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A Model of Success: Franchising's Future Grows Bright

Franchising has proven to be a successful and popular business model since its mainstream inception many decades ago. There are three constants that have fueled the growth of franchising over its long history: the desire to expand, the need for capital to fuel that expansion, and the goal of operating seamlessly across large geographical distances. While the earliest uses of franchising can be traced back to the Middle Ages when the church was seeking to broaden its central government control, it is Ray Kroc, who discovered McDonald’s when it was still a small California hamburger stand, who is credited with developing the restaurant franchising model that we know today.

This enticing operating platform has grown massively in scale since the 1950’s, becoming one of the most prominent and favored business models for those with a desire for self-employed vocation. The concept of franchising has become one of the most important and influential in the business world, but has it reached its tipping point? In this article we are going to discuss the current state of the franchise industry as well as what we can expect to see in its future.

Current State

Today, the method remains robust, with more franchise concepts alive and thriving than ever before. While the multi-unit restaurant industry continues to be the most ubiquitous in the franchising world, this lucrative model has spread across a variety of industries from early childhood education to doggie day-care. So why is it that we are continuing to see such positive momentum?

One key factor is the consumers’ strong reliance on the power of branding. Franchising leverages the power of branding by providing mass scale in terms of advertising, market penetration, and customer recognition. There is also the power of legitimacy (whether perceived or accurate) that accrues as a benefit to the most recognizable brands. Many people are less inclined to dine at an independent concept that they are unfamiliar with, preferring the comfort of sticking with a known, established brand. A widely known brand name carries a lot of clout, putting potential diners at ease on the value/experience equation. People like to know ahead of time what kind of food and service to expect, giving the widely known brand names an immediate advantage over the unknown option.

Entrepreneurship also plays an important role in the franchising industry. There is a large and growing number of people who aspire to run their own business, but there is also great uncertainty when it comes to creating an entirely new concept. Franchising provides an opportunity to be self-employed while subsequently mitigating the risk of an independent concept.

Another important facet of franchising’s success stems from today’s accessibility to debt financing. Lenders are very comfortable with the franchise model, having lent in the space for many years now, perceiving it as a safer option than most, and therefore providing funds that are more readily available.  Lender’s aren’t just lending to an entrepreneur, they are lending to an individual business that is backstopped by a meaningful number of other potential operators, and even the franchisor, should their borrower not perform.

Just like debt financing, individual equity has greatly contributed to the ongoing success of the franchise model. In today’s economic landscape, individuals are less enamored with investing in securities (stocks, bonds, annuities) and are instead looking for investments where they have more individual return opportunity. This comes in the form of control adjusted risk.  If an owner-operators risks their treasure, but has the means to oversee that capital and an ability to voice their opinion about the business and its operations, this can become an appealing lifestyle and investment alternative. Another appealing aspect is the notion of often steady cash flow generation from this initial investment.

Private equity supports franchising much like individual equity, but on a larger scale. The abundance of capital available in many of today’s private equity groups is staggering, and franchised concepts have become one of the most attractive investment opportunities available. Many private equity firms have embraced the franchise model due to the lower risk/return scenarios that franchising provides, and we expect to see this trend continue for quite some time.

The scarcity of new locations and markets also contributes to the success of franchising. Many of these brands are real estate or location dependent. Given the lack of acceptable new locations available in today’s marketplace, the valuations of mature, developed brands will continue to increase.

Lastly, the operational transfer of risk is an increasingly popular trend, and proven advantage, among franchisors. Those who are developing and expanding successful brands have the capacity to shift the risk of operation and capital to others while generating strong return on assets. This is why we continue to see franchisors undergo refranchising initiatives, selling off their company operations to franchisees. This is a trend that we believe will remain compelling and active in the years to come.

Forecast for the Future

Considering all of these dynamics, the future of franchising is bright. We will continue to see strength and growth in the franchise segment, as franchise operators further invest in mature brands through organic growth and consolidating M&A activity. There are still many entrepreneurial franchisees who are reaching retirement age and will create additional buying opportunities for the foreseeable future.

Additionally, we will continue to see the evolution of new industries adopting and growing the franchise model that haven’t necessarily done so before. Many of these will likely be within service industries, where we have already begun to see some franchising occur. These businesses include beauty services, like hair parlors and waxing salons, massage parlors, pet care, health care, and housecleaning services. We expect to see a widespread embracement of the franchise business model in these industries, with companies seeking the same success as the aforementioned first adopters. It has become increasingly clear that because of the immense success franchising has achieved, this business model is here to stay.