The Viability of a franchise investment

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This report explores whether a franchise is a more viable business opportunity than establishing a new business for a prospective young entrepreneur, mainly focusing on an age group between 18 and 24 years old specifically graduates and school leavers. Analyzing the opportunities and obstacles faced by this group of potential young entrepreneurs, highlighting issues including support, finance, management skills, risk, contact networks and access to markets along with looking at the business options strengths and weaknesses as to show the feasible business option. In terms of graduates, as shown in figure 1, despite top United Kingdom employers expecting an increase in "graduate recruitment by 9.4% in 2011, following a rise of 12.6% in entry-level roles for university-leavers during 2010...recruiters have confirmed that a third of this year's entry-level positions are expected to be filled by graduates who have already worked for their organizations. " (High Fliers, 2011) Consequently there are fewer spaces available for the students graduating in 2011 and an average of 45 applications per vacancy showing a highly competitive job market.


Source: (High Fliers, 2010)

As a whole, there were 737,000 unemployed 18 to 24 year olds in the three months to October 2010, up 9,000 from the three months to July 2010. (Office of National Statistics, 2010) As shown in figure 2 , unemployment rates have increased for young people including graduates and non-graduates demonstrating that investing in a business could be their only option rather than been economically inactive.


Source: Office for National Statistics, 2011

There is still a high amount of young people that are economically inactive in comparison to past "widespread redundancy and a lack of new jobs, many employers have indicated they do not plan to recruit school leavers." (Hopkins, K, 2009) As shown in figure 3 there is still a high level amount of economical inactive people which could be changed with the right resources of information and advice.


Source: South West Observatory, 2011

Background of the research


Entrepreneurship has mainly been directed to an older age group for instance, "the average age franchisee now 46 increasing on average by 6 years over the previous year's survey" (Howell, D, 2010). As young entrepreneurs, due to certain factors such as confidence, experience and disposable income, "most small business employer owners and co-owners fall into the 35 to 44 (25%), 45 to 54 (31%) and 55 to 64 (26%) age categories."( However with the support and knowledge of investment opportunities young entrepreneurs could contribute to the market. For example, Richard Branson, first successful business venture was a magazine called Student at age 16 and who is best known for his Virgin Group of 400 Virgin companies, including a mobile phone network, an airline and a train company with total revenue in the first quarter of 2011 was up 5.7% to £982.3m. (Virgin Media, 2011)Young entrepreneurs represent the minority of clientele for the majority for business support in organizations according to CEEDR, Middlesex University: Final Report. Although there is presence of specialized organizations such as The Prince's Trust and Shell LiveWIRE, offering key advice and a range of support on development of young people under 30 years old with start-ups. Support is an important issue for young entrepreneurs as they constantly need to develop their management skills and require vital advice. When starting a new business there are many obstacles for young entrepreneur, one of the major issues is getting finance as young entrepreneurs do not have credit history or tangible assets to back the loan in support of security for the lender. Although, a sound business plan improve the chances of finance approval. Other factors include management skills, risk, contact networks and access to markets which heavily affect investment opportunities and its success. Economies could benefit significantly from the development and support of young entrepreneurs to help them create a good financial position with lenders in order to be able to obtain ongoing loans. Many businesses lack the management knowledge and innovation to maintain success and research shows many in the hospitality industry find it difficult to surpass the second year in business therefore support or development by external advices on growth is vital. Entrepreneurs need well established management skills both in a franchise and a new enterprise in order to utilize strategic methods in order to be successful. "According to both entrepreneurs and venture capitalists, the most common reasons why new ventures fail are internal. Specifically, the number - one reason cited by both groups is lack of management skill. Entrepreneurs often have enthusiasm, optimism, and drive but do not possess the business skills they need to make a venture successful. In addition, entrepreneurs often lack the ability to manage finances effectively." (Hoboken, N.J John Wiley & Sons, Inc, 2010)

Research shows that young would be entrepreneurs feel they lack business acumen and have little idea how to actually get a business off the ground. (Guardian, 2009) A huge hurdle for young entrepreneurs is the knowledge on the legalities and processes to start-up a business. "A growing number of start-up businesses are reliant on external investment yet few graduates fresh out of university are armed with the tools they need to raise capital to create their business. Often, their ideas are not developed enough to be 'investment ready', and even if they are, these graduates may not know how to identify potential backers or deliver a pitch that could help them secure that elusive seed funding." (Guardian, 2009) "The cost of starting a new franchise continues to be wide. The average cost can be well over £100,000, but there are still many franchise opportunities that do not require this level of investment. When sourcing financial support the banks are still the most popular with over 80% of new franchisees borrowing from their banks, with over 90% borrowing more than £20,000. The average borrowed is now nearly £30,000." (Howell, D, 2010) Considering circumstances of many young entrepreneurs especially graduates with student loans this could be daunting, although there are lower cost franchises available but this could cause a higher risk. It is important to emphasize the importance of finance as many businesses are unable to maintain business for a long period of time due to major initial costs.

