Truth About Franchising

If you are considering buying a franchise, don't believe everything you are told. And look carefully before you leap.

Franchising is touted as the solution for all wannabee entrepreneurs who feel they don't know enough, or are too frightened to start a business on their own. Reported success rates and profitability are impressive. But should we believe them?

For four decades, the International Franchise Association has insisted that independent small businesses have much higher failure rates than franchised small firms. IFA surveys suggest that, in the USA, 92% of franchise businesses are still operating after 5 years. This is compared to an 80% national small business failure rate. However, findings of the studies presented to support this assertion have been totally discredited.

Research on franchising in the US by Timothy Bates, a Wayne State University Economist, paints a very different picture. After 4 years, only 62% of franchised businesses had survived, while 68% of independent small businesses were still open for business. And independent businesses are far more profitable. Profitability was actually negative, on average, for franchised firms over the four-year period.

The UK experience reflects similar trends. The British Franchise Association survey report predicts each year that franchising will double in size during the following five years. But the reality is that the UK franchise industry has experienced negative growth since 1990 and is currently less than half the size that was predicted for it in 1990 by the BFA. Franchisee survival rates are similar to independent start-up survival rates over a 5 year period. And 50% of franchisee systems fail over a period of 10 years.

"Despite the hype that franchising is the safest way to go when starting a new business, the research just doesn't bear that out," says Timothy Bates. Independent research into franchising in New Zealand would, most probably, also reflect this. The NZ Franchising Association claims that 93% of franchisees survive. Which is hard to believe, in the light of the US and UK experience.

The reason for the discrepancy between statistics reported by the franchise industry and independent studies is difference in methodology. Surveys done by Franchise Associations are done by sending questionnaires only to existing franchisees. Which means that all those franchisees who couldn't make it work and sold their franchises are excluded from the figures. Only the franchisees who went bust and couldn't sell their franchises are taken into account.

This serious omission means that, survival rates, profitability, involvement in disputes and other reassuring indicators dished up by franchisors and Franchise Associations, are grossly under reported. And positively misleading! The much vaunted franchising awards are similarly flawed.

Bates' Research Underscores Three Harsh Realities:

1. Many franchisees never make much money. Average profitability is poor, especially after taking into account the purchase price of the franchise. So take the hype used to sell franchises with a big pinch of salt!
   
   
2. "Studies" used to sell franchises are paid for by the franchisors. Don't mistake the information provided for balanced consumer guide information. It's a carefully engineered sales pitch. Getting hold of the information you need to make a rational buying decision is difficult, to say the least. So use your common sense and a healthy dose of cynical discretion.
   
   
3. Franchise agreements always favor the franchisor. It is very easy to be swept away in the heat of the moment and get into a binding contract that is not in your best long term interests. And it is very hard to get out of a franchise agreement without taking a big financial loss. Remember, the main purpose of franchising is to make the franchisor wealthy. So be careful.

A 1995 study by Dr. Timothy Bates, a professor at Wayne State University in Detroit, found that the franchise failure rate actually exceeded 30 percent and that franchises made lower profits than independent entrepreneurs. Dr. Bates' study also found that the average capital investment of franchisees was $500,000, compared to $100,000 for independent entrepreneurs.

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