July 2009 Franchising World
 
Identifying high-performing operators as potential multi-unit operators can be accomplished by implementing a comprehensive evaluation system.
 
By Norm Murdock, CFE 
       
Simply put, franchisors have two ways to expand their systems: same-store-sales growth from existing units and expansion of the franchise system by adding more units. With many concepts experiencing flat or declining same-store-sales growth in this struggling economy, the focus on unit growth is more vital than ever for the long-term success of the franchise system.  
  
Historically, recessions have been a boon to franchisors as displaced, entrepreneurial-minded professionals, fed up with the corporate world, choose franchising to control their destinies and secure their futures. The current recession is no exception since many franchisors are “flush” with leads today from this type of prospect. However, most conventional lenders are offering financing to only the most qualified of prospects, making capital access one of today’s biggest obstacles to new-unit development and turning the customary recessionary boon into a bust for many franchisors. This is especially true for those concepts that require large amounts of start-up capital. And, for those franchise concepts that have not benefited from increased lead flow in this economy, the path to unit growth is even more challenging.
  
Facing these realities, franchisors are compelled to “change their swing” and seek unit growth through   other, perhaps less conventional means. Highperforming, single-unit operators may offer franchisors the greatest opportunity to increase their franchise network and secure their future.
  
There are many benefits associated with expanding a network internally. Strong, single-unit operators who are awarded another franchise offer the franchisor an opportunity to “own the market” in cases where competition is scarce. Economies of scale can be gained from the efficiencies of shared resources in sales, marketing, human resources, operations and finance. For service franchises, the cost of overhead can be reduced if existing office and warehouse space can be shared when a franchise expands into an adjacent territory. Franchisees who spend a significant portion of their marketing budgets on local network television advertising usually have to accept when they see a portion of those buys go to designated market area’s that they do not own or service. Expanding into these open territories decreases their cost-per-lead allowing those advertising dollars to go further. And if these open territories are lower profile, secondary markets that likely will not attract interest from outside the system, existing franchisees represent the best opportunity for franchisors to penetrate these markets.
  
Further, franchisees who expand typically require less start-up training and support from the franchisor. And because of their successful track record, they have a higher probability of success. Similarly, their first year performance is likely to be much better than a start-up from outside the system that has little or no prior experience with the concept or industry. Franchisors will likely enjoy improved franchise relations and goodwill associated with expanding the “high-flyers” in the franchise system.
  
But there are risks. Franchisors who “rubberstamp” franchisees for expansion without a diligent evaluation process run the risk of severely undermining their entire franchise network. Expanding underperforming franchisees serves only to put “dots on the map” but guarantees that prime territory may be locked up for years by mediocre operators. Service franchisors who offer exclusive territories must be cautious of franchisees seeking to expand merely for reasons of self preservation and territory protection. 
  
One successful retail service franchisor limits its exclusive territories to 1.25 million people because it has concluded that its franchisees are unable to effectively penetrate the market and optimize sales in territories any larger than this. In the interest of unit expansion, franchisors must avoid over-selling territory to existing   operators without measures in place to assure it will realize the full potential of that sale. After all, the franchisor has only a finite number of units to sell so it is imperative that it award franchises to those prospects who offer the greatest opportunity for long-term success. 

How does a franchisor identify those franchisees who may be worthy of expansion? What distinguishes a “high-flyer” from the rest of the pack? Are all highperforming, single-unit operators capable of being successful multi-unit operators? What are the specific performance criteria a franchisor should consider?  
  
The Balanced Scorecard 
The place to start is by establishing basic benchmarks and minimum standards of performance that a franchisee must meet to even be considered for expansion. Two Men And A Truck employs what they call a “balanced scorecard” to evaluate whether a franchisee is capable of taking on another unit. “Our scorecard measures key areas of the business, with customer service making up a majority of it,” says Randy Shacka, CFE, vice president of operations. “Franchisees have to meet minimum criteria in order to be approved for an additional location. This makes for an objective analysis that is hard to dispute. We will not approve a location that is struggling to service the customers it currently has and add an additional marketing area that could further hinder service levels.”
  
At a minimum these objective measures should include length of service, financial compliance and operational compliance.  
  
Length of Service 
First, a franchisor must define the minimal length of service required for expansion. This should be the time necessary for the franchisor to fully measure the performance and capabilities of the operator. For most franchisors, this will be at least one full year of operation. Franchisors must be cautious about expanding a franchisee too quickly. Even an operator who enjoys early success needs to prove sustainability over a length of time before being considered for expansion. A franchisee must demonstrate his ability to develop a stable infrastructure and system of operation that is repeatable. And a franchisor needs sufficient time to size up the capabilities of the operator. Plus this “honeymoon” period is an essential gettingto-know-each-other phase necessary to cultivate the franchisor-franchisee relationship.
  