The Franchise industry

A frequent problem within the hospitality service industry for businesses is that it is vulnerable to the buying power of customers. "Even if a venture has excellent management, sufficient capitalization, and a good service - delivery system, it can still fail if market conditions are not favorable. This is another timing issue. An entrepreneur may launch a new hotel or restaurant right before a downturn in the domestic economy, as Metro was, or in a foreign economy on which the new venture is dependent. Tourism is extremely vulnerable to localized recessions and seasonal demand." (Enz, C, 2010) Therefore it is important to have industry experience and knowledge for instance, demand, as these changes could be critical to the business's survival. According to 'The NatWest/bfa Franchise Survey 2010', the United Kingdom franchise industry is worth an estimated £11.8 billion and increased by 44% over the last 10 years of which 90% of all the franchises surveyed made a profit. Dominos Pizza Group that will open an addition of 50 stores in 2010 is an example of a successful franchise. (Howell, D, 2010) This shows evidence that there are great opportunities within the franchise industry with high success rates and is fast growing. In terms of the hospitality industry, "Franchisees agree to give the franchisor a combination of fees and royalties, usually in the form of a percentage of unit sales in restaurants or a percentage of room sales in hotels. Also included in these agreements are an advertising contribution paid to the franchisor as a percentage of unit revenues. Hospitality firms engage in what is called business - format franchising, which is when the franchisor sells a way of doing business to its franchisees" (Hoboken, N.J John Wiley & Sons, Inc. (US), 2010) Allowing franchisees a higher chance of achieving success by adopting an already proven successful business plan. Young entrepreneurs can take advantage of low barriers of entry into the hospitality market and take ownership of a business achieving total financial gain and achievement. Research has shown that higher achievers who find a difference between contribution and reward tend to be happier in self-employment. "In the specific context of self-employment and job satisfaction, a large number of studies support the notion that the self-employed enjoy higher levels of job satisfaction, compared with salaried, organizationally-dependent employees." (Thomas Lange, 2009)


Source: Pew Research Center

It is essential to mention that franchises may have their advantages however as a young entrepreneur with lack of business experience, franchisors also make choices about the people they recruit as franchisees. Business experience, especially in dealing with customers or in selling, is an important factor and, franchisors are increasingly looking for experience in their own sector, the recession having made them more cautious. Understanding a business sector is often half way to making a success of a franchise, so without that first-hand knowledge, a new franchisee is likely to face a steep learning curve. ((Baxter, J, 2010, p59)

It is important to state that there is potential risk when investing in a franchise. Current research suggests that joining a new and small franchise may be more risky than starting one's own business because success depends on the capacity of the franchisor and the other few franchisees to make the entire chain work. The likelihood of failure is lower when one joins an established chain with many units such as Subway, Pizza Hut, IHOP, McDonald ' s, or Red Lobster. (Enz, C, 2010, p 376) While franchising can give entrepreneurs a potentially successful business, it is essential to evaluate the risks and mention that investing in a well established franchise as mentioned before would come at a considerable cost. For instance, the cost of establishing a franchise such as Domino's Pizza in the United Kingdom is a total investment of £240 000 which is a significant investment amount for a young entrepreneur to acquire (Baxter, J, 2010, p27) Risk in a franchise business is the reported in the market for instance the financial decline of the donut maker business who owns stores internationally, Krispy Kreme. The company has reported the intention to close a number of stores due to a decline in sales and increase in costs with a net loss of $27 million and a 57 percent loss of market value. (Enz, C, 2010, p 377) Krispy Kreme franchise cost is approximately over $720 000 which is a significantly high cost of investment, considering their current position that would be extremely risky. It is fair to assume that despite advantages such as brand awareness there is still risk in franchise investments, especially with the effect of external environment circumstances such as the recession.

Structure of the report

Section 2 is in depth investigation of the opportunities and threats affected by young entrepreneurs for both a franchise and a new business, describing various internal and external issues such as risk, finance, legislation and regulations affected by a franchise business and a new business.

