10 Points of Probability in Selecting a Successful Franchisor

Placing An Educated Guess On Which Franchisor Will Be There To Grow Old With You

CLEVELAND, Ohio (Blue MauMau) - The numbers say that for any given new franchise system that you are thinking about buying, chances are it will NOT be around in the next 10 to 20 years. Dr. Scott Shane, Professor of Entrepreneurial Studies at Case Western Reserve University, shares his findings on what to look for in choosing a franchisor that has staying power.

Says the good doctor, "Business failure rates are particularly high for young businesses and decline over time. Even franchisors are not immune to that. The probability of failure for franchisors that are one to two years old are really quite high."

From 1979 to 1996, Dr. Scott Shane crunched the numbers of franchisor attributes and system terminations. The professor looked at data that was collected over time through various guides, places that kept extensive records of franchise systems year by year. He found that only 15% of franchisors live to be 18 years old.  That is to say, of 1292 systems, 1097 failed (pdf), an 85% failure rate that is virtually indistiguishable from the rate of independent start-up failures. So, in the graveyard of franchise concepts, how do you differentiate one franchise from another in being able to last? The answers may surprise you. Statistically speaking, here are 10 points to consider that raise the probability that a franchise system will exist 10 years from now. Franchise buyers should seek franchisors who are:

1. Older. There is a very high correlation between a system's maturity and less risk of failure. So look at a franchisor's age - the older, the better.

2. Larger. Look at the size of the network. The larger the franchise system, the less chance of system-wide failure. A franchise buyer should ask, how long has this system been around and how big is it?

3. Highly ranked by the media. The more highly ranked a franchisor is by the media, the less chance of failure. That's not necessarily because the media understands how to rank better franchisors. Dr. Shane observes, "This has to do with the nature of the attention people give to established businesses versus smaller ones. Failure rates of smaller systems at the bottom of the list are much higher but people do not focus their attention on them. It's not that higher ranking systems do not fail, it is just that lower ranking systems fail at a higher rate. Most of us just do not notice how much of a higher rate the lower ranking systems fail because we do not pay attention to the lower ranks precisely because they are lower ranked and not as well known." He continues, "I suspect what is going on is that there is a self-fulfilling prophecy in franchising. If I get enough attention, then franchisees pick me, and my system gets bigger. I get all the advantages of getting the franchisees, and that makes me less likely to fail."

4. Concentrated. Franchisors that build up and saturate a specific state as opposed to being spread out with just a few units in every state are less likely to fail.

5. Providing franchisees with exclusive territories. Franchisors who provide exclusive territories to franchisees are less likely to fail. The study does not specify the size of the territory, since territory size would vary greatly by industry, but rather correlates a positive relationship between granting any sized exclusive territory to franchisors who have survived. 

6. Seeking franchisees with industry experience. Statistically speaking, franchisors who recruit largely within their own industry are less likely to fail. Their franchisees come to the system highly skilled in the business.

7. Not allowing passive ownership, that is to say owners should not be working elsewhere. A test of the strength of a newer system is if franchisees work there full time. Dr. Shane says, "franchisors that allow passive ownership have higher failure rates." 

8. Not master franchising domestically. Franchisors who delegate their franchise selling, training and royalties have higher failure rates. In his study, Making New Franchises Work (pdf), the point is made that delegating core competencies to master franchises has franchisors more easily losing their way.

9. More expensive. It may be counter-intuitive but the more amount of money it takes to run an outlet, the more the franchisor is likely to survive. Dr. Shane explains, "The business is more substantial. It has more capital invested in it. If you have a system with outlets that are cheap to launch, those are easy for others to replicate and drive franchisees out of business and then finally the franchisor." But make sure you, the franchise buyer, can afford the higher price.

10. Minimizing company-owned outlets. The fewer company-owned outlets, the lower the risk. Franchisors need company owned outlets but more than a couple are a distraction and a waste of resources.  The professor explains, "Marginal benefits from company-owned units maximize after two units. The resources that get devoted to adding the company owned outlets provide much less benefits than if you applied those resources towards adding franchises. Once you get past the demonstration outlet part of this, you are better focusing on franchising. However, once a franchisor gets past 500 units or so, that's a different, mature model. Large systems can benefit from corporate units experimenting in different markets. Keeping company-owned units to two is for young franchisors and does not include the large systems that have franchise buy-back programs for stock price advantage."

And the most important question to consider for franchise buyers is saved for last.

"If I were a prospective franchisee, the first question to ask is whether a franchise concept will work in the kind of industry I am looking at," observes Dr. Shane. "There's a chapter [in my book] on how franchising is more effective in certain industries."

I guess if we want to know what industries are most conducive to franchising, we will have to buy the book and read it.

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Further readings:

• From Ice Cream to the Internet: Using Franchising to Drive the Growth and Profits of Your Company (Hardcover) 
• Making New Franchises Work (pdf)
• New firm survival: An institutional explanation for franchisor mortality (pdf)
• Dr. Scott Shane's web page of academic studies