Franchising is full of numbers. But which numbers really tell the story?
If you’re looking to buy a franchise, you can easily drown yourself in data. Just pick up a company’s franchise disclosure document (FDD), and you’ll see granular breakdowns of every brand’s health. That’s important stuff. Look closely!
But what does it look like to take thousands of brands’ data, and track them across years? The answer: You see big-picture trends that no single brand can ever capture.
That’s something Entrepreneur can uniquely do, because we collect mountains of information on thousands of franchises every year. Usually, we use that information to rank the strongest franchises in our annual Franchise 500 list (which we publish every January). But now, for the first time ever, we also crunched that data and started to look for industrywide trends — and boy, did we find them.
We took five years’ worth of data, and then analyzed it in slices. What we found were some curious statistical anomalies: Failure rates change depending on how much a franchise costs to buy! Franchise fees are up in some places, down in others! Some categories are thriving, and others are coasting!
Then, we started calling up experts to ask: What’s going on here? And what do franchisees need to know? On the following pages, you’ll find four surprising trends — and the need-to-know explanations behind them.
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There’s a franchise for almost every budget. Some brands can be started for only $10,000, for example, while others cost $100,000 or even $1,000,000 (and every number in between, and beyond). But Entrepreneur‘s research identified a curious trend: Franchise brands with lower initial investments tend to have higher termination and closure rates — which is to say, franchisees of low-cost brands tend to fail more often.
The cutoff price seems to be $25,000. For anything above that, the average failure rate typically stays below about 5%. But when the franchise fee is between $15,000 and $25,000, that failure rate jumps to 9.3%. It’s nearly as high for initial investments below $15,000.
Why? Franchise industry insiders agree: The problem is likely more with the franchisees, not the franchises themselves.
“Probably, individuals that are less well-capitalized and less sophisticated, with less experience or no experience running businesses, are entering the franchise sector at the lower investment end of the business,” says Matt Haller, president and CEO of the International Franchise Association in Washington, D.C.
Edith Wiseman, president of FRANdata in Arlington, Virginia, agrees with that — and says her own company’s research can offer more detail. “Net worth and liquidity requirements are connected to the size of the initial investment,” she says. This means that franchisors must target higher net worth individuals to afford higher-cost franchises. Those people have probably already had some significant business or executive-level success. Meanwhile, low-cost brands tend to appeal to people with a lower net worth, and those people are likely to have less business experience.
But that’s not the only factor driving this issue, she says.When comparing fast-growing, low-cost franchises to high-cost franchises, the low-cost brands tend to shed units faster. There’s also the issue of risk tolerance: “If you’re investing $3 million into a business versus $20,000, you have more at stake,” Wiseman says. “You’re probably going to have vetted it more, put more ‘sweat equity’ into it. That risk is another component.”
There may also be a perception problem. That’s what Kathleen Gosser sees as director of the Yum! Center for Global Franchise Excellence in Louisville, Kentucky. Some newer franchisees assume that their business will produce strong revenue from day one, she says. As a result, they don’t budget (or don’t have) a financial cushion to help them absorb costs in their franchise’s early days. By the time they realize the mistake, it’s too late.
“You have to have three months of working capital, and you can’t take a paycheck right away,” Gosser says. “Nobody believes that. They think they’ll make money right away. I don’t know why — why do people put money in a slot machine? It’s optimism bias. They think they’re going to do great in the first month.”
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Across the entire franchise industry, the total number of units grew 13.7% in the past five years. However, as Entrepreneur‘s data reveals, that growth was not distributed equally. Some categories experienced stronger growth, including tech businesses, health and wellness, pets, and home improvement. Some categories were much weaker, including food retail, financial services, and maintenance.
What makes the difference? It’s not just a franchising issue, says Wiseman of FRANdata. It’s a reflection of trends in the broader consumer market. For instance, the years that the data covers (2017-2022) include the worst part of the COVID pandemic — when people were working from home more (and needed tech businesses for support), were trying to stay healthy (and looked to health and wellness businesses), were buying and adopting dogs like crazy (and needed pet supplies by the truckload), and were spending lots more time in their houses, noticing all kinds of things that needed fixing (and calling up home improvement businesses).
“It’s just a reflection of what consumers want,” Wiseman says. “Health and wellness, for instance — we’ve seen an explosion of brands just caring for people and our bodies and our overall wellness across a spectrum of needs.”
Nobody can predict exactly which trends will continue, of course, but the IFA’s Haller says he sees reason to keep betting on health and wellness in particular. “I think that people are focused on their health and wellness, mentally and physically, more than ever,” he says. “It’s been that way since the pandemic started.”
But with the pandemic’s effects easing up, categories like home improvement may start to ease along with it. “I don’t know if that one will continue,” he says, “because during COVID, everybody was sitting around their houses looking at ways to make improvements, and the government put out all kinds of capital that helped them do that. So we may see a change in that category as interest rates continue to spike and the real estate market weakens.”
Home improvement is different from health and wellness in other ways, too. Wiseman points out that health and wellness now includes areas of business that never existed previously in franchising — creating opportunities for franchisees and consumers alike.