Section 3 is analysis of the strengths and weaknesses for both investment approaches as to evaluate the viability of a franchise business opportunity rather than a new business for a potential young entrepreneur.

Section 4 provides an overall discussion and conclusion from the factors argued in the previous chapters.

Section 5 is a short reflective report on the limitations and learning outcomes of the report.

Opportunities and Threats for young entrepreneurs

Franchise Market


Opportunities exist in most business sectors, but with any franchise there needs to be an assured and continuing high level of profit in order for it to be financially viable. (Baxter, J, 2010, p56) As mentioned earlier in the report, the franchising industry in the United Kingdom is producing high levels of profit, with 90% of franchises making a profit in addition turnover per franchise is estimated at £323,000 and the average turnover of a franchise has increased by 83% over the last 10 years showing reasonably stable and resilient market. (Howell, D, 2010) There are likely to be more niche sectors for franchising in the future, (Baxter, J, 2010, p56) demonstrating the diversity and growth within the franchise market as sectors such as food, health, personal care and property management seem to be set for growth. (Baxter, J, 2010, p56)


Location can affect business performance considerably, as it is more than just a premise which is cost for the business. Czamanski (1981) expresses his concern that most location decisions should involve more than the "cost factors". Schemenner (1979) supports this view and states that costs can be estimated through any quantitative analysis and should definitely consider the intangible and qualitative factors. He cites that the intangibles could be risks associated with the costs or demand estimates, business climate of locations, education of the labor force, attitudes of the workforce toward productivity, change, unionization, cultural attributes of the location, local and state government attitudes, commuting distances for workers and managers, and impact of other businesses in the area. (Karakaya, F, and Canel, C, 1998, p321) Keeping this in mind, a franchisee's territory can be altered by the franchisor, which in some cases, affects the profitability of the franchise which amounts to a reasonably damaging threat. As mentioned previously in the report the hospitality industry can be heavily affected by its external environment. The economic downturn for example has caused the tightening on consumer spending and can affect franchises depending on what products and services they offer. (Baxter, J, 2010, p57) For instance in the catering sector of the market Mintel in 2010 reports that despite the relative resilient performance of the market during the recession, the eating out market has still contracted slightly with around a quarter of out-of-home diners that have either reduced their expenditure per head on eating out or reduced the frequency of their visits. Communication is an important element in the franchise market, both between the franchisor and the franchisee along with their target market. A franchisor's development strategy can be threatened by their franchisees if the strategy is not implemented with sufficient consultation. (Baxter, J, 2010, p57) Many franchises are taking this on board and realizing the importance of communicating with their franchisees as this can optimize operations and profitability, for instance, Domino's Pizza Group are now committed to learning from their franchisees' experiences. (Buttle, F, 2009, p339) In some sectors, there are nearly identical franchises, sometimes with similar names, which can confuse their markets and threaten the reputation of the franchises. (Baxter, J, 2010, p57)

New Business


Low barriers of entry into the market is a great advantage as it accounts for a cheaper investment opposed to markets with high barriers of entry which tend be more expensive. There are a number of reasons why the hospitality industry attracts the small business owner. Undoubtedly one of the main reasons is the fact that the barriers to entry are low. Relative to some other industries the hospitality industry requires a lower amount of capital investment. Catering is one type of business where it is easy to start small and grow big and there are many examples of this pattern of success. (Quinn, U, Larmour, R and McQuillan, N, 1992, p12) Internet gives entrepreneurs a great opportunity as social networks can aid in reducing marketing costs, "Greve and Salaff (2003) also recognised that social relations and networks play a significant role in establishing an enterprise, whilst Anderson et al. (2005) noted the importance of family members in entrepreneurial networks." (Pickernell et al, 2010, p187) Networks aid in many ways, access to the right suppliers and recruitment for example. "Using networks to recruit employees is a good strategy, particularly for new or small businesses that may have problems attracting talent (Leung et al., 2006)." (Martinez, M and Aldrich, H, 2011, p18)


