Go forth - and multiply

By Fiona Rotherham

Tuesday 1st June 2004

Thinking of franchising your business? Mike Pero, the face behind Mike Pero Mortgages, says it's hard yakka - but the rewards make it worthwhile

When Mike Pero decided to franchise his then seven-year-old mortgage broking business back in 1998, around two-thirds of the brokers left in disgust. "They figured I was out to hoodwink them," Pero recalls.

It was a major setback - one that initially made Pero doubt franchising was the right move. Then he thought, "we'll show you". He did. The brokers who left have ended up with red faces, he says triumphantly. "I can now say, 'I told you so'."

He may sound smug; perhaps he's entitled. Mike Pero is the biggest name in mortgage broking in New Zealand. He sold a 90% stake in the business to Christchurch businessman George Gould for $13.5 million in March, and, as Unlimited went to press, the company was about to list on the stock exchange after a $7 million IPO. In a Colmar Brunton survey last year, 63% of New Zealanders named Mike Pero Mortgages as the first mortgage broker that came to mind. Yet his network of around 35 franchisees is only of similar size to that of rival Mortgage Choice.

The difference is branding. Mike Pero won the 2003 New Zealand Franchising Award, in part on the strength of its brand building. Although a self-confessed "media slut", Pero keeps tight control of his image. He wanted his own photos used in Unlimited and to have questions emailed rather than do a face-to-face interview. During our interview, Pero at times dictated his answers as if he was talking to his secretary ("the internet, comma...", "the interpretation, brackets"). He also asked several times -unsuccessfully - to vet the copy before it went to print.

Despite stepping back from day-to-day management after the sale to Gould, Pero still fronts the one-man brand. He's also still in charge of recruiting new franchisees, an area he regards as crucial to the company's ongoing success. One of the biggest pitfalls in franchising is picking the wrong franchisee, he warns. "You think employees are hard to get rid of, but a franchisee can be even worse." Clearly, this is an area that hasn't been all plain sailing for Pero: last year he settled disputes with three former franchisees.

That's just one of the lessons he's learned since he cloned his business six years ago. Another was the importance of getting the paper work right. Back in 1998, he naively though he could just borrow someone else's franchise agreement rather than write a company-specific one. He's since learned that most franchise disputes stem from misinterpretation of the franchise agreement. "You may have a document that says things in black and white, but the interpretation (just like of the Bible) can be taken a hundred different ways."

It doesn't matter how good the concept is, it will fail unless the internal workings of the franchise system are done properly. Pero says franchise documents need to be realistic in terms of how much the franchisor needs to earn to support the franchise system, and what franchisees can afford to pay. "It has to be well balanced for both sides."

If it's so hard to get the right franchisees and requires such a pile of work setting up systems to replicate your business, is it worth it? "Oh, yeah," Pero says emphatically. "But don't underestimate the effort, work and commitment involved."

The key to success, in his book? Making sure both the franchisor and franchisees make money.

Big and getting bigger
In the past decade, franchising has become one of the fastest-growing ways of doing business. Many of our best-known brands are franchised: Lotto, Stirling Sports, The $2 Shop, Paper Plus and McDonald's. The size of the industry in New Zealand is estimated at 350 active franchise systems - making us, along with Australia, the most franchised country per capita in the world.

The National Bank-sponsored Survey of Franchising 2003 shows businesses are replicating themselves at a frenzied pace. The number of franchised and company-owned outlets was up 25% from 3377 in 2002 to 4217 in 2003.

At odds with this increase in franchised stores is a drop in turnover for the franchise sector, from $10.4 billion to $6.9 billion. This has been blamed on a high number of new franchises responding to the latest survey, compared with more established and thus bigger turnover respondents last time. Similarly, the estimated number of people employed in the sector is down, at 40,915 compared with 70,000 in 2002.

Businesses are also franchising themselves at a younger age these days. The average age of a business before it starts franchising has reduced from 11.5 years in 1997 to 8.2 years.

Take Body O2, a company offering simulated altitude training that's been in business just three years. It has ambitions to set up 12-24 Australasian franchise outlets within a year. Simulated altitude training was originally developed by the Russians to improve the endurance of cosmonauts. The technology has been further refined in New Zealand and is now owned and patented by three shareholders and a private equity fund managed by ICap. Body O2's hypoxicator can simulate altitudes of up to 6600 metres; the customer sits back in a chair and breathes in the thin air at short intervals through a face mask, while a monitor attached to a finger keeps tabs on the heart rate and blood/oxygen level.

