How many is too many for multiple-unit franchisees?

A lot has been written about the benefits of franchisors granting (and franchisees acquiring) multiple franchise units, but how many outlets is too many for one franchisee to operate?

The exact figure is hard to define, but will require a close assessment of the franchise system itself, the spread of the outlets to be operated, and the attributes of the franchisee.

For starters, there are some systems that lend themselves to multiple franchise operators more than others. Mostly these are retail or fixed-location service franchises, rather than mobile service franchises.

This is not to confuse a multiple unit service franchise with a multiple-territory service franchise. The stereotypical “man and a van” mobile service franchise will generally require a van (and a man) per territory. However, if multiple territories are being operated by just one “man and a van”, this may hardly be a “true” multiple-unit franchisee.

Where an existing franchisee is redeploying the same assets (the van and equipment, etc) to service additional territories, it means that by definition those assets must have been underutilised in the initial territory.

There could be two reasons for this. The first is that the franchisee failed to adequately penetrate the market in their allotted area, which is a common problem in mobile service franchises.

The other reason could be that there was insufficient market demand in the original territory for the franchisee to make a meaningful return on their investment, and therefore they have “doubled-up” (to use gambling terminology) to increase the utilisation of their assets by adding additional territories.

If this is the case, the franchisor should take a long, hard look at their territory planning criteria (or possible lack thereof) to ensure they are providing areas with sufficient market demand for a franchisee to achieve a reasonable level of asset utilisation to justify their initial investment.

The evaluation of the market demand in an area is equally critical in retail franchising, and instances of retail franchisees acquiring additional outlets to offset poor profitability in their initial outlet have also been known to occur.

Unlike the “man in a van” who can redeploy their existing capital assets (vehicle and equipment) to service an additional territory, a retail franchisee who “doubles-up” due to poor profitability in one outlet takes a much greater risk because of the extra capital (usually from borrowings) required to open the extra outlet/s.

Doubling-up in this manner for a retail franchisee – where profitability is low and borrowings are high – is a risky strategy that can be a recipe for disaster and either accelerate their demise or accelerate their recovery. Often the outcome is more of the former and less of the latter.

The challenge of the model itself

A common challenge of mobile service franchises which does not readily lend these types of businesses to multiple-unit franchising is that a franchisee’s total sales is usually determined by an hourly rate applied for the work performed.

Where the work performed is an unskilled service and the capital required is low, the potential for any employees hired by the franchisee to leave and start their own competing business is significant.

This becomes much less of a problem in retail and fixed-location service franchises because there is generally a much higher capital investment required for these businesses, and unlike “man and a van”-type mobile service franchises, these usually have scope to employ multiple staff across a range of different roles within the same business. The variety and complexity of the job roles in a retail business often mean that fewer staff are conversant across ALL aspects of the business (compared to a mobile service retail franchise) and fewer still will have the available capital or will to start out on their own.

Additionally, retail franchises (and fixed-location service franchises) generally have a completely different revenue model based on numbers of transactions rather than jobs.

For example, one person may be unable to mow more than six lawns per day in a mobile service franchise, but one person may be able to sell potentially an unlimited number of items (subject to inventory) in the same timeframe in a retail environment.

Such transactional revenue can be more easily leveraged than activity-based revenue, providing that there are strong operating systems and management controls in place.

Highly-evolved franchise brands will recognise that the operating systems and management controls for a multiple unit operator must be even greater than those for a single unit operator, and have evolved accordingly.

This then begs the question: How many outlets are too many for a franchisee to have?

Unfortunately there is no easy answer. It becomes a combination of the franchisee’s individual skills and attributes, their capital position and level of gearing, and any synergies available from the multiple outlets to be operated.

Multiple-unit operations work best where there is a clustering of outlets within a proximity of one another that provides for economies of scale in logistics and marketing, management supervision, and the rapid redeployment of resources such as staff and inventory from one outlet to another to cater for peaks and troughs in demand.

Where multiple-unit operations are geographically disparate (e.g. hundreds or thousands of kilometres apart), these economies of scale are difficult if not impossible to access and undermine key benefits of multiple-unit ownership.

On the flipside, a franchisee who totally dominates a regional market by owning every outlet in that location presents both a great asset and a risk to the franchisor.

While the franchisee benefits from economies of scale, and the franchisor benefits from market coverage and a primary point of contact across multiple outlets, there is also the risk that if the relationship sours, the franchisee can leave a very large hole in the franchisor’s network if they withdraw or are terminated.

In determining this risk, the franchisor should ask to what extent they are prepared to allow the tail to wag the dog?

It is unlikely that many franchisors give this much consideration in developing their multiple unit franchising policy and procedures until it’s too late (i.e. a dispute with a multiple operator has occurred).

Lastly, there is also the risk that multiple unit operators – while opening additional outlets and expanding the market presence of the franchisor’s brand – can also operate their individual outlets at a lower level of overall performance than single-unit owner-operators. The risk for franchisors (subject to their royalty model) is that while multiple-unit franchising can increase the number of outlets, it might also result in an overall decrease in royalty income for a network of the same size.

Determining how many outlets is too many for a multiple-unit franchisee is a difficult question, with no simple answer for either franchisees or franchisors. But it is a question that needs to be asked and assessed by both parties to ensure the best outcome for both in the relationship.

Jason Gehrke is the director of the Franchise Advisory Centre and has been involved in franchising for nearly 20 years at franchisee, franchisor and advisor level.

He advises both potential and existing franchisors and franchisees, and conducts franchise education programs throughout Australia, and publishes Franchise News & Events, a fortnightly email news bulletin on franchising issues and trends.