Many people think that buying a franchise is a sure way to become a successful business owner, but in reality, there are a number of reasons why becoming a franchisee isn't all it's cracked up to be. In this article, we'll take a look at some important considerations before you dive head-first into a franchise purchase.
Pesky Start-Up Costs and Royalty Fees
Start-up costs and royalty fees can put a serious damper on a franchisee's take-home pay. For example, when opening a McDonald's, the franchisee must not only pay money toward the location, they must also pony up a $45,000 franchise fee for the right to operate the business for a period of 20 years. After 20 years, assuming the company agrees to renew the contract, another $45,000 franchise fee is charged.
The real kicker, however, is the ongoing royalty fee. Here's how it works: Each and every year, franchisees must pay the franchise a fee equivalent to a percentage of sales. It also means that no matter how successful you are as a business owner and how innovative you are at driving revenue, you'll always have two partners: Uncle Sam and company headquarters.
The unfortunate part is that royalty fees are pretty standard in the franchise world. In fact, Burger King charges its franchisees 4.5% of sales in addition to a $50,000 franchise fee, and Dunkin' Donuts has its franchisees cough up 5.9% of sales each year in addition to a franchise fee that can range anywhere from $40,000 to $90,000, depending upon the location. Subtract payroll, food costs, and taxes—in addition to these royalties—and it's easy to see why being a franchisee may not entail the life of luxury you imagined.
Is Buying A Franchise Wise?
Lofty Raw Material Costs
In order to maintain consistency among their offerings, most franchises insist that their franchisees buy raw materials directly from them or from a supplier with which they have an exclusive relationship, meaning they often receive rebates on what the franchisees order. In any case, the prices they charge for these materials (either the company or the supplier) are often much higher than what the materials would be sold for elsewhere.
In fact, it's not uncommon for some fast-food franchisees to pay 5%–10% above the prevailing market value for a box of lettuce or tomatoes, or other produce that could easily be bought elsewhere. Some franchises have been sued for charging franchisees high markups on supplies. After all, produce is produce, right? It's fairly consistent from vendor to vendor. The point is that over a year's time, the premium that a franchisee may have to pay for raw materials can equate to big bucks.
Lack of Financing
Most franchises don't provide financing. This means franchisees will probably have to tap their savings or obtain some other source of financing (such as a small business loan). In other words, franchisees are on their own.
With that in mind, some franchises, such as Lawn Doctor (which offers lawn and turf treatment services), will finance franchise fees, start-up costs, inventories, and equipment to help their franchisees get started. Situations like these are particularly attractive because, although franchisees will probably have to put up a portion of their personal assets as collateral for the loan, at least they won't have to zero out their bank accounts or tap retirement funds to set up shop.
Lack of Territory Control
While most franchises will limit the number of stores they open in a given area because of fears of market saturation and diminishing returns, many franchises will still try to fit as many retail locations into a given area as possible. That's why it's not uncommon to see five different McDonald's locations within a five-mile area—the corporate head is trying to squeeze every last dollar out of the territory. But the individual franchisee is really the one who suffers. Every time a new location opens within close proximity, their potential market is cut.
Lack of Individual Creativity
Franchises demand uniformity. In fact, everything from in-store decor, signage, products offered, and the uniforms the employees wear is dictated by the franchise. For a person who likes to be creative, this can mean a bleak existence. Unfortunately, almost every (if not all) franchise has similar requirements. So, if you like to be your own boss, a franchise is probably not for you.
Buying a franchise might seem like easy money, but those royalties and fees will quickly cut into profit margins. The majority of franchise owners earn less than $50,000 per year.
Franchise May Not Know Your Area
You've probably heard many times that "location, location, location" is the most important factor in determining the success or failure of any business. The point is, unless the franchise sets up shop in a favorable location that's going to support the business, the franchisee will have an incredibly difficult time making ends meet.
Although franchises may be able to do a quick demographic study and gauge whether there is a good chance that a location will perform well, they rarely know an area as well as the locals.
How Much Franchise Owners Make
According to a survey by Franchise Business Review, the average annual income of franchise owners is about $80,000. But there are many factors that affect franchise income, such as neighborhood demographics and traffic. The same study found that the majority of franchise owners earn less than $50,000 per year, while 7% earn above $250,000.
The Bottom Line
Running a franchise is a serious decision that should be made with care. If you're looking to buy a franchise, learn as much as you can about the company, its products, and the city or town where you are looking to set up shop.
Buying a Franchise FAQs
What Should You Do Before Buying a Franchise?
The first step is to conduct thorough research. Carefully read the franchise disclosure statements and marketing materials, to understand the costs and fees associated with the business. It is also important to understand how the franchisor assists struggling franchises and the rate of franchise turnover. It may be worth meeting other franchise owners to get an idea of their experience.
What Questions Should You Ask Before Buying a Franchise?
The International Franchise Association suggests nine questions before buying a franchise. These questions focus on the costs of operating the franchise (both start-up and ongoing), the expected level of commitment from franchise owners (both hours and money), and the franchise's financial state and track record with other owners.
How Will You Save Money By Buying a Franchise?
Buying a franchise lets you skip over some of the early phases of business development, like creating a business plan, branding, and conducting product research. Instead, you can start your business with a market-tested product that is already familiar to your consumers.
What Are the Most Popular Franchises?
The most popular franchise in 2021 is McDonald's, followed by KFC and Burger King, according to FranchiseDirect. Outside of fast food, the most popular franchises were 7-Eleven, Ace Hardware, and Century 21.