We were recently sent a press pitch for a certain cookie franchise, being sued for appropriating the business model of another cookie franchise, that boasted about the concept’s “low-risk, high-reward franchise model.”
This is arguably the biggest misnomer in the franchise business, that operating one is a low-risk investment. That could not be further from the truth.
To be sure, there are a lot of reasons for an investor to operate a franchise and plenty of people have grown wealthy running restaurants or other businesses for franchisors, whom they pay for the right to operate a brand.
It can be a relatively simple method for operating a business. The operator gets the benefit of brand recognition that can be difficult for someone to build on their own. As long as the franchise is healthy, as long as they find a good site, stick to the playbook and run a good business, they can make a good living for themselves. We’ve seen enough rags-to-riches stories in this industry to fill an encyclopedia.
But all businesses carry substantial risk for the investor. And boasting about franchising as a “low-risk” investment of any sort gives people a false sense of security regarding their financial health. Companies that take this step end up targeting people who are less experienced or less financially sophisticated. Often they don’t have the financial wherewithal to truly operate a franchise.
These folks then fork over savings, taking on debt and signing a lease, to open a business, all while thinking it’s less risk than just opening one themselves. And when problems happen, they are the ones who end up working furiously to protect their homes from being sold off as loan collateral, and not the franchise salesperson.
A 2018 study by the University of Michigan found that franchising is no safer on average than an independent business.
The study did find that a franchise is more likely to survive the first year or two, though it noted that the difference was “small.” And that difference evaporates after that as some of the disadvantages of owning a franchise become more of a problem—namely, the royalty fee and some other franchise requirements.
While franchising offers more brand recognition and support and a theoretically proven model, along with group buying that can offer some lower-cost alternatives, it has some clear disadvantages. A franchisee can’t simply change the menu or the ingredients if things go wrong or items don’t sell. They have less ability to run deals or change prices. They have to get their food and equipment from certain vendors.
They can’t shop around by price, and the price they get may not be as cheap as they think. The McDonald’s ice cream machine story is one tale of what can happen with these sorts of requirements. An independent could simply find someone on their own to fix the machine. Or they just find a different vendor.
While there are plenty of legitimately safe franchise investments, most of those investments are generally untouchable for most franchise investors. Those investors are then left with less proven, and therefore riskier, business models.
And over the years, we’ve seen many franchisees lose everything they have investing in these types of businesses.
Quiznos, for instance, furiously signed a few thousand franchisees with a bad business model and then watched 95% of them shut their doors. That’s some 4,000 or so franchisees who didn’t get to cash out of their business when they closed up shop. And that was the least of their problems.
The founder of Burgerim talked hundreds of people into signing up for a franchise, in part by boasting about the alleged low risk of the deal, and many of those we spoke with for that story thought a franchise was an easy investment.
As we said, franchising is a good and important business that can clearly provide a path to wealth, or at least a substantial source of income. But companies have to be realistic about the risk they’re asking investors to take on. And investors need to be aware of that risk before they hand over their cash. It's substantial.
There’s a reason why so many franchisors would rather just sell the right to operate a brand, and thereby collect just a fraction of the revenue. It’s a lot less risky to do so.