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Chapter 3. The Wealth-Creating Power of ... > Franchise Risk Profile Template: An ...

Franchise Risk Profile Template: An Introduction

The franchise risk profile template (FRPT), shown in Table 3-1, is a guide in the franchise environment to perform due diligence on a specific franchise. As a prospective franchisee, you can use this tool to evaluate the risk–return scenario. The template allows the franchisee to filter the prospective franchise and the franchisor to construct or modify the franchise so that it scores well and appeals to a larger segment of the prospective franchisee population. This guide has been constructed to help you make an initial assessment of the franchise’s strengths and weaknesses that will likely require further investigation. It is by no means meant to assess the overall potential of a franchise. Rather, it offers a perspective on the balance of risk and return that the franchisee requires. The FRTP is a mapping device, not a formula. We have segmented the FRTP by the business model–scaling hurdles that franchising addresses: administrative efficiency, risk management, and resource deconstraining. In the FRTP the level of market performance a franchise has achieved indicates the extent to which it has overcome the given hurdle.

Table 3-1. Franchise Risk Profile Template
Criteria Risk/Return Profile  
 Low RiskAcceptable RiskHigh RiskExtreme Risk
 Avg. Market ReturnIncrementalMarginalLarge Return
 15–20 Percent Return30 Percent Return40–50 Percent Return60–100 Percent Return
Agency Concerns:    
Outlet performance disclosed or discernedYes, 90 percent + apparently profitableYes, 80 percent + apparently profitableYes, 70 percent + apparently profitableNo, or less than 70 percent profitable
Business formatSophisticated training, documented operations manual, identifiable feedback mechanism with franchiseesInitial training and dynamically documented operations manual, some field supportTraining and operations but weak field supportQuestionable training and field support and static operations
Term of the license agreement20 years with automatic renewal15 years with renewalLess than 15 years or no renewalLess than 10 years
Site developmentQuantifiable criteria clearly documented and tied to market specificsMarkets prioritized with general site development criteriaGeneral market development criteria outlinedBusiness format not tied to identifiable market segment(s)
Franchise fee and royaltiesPresent discounted value (PDV)[a] of the fees are less than the demonstrated economic advantages (reduced costs or increased revenue) of the franchise versus standalonePDV of the fees are equal to but projected to be less than the economic advantages of the franchise versus standalone.PDV of the fees are projected to be less than the expected economic advantages (reduced costs or increased revenue) of the franchise versus standalonePDV of the fees are not discernibly less than the expected value of the franchise
Multiple market presenceNationalRegionalStateLocal
Market share#1 and dominant#1 or #2 with a strong competitorLower than #2Lower than #3 with a dominant player
Number of company owned outletsCluster of company owned outlets near headquarters and or regional franchisor officesSome company owned outlets used for R&DNo company owned outlets or a large number of company outlets purchased from former franchiseesNo company outlets and no strategic plan to develop such outlets
National marketing programHistorically successful creative process, national media buys in placeCreative plus regional media buysCreative plus local media buysLocal media buys only

[a] The present discounted value of an income stream evaluates the income stream of an opportunity and the discount rate that incorporates a measure of risk into the equation.

A company that is lower on the risk scale will offer a lower average market return than a company that is higher on the scale. The higher risk franchise will clearly require the promise of an extremely large return to induce investment. You should consider the criteria in the FRTP before purchasing a franchise. Of course, franchisors should therefore consider these criteria when they make a franchise offering.

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