Why buying a franchise in Australia can be very risky

Thinking of how to buy a franchise in Australia? Wondering if a franchise like Mcdonald’s or KFC is the best kind of franchise? What are the advantages and risks of franchises?

On The Australian Business Podcast this week (don’t forget, we go live twice a week), I — Owen Rask — catch up with my co-hosts Danil Goloubev and Jordan Kidis to talk about franchises AKA “businesses in a box“.

This Australian Business Podcast episode was prompted by a question from a loyal Rask podcast listener, who asked:

I am a Physio planning to start my own Clinic (small business). I am torn between joining a Pre existing Physio franchise group (with processes and structures already in place) or starting my own clinic and trying to climb that mountain myself! What factors would you consider when making a decision on this conundrum? Any advice from the Finnies is appreciated!

In my day job as an investment analyst, trying to analyse Australia’s (and the world’s) best businesses, and speaking with CEOs and other investors every day; there’s a saying we have:

The best way to get rich is to use other people’s money to do it… [adding my own bit] so when you buy into a franchise, you are making someone else rich.

I believe most franchises are very risky businesses to own because:

• You pay for the rollout of a brand you don’t fully control
• You often aren’t in control of many things like marketing, branding, store layout, etc.
• You often rely on their software, systems, inventory platform and pricing (meaning, they control your ability to run ‘your’ business)
• You typically pay them a fee upfront, plus a hefty percentage of all sales (not profit, sales)
• Even if you are successful through all of that, you will likely have to pay them a big slice of the sale price (if you can get out) and there may be a non-compete clause in your agreement.

Are McDonald’s franchises a good investment?

Now, I should be clear: buying into some franchises could be incredible.

Depending on your source, it’s believed the average McDonald’s franchise in Australia might generate sales of $2 – 3 million per year. However…

Looking at the McDonald Corporation (NYSE: MCD) 2022 annual report, I can see it had 40,275 stores globally (95% were franchised). The agreements which govern McDonald’s franchises are typically set for 20 years.

In a typical or ‘conventional’ McDonald’s franchise:

1. The company (the US-listed mothership, not you) owns the land and the building (so you’re kind of like the business ‘renter’?)
2. You are responsible for all equipment, signage, seating and decor
3. You are responsible for reinvesting back into the business
4. “The Company requires franchisees to meet rigorous standards and generally does not work with passive investors.” 
5. You pay them rent and a percentage of sales
6. There are guaranteed minimum rents
7. You pay them an initial fee when your new Maccas store is opened.

Bottom line: you work for McDonald’s.

Of course, McDonald’s wouldn’t have survived this long if the relationships didn’t work for the ‘owners’ as well. But, remember, McDonald’s is probably the ‘gold standard’ — and we’ve all heard the stories of franchises/chains which didn’t make the podium (but instead made the front page of the news).

Here’s McDonald’s stock price

What does a franchise owner make?

According to IBIS World, the franchising market is worth $170 billion in Australia and it employs 573,794 people. However, it’s hard to get a handle on what a franchise renter, pardon me, ‘owner’ would make from their franchise. Some estimates suggest it might be around $75,000 per year.

Keep in mind, averages would include a few Jim’s Mowings, KFCs, 24-7 Gyms, your local pilates studio, plumbing franchises and everything in between.

The well-known Jim’s website says that because a lot of small businesses fail, so, “Owning a franchise allows business owners to leverage brand value and recognition from day one, giving them the kickstart that they might need to win in the entrepreneurial game.”

Jim’s says it offers a guarantee to franchisees.

Before you buy into a franchise, consider this:

1. Do you want to be in control of your empire? If you planning to start from scratch, take our free business course. It’s free and provides basically every piece of essential business knowledge for nothing.
2. Do you have the experience to launch your own brand and business? If not, go and work for one or two for 6 months — and keep detailed notes of what works and what doesn’t. Take a business owner for lunch – we like coffee and food just as much as the next person!
3. What would be the cost of starting your business and brand from scratch? 
4. Which parts of a franchise are the hardest bits to do yourself? Could you find another way to replicate the process? For example, instead of relying on them to design your website branding, could you use someone from Freelancer or Fiverr?
5. What is the brand’s competitive advantage? At the end of the day, in my experience working with businesses, running them and studying others for over a decade, all businesses require hard work and sleepless nights — franchised or not. Of course, there’s only one McDonald’s and one KFC, but does ‘Bilbo Baggins’ Z45 Mowing’ actually have a national brand that drives heaps of buyers to you? I doubt it. A way to answer this question is, how hard would it be for me to replicate this (#2) and find my own clients?
6. Finally, always get legal and tax advice before signing a franchise agreement! Ask them about the total upfront costs, whether it is a fair agreement, what rights you have to break the contract, what rights you have around marketing, choosing your own equipment, finding your own clients — and what happens if/when you sell your business!

There are a lot of other considerations, so please get expert advice. Or just listen to the podcast.

Drop me a message if you want to chat about it.