Franchising

by Judie Bizzozero

Since the late 1970s, the indoor tanning industry has grown into an industry with an economic impact of more than $5 billion. Statistics suggest that there are about 20,000 free-standing tanning salons and another 25,000 to 30,000 locations such as health clubs, spas, video stores and beauty salons that offer indoor tanning. The industry has been able to deal with the last few years of economic uncertainties that have hit many other industries in their pocketbooks. One reason for its resilience is that tanning provides consumers with a way to look and feel good.

According to the Indoor Tanning Association, most indoor tanning facilities in the United States are small businesses, and more than 50 percent of them have female ownership, as compared to 25 percent of businesses in other industries. The ITA estimates that the business of indoor tanning employees approximately 160,000 individuals and tans about 30 million people annually.

The LOOKING FIT® State Of The Industry 2004 Report cited an influx of financially strong people entering the industry who have been successful in other businesses. Industry experts agree that the only way the industry will grow dramatically is if there is an improvement in professional management of salon owners. That means salon owners must make a long-term commitment to the industry through a sound business plan. More professionally run salons will lead to the ability to present a better financial picture of the industry to lenders. It also will allow salon owners the ability to educate the public and grow the industry.

Independent salons account for the majority of salon ownership; however, more and more franchise operations have joined the market over the past few years. While some salon owners view franchise operations as intense competition, many industry veterans believe it is important for the industry to continue to become more mainstream—and that includes franchise and chain operations. This thinking holds true for almost every other industry and helps expand the concept of indoor tanning.

The International Franchise Association’s Educational Foundation economic impact study, conducted by PricewaterhouseCoopers, found the nation’s more than 760,000 franchised businesses generate jobs for more than 18 million Americans and account for $1.53 trillion in economic activity. (The 630- page study was published in 2003 and was based on 2001 economic data—the most current data available.) The study also found that more than 75 industries are engaged in franchising and, that even in difficult times, franchising creates jobs. In fact, Entrepreneur Magazine’s 26th Annual Franchise 500® issue recently ranked the 2005 top five fastest-growing franchises as Subway, Curves, Quizno’s, Jackson Hewitt Tax Service and The UPS Store, in order. Four indoor tanning franchises made the list: Planet Tan, Hollywood Tans, Palm Beach and Executive Tans.

Franchises are not the same entities as chains. A chain is created when the successful owner of a conventional salon decides to open an additional store or stores in a complementary area. A chain consists of two or more stores; however, it is not always a franchise.

Operators that have a good and profitable business concept actually can make more money if they just open their own stores, but chains are very capitaland resource-intensive from the standpoint of human resources. Operators are using franchising to expand their names and get more brand recognition at a more cost-friendly rate than simply opening more and more chain stores.

According to the International Franchising Association (IFA), franchising is a method of distributing products or services. At least two levels of people are involved in the franchise system—the franchisor, who lends his trademark or trade name and a business system; and the franchisee, who pays a royalty and often an initial fee for the right to do business under the franchisor’s name and system.

Technically, the contract binding the two parties is the franchise, but that term often is used to mean the actual business that the franchisee operates. Franchising basically is signing up with a company that gives all of its years of experience the day the franchisee salon opens. In a franchise system, the franchisee is the owner and operator of the business, very much like a conventional salon owner. However, the franchisee also has a business entity (the franchisor) to show them the way. In many ways, franchises can be likened to turnkey operations with the franchisor offering the franchisee guidance on location selection and operation manuals to run the business, as well as customer service and marketing programs.

A franchisor has everything set and ready to go for the franchisee. Everything has been researched including advertising print work, computer programs and sales techniques. However, it’s important for potential franchisees to know how much experience the franchisor has.

Imagine a store owned by an individual with a particular concept. If the business is successful, the owner may develop a second or third store and hire employees for the day-to-day operations.

At that point, if the entrepreneur still wants to expand but prefers not to operate additional stores himself, he or she may decide to franchise the store name and business system to an independent businessperson, a franchisee. In return, the entrepreneur may ask for an initial fee and/or a continuing royalty payment based on a percentage of that franchisee’s sales. The business now is franchised.