The theory is that by stimulating your body to increase its ability to carry and use oxygen, you become able to sustain higher levels of physical and mental exertion. All while sitting, reading a magazine.

The walls of Body O2's Auckland office and its franchise marketing material is full of endorsements from some of the country's top athletes. The simulator is even used on race horses. Director Mike Davis says the company wants to widen the appeal to recreational sports people, those recovering from injury or anyone interested in health and fitness.

Franchising this sort of new idea for $190,000 a pop would have once met with scepticism, but perceptions have changed, says Franchise Association chairman Simon Lord. "Twelve years ago if you published a business opportunity ad in the NZ Herald and put in the word 'franchise', it would reduce your responses by 50%. The perception of franchising is no longer negative."

In fact these days some businesses, such as It's a Bargain, are being set up specifically to be franchised. The company was launched by Terry Newby as a tailor-made franchising concept, offering consumers excess inventory and end-of-line products online. The catalyst was a chance meeting in Monaco between the former America's Cup campaign manager and Fastways founder Bill McGowan - himself a mega-franchiser. "He made me realise how easy it is to pick up and deliver goods anywhere in the world," Newby says.

It's a Bargain offers consumers 11 different shops - from cars to cosmetics - stocking a range of products. These products are backed by manufacturers' warranties and a 14-day money-back guarantee. Newby, funded by a consortium of private investors, ran a pilot in New Zealand for six months to test the IT platform for the business. He recently sold the master franchise rights for Australia and New Zealand, and these franchisees will then sub-franchise each of the shops to people experienced in that industry. Newby retains the global rights to the business, and plans to expand further offshore within the next year.

The reason he opted for a franchise model was simple: "Franchisees are more driven, more likely to have business experience, be experts in their own field, and are more likely to be more successful than employees."

Why the rush to franchising?
Because it seems to work. Banks are falling over themselves to lend money in this area, and it's not hard to see why. Only about a third of new small businesses survive the first five years; by contrast over 94% of new franchisees surveyed are still in business after three years. Westpac's national franchising manager Daniel Cloete says loans to small businesses require 100% security, whereas loans to franchised businesses are made on normal lending terms.

Why? The risk of failure for a franchisee is considerably less than that for an independent small business because many of the risk factors have been removed. Franchisees are able to learn from others' trial and error. Buying a franchise allows those who want to be self-employed to go into business properly trained and equipped, with the security of a well-proven brand, product and system behind them.

Franchising is a relatively inexpensive way to expand - after all, you're using the franchisees' money to do so. That said, the costs of getting underway shouldn't be underestimated. Just under two-thirds of franchises surveyed in 2003 had startup costs of below $100,000 while just over a quarter were above the $200,000 mark. On the other hand, the average price paid by franchisees in startup costs was $132,000.

Another advantage of franchise businesses is a flat management structure - and consequently lower overheads. Green Acres, the country's largest, with over 800 franchisees, has only six people in its head office. The franchisees are also supported by the 60 master franchisees.

And while the franchiser doesn't have as much control as with company-owned stores, a well-structured franchise agreement can ensure tight control of the standard and image of outlets. What you forgo in profits from an outlet that was previously 100% company-run, you can make up for in terms of increased sales and input by the owner/operator, Lord says. When book retailer Dymocks started franchising, turnover in one of its outlets in downtown Sydney went up 30%. It was doing so well management decided to buy back the store from the franchisee. Turnover promptly dropped 30%. So then it was franchised again and turnover rose 30%.

Because they benefit directly from their efforts, franchisees tend to work harder than employees at controlling costs, marketing and day-to-day store management, Lord says. "All of these incremental issues have an exponential affect on profit."

The National Bank survey shows the average annual turnover of franchise systems increased by 19% on the previous year. But the figures also show franchisors do better when they think long term rather than being in it for a quick buck. Most survey respondents who started franchising after 2000 were making under $100,000 in annual gross income from royalties and other payments, while those who started during the 1980s were more likely to be in the $1 million and over category.

Do it right
Virtually any business can potentially be franchised. In the US franchising is applied to 62 different industries. New Zealanders have tried franchising everything from shoe shops to sex shops (this one never got off the ground) to dog washing and business coaching. The business needs to be replicable, have sufficient margins to support a franchise system, and have a point of difference from the competition.

