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Franchises fail at higher rates than independent businesses
A 1994 research of some 20,554 small businesses by Prof. Timothy Bates showed that franchises generally have lower success rates than independent businesses, with the biggest gap in restaurant franchises falling short of their independent business counterparts (see table above). The study (pdf) concluded, "Independent business vs. franchisee comparisons reveal that the young firms started without the benefit of a parent franchisor were significantly more profitable than the franchise firms."
The International Franchise Association criticized Prof. Bates study that franchises generally have lower success rates than independent business and used an IFA and FranData Corp. survey to show how much safer franchise investments were. But regarding the IFA and FranData numbers, Professors Roger Blair and Francine LaFontaine observed: "Since we do not know the age of these units [in the IFA/FranData statistics] at the time they stopped franchising, the figures are not directly comparable to those from Bates, but they still clearly support the high failure rates he [Bates] found in the CBO [Characteristics of Business Owners database produced by the US Census Bureau that Bates uses] data."
In two separate studies, the federal government's Small Business Administration reports that franchises fail more than independent small businesses. It has warned its six hundred preferred lenders that “Despite the popular view that franchisees are much more successful than non-franchisees, SBA’s experience with defaulted loans does not support this.”
After studying 800 franchisors and 250,000 franchised outlets from 1993 to 1997, Steven Holmberg and Katheryn Morgan of the Kogon School of Management, American University, observe, "Overall franchisee turnover [failure] rates are significant and appear to have increased. The result is a 1997 median franchisee turnover with a transfer rate of 10.49% (8.86% in 1994)."
In The Economics of Franchising (p. 35), professors Roger Blair and Francine Lafontaine observe in their own study: "In fact, franchising is no safer on average than independent business ownership, and in some cases is actually more risky."
Considerable discussion and research has gone into survival rates of franchisees. Websites selling franchises often tout how much safer operating a franchise is when compared to starting an independent business. The table below is a compilation of various studies. It should be pointed out that the first two rows are false and misleading.
Franchise Myths: The most exaggerated success rates for franchising have been overheard from sales persons at franchise trade shows to franchise buyers that only 5% of independents survive while 95% of franchises succeed. This is possibly a variation of the incorrect Department of Commerce numbers with a sales twist.
The 5% success rate of independents appears to incorrectly complement the 95% franchise success rate to make 100%. i.e. The bad logic might go like this: If 95% of franchises succeed, then that must leave only 5% for independents to succeed, since both must equal 100%. That's bad math. Both are mutually exclusive and together do not need to add up to 100%.
The Journal of Small Business Management in 1993 alluded to an earlier 1988 survey:
the primary referent for examining franchise failure rates has been surveys conducted by Andrew Kostecka (1988)(1) under the auspices of the U.S. Department of Commerce, which indicate that less than 4 percent of all franchises fail each year.
The International Franchise Association, a trade group which largely represents the interests of franchisors, made this declaration:
Many years ago, the U.S. Department of Commerce conducted studies about franchising which presented such statistics. That information is no longer valid. The agency stopped conducting such studies in 1987. We strongly urge you to remove any information from your Web site and published materials that make such a claim. The use of such data, in the absence of current research, could mislead prospective franchisees who are attempting to conduct responsible investigations.
This IFA statement can be read in its entirety here.
|Success Rates - Source||Yrs||Franchise||Indep|
|Department of Commerce1||16||95%||?|
|Franchise Salesman Overheard at Franchise Expo||5||95%||5%|
|Dr. Tim Bates: General||4||62%||68%|
|Dr. Tim Bates: Restaurant||4||55%||77%|
|Sourcebook of Franchise Opportunities||5||92%||23%|
|D&B SME < 20 employees||4||-||37%|
|Sloan Management Review3||3||70%||-|
|Small Business Administration4||5||-||35%|
Independent small business failure rates
Scott Shane, author, venture capitalist, franchise scholar and professor of Entrepreneurial Studies at Case Western Reserve University observes that some 71% of start-ups will have gone out of business by year ten. Shane shows that some 25% of start-up businesses cease in year one.
Success rates vary by study group. It depends on the details of each study. One study defines a small business as anything less than 20 employees while another defines small business as having at least one staff member. Success rates of independents are as low as 35% (considering 5% and 23% as outliers) versus a low of a 62% success rate for franchises in a 4 year period (throwing out the low of 55% that was assigned specifically to franchise retail outlets).
The D & B study measures "small businesses" without breaking down whether they are independent versus franchises as Dr. Bates' study does. Time frames differ as well.
It is safe to say that a franchise's success rate really depends on the franchise system that you buy a franchise in. Some franchise networks succeed better than others while other franchise systems might be worse than independents in their industry.
Franchisor failure rates are higher than independent business' too
When buying a franchise in a new franchise network, the buyer faces the prospect that their franchisor may not be around.
Professor Scott Shane was asked in an interview if an established business begins franchising that the new franchisor would be put in danger of going belly up again at the same high failure rate as when they established their business as an independent start-up. Shane replied:
When someone franchises their business, there is no guarantee that just because there was a successful business they will have a successful franchise. Only about one out of four franchise systems will successfully stay around over a ten-year period.
In an earlier article, Shane established that the success rate for independent businesses in a ten-year period is three out of ten. That puts new franchisors (1:4) at slightly under the success rate of non-franchising businesses (3:10).
Editor's note: This is an ongoing project, a collection of studies and success rates of franchises, independents and small business as a whole. There is a wide range of variation of results.
1Department of Commerce success rate numbers are flawed, Entrepreneur Magazine. Study conducted annually between 1971 and 1986 measuring if 5 year old franchises were still in business.
2NFIB is the National Federation of Independent Business Education Foundation. Their estimates are for businesses with employees who close their doors within a five year period. It should be noted that this leaves out the majority of start-up businesses who initially DO NOT employ someone.
3Unable to find original work online but this statistic is quoted on Joshua Sharf's blog at View From a Height. He references Shane, Scott and Spell, Chester, "Factors for New Franchise Success," Sloan Management Review, Spring 1998, pp. 43-50.
4There is another set of data released by the SBA that has a 39.5% success rate at six years of start-up businesses with employees. (See Survival Rate After Startup Source: SBA, "Small Business by the Numbers," May 2002)