The IFA says the franchisor must have some degree of distinctiveness, or the potential to achieve distinctiveness. Without distinctiveness, the franchisor will have difficulty attracting high-caliber franchisees. The elements of success must be teachable to persons with capabilities that exist among prospective franchise buyers.

Some salon owners say the documentation required to start the franchising process is very extensive. Experts agree that the franchising process is multifaceted and somewhat confusing. Consulting an attorney who specializes in franchise law will help guide the potential franchisee through some confusing and costly times.

A franchise attorney is tasked with ensuring that a franchise system meets with federally mandated standards and that the franchisor has addressed very important issues regarding the franchisor/franchisee relationship such as protected territories, performance expectations and payment arrangements.

A franchise-development firm is another option salon operators can consider. Franchise-development firms are instrumental in creating a franchise structure that is marketable and has all of the necessary components to make it run smoothly. When developing a franchise, the use of the attorney and the development firm are important because they offset one another. The attorney creates a legal and compliant atmosphere with contracts that favor the franchisor, which tends to reduce the franchise’s marketability, so the development firm is used to bring the system back in balance.

As with any business venture, there are challenges to being a franchisor and a franchisee. Franchisors have to satisfy their own goals as well as everybody else’s. For the franchisee, the biggest challenges are to keep up with the franchise system, make it better and be more productive. Franchisees don’t have the same challenges as a chain-store operator. They don’t have to develop programs; they only have to make the franchisor’s program better.

It is important to note that franchising is not something anyone can just go out and do. First of all, a potential franchisor has to be in business one full year legally. Next, the franchisor needs to be able to show the franchisees how to open a business and make money at it.

It’s very important for anyone who is looking into buying a franchise to choose wisely. Beware if somebody who boasts that his or her salon does X amount of dollars. Federal law makes it illegal to make earnings claims.

Franchisors do have to give franchisees audited financial statements when they are presented with a franchise agreement. The Uniform Franchise Offering Circular (UFOC) contains information that the franchisor must disclose before selling a franchise. The Federal Trade Commission regulates the subject matter and format of this document to try to make the information as useful and comparable as possible. The UFOC must be provided to the potential franchisee at least 10 days prior to signing the deal.

This audited financial statement gives the franchisee a clear picture of how that particular company is doing; beyond that, franchisors really need to do their own homework and figure out whether their market is conducive to what they are trying to do.

The challenge is to not just go out and sell the name, give it away or make deals to move some equipment and turn some cash. The real challenge is to constantly have salons that make good money for the owners so the owners can get people to invest with them and grow the business in their exclusive territory.

While it may be complicated for the franchisor to put together a franchise, it isn’t difficult for a franchisee to own one. And whether a person is a potential franchisor or franchisee, the best advice he or she will ever receive is to do the homework.

Ask a lot of questions. How many locations does the company own? What kind of unique items does it have that goes along with the franchise? How does the franchisor define why it’s different from somebody else? Does it have operations manuals and an ongoing training program available? A franchisor has to have a good enough training program and facilities to fulfill the needs of the franchisee.

It is important that a prospective salon operator be aware that the brand and the system are there to service the customer, not to service the franchisee.

Like everything else in life, there are advantages and disadvantages to owning a franchise. First and foremost, with a franchise, franchisees have the backing and knowledge of a corporation. They also will share in the advertising costs, and because the corporation is dealing in mass equipment purchases they will get products at a discounted rate.

One of the biggest advantages of owning a franchise, or a chain for that matter, is name recognition. While name recognition is a huge advantage, the financial advantages also are tremendous.

Some veterans agree that people want to buy a franchise because they want somebody to put them in a successful business overnight. Franchising is great for the industry as long as the franchisor is doing the right job. Franchisors have to provide support. Otherwise the franchisees aren’t buying franchises, they’re simply buying a name.

Another advantage for the franchisee is security of knowing somebody else has worked through the majority of difficulties in running a business. That somebody, the franchisor, has been through all of the hard knocks and has set up a program that has demonstrated success in the past. So the risk of failure to the franchisee has been reduced.