Financial Compliance 
It may be stating the obvious, but any franchisee being considered for expansion should be current and in good standing with the franchisor on any receivables due, including royalties, cooperative marketing payments, product purchases and notes payable for franchise fees financed by the franchisor. At the very least, the franchisor should require the franchisee to bring his account current as a condition for expansion. Some franchisors leverage the opportunity for expansion as a means of requiring the franchisee to pay his account in full.  
  
Additionally, given the size of the market serviced, the franchisee must demonstrate above-average performance in top line sales, profitability and any other financial metrics the franchisor deems important. Franchisees who cannot profitably operate a single unit can be quickly dismissed from expansion consideration.
  
Operational Compliance 
Any franchisee being considered for expansion must demonstrate a sound system of operation. Rarely is a franchisee 100 percent compliant on every operational measure, so the franchisor must identify those essential compliance standards that must be met as a condition for expansion.

These may include:
   • Minimum marketing requirements,

   • Passing grade on store/operational audits,  

   • Meeting customer satisfaction standards,

   • Proper use, representation and application of the brand, and

   • Evidence of a good-faith effort to consistently follow the system.
  
For each of these three basic benchmarks, the franchisor must be careful not to set the bar too low. The goal here is to identify those above-average performing operators who have a sound, well-run business and are committed to following the franchisor’s business model. It is likely that this first weeding-out process will follow the 80-20 rule. If the standards are set appropriately, it should.
  
To Expand or Not to Expand?
Once the target group has been identified, the franchisor must then evaluate whether these franchisees possess the essential characteristics found in successful multiunit  operators. These can be summarized as human and financial capital.
  
Human capital refers to both the quality of the operator and quality of the team. The skill set of the multi-unit operator is much different than that of the single-unit operator. Day-to-day, hands-on managing of the business is the focus of the single-unit operator. In contrast, leadership, delegation and strategic planning are the success characteristics of the multi-unit operator. The franchisor must examine the franchisee fully to determine if the operator has the skill set necessary to make this transition.
  
Additionally, there are two intangibles that franchisors should look for in operators being considered for expansion: unbridled passion for the business and a tireless work ethic. Together, these characteristics will enable a franchisee to overcome even the most difficult of circumstances associated with multi-unit growth.  
  
Successful multi-unit operators are effective at developing people. To duplicate the successful system of operation, the operator must be able to duplicate the team. The franchisor can evaluate this by examining the quality of the team the operator has assembled in his current unit.

   • Is there a stable, high-quality team or has there been frequent turnover?

   • Has the success of the single unit been a result of the sweat and grit of the operator or due (at least in part) to a strong supporting cast?

   • Is the operator a micromanager or “control freak” or is the team empowered to do its job?

An efficient, high-performing infrastructure that operates effectively (especially in the absence of the franchisee) is reflective of an operator who understands how vital it is to develop a strong team. 
  
To expand, a franchisee must have the financial capital to invest in the start-up of the new unit while continuing to effectively operate and expand the current unit. With financing from conventional lenders harder to come by, now more than ever “cash is king.” The best-case scenario for franchisor and franchisee alike is if the existing unit is generating cash flow sufficient to fund (at least in part) the start-up of the new unit, thereby reducing or eliminating altogether the need for outside capital. Franchisees who come to the table with a strong cash position do so from a much stronger negotiating position. They will find a franchisor that is ready and willing to talk expansion.
  
To fully evaluate the financial strength of the franchisee, the franchisor should require the following:
   • Credit report,

   • Statement of net worth, and

   • At least two, full years of business financial statements (balance sheet and income statement).

Next, as a condition for consideration, the franchisor should require a detailed and comprehensive business plan to include:  
   • Market analysis, including target market demographics and analysis of the competition,

   • Marketing plan,

   • Operations plan.

   • Development plan, detailing how the franchisee will be ramp up the new unit,

   • Management/Staffing plan,

   • Financial plan, including a break-even analysis and one, three and five year pro forma income statements, balance sheets and cash flow projections, and a

   • Funding plan, including sources and uses of funds.  

The business plan may be the franchisor’s best tool to judge a franchisee’s readiness to expand into multi-unit operation. A professional, comprehensive business plan requires a measure of discipline, business savvy and sophistication that parallels that required to be a successful multi-unit operator. Franchisors may find that the business plan itself serves as a weeding-out process for those franchisees unwilling to undergo the effort required or incapable of submitting a coherent plan that lays out a compelling case for expansion.
  
Franchisors would be well served by implementing a comprehensive evaluation system to identify those high-performing operators within their networks who meet the profile of successful multi-unit operators. This type of “organic” unit expansion coupled with traditional means of expansion offer the franchisor a comprehensive approach to system growth.  

 Norm Murdock, CFE, is vice president of franchise operations for Re-Bath LLC, Inc. He can be reached at  nmurdock@rebath.com  .  

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