When looking at the health of a franchise network, the quantity and nature or resales of existing outlets can provide several useful indicators.
The first indicator to look at is the proportion of total existing outlets available for sale at any one time. (For ease of reference, this will be referred to as the resale ratio from here on).
If the resale ratio seems excessively high, this will indicate problems such as a lack of profitability, a loss of confidence in the business model or the franchisor, or other issues in a network that can cause a stampede to exit in the same manner that a fire will cause the occupants to abandon a building.
Alternatively, if the resale ratio is very low, this is likely to indicate a high degree of satisfaction with the business. To calculate the resale ratio of a network, divide the number of all existing outlets available for sale by the total number of outlets in the network, and multiply by 100.
Average resale ratios will differ from one industry to another, and from one network to another. For example, resale ratios in blue collar home services franchises where the work typically performed by the franchisee is physically demanding can be expected to be higher than the resale ratios of say a white collar management franchise. Likewise, the resale ratio may differ significantly between two franchise networks which operate in the same industry. For example, Coffee Franchise A may have a lower resale ratio than in Coffee Franchise B because franchisees in network A may be more profitable than those in network B.
Resale ratios often range between five and 25 per cent. A healthy resale ratio is up to about 10 per cent. This provides for a steady level of renewal in a network as retiring or underperforming franchisees are replaced with new operators who may perform even better than those they replace.
However, franchisors should be concerned when resale ratios increase beyond 10 per cent, and if the ratio is between 10 to 20 per cent, franchisors should carefully look at their system to see if there is a problem with the franchise or business model, an underlying lack of profitability, a serious competitive threat, or a toxic organizational culture that may be contributing to such a high resale ratio.
“Franchisors should be actively engaged with the franchise resales process wherever possible”
Further to that, if the resale ratio climbs past 20 per cent, be alarmed. This is an indicator of serious problems in the network, and it is likely that the franchisor’s efforts in recruiting new franchisees will be wasted as any demand among potential franchisees will be soaked-up by resales. Even worse, when there is a glut of resales on the market, it will drive down prices for existing businesses which can often be bought at a lower cost that establishing a new franchise, which further erodes the franchisor’s recruitment efforts.
Other factors to consider in franchise resales include:
Time on market
The resale percentage of a network can begin to climb if it takes longer for existing businesses to sell, particularly as more businesses are listed for sale before existing listings are sold. This Time on Market indicator may increase as a result of excessive prices sought by vendors, by financing problems among buyers, a change in the market itself, or a flooding of the market by listings triggered by changes in the franchise business model or ownership or management of the franchisor.
The time a property takes to sell has been a common measure of the buoyancy of the residential real estate markets for many years, and increasingly is now being applied to understand the sales cycle of existing businesses. Time on market is particularly affected by price, and can range from days to months, and even years for some businesses.
Sale price multiples
There are two types of sale price multiples to consider when assessing the resale of an existing franchise. The first is the profit multiple used to measure prices of both independent and franchised businesses. The profit multiple method can see business sale prices range from as little as one times profit to five or six times profit, depending on the nature of the business and the industry in which it operates (and assumes of course, that the business is actually profitable).
Another price multiple measure is a comparison of the sale price of an established franchise with that of a greenfield (i.e., yet to commence trading) outlet. If resales are sold for consistently lower prices than greenfield outlets in the same network, the network may well have fundamental problems it needs to address among its existing franchisees before it can hope to recruit others.
“If the resale ratio climbs past 20%, be alarmed”
Similarly, if the average price multiple of existing outlets is greater than for a greenfield site, then these businesses should be expected to be profitable and delivering a capital gain to their sellers.
Tenure of selling franchisees
Another factor that can indicate the health of a franchise network is the average tenure of franchisees who list their businesses for sale relative to the initial term of the franchise.
If, for example, franchisees are listing their businesses on average half-way through the initial term of the franchise, this may indicate issues around profitability, the business model and confidence in the franchisor, subject to some of the other issues listed previously.
In other words, the longer a franchisee has operated the business before offering it for sale, the more likely it is that the franchisee has been satisfied with the performance of the business, and hence the more desirable it may be in the eyes of a potential buyer.
Conclusion
Franchisors should be actively engaged with the franchise resales process wherever possible, and track resales data such as resale ratios, sale multiples, capital gain, time on market and franchisee tenure at time of sale as indicators of the relative health of their network and satisfaction of their franchisees.
This article does not represent an exhaustive list of measures to assess resales as an indicator of system health, but can be a key starting point for observers of the sector to monitor system performance, as well as for franchisors themselves to better understand their points of differentiation in a highly competitive franchise marketplace.
THE AUTHOR
Jason Gherke has 30 years’ experience in the franchise sector and is the founder of the Franchise Advisory Centre, and publisher of Franchise News, Australia’s leading email news bulletin on franchise trends and issues. He is a director of the Franchise Council of Australia, past chairman of the World Franchise Council, and a director of two national franchise brands: Inspirations Paint, a 136-store home improvement group, and Thinkwater, a 50-outlet chain of irrigation specialists.
