Fred Dunayer: Welcome to the SCORE Small Business Success Podcast, Been There, Done That! To get free mentoring services as well as to see the wide variety of resources available for small businesses, visit our website at www.score.org or call 1-800-634-0245. Now here’s your host, Dennis Zink.
Dennis Zink: Episode number 3, Franchising. Fred Dunayer joins me in our studio today as co-host, SCORE mentor and our audio engineer.
Fred Dunayer: Morning, Dennis.
Dennis Zink: Good morning, Fred. Our guest today is Bob Melberth. Bob has been a franchisee three times and is currently with the Entrepreneur’s Source, where he coaches individuals in selecting the correct franchise. Bob has also been in a franchise operations and support role with large and small franchises alike, including McDonald’s, Wendy’s and Popeyes. He has been responsible for almost two billion dollars in sales. Good morning, Bob.
Bob Melberth: Good morning.
Dennis Zink: Welcome to Been There, Done That!
Bob Melberth: Thank you.
Dennis Zink: Bob, let’s start with the basics. What exactly is a franchise?
Bob Melberth: A franchise really is a method of distribution of a product or service that includes several points. Number one, the licensing of a trademark or a trade name. It does include what we call payment now and forever, which is a franchise fee and typically a royalty; a proven business system, training and ongoing support, a win-win business relationship and regulatory oversight. That’s really what a franchise is structurally.
Dennis Zink: What are the biggest benefits for someone getting into a franchise?
Bob Melberth: I think the biggest benefit that I see is, number one, you have a proven business concept that you can explore and validate to be sure that it’s going to work for you, fits your skills and talents and delivers what the individual wants in terms of their success. I think that another major factor is the intangible asset of being able to join a community of franchisees. If you’re an independent business person, you’re by yourself and an independent business person doesn’t have a franchisor and a community of franchisees rooting for them to be successful. An independent guy can’t go down the street and borrow product to sustain his business from a neighboring franchise; they don’t have that. The value of that community is really priceless.
Dennis Zink: It’s almost like having cheerleaders and coaches on the sideline.
Bob Melberth: Absolutely.
Dennis Zink: What are the biggest negatives to owning a franchise?
Bob Melberth: I think the negatives are somewhat individual. The negatives would be that if someone is truly very, very entrepreneurial and just can’t seem to fit into a set of parameters, they want to be the boss totally and make every decision, then really a franchise isn’t for them. It does have some structure that will vary based on the type of business. Food, for example, are going to have some very strict guidelines about how to operate because of public safety being involved. If you’re in a service business, then it’s a lot more flexible and the rules aren’t quite as rigid. You can build your business how you need to. You can see where that might be a negative for someone who really wants to work outside the lines, continue to create new products all the time, things like that, so that might be perceived a negative.
The other typical franchisee/ franchisor argument is around marketing. In all my years, I’ve never seen a franchisee/ franchisor relationship not be adversarial to some extent around marketing. Everybody’s a marketing expert, okay? The franchisee says the national advertising program doesn’t work for me in my marketplace and yet you are asked typically to contribute to the support of that. Because there’s money involved, there’s always an argument of how that money should be spent. Typically, these marketplaces are much more similar than the individual franchisee believes and the franchisor just typically got a pretty well developed and proven plan of how to market that business.
Dennis Zink: In general, if I were looking at either buying an independent business versus a franchise, how much control would I give up if I go into a franchise?
Bob Melberth: As I said, I don’t think you give up control of the franchise because it’s still your business; you’re in business for yourself, not by yourself. You give up some control if let’s say you go into a food chain franchise. They’re going to dictate what the menu is. If you are a chef, you may not want to be in a franchise because you’re going to want to create the menu. Other than that, there’s going to be operating parameters that are typically pretty broad and you can work anywhere in between that.
When it comes to operating your own business, you’re still in total control of that: who you hire, who you fire, how you structure your business. Obviously, you’re going to want to perform in a way that doesn’t jeopardize the rest of the system. Those would be the only broad parameters where you might be limited. Certain types of advertising and things like that that might be considered risque or something like that might be prohibited in a franchise, where an independent guy doesn’t have those restrictions.
Dennis Zink: Does the franchisor give you an idea of what kind of ratios or how much to pay at different levels; the managers versus the people that are serving food?
Bob Melberth: Sure, sure. It comes from two things. It comes from the marketplace. We’re using food examples, but there are in our portfolio, eighty-seven different industries, only about six of which are food, because of the different categories of food. All of that can be either gained from knowledge of the marketplace and what industry you’re working within in the marketplace, as well as the entire body of franchisees, who are out there executing the brand, have parameters. You can do your research and find out what all the other franchisees are paying for this cost or that cost. In fact, that leverage buying power is one of the real strengths of becoming a franchisee.
Dennis Zink: What are the hot franchises now?