“They’re touching on medical services, which is a key component to this,” Wiseman says. “Chiropractic services have exploded. Now you’re seeing things like infusion therapy and stem cell therapy. There’s a whole category of business types that are growing very quickly in the health and wellness space.”
And what about the weaker categories? Same story, the experts say. Take the food category: It saw weaker growth trends, but that tracks with the pandemic’s calls for social distancing and broader shifts in consumer behavior. More than a few longtime franchisees in the food category simply decided they’d had a good run over the years and left the industry.
“A lot of people took the opportunity to get out,” Haller says.
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Tens of thousands of new franchise units are opened every year — so where are they going? Increasingly, it’s beyond U.S. borders. Entrepreneur‘s data showed growth and momentum in franchises that opened in Canada and other international locations. Conversely, it revealed low and even negative growth in company-owned units, particularly in categories such as lodging, personal care, business services, and quick-service food.
What’s happening? It’s all about brand strategy, the experts say, and this trend can present real opportunities for would-be franchisees.
Generally speaking, says the IFA’s Haller, the franchising industry is shifting away from company-owned units. (These are units owned and operated by the brand itself, not a franchisee.) In past years, these units were seen as good places to train staff, test new products, and work out process kinks. Today, company-owned units can be seen as unnecessary corporate expenses that just don’t do as well as franchisee-owned locations.
“Franchises don’t want to be operating; they want to be supporting,” he says. “It costs a lot of money to run a hotel when you’re also trying to provide operational support for a thousand hotels.”
That’s not to say companies are all shedding their owned-and-operated units, says FRANdata’s Wiseman. Some keep them for specific strategic reasons. “Some companies are very strong operators, so they’ll have a more significant number of units,” she says. “They have certain corporate markets where they know them intimately, so they’ll hold onto those markets and franchise in other areas.”
Brands sometimes do sell their company-owned units to franchisees, however — and Wiseman says that franchisees might want to grab them. To anticipate those sales, franchisees should watch the way a brand talks about its strategy. If it uses language about going “asset light” or “refranchising the corporate-owned units,” then a company-owned unit sale may be coming.
“No company ever stays on top all the time,” she says. “If you’re going through an evolution where, as a corporation, your franchisees are better operators, then it makes sense to give those units to franchisees that are in the market and closer to the local customers.”
Another interesting trend in this space: Instead of testing new ideas at company-owned locations, brands are now increasingly partnering with their franchisees to run those tests. The Yum! Center’s Gosser says this has long proven to be good business: Franchisees come up with great ideas that corporate headquarters never envisioned, from the McDonald’s Big Mac to the Dairy Queen Blizzard to Wendy’s Baconator Fries.
“Even with big national or international research, the best voices are the ones walking through the door,” Gosser says. “There were so many successful things that came, I really believe that now franchisors are looking at franchisees as valued partners in the business. I think you’ll see more and more of these franchisors not owning so many [company-owned locations]. There are now franchisors that own zero.”
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When a franchisee buys into a system, they must pay two main types of fees. The franchise fee is the upfront cost of buying in. Then they also pay a royalty fee, or a percentage of revenue. Entrepreneur‘s data finds that the size of these fees is in flux: Across the industry in the past five years, franchise fees increased by an average of 9.5%, while royalty fees increased by an average of 3.2%. But in many categories, franchise fees went up while royalty fees went down, or vice versa. In some categories, both types of fees saw reductions.
Why? Changes in these fees can reflect corporate strategies, FRANdata’s Wiseman says: “Some franchisors are putting an emphasis on growth, so they’re willing to discount the initial franchise fees.” They might, for example, discount fees in a certain geographic region, or as a way to attract veterans or other kinds of people they want to attract as franchisees.
Fee changes might also be driven by the market. Competition can also drive fees down, as brands in the same category compete for the best franchisees. But if a brand is hot and attracting many prospective franchisees, its fees may go up — a simple issue of supply and demand.
Despite all that, some categories’ fees are inherently higher than others. That’s usually because of the level of complexity of the business — such as, for example, whether a brand offers home-based franchises or ones that require a physical store location. “I think that’s about financial solvency,” the Yum! Center’s Gosser says. Brands with physical locations sometimes use a higher initial investment as a weeding-out tool, to make sure a franchisee will be able to pay their location’s monthly lease.
Franchise and royalty fees aren’t the only fees in play, however. New franchisees should watch out for the “technology fee” — a monthly fee that many brands are adding to help cover the costs of their technologies. Gosser says she’s seen these fees go as high as $1,200 a month.
Also, experts say, keep an eye on how fees might be designed to change over the term of the franchise contract.
“I saw one brand that said as your sales grow, your royalty fee percentage grows,” Gosser says. “They know it takes a lot when you first get started, so they don’t want to charge a high royalty percentage at first, but they want to take their cut as it grows.”
For all these reasons and more, fees can be difficult to compare across brands. It’s not always an apples-to-apples situation — which is why the experts always say: Do your research!
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