Igor Jekauc often wishes he didn’t have to fork over 19% of his annual revenue, but he says he wouldn’t have been able to open a tax preparation business without Liberty Tax Service’s business model and support system.
A computer software that allows Jekauc to instantly issue tax return checks to customers was essential – and a comparable one would have been price prohibitive for a startup, Jekauc said. Franchisees like Jekauc can perhaps best be called quasi-entrepreneurs. Like their independent brethren, they bear all the risk associated with their ventures in addition to the daily grind of running the businesses (cranky employees, late invoices, etc.). But while independent business owners start from scratch, a franchisee buys a pre-tested set of plans that includes directions on everything from how to find a location to what charities to support. Most franchise agreements also include extensive training and provide access to a forum of other owners.
But all that wisdom comes at a price. Franchisors charge a territory fee upfront that can range from $10,000 to upwards of $500,000, depending on the strength of the brand (McDonald’s costs more than Joey’s Teeth Cleanings, for example.) The franchisor also takes a cut of a branch’s revenue, some of which the store owner gets back in the form of advertising dollars.
Jekauc said he grew fond of the tax-preparing business model while working as a part-time tax preparer at H&R Block. In 2006, and with a freshly minted MBA degree from VCU in hand, he cashed out his 401K and maxed out his home equity to open tax preparation office of his own. He first researched H&R Block, but they weren’t selling franchises. That’s when he researched Liberty Tax Service and thought the model looked solid.
Soon after he signed a check for around $90,000 for the rights to three markets (comprising a downtown zone, Innsbrook and Short Pump) and entered the world of franchise entrepreneurship.
But profitable franchises are not guaranteed. Indeed, some critics say it’s difficult for potential owners to obtain revenue projections from parent companies. And, like other forms of business, franchises can rise and fall with changing tastes. Some lesser known franchises disappear every year. According to American Association of Franchisees and Dealers, companies that sell franchisees go under at a rate of about 15% a year. Big names (Krispy Kreme) can get into hot water when they expand too fast. Others, such as Applebee’s or Quiznos, fall out of favor altogether.
Highly leveraged and still working evenings as an engineer at Qimonda (a job he still has), Jekauc struggled to find a suitable location. Each time he found a potential office, Liberty wouldn’t approve it, or by the time they did, the space would be leased. A few days before his franchise agreement was set to expire, Jekauc leased space on the corner of Boulevard and Broad Street. The building needed drastic repairs, some of which Jekauc did himself.
“Last year made me extremely nervous,” Jekauc said. “I lost $35,000 without paying myself a salary. There was 2,000 hours down the drain.” But that’s still better than he expected. Jekauc says this year his efforts are starting to pay off. Business is up considerably, and already he’s thinking about opening stores at Innsbrook and Short Pump. He’s also branching out to bring in more business clients, following Liberty’s advice to foster personal relationships – something he does by bringing business owners donuts or dropping off candy.
Part of his recent success stems from Liberty’s business model, he says. “Liberty is really big on customer service, unlike some other companies where customers sit around waiting,” he said.
Perhaps the best example is the guy Jekauc hired to stand on the street dressed as the Statue of Liberty and wave to passing motorists. Jekauc’s waver, as the company calls them, ended up being one of the best in the country. He dances on the corner of Boulevard and Broad and does a special hop when people honk. That dancer alone helped drive almost a third of the traffic into the store last year, Jekauc said.
Sometimes it takes a dancing Statue of Liberty to separate one chain from another. There were around 900,000 franchise establishments nationwide (with each store location counting as one) in 2005, according to a recent PricewaterhouseCoopers study, which means franchises make up about 3.3% of all businesses in the United States. Some statistics say that franchises make up around 30% of all retail and service businesses. In Virginia alone there were 26,028 franchise locations in 2005, according to the study.
Why so popular?
For one, a franchise is a proven business model that comes with a blueprint for exactly how to run the operation. Owners are then expected to follow directions..
The name recognition and business plan are a hedge against failure. Adam Marquardt, a marketing professor who teaches entrepreneurial marketing strategy at the University of Richmond, said that about one-third of independent startup businesses are still in business after ten years. That figure skyrockets to around 85% for franchises.
It’s an attractive option for people who don’t have significant entrepreneurial experience, and for those who are hesitant to risk the time and monetary resources required to grow a business from nothing more than an idea,” Marquardt said.
“You avoid the risks of starting from scratch, and you don’t have to reinvent the wheel.”
Perhaps more than anything, franchisors sell the power of the brand.
Around seven years ago, Midas franchisee Mark Smith and his wife, Patty, didn’t think the Midas name was adding demonstrative value, or value consistent with the 5% of revenue and 5% for ads that comes directly off the top. The couple drafted a letter to Midas and were ready to leave the Mothership.
At the time, Mark had spent 14 years in management at Midas, more than enough to convince him he knew what he was doing. He was also pretty sure he knew why his customers shopped at Midas – that is, until he read the results of a 400-person study he commissioned (he paid $6,000 for the study).
“I was sure people would say they love Mark and Patty,” Smith said. “When we got the results back, we realized people were pretty fond of us, but we also realized very loudly and very clearly that for more than 70% of our loyal customers (those who do business more than three times a year) the Midas shingle was “critical” or “very critical” to them doing business with us.”
Smith decided to stay with Midas, and has since added new Richmond locations. He’s also part of the Midas franchise association, which allows him to run ideas by other store owners and learn from their successes. And in a search for better margins, he traveled to China to see if Midas stores can buy new products that will cut out current middlemen in the parts supply chain.
A similar network of franchise owners has helped Mike Meyer run the Central Virginia franchises for “Reach Magazine” and Valpak. Those contacts allow him to help local companies place ads around the country. “We’re doing business with AMF Bowling. It’s a real advantage for them – they can deal with one person here and there are economies of scale, Meyer said.
Meyer had been a franchise owner for more than 20 years. Overall, the franchise adds a lot of value, he said. “In exchange for paying upfront and monthly royalties, you essentially get a success plan.”
On Friday BizSense looks at how independents compete against brand names. Also, check BizSense for coverage from this weekend’s Franchise Expo.
Risk/Reward: a balanced story from Fortune (2006) about the tradeoffs of the franchise model.
10 Things Every Franchise Owner Should Know: Solid questions by Cliff Ennico in Entrepreneur. (2003)
Top Reasons to buy a franchise: A little fluffy, but a good list in Entrepreneur (2007)