Bob Melberth: I get that question a lot, about what’s a hot franchise and I tend to steer people to industry. There’s no real answer, because the hot franchise is whatever is best for you, because that’s the one you’re going to believe in and be most successful at. Annually, they write about what are the top five industries that are really strong in franchising at this point. Off the top of my head, there about five that I think right now are really pretty strong. Elder care, because of the demography of the country and it’s shift. Anything having to do with elder care is a strong industry that the demographics just continue to support. Another is staffing and personnel services. In the other countries that have health care systems like we’re moving into, the percentage of temporary workers in the work force is four to five times what it is in the United States, so that’s a very strong industry with a good trend to continue to be strong.
Dennis Zink: That may increase with ObamaCare.
Bob Melberth: That’s what I’m talking about, exactly. In England and in Canada, the temporary work force represents four and five percent. In the United States today, it’s about one percent, so the outlook for that particular industry, which is really strong right now anyway; the numbers in that industry are pretty impressive. There’s only an upside to that in terms of the industry.
Dennis Zink: What typically does a franchise cost? Give me a range if you would.
Bob Melberth: Sure and I’ll give you ranges around industries.
Dennis Zink: Sure.
Bob Melberth: Obviously, a service industry where you as the franchisee really are providing a service and there’s no physical asset other than your knowledge and your skill that you’re delivering, those are lower costs. In our portfolio at Entrepreneur’s Sources goes from about twenty thousand dollars up to about eighty thousand dollars. That number represents the franchise fee plus an estimate of hard operating costs and a projection of three months worth of operating capital. That’s really to get the start of your business, it’s in that range.
When you start to add things where you start to have some equipment and the total investment will range from that eighty-five or so thousand dollars to probably two hundred thousand dollars, maybe two fifty. Maybe starting to get into retail with furniture fixtures and adding inventory. The most expensive are typically restaurants or things that are capital intense in terms of equipment, plus inventory, plus a lot more moving parts in terms of labor as well. I would say that that range will go from about two hundred thousand to three hundred fifty, four hundred, maybe even five hundred thousand dollars as an initial investment.
Fred Dunayer: That doesn’t include any real estate costs or anything else that are associated with say a fast food restaurant, right?
Bob Melberth: What I’m talking about in terms of … it can, because depending on the way that the business is structured, I’m talking about cash up front or cash you might need to be able to invest in or get financed to make the business go. McDonald’s, for example – I worked for them for eleven years – everyone thinks they’re terribly expensive, but the franchisor, McDonald’s, typically owns the land and the building and the franchisee just pays them a rent. In that scenario, their costs are only the furniture, fixtures and equipment to get started. That’s the hard cost they get into, so it really varies by brand.
Dennis Zink: Who selects the location? Does the franchisor give you a choice as we’re looking at three McDonald’s locations, for example and how does that work?
Bob Melberth: McDonald’s is a little different than everybody else in the industry, because they do step up and they own the building, they own the land, so they make that decision. Then it’s awarded to a franchisee within their system, typically.
Dennis Zink: How about everybody else?
Bob Melberth: Everybody else typically will help in varying degrees. It will go from saying let’s identify area of opportunity and Mr. Franchisee, you go out and find two or three spaces that you think will work and then we’ll send a real estate representative there to evaluate those, to the point where a franchisor will send a representative into the marketplace, select a location and even do the lease negotiations, so there’s a whole range of services in that real estate, it just depends on the brand with which you’re associated.
Dennis Zink: Is there a degree of truth, if McDonald’s is on one side of the street, then maybe Burger King or Wendy’s will be on the other side, sometimes?
Bob Melberth: Absolutely.
Dennis Zink: So they don’t have to reinvent the wheel.
Bob Melberth: Absolutely, yeah.
Dennis Zink: Just change the street. How do I find the right franchise?
Bob Melberth: That’s a great question and there are a lot of franchises available out there. I think the IFA, the International Franchise Association says there’s well over thirty-five hundred franchises in the United States, so there’s a wealth of brands to pick from. I think it’s really driven by an individual’s needs and that’s what our approach really does. We help our people identify what income they’re looking for, what kind of lifestyle they really want to lead and even talk about longer term wealth building and equity positions as you would leave a franchise to help define what business model might be most suited for them.
You want to look at something that you can use your transferable skills within, that apply to that, but so many people continue to confine their search to what they’ve done in the past. They don’t realize they’ve got a skill set that they’ve developed over a career that when they start to look for a franchise, they can apply in many different business models, so we work with our clients to help them do that.