Finance issues is a major issue when establishing a new business as they are vulnerable to its external environment, for instance in the current economic climate the base rate (is) at its lowest level in historical terms, banks have raised their interest rates in order to recover their capital levels - at the expense of their clients. (Hughes, K, 2010, p2) Small businesses are continuing to experience tightening on access to finance from banks and could a reasonable threat to business starting up in this environment, as it could cause a high increase in cost. According to the FPB Referendum 186, 2009, responses showed that 29% of firms with overdraft facilities had experienced tightening in access, and 35% had experienced a tightening access to loans. Overdraft facilities were withdrawn for 5%, and loans were no longer offered to 12%. From July to December 2008, 40% found an increase in the cost of banking. Interest rates fell from 5% to 2% over the 3 months from October to December 2008, but interest rates on loans rose by 1.5 percentage points and overdraft rates rose by 1.7 percentage points. (Hughes, K, 2010, p83) Also if a new business does not predict the right start-up investment costs the business could be in a high amount of debt prematurely and be unable to sustain itself. Development and implementation of particular business strategies can be very costly for businesses, for example, the level of debt that is needed to fund a CRM-based approach to business development can be very high. In fact it may be too high a risk for most private business owners to bear. (Buttle, F, 2009, p351) Lacking both the economies of scale and the financial means of the big brands, many independents have been pushed out of the market as a result of recessionary pressures. (Mintel, 2010)

Strengths and Weaknesses of a Franchise business and A New business

Franchise Market


Franchising has a business model which has been put into practice and has proven to be successful. (Baxter, J, 2010) This gives an entrepreneur a higher guarantee of success and also saves on finance losses by adopting a faulty system. Furthermore, a potential franchisee can evaluate franchisor's business performance prior to investment. The franchising approach is utilized widely across many sectors of the British economy at various different start-up investment costs, despite the economic downturn the total number of franchisors in the market increased by 2% in 2009. (Baxter, J, 2010, p1) Particularly the hotel and catering sector which is major part of the franchising market. This sector is growing organically, through the expansion of existing franchisors. As mentioned previously in the report Domino's Pizza Group Ltd is expected to open an extra 50 stores in 2010, consequently in the year ending 28th December 2008, turnover at Domino's Pizza Group Ltd increased by 20%, to £110.4m, and pre-tax profit rose by 20.8%, to £20.4m. (Baxter, J, 2010, p28) Demonstrating a clear opportunity for entrepreneurs and resilience within the market, around 90% of franchisees were profitable in 2008, according to the British Franchise Association (BFA). (Baxter, J, 2010, p56) The franchisor's brand name enables the franchisee to benefit from immediate recognition and brand awareness, also benefiting from any advertising or promotion carried out by the franchisor. A marketing strategy is a key factor in a business's survival (it) allows a company to truly understand its market and the customers that are the basis for this market. This effort allows for a more effective integration of all activities that may impact customer value, which in turn affects both return-on-investment and profitability. (Leventhal, R, 2005, p3) In addition, brand awareness as a result of marketing is important as enables a business to communicate to its customers, "Brand name communicates quality to me." Approximately 20 percent of the respondents disagreed with the statement, while twice as many (40.3 percent) agreed." (Seitz, V et al, 2010, p239) and create brand loyalty which happens over a period of time. The franchisor gives you support including training, setting up the business, network of contacts and ongoing advice. External advice is an essential part for business growth particularly for young entrepreneurs as most have lack of experience in business processes and management. "In a survey of over 2,500enterprises, Bennett and Robson (1999) found that 95 per cent of enterprises made use of external advice. Hill and Neeley (1988) and Clark (1993) also suggest that external advice is sought to supplement existing staff and managerial expertise and enhance organizational efficiency and effectiveness." (Pickernell et al, 2010, p187) Young entrepreneurs lack of an extensive network of contacts, as they are amateurs to the market which leave them at a disadvantage. A franchise business offers a connection to these relationships with suppliers which have already been established. A franchisee can also benefit possibly from sharing information and communicating with other franchisees in the area, to have extra support as they would possess firsthand experience. Easier access to finance is an important benefit of a franchise as banks are more likely to lend funds with the security of having previous performance history of the business already in existence opposed to new business where an entrepreneur would propose a new business model and forecast profitability and success. Start-up duration which can take a long time when starting a new enterprise but it could be an advantage for entrepreneurs in the franchise market as on average it takes six months to find, plan and open a new franchise for business. However, it can take nearly eight months for franchise businesses that have a catering element as there is often a delay in obtaining all the required permits and sourcing appropriate premises for the new franchise (Howell, D, 2010)


