For restaurants looking to expand to new locations, or individuals looking to launch a new restaurant, there are a lot of benefits to franchising.
It allows restaurateurs to leverage their recognized brand name, boost their business image and branding, ensure consistent quality at their new stores, attain motivated and productive staff, and gain access to good locations, said Jeffery Elsworth, an associate professor at the School of Hospitality Business at Michigan State University.
Franchising can also help restaurateurs attain economies of scale for purchasing and marketing, while facing less risk of failure as they operate under the support of the franchisor, he said.
Additionally, franchisees also get access to a “playbook,” including everything from systems, procedures, recipes, kitchen layout and design parameters, said Rick Camac, executive director of industry relations at the Institute of Culinary Education. Operators may also get marketing help and assistance in picking a new location, including demographic research, he said.
But franchising can also be costly both for franchisors and operators. The franchisor collects on average 7% to 9% of revenues — a fraction of the income available if they were to own the concepts instead, said Elsworth.
And the model gives franchisees less room for creativity, while their top-line revenue is often limited, given few QSRs or fast food restaurants take in $5 million to $10 million in sales, Camac said.
“The path and timeline to revenue is clearer but often relatively limited,” said Camac.
A number of factors need to be considered before a restaurant can franchise and open new locations, experts say.
That process includes weighing the challenges and benefits that franchising different restaurant types pose, being strategic about where to open new locations and how brands should implement operational procedures and set fee structures. It necessitates deep dives into a franchisee’s financials and ethics.
Lastly, franchising should only be considered when a restaurant’s concept is “established and proven,” with a clear path to positive revenue and profitability, said Elsworth.
That’s important for the franchisees as well, added Camac.
The challenges and risks “are less as it's a proven concept and the roadmap has been given to you,” Camac said.
Picking the right type of restaurant to franchise
There are different benefits and challenges related to franchising restaurant types and concepts.
Quick-service restaurants are, by far, the least complicated and least expensive restaurant types to franchise, said Elsworth. QSR franchisors usually have a very detailed set of standard operating procedures in place for the franchisee to follow, and the build-out of the restaurant is typically simpler, Elsworth said.
In most cases, the food is ordered through a centralized commissary, while branding and marketing is mainly handled by the franchisor, he said.
It’s also easier for staff to learn the systems and how to execute the menus through fast food and QSR formats, Camac added.
On the other hand, QSRs need to be in highly visible locations, such as corner lots on major roads, which means the real estate is typically more expensive for the franchisee, said Elsworth.
There are less stringent standard operating procedures for fast casual concepts, such as Panera or Qdoba, said Elsworth. And those types of restaurants are often in locations, like shopping centers, where the real estate is less expensive, he said.
But fast casual restaurants typically require higher-end fixtures, furniture and equipment, making the build-out more expensive, he added
In general, simpler restaurant concepts are better for franchising, said Camac. A burger concept, for example, would be a lot easier to scale and expand than a fine dining concept, he said. Same with restaurants with smaller menus or easier recipes, since it’s easier to find chefs and cooks who can make the food, and it's cheaper to pay them, he said.
Casual and fine dining restaurants, on the other hand, are the most expensive restaurant formats to franchise given the food, beverages, furniture, fixtures, equipment, human resources and real estate are all more expensive and require a much bigger investment, said Elsworth.
“Each concept type has its own unique challenges,” said Elsworth. “But as you progress from QSR to fine dining, the main issue is the cost of the investment in every expense category of the income statement.”
Finding the right location
A restaurant concept should have name recognition in the areas they are looking to move into — a component that is essential for marketing and advertising, said Elsworth.
“The customer should recognize the concept either through social media or word of mouth,” Elsworth said. “You cannot expect customers to be excited by a new concept coming to town unless they are aware of the brand.”
The first franchised locations should be launched locally or regionally, said Elsworth. A restaurant concept based in Michigan, for example, should consider expanding to other parts of the state or perhaps nearby Indiana or Ohio.
Staying within reach of the corporate office provides operators access to continued support, he said, while staying within the same timezone avoids the need for expanded support hours, he added.
Selecting the right location for a new franchised restaurant takes a lot of research and visits to the site to evaluate how it would fare on different days of the week and times of the day, and whether the demographics, psychographics and geographics are right for the concept, Camac said.
Securing a lease for a restaurant on a busy street, for example, could be costly, but it could also provide the best visibility, Elsworth said. Fine dining restaurants don’t necessarily need to be located on a busy street, since they can be a destination-type business, he said.
Franchisors typically work with real estate experts and utilize data to determine the best and areas for successful franchise locations, Elsworth said.
Launching a new franchise
It’s essential that franchisors thoroughly verify the potential franchisee’s financials and vet their reputations and ethics, said Elsworth.
And both the company and the franchisee need to make sure the numbers work — seeking the advice of financial and legal experts who understand franchising and have dealt with such it before, he said.
“If something does not feel right, or make sense it might be best to walk away from a deal,” said Elsworth. “There are too many great opportunities in the market.”
Franchising a restaurant can also come with a number of regulatory requirements that can be expensive and challenging to navigate, said Elsworth. That includes preparing a federally-required Franchise Disclosure Document, which covers a host of details about their business.
Franchisors also need to create standard operating procedures that give franchisees detailed instructions on how they should run their restaurants to ensure brand, operational and quality consistency, he said.
When setting obligations for franchisees, restaurants should make sure they are able to keep control of their brand promise, quality and consistency, said Camac.
That’s a “very difficult task, which is why the systems and procedures have to be so specific,” said Camac.
Setting franchise fees
Franchisees need to raise enough money to purchase and develop the restaurant, said Elsworth.
That can be a costly proposition as franchise fees alone can range from about $10,000 to more than $500,000, he said, and operators must then acquire the restaurant’s property, build out the store, purchase inventory, hire staff, provide marketing and set aside money for operations.
“Most franchisors will require proof of wealth and assets in the millions of dollars,” said Elsworth.
Franchisors, in return, should set the fees at a rate that’s best for both the company and the franchisee, while showing the potential for profit in the contract obligations, said Elsworth.
If a franchise earned $1 million in sales and 15% in net profit during the first year, they would receive $150,000 in profit, Camac said. If a franchise fee costs $50,000, that would equate to about one-third of a year’s profit, an amount that “seems more than reasonable,” he said.
Franchise models that provide the most support to the franchisee tend to be effective in ensuring long-term success, said Elsworth. Chick-fil-A, for example, only requires a $10,000 franchise fee, and the company provides a lot of support in different areas such as marketing, technology, and menu development, he said. Chick-fil-A also has some of the highest average unit volumes at over $9 million within the QSR segment.
It’s relatively easy for a prospective franchisee to determine the best range of franchise fee expenses since FDDs are public, said Elsworth.
Franchisees should “be able to see the value in the services offered for the fees,” he said.