Then, of course, your resources dictate what you can afford. Finally, I think in the process of validation, one of the last steps is getting a chance to meet the leadership of the franchise. They call that in most brands a discovery day. I think as a franchisee or prospective franchisee, you want to go meet the leadership who are going to be responsible for keeping the brand vital and keeping your business moving forward, because you’re going to be out there executing it. It’s one of the beauties of franchising and not having to be independent and do that all yourself. You’ve got a team of people that are going to keep that brand vibrant and moving forward and relevant to the industry, so you can go ahead and execute.
Those are the key things that I think people go through. You want to find an environment that’s safe to do that discovery and that’s what we help people do.
Dennis Zink: You mentioned resources and I just was wondering, how available is financing for franchisees?
Bob Melberth: It’s becoming more available than it had been over the past few years. Not that I think commercial lending is loosening up, but I think that there are alternative means to financing that have come up that a lot of people are now being able take advantage of. A statistic was quoted the other day at our conference of fifty-two percent of the franchises purchased were purchased with retirement funds. There are methodologies where you can roll your retirement funds over into a new corporation that makes an investment in a franchise and not suffer any early withdrawal penalties or any sort of taxable event, so that’s become very, very popular.
There are SBA vehicles out there now that are being utilized and some are even unsecured, that I know that clients of mine have taken advantage of. As well as creative things like … and it’s not one I like, but it is available … is that there are companies out there that will put together several low or no interest for a period of time credit cards that you can draw against and then eventually you’ll pay a higher interest rate, but for a period of time, you’re not paying any interest against that loan. If you think you’re going to be in something that can ramp up quickly and be profitable and you can pay it off quickly, you won’t be paying a very high interest rate.
You have to get a little creative. There are some more vehicles out there than there used to be in terms of traditional lending and now the traditional lenders are starting to get wind of that and being a little more open.
Dennis Zink: How safe are franchise companies?
Bob Melberth: There’s no guarantees to anything in life, particularly being in a business, but the success rate of a franchise versus an independent business, let’s say, is remarkable. The U.S. Chamber of Commerce did a ten year study. At the end of two years, about fifty-five percent of the independent businesses had already failed, where only about four percent of the franchise businesses had failed. Over a course of ten years, about eighty percent of the independent businesses had failed and the success rate was over ninety percent for the franchises. You ask me why is that? Well –
Dennis Zink: Why is that?
Bob Melberth: Why the difference? First of all, lack of resources and typically that means money, so people run out of money. One of the reasons is; independent versus franchise is, when you start an independent business, you don’t know how much it costs, where a franchise, you absolutely can define how much it’s going to cost. There will be some variables when you talk about real estate, but at least you’ll have a research background to review before you make any of those decisions.
Then, people feel like they have to be an expert in everything to be successful in business. That’s truer in the independent business operators case than it is with a franchisee, because the franchise community then allows you to access lots of different levels and types of expertise to help you run your business and you don’t have to be the expert in everything.
Finally, I think that in independent businesses, people have a tendency to work more in the business and the franchise creates an environment where you’re working on the business. Michael Gerber wrote a book called “The E Myth” and the “The E Myth” talks about the entrepreneurial method, you can do something you love and you’ll be successful and he says that’s a myth.
Dennis Zink: I read that book.
Bob Melberth: Did you read that book?
Dennis Zink: I did. What are franchisors looking for?
Bob Melberth: Franchisors are looking for generally a good broad spectrum of business skills. They’re looking for business owners, they’re not looking for technicians, another one of Mr. Gerber’s terms. They’re not looking for somebody who’s necessarily expert in their business or their industry, because they’ll train you on how to become expert. They’re looking for good, solid business people who have a drive to succeed, can follow a system and have the ability to execute a system.
Dennis Zink: What happens, I buy the franchise and I decide this isn’t right for me, I want to sell or get out, what are my options at that point?
Bob Melberth: It is an asset that you own and here’s another comparison to independent business ownership; if it’s something unique, you have to educate whatever marketplace you might be offering the business to. In a franchise, you have somewhat of a built in customer base already to which to offer the franchise. You’ve got all the other franchisees in the brand that would like to live maybe in Sarasota, where they can say, okay, I’d like to acquire that franchise, so that’s the first place you market it. Then the franchise owners themselves are typically fielding lots and lots of inquiries about the brands, so they’re having new people come in and somebody from Sarasota inquires about the brand and say, oh, we can help because we’ve got somebody who wants to sell in Sarasota. It is a good business structure from which to be able to get out of, because you can sell it more easily, I think.
Dennis Zink: Thank you, Bob.
Bob Melberth: You’re welcome.
Fred Dunayer: You’ve been listening to the SCORE Small Business Success Podcast, Been There, Done That! The opinions of the hosts and guests are theirs and do not necessarily reflect those of SCORE. If you would like to hear more Podcasts, get a free mentor, view a transcript of this Podcast or would like more information about the services we provide, you can call SCORE at 800-634-0245 or visit our website at www.score.org. Again, that’s 800-634-0245 or visit the website at www.score.org.