A franchisor depends on the franchisee's to maintain the success and reputation of the brand if it is damaged this partly affects the franchisee's success for example McDonald's in 2004/2005, after it received unfavorable press coverage. (Baxter, J, 2010, p56) A franchisor has to ensure that it implements quality management within its organization to guarantee that it has the same level quality in all its franchises as franchisors could be heavily affected by franchisee managerial performance. Poor performance and service by franchisees could be highly damaging for a franchise company (Baxter, J, 2010, p56) this could affect brand loyalty and could receive damaging negative brand awareness affecting all franchisees profitability. Inflexibility is a major issue for franchisees as franchisors can be restrictive and do not allow them to have enough control of their business; for example, purchasing and sourcing controls might be very strict. (Baxter, J, 2010, p56) Franchisor restrictions can be detrimental for a franchisee because "if franchisees were found to be changing the product offer and modifying processes, the franchisor would most likely terminate the contract." (Buttle, F, 2009, p339) also rigid bureaucracy can stifle creative activity which is an important asset especially in knowledge based economies such as the United Kingdom. (Enz, C, 2010, p380) Franchisees can also find it difficult with financial management in terms of control of their cost bases or profit margins, since some of the terms of business, such as customer pricing, are set for them by the franchisor. (Baxter, J, 2010, p56)

New Business


A business owner has advantage of total control and independence for instance been able to dictate hours of work, set goals and aims for the business and most importantly they do not have to abide by restrictions and rules of the business operations set by a boss if in employment or franchisor in a franchise. Business owners have the flexibility to choose the products, services and business strategies needed for the business. For instance, an entrepreneur has total control and flexibility of the 'vision' for the business which is an important element as it dictates its direction and purpose of the business. Entrepreneurs are given the freedom to utilize their creativity to distinguish themselves from other businesses as entrepreneurial success comes from more effectively accumulating, combining, and directing resources to satisfy a need than other firms can. (Enz, A, 2010, p380) As mentioned previously in the report location is more than merely a cost for the business, it has many elements to it, such as accessibility for customers, employer and employees. Therefore it is very important that a business owner can decide the location of the business without the restriction of territory and change of premises in franchising. A major benefit of a new business is financial gain, the ability to have a better lifestyle also benefiting from tax reductions without the worry of job security due to the threat of redundancies and a variety of insurance policies to act as a form of security.


A major issue when establishing a new business is high initial investment costs as well costs for sustaining the business for instance using a market penetration strategy. Many new ventures fail because of a lack of capitalization. New businesses often need a substantial amount of capital at the beginning if they are going to succeed. Without sufficient capital, the venture may fail even if the idea was good and the management skills were present. Many entrepreneurs underestimate how much money is needed to get the business up and running and sustain it while getting a foothold in the market. (Hoboken, N.J John Wiley & Sons, 2010) For new businesses there is an extended period to the ultimate result which is profitability due to factors such as the implementation of marketing strategies to achieve brand awareness as customers are more profitable over time as shown below.


Entrepreneurs have to create and validate the viability of its new business model which could make access to funds more difficult opposed to a franchise where a proven business model is already in place which gives lenders more security. There is a much higher risk when establishing a new business as opposed to the a franchise business, the British franchise market as whole shows that 10 percent of new franchise businesses are not operating after 5 years although this significantly higher for new business start-ups with 70% not operating after this same period. (Baxter, J, 2010, p19) Running a new business takes high commitment as the business owner has total control of the business operations and implementation of business strategies. In order to be successful there has to be a continuous effort put into the business.


There are three parts to this section:




"So what?"

What significance do your research findings have?

For whom? Why? and How?

Which do you see as most important and why?

Furthermore, research has found that the most likely sources of advice and guidance

for graduate entrepreneurs are informal sources involving family, work colleagues and

social networks, as well as universities (Greene and Saridakis, 2007). Hegarty and Jones

(2008) also commented, however, that there is still considerable work to be done to

develop social networks for young graduate entrepreneurs. They also note that social

networks for graduate entrepreneurs are dependent upon industry experience and the

acquisition of capital. It can therefore be argued that the strength of these social

networks is best examined via their impact on advice and finance.

Mature franchising operations, such as Domino's Pizza, are now committed to learning from their franchisees ' experiences. They no longer believe that headquarters is the source of all innovation and knowledge about their business.

A franchise investment would give a young entrepreneur the ability to obtain easier access to finance, training, a business plan already proven successful, and a network of suppliers at a lower risk. Multi-unit franchises would give the franchisee the ability to have more bargaining power.

Reflective report

what the benefits and limitations of your approach were, should be left for the 'reflective report' section

This should provide a commentary on both the success of the project and validity of your conclusions, eg: as noted above, the benefits and limitations of the approach taken, problems in analysis etc., and also include self-reflection on the development of your transferrable skills (see Section 1.2 above). High quality work will incorporate literature on research methods & process and/ or reflective learning and skills development. There will be a Project Masterclass on 'reflective writing' in Semester 2 (see 2.0 Project Calendar).