Does Buying a Franchise Guarantee Success?
An underlying assumption of many entrepreneurs attending the International Franchise Association's recent 53rd annual convention in Las Vegas, not to mention many entrepreneurs over the last half-century, is that buying a franchise improves their chances of business success. But does it?
Some research reveals that franchising in general may not help much and, in fact, could actually hurt chances for business survival and success.
In August 2012, for instance, the Small Business Administration’s Office of Advocacy newsletter, “The Small Business Advocate,” posed the question: How does franchise survival compare with independent business survival?
The SBA’s answer: “Survival among independent businesses and franchises appears to be similar, as they have similar age distributions.” The newsletter later says that about half of new businesses survive at least five years, about a third last a decade or longer, and being a franchise doesn’t change that.
Other studies have cast a more negative light on franchising. In a 1998 article in the Journal of Business Venturing, Timothy Bates, a professor at Wayne State University, compared new retail firms started in 1986 or 1987 and tracked their survival through late 1991. Of franchises, 38.7 percent had closed, vs. 26.9 percent for independent retail firms.
The profit comparison was also bleak. New franchisee startups averaged a $15,877 loss for 1987. Similar independents, meanwhile, earned $10,368 on average.
5 Questions to Ask Before Buying a Franchise
In 1995, Bates published an article in the peer-reviewed scholarly journal, Small Business Economics, which looked at Census data on 20,000 companies that started in the mid-1980s. Again, franchises earned less and failed more.
“Although the franchise operations are larger scale, better capitalized young firms, the independent business startups are found to be more profitable and their survival prospects are better than those of franchises,” Bates wrote.
Bates suggested two explanations. First, he said, franchising was concentrated in crowded, competitive industries. Second, franchisers had extra costs in the form of one-time franchise fees and ongoing royalties paid to parent companies.
The Franchising Rebuttal
Franchising industry spokespeople are critical of these sorts of studies. For instance, Alisa Harrison, vice president of communications and marketing for the International Franchising Association, says Bates’ earlier sample of franchised and non-franchised businesses wasn’t large enough.
She adds that “there was no apples to apples comparison—e.g., a franchise restaurant to a non-franchise restaurant, of the same size and type, operating at the same time, in the same market and economic conditions, and with the same levels of capital, etc.” Reliably measuring franchising’s effect on profit and survival requires comparing franchises to non-franchises for a long time while controlling for all variables, Harrison says.
No such study exists, which is one reason franchisers several years ago began backing away from longstanding claims that 95 percent of franchises were successful. “We know of no definitive data that proves that franchise businesses succeed at a better rate than non-franchise businesses,” Harrison says. She adds that data does show franchise businesses grow at a faster rate, however.
The Economic Analysis
Without definitive studies, franchising supporters point to the industry’s growth and size. According to the IFA, there are about 750,000 franchise business establishments, down from about 775,000 in 2008 but up from 736,000 in 2011. Franchise businesses employ nearly 8.3 million and generate $802 billion annually, the group says in its 2013 Franchise Business Economic Outlook report.
Franchising’s growth has to mean something, says Rick Bisio, a Bradenton, Florida, franchise consultant and author of The Educated Franchisee. Until about the time the IFA started up, he notes, franchising had little presence. “In 50 years, it’s gone from having no impact to having a very large impact on the U.S. economy,” Bisio says. “What we can deduce from that is that franchising works, in the same way that many chain-based business models have created competitive advantages for themselves since World War II.”
Following the Money
If franchising works, the question is for whom. If franchisees pay fees and royalties without boosting profits or longevity, franchising arguably benefits mostly franchisers.
One critic of franchisers is Robert Purvin, a former longtime franchising industry attorney, author of The Franchise Fraud: How To Protect Yourself Before And After You Invest, and chairman and CEO of the American Association of Franchisees and Dealers, a nonprofit trade association based in Palm Desert, California.
Purvin says that, although buying a proven franchise system can be a path to business success, too often, franchisees buy a ball and chain. “In a franchise business, you have to gross dramatically more in order to meet your capital burden, your operations burden and your royalty burden,” he says. “As a consequence of that, franchises tend to fail at a slightly faster pace than independent startups.” Only strong systems that deliver market power and operational efficiencies will offset and justify the additional costs, he adds.
How to Pick a Franchise That's Right for You
Purvin also criticizes most franchise agreements as too protective of franchisers with little respect and concern for franchisee interests. “Typical franchisee agreements mandate franchisee operations and supplier sources, often at increased expense, and reduce business owners’ flexibility and ability to respond to changing conditions,” he says.
IFA produces many statistical studies like its economic outlook that reports, among other things, franchise businesses produce jobs faster than other firms. Harrison says the association has not studied franchising’s effect on survival and profitability, however, because it involves too many factors. “It’s also proprietary information from the franchise companies and we could not guarantee we could get the info,” she says. “So we watch the growth in units, jobs and revenue.”
Bisio doubts whether any studies adequately measure franchising’s success rate. “There is data that can tell you franchising is more successful than anything else and there’s data that will say the opposite,” he says. “It’s a very difficult thing to pin down statistically.”
Critics and fans of franchising agree that some franchises are better than others. While IFA doesn’t say franchising alone guarantees success, joining a franchise that is a “proven brand” can help, Harrison says. Purvin concurs: “Buying a good franchise is probably a good business strategy.”
How to Tell Which Franchises are the Biggest Failures
What’s a good franchise? A just-published Dutch analysis of 126 peer-reviewed journal articles on the topic found winners had recognizable brand names, exclusive territories, high-quality support, good franchiser-franchisee relationships, decentralized decision-making and fair contracts.
No one claim describes all franchises. Even success itself, Bisio notes, isn’t defined identically by all business owners. “But when you start looking at franchising and its impact on the economy,” he says, “it’s a pretty persuasive story that when done correctly it’s a pretty competitive way of getting into business.” For now, when it comes to evaluating franchising’s overall value, that will have to do.
Read more articles on franchising.
Photo: Getty Images