?

  The first part of an answer to that question lies in picking an industry in which you have some interest and perhaps even some experience. If you aren’t much interested in how food is made, maybe a gym, rather than a Burger King, is the right answer. Having an interest in cars may point to a Jiffy Lube. A talent for working with kids might lead an aspiring franchisee to an enriched curriculum childcare business like Goddard School, or a franchised tutoring and learning service.

  Once personal interest and experience have narrowed the field, a potential franchisee should look at the widest possible array of opportunities. That research begins with a combination of assessing your financial capacity to purchase a particular franchise and getting the materials that every company will supply. For example, an existing McDonald’s location is pricey: according to the company, it can require a total investment of one to more than two million dollars, including liquid capital of $750,000 and a franchise fee of $45,000. Other franchise opportunities, even those with established brands and good reputations, may be much less costly.

  You also will need to examine—with help from an experienced lawyer—the “franchise agreement,” the contract that will control the relationship between the franchisor and the franchisee. Understanding and analyzing that agreement is critical to any applicant’s decision; it likely will bind you to the franchisor for ten to twenty years and, for a franchisee, “divorce” can be a painful and expensive process. Almost all states require franchisors to be licensed before offering franchises for sale, which means that they have submitted their standard agreements for a regulator’s review. And, similar to the government’s oversight of the sale of a publicly traded company’s stock, both state and federal laws require that a franchisee agreement disclose all of the important terms and conditions of the relationship. Nonetheless, franchise agreements are complicated documents, and it’s important that you understand what you’re buying. One of the most critical elements of the franchise agreement is the definition of a franchisee’s rights to an exclusive geographic area, a “territory,” in which the franchisee has the sole right to develop additional locations and, even more important, precludes other locations of the same franchise moving in to compete nearby. Turning to an experienced franchisee lawyer is critical.

  As a potential franchisee, you will need to research and explore opportunities while being very mindful that franchisors are trying to recruit qualified applicants. The sales pitch to an attractive candidate likely will be bullish and persuasive. After all, the business of the corporate parent is not to fry hamburgers or supervise home health care aides, it’s to make franchises. Be skeptical and well-prepared for these conversations and don’t be hurried into a decision. Aspiring franchisee-entrepreneurs often take three or four years to decide on an opportunity that best suits their talents, ambitions, expectations, and price range.

  As you compare opportunities, imagine yourself owning that operation and working there every day. That brand will become your brand. Are you comfortable with the franchisor’s products and services, its values, its business methods, and the franchise agreement that you’ll sign? Your decision should be shaped by the answers that you receive to six questions.

  Is the Market Niche Stable?

  Every business exists to fulfill or create a market need. Obviously, franchising focuses on the “fulfill” side of business as the franchise product or service is (or should be), by definition, a proven concept. But markets are dynamic, determined by consumer preferences, changing technology, and economic conditions. Before Netflix gave us mail-order DVD delivery (their first-stage ancient history) and today’s streaming video, there were nearly nine thousand Blockbuster stores across America that rented DVDs to walk-in customers. You wouldn’t have wanted to buy the last franchise sold. Likewise, Sbarro was once a coveted brand with a targeted market of teenage mall rats, a population that disappeared when social media enabled more spontaneous meet-ups in many other places.

  When evaluating a franchise opportunity, it’s also important to acknowledge that changing economic conditions influence some businesses more than others. Recessions are tough on lawn-care businesses but great for car-repair franchises. Pizza and dog grooming seem immune to economic fluctuations. Specialty food franchises, including those that sell cookies, gelato, and boutique cupcakes, flourish until consumer tastes move on.

  What Do Other Franchisees Say?

  As soon as you’re focused on one or even two franchises as a possibility, begin talking to its current operators. Most franchisees will be forthcoming about nearly everything, including profits. (After all, you won’t be locating in their “territory”; you’ll be a colleague, not a competitor.) Ask if their experience mirrors the franchisor’s portrayal of the investment needed for the franchise, and the projected sales and expected profits. If there are differences, how does the franchisee explain them? Have they received the expected or needed support from the franchisor? Does their parent’s reputation affect their sales, either positively or negatively? What is their experience with the franchisor’s commitment to marketing and advertising? Does it square with the promises that were made? Ask how the franchisee would describe her ongoing relationship with the brand and “corporate”: Is it easy to get assistance from the home office when it’s needed? Does the franchisor help to solve problems? Are required supply chains well managed? Are the products of good quality?

  How Do I Make Money, and How Much?

  Unlike entrepreneurs choosing other paths, buying a franchise provides the best chance to analyze the investment before setting forth on the journey. Existing operating units, often called “stores,” provide tangible examples of the business in real time. Can you discern how profit is made, and how to make more?

  A franchise should be tested as an investment. Will the return on capital invested, plus the time and pressures of running this new business, pay off? As a general rule, a franchise should return at least fifteen percent profit every year after the first three years. Will your yield, after three years, be at least as much as if your money had been conservatively invested and you had continued to work regular hours at a regular job?

  There are a number of elements critical to a franchisee’s analysis of the future value of a franchise investment. As mentioned earlier, the terms of the agreement between the corporate franchisor and the franchisee is key, and this is most particularly true with respect to the franchisor’s grant to a franchisee of exclusivity in a defined “territory.” You don’t want your hard work and investment jeopardized by a new franchisee’s location just around the corner. Reputable franchisors value their brands and their relationships with their operators, which is how they make their profitable businesses grow and thrive; they don’t usually engage in undercutting. But, look carefully at a franchisor’s record on this front—it is a common source of friction between franchisees and franchisors—and be mindful that this is a very important term of your agreement, especially with less-established franchisors.

  How Will the Brand Support You?

  Strong franchises provide education and continual training about how to be a successful operator, usually in the form of an ongoing and valuable curriculum. In established and successful franchising companies, attending training school is a required step. Does the franchisor that you’re considering provide effective training? Beyond learning how to run the store, are there programs to help you increase sales and improve profitability?

  Successful franchise companies also know that location is key to success and that they need to provide direction and assistance on this front. For fast food, childcare, or a walk-in critical-care facility, siting in a well-travers
ed, and easily noticed and located, area is critical. A carpet-cleaning franchise can locate in a backstreet warehouse district; that business usually goes to its customers, not the other way around. The next time that you pass through an airport, notice where the best franchises are located. Auntie Anne’s, devised to be a quick and portable snack before or during a flight, often is found at the intersection of two piers, the highest-trafficked spots in airports. Frequently, established franchisors offer already-determined locations and building sites for sale when they know that they want to expand into new areas.

  Financing is another area in which franchisors generally will aid and support new franchisees and established franchisees who seek to expand. All reputable franchisors require franchisee applicants to show that they have sufficient funds or assets—or the creditworthiness to borrow—to buy or lease real estate and build and equip the store, and also have sufficient financial resources to cover operating losses in the first year of operation. Many franchisors provide direct financing. Chick-fil-A, which is known for its meticulously careful selection of franchisees, then commits to those operators and will provide most of the startup capital needed to buy land and build stores. But, be inquisitive and prudent on this front: Depending on your financial situation and experience, you may be able to secure better financing terms from an independent lender than from your franchisor.