The annual fee that franchisees pay to franchisors can be classified as a disadvantage, but it is a necessity. Franchisors cannot support the franchisees entirely. The annual fee goes toward marketing and the franchisor’s efforts to continually fine-tune its program. On the other hand, it should be noted that the annual fee works out to be an advantage as well, because the franchisor is there to increase the franchisee’s productivity.

Another disadvantage exists when a franchisor wants to convert an existing salon. It might be difficult for an existing salon to buy into a franchise. Some companies have found that hiring employees from other tanning salons can be very difficult because of some of the bad habits they have acquired. It is much easier to start with a salon and do everything correct from the beginning.

Experts agree that business-format franchising helps bring uniform standards to the industry. Franchise systems are monitored by the FTC, state regulations and mostly by the franchisees themselves for their compliance with regulations, their ability to meet the needs of the customer and to provide a safe and profitable business environment. Higher standards set by tanning-salon facilities will lead to a smarter customer, which translates to a growing and profitable market.

Whether a person is developing a conventional salon, mega-salon, chain or franchise, the top priority should be professionalism. That professionalism should be passed down to each and every location.

The bottom line is salon owners should not open their stores on shoestring budgets or hire barely living people to work behind the counter. In addition, owners of conventional salons, mega-salon, chains and franchises need to make sure they emphasize education. That still is a major part of a professional’s responsibility.

• Do you have adequate financial resources to fund your expansion?
• Will your concept be successful in other markets?
• Do you want substantial control over your expansion?
• Is your trademark or service mark capable of being federally registered?
• Will a franchisee obtain an adequate return on their investment?
• Are you prepared to support your franchisees?
• Do you have sufficient management staff?
• Are you prepared to enforce standards?
• Will the projected fees and royalties that your salon will receive from franchising offer a significant profit?
• Are you willing to learn the methods and techniques used in franchising?

FAST FACTS

• There are an estimated 1,500 franchise companies operating in the United States doing business through more than 320,000 retail units.
• 75 industries use franchising to distribute goods and services to consumers.
• Average initial investment level for nearly eight out of 10 franchises, excluding real estate, is less than $250,000.
• Average royalty fees range from 3 percent to 6 percent of monthly gross sales.
• Most franchise companies have fewer than 100 units.
• Average length of franchise contract is 10 years.

Top10 Franchise Industries

1. Fast Food

2. Retail

3. Service

4.Automotive

5. Restaurants

6. Maintenance

7. Building and Construction

8. Retail—Food

9. Business Services

10. Lodging

Source: International Franchise Association

Conduct Research

The Federal Trade Commission suggests that prior to investing in a franchise, do your research. In addition to reading the company’s disclosure document and speaking with current and former franchisees, you should examine the following:

Lawyers and Accountants. Investing in a franchise is costly, and an accountant can help you understand the company’s financial statements, develop a business plan, and assess any earnings projections and the assumptions upon which they are based. An accountant can help you pick a franchise that is best suited to your investment resources and goals.

Franchise contracts usually are long and complex. A contract problem that arises after you have signed the contract may be impossible or very expensive to fix. A lawyer will help you understand your obligations under the contract so you will not be surprised later. Choose a lawyer experienced in franchise matters.

Banks and Other Financial Institutions. These organizations may provide an unbiased view of the franchise opportunity you are considering. Your banker should be able to get a Dun and Bradstreet report or similar report on the franchisor.

Better Business Bureau. Check with the local Better Business Bureau in the cities where the franchisor has its headquarters. Ask if any consumers have complained about the company’s products, services or personnel.

Government Departments. Several states regulate the sale of franchises. Check with your state division of securities or attorney general’s office for more information about your rights as a franchise owner in your state.

Federal Trade Commission. The FTC works for the consumer to prevent fraudulent, deceptive and unfair business practices in the marketplace and to provide information to help consumers spot, stop and avoid them. The FTC publishes other information that may be of interest to you, including business guides such as Getting Business Credit and Buying by Phone.

Resources

Franchsinglaw.com
www.franchisinglaw.com

The International Franchise Association
www.franchise.org 

FTC’s Consumer Guide to Buying a Franchise
www.ftc.gov/bcp/conline/pubs/invest/buyfran.htm 

Source: FTC’s Consumer Guide To Buying A Franchise