Lack of capital drives record growth of franchisors

The latest Franchising Australia survey indicates continued growth in the franchise sector, with numbers of franchised outlets, franchisees and overall sector revenues demonstrating slight increases.

These modest increases over the 2010 survey are not unexpected and sit in the range of 2-5% growth.

However the most significant area of growth revealed by the 2012 survey was the additional 155 franchisors compared to 2010. This represents an increase of 15% from 1,025 to 1,180, and the largest net increase in numbers of franchise brands between surveys in 20 years.

This outstanding growth indicates a degree of confidence in franchising as a method of business growth never before seen in the sector, and outstrips the previously largest net increase of 140 franchisors which occurred in the two years from 2006 to 2008 during the economic boom prior to the global financial crisis.

So what does this unprecedented surge and proliferation of franchise brands mean?

Here are a few things to consider:

Existing franchisors are adding additional brands

Franchisor multi-branding is nothing new. As a number of systems mature and begin to approach saturation in the Australian market, growth via complementary brands supported by franchisors’ existing infrastructure provides economies of scale and new revenue streams. (This in turn can have a flow-on effect to franchisees who can also benefit from growth opportunities into brands provided by the same franchisor).

International franchisors are entering the market

The high dollar has made Australia an attractive market to international franchisors, particularly those from the United States, who can realise disproportionately greater revenues from franchise fees and royalties compared to the relatively small size of the Australian market.

Additionally US-based franchisors often consider Australia to be an easier market to penetrate due to a perception that the culture here is similar to that of the US. However the assumptions that create this perception are often proven false on entry into the market, with the customisation and establishment of operations usually proving more difficult than originally expected.

The survey reports that the proportion of Australian-developed franchise brands sits at 92%, a figure which has hardly varied during the history of the Franchising Australia surveys.

More businesses are turning to franchising as a method of growth

Adding additional brands and international franchisors entering the Australian market are plausible reasons to explain some of the 15% increase in the population of franchise brands over two years, but not the whole increase.

By far the most likely reason for the increase in franchise brands is due to money – or the lack of it.

Businesses seek to grow via franchising for a variety of reasons, but in particular, the choice of franchising in preference to other methods of expansion is often driven by a lack of growth capital.

Since the onset of the GFC, many businesses have found it more difficult to raise finance due to greater securitisation or servicing requirements sought by banks who are naturally keen to reduce the risks of their loan portfolios.

Consequently, debt finance becomes scarcer. Equity finance is rarely appealing, as business owners don’t like selling off parts of the farm, and seek to maintain control of their concept.

That leaves franchising, where the development of new outlets are funded by the people who operate them (i.e. franchisees, and who expect to profit from their investment accordingly).

Franchisor viability

Businesses drawn to franchising as a method of growth in response to a lack of available capital may not in all cases have fully explored alternative methods of growth.

Such alternative methods of growth could include aligning with existing channels to distribute their products or services, rather than trying to create a new channel (and capital-intensive channel) by growing their own outlets, and consequently underestimating the challenges ahead.

Franchising is a very successful method of growing a business when done well. When done poorly, franchising can be fatally problematic for both franchisors and franchisees.

Any business contemplating franchising should take a long-term view, and be prepared to invest heavily in the development of operating systems and infrastructure to support future growth.

For those 155 new franchise brands counted in the 2012 survey, the challenge will be for them to grow and prosper so that they can be counted again in the next survey in 2014.

Jason Gehrke is the director of the Franchise Advisory Centre and has been involved in franchising for 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.