Why Are Franchise Sales Outstripping Unit Openings?

November 9th, 2018 by Ritwik Donde

Franchising has rebounded since the recession, with the nation’s franchise establishments expected to increase to ~759,000 in 2018.[1] However, as the economy recovered from the downturn and credit became more readily available, an increasing number of franchisors went on franchise selling sprees. A large number of these franchise sales are yet to yield positive returns to these companies’ recurring revenues. A snap analysis conducted by FRANdata revenues that there are 67 franchise brands with signed agreements for more than 100 unopened units, representing close to 16,000 unopened franchise locations. Projections indicate that only about ~7,600 would end up being opened in 2018.

So why is it that, despite financing being more readily available and a positive small business ownership attitude in the economy, is the number of unopened units so high? Many franchise concepts in sectors like hair salons and fitness centers continue to or began selling multi-packs, requiring franchisees to buy more than one unit at a time from the franchisor. While the restaurant and retail franchisors have shown an increasing propensity towards larger development rights to franchisees who agree to build scores of outlets within specified time periods.

Most franchisors with a large backlog of unopened units have been able to sustain their operations, as their existing system base is able to generate proportionate recurring revenues from lines like royalty fees and other ongoing fees. Having a large backlog of unsold units, without adequately establishing recurring revenues to support growth can have negative effects on a franchise system. Take Midici’s for example. Starting in 2015, the franchisor sold more than 500 franchises and predicted that hundreds of them would be open by now.[2] As of last count it had close to 460 unopened units. The company has now landed in bankruptcy court.

One of the issues that leads to such high number of unopened locations is directly related to site selection. In today’s times, the demand for traditional A+ endcap locations in premium developments far exceeds supply. The availability of attractive second-generation sites has tapered off significantly from high levels seen after 2008 when brands with access to financing went into real-estate vulture mode. So what’s an operator to do? Real estate pros at growth-oriented companies say they’re sharpening their site-selection strategies with bigger data, stronger relationships, more flexible formats, and a proactive approach to mining new and emerging opportunities.[3]

Another strategy that fast growth franchisors have adopted to ensure sustainable development relates to Minimum Development Schedules. To help ensure that development schedules are reasonable, franchisors should conduct meaningful due diligence and get in-depth business plans from prospective franchisees. Accordingly, a franchisor may want to consider dividing the development period into intervals and negotiating in good faith a separate development schedule for each interval. Franchisors may also want to consider imposing minimum performance standards as a condition to the development of additional units.[4]

According to our CEO, another way for ensuring success in an era of fast growth is to focus on recurring revenue self-sufficiency. This is a franchise brand’s ability to support its franchisees as promised through income from royalties and corporate locations (if any) — without having to sell additional franchises. This helps build up the cashflows that a franchisor may require in order to create a support infrastructure to help struggling franchisees implement their pre-planned development schedules.

[1] IFA Franchise Business Economic Outlook for 2018

[2] Franchise Times

[3] Restaurant Development and Design Magazine

[4] Franchising World