Friday, February 19, 2010

Franchisee or Franchisor?

Currently there are around 1 million franchise outlets in the United States and over 40,000 international ones operated by U.S. based franchisors. Ownership and operation of these outlets can differ greatly depending upon their parent corporation. For instance Burger King franchises around 90% of their restaurants, McDonalds 80%, Wendy’s 79%, and Arby’s 69%. Conversely, large investor groups, such as Bain Capital, can also decide whether to license out the business model and make money off royalties or operate the franchises themselves, earning revenue directly. This decision is highly dependent upon the market in question and impacts future management of the property.

Typically, franchisors have three main sources of income, (1) retail sales at Company-operated restaurants; (2) franchise revenues, consisting of royalties; and (3) property income from restaurants that the parent company leases or subleases to franchisees. If a company were to engage in the first, it would necessarily negate the latter two and vice versa. In order for the first option to make sense, the specific franchise would need to operate with larger margins. For example, Bain Capital, which owns a 93% controlling economic interest in Dominos Pizza, chooses to sell the franchise rights of most of their stores (including U.S. based ones) but operates outlets based in Japan. This is because pizza delivery is considered a luxury item there, with people willing to pay up to $43.00 dollars for a single delivered pizza. Thus in Japan, it is more economical to operate rather than sell the franchise rights. Conversely, in the U.S., where pizza delivery is assuredly not a luxury item, it makes more sense to sell the franchises as margins are lower.

Should a parent company choose to own and operate a store, it can receive benefits related to its applicable real estate. A location operated by a parent company with investment grade credit, will instantly increase in value. This is because the locations returns are no longer guaranteed by an individual franchisee who has no credit rating but by a company which does. Furthermore, that company can still pull money out of the property through a sale-leaseback. This allows the company to take advantage of the properties increase in value and pull capital out for other uses. These factors are highly evident in net lease properties, where credit ratings are of high importance and sale leasebacks have always been very popular. A property which is corporate owned and guaranteed will typically fetch a much higher price than an individual franchisee due to the flight to quality in the current market.

The decision between owning/operating and franchising a property greatly impacts how it is valued. It also impacts the level of commitment and funds a franchisor dedicates to it. The applicable margins of the specific locale and the opportunity for greater profitability will then be the decisive factor.

1 comment:

  1. Franchise is the best way to elaborate the products of business as well as brand. You can take franchise of any branded products and gain the profit with the market value.

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