Franchising is simple in concept, difficult in detail, says Win Robinson of Franchize Consultants. He reckons there are five steps to successful franchising:

1. Strategic planning - this is made up of two parts: a feasibility study and an implementation plan. The first tells you where and how you should franchise and what format to choose. Franchising ranges from simple licensing at one end to a full-format licensing at the other and there are other options such as co-operative buying groups in between. Once you've worked out what franchise structure to go for, you need an implementation plan. "A lot of people can do the franchise theory but it is very difficult for the uninitiated to roll it out," Robinson says. The implementation plan nuts out the detail, such as how big to make the territories for each franchisee and whether to have a tiered system, with master or area franchisees who then sub-franchise their area.

2. Systems - franchisors need to document in operating and training manuals how they want franchisees to run their business. The biggest cause of franchise failure is that the systems weren't set up properly in the first place. Getting the balance right so that territories can be developed properly yet still provide a decent return is one of the trickier tasks.

3. Legal - it's important to consult a specialist franchise lawyer on a company-specific franchise agreement. "This is where a lot of people make a big mistake. They go to a lawyer before they've done the first two [strategic planning and systems] and don't use a specialist franchise lawyer," Robinson says. There is no franchise law in New Zealand but the courts have recognised a franchise agreement is a specific contract that is more binding than just an agreement between two people.

4. Recruitment - it's pivotal to the success of your franchise system to choose the right franchisees, so you need a recruitment package that will attract the right sort of person. Franchisors need to protect themselves when recruiting and, for legal reasons, should avoid giving financial projections on how much franchisees will make - although you can say how well your business and other franchisees have done, Robinson says. In a landmark case in 2001, the High Court awarded more than $550,000 to a couple who had bought a United Video franchise, because their store never met the turnover forecasts claimed by the company's business manager.

5. Ongoing support - head office support needs to grow in line with the growth of the franchise system. Typical support services range from training on how to run the business, to research and development on products and services offered, protection of intellectual property, and developing relationships with suppliers - including preferential pricing arrangements which are passed on to the franchisee. At certain stages in the franchise development it is a good idea to introduce a franchise advisory council or ethics committee to help deal with potential disputes before they get out of hand.

Of all these steps, perhaps the hardest is finding the right recruits - and low unemployment means it's getting harder. Franchise consultant David McCulloch says franchisors are more choosy about who they sign on than when he started out in the industry 20 years ago. Back then, franchisors used the mirror test - if the mirror held up in front of the prospective franchisee fogged and they had the necessary money, they were in, he quips.

Most franchisors don't regard industry experience as critical - 80% of franchisees are new to the sector - because they like to train recruits "their way". A franchisor has to be like a psychologist when picking recruits, says franchise lawyer Stewart Germann. It is no good picking someone who is not used to discipline and having to abide by the rules. "Some self-employed people who have been in business on their own account for ten years or more may not make good franchisees," he says.

Another problem, points out Westpac's Daniel Cloete, is that new franchisors frequently pitch their royalty fee too low (these vary from 1-7% of sales). "They often charge too little to be able to deliver what they promised in the franchise agreement." The franchisor has to ensure it's making enough to match the head office support structure with the system's growth.

The nature and quality of that support can be highly variable. Take training: the National Bank survey shows the average training given to franchisees is 13.1 days. But Bakers Delight, which has 700 franchised bakeries in Australia, New Zealand and Canada, puts its recruits through a 16-week induction course. The course covers everything from baking to financial management and sales, says New Zealand training and recruitment manager Richard Nind. The more competent the franchisee, the more successful they are likely to be, he says.

The company's lengthy recruitment process includes a visit to three franchisees and spending two days in the bakery. Don Brown, the first to sign up as a New Zealand franchisee seven years ago, has three Auckland stores. He says the franchisor has got better at training and support as the system has grown.

In Brown's view, the biggest benefit of belonging to the franchise is the bulk-buying opportunities that have been leveraged - something other franchisors often don't take advantage of. "I'm paying less for flour now than I was 15 years ago when I had my own business. The royalty fee is well offset by that bulk buying and support you get."

Export yourself
Only one in five Kiwi franchise systems venture offshore. However, half say they plan to do so. They could do worse than study the success of Napier-based Fastways, the world's biggest courier franchise, with 1200 franchisees. The company, set up and franchised in 1983, operates in 12 countries. Managing director Brem Ellingham says the company took two years and spent $800,000 researching the Australian market before it franchised there ten years ago.

The money made in Australia enabled it to do a worldwide study on expansion opportunities. It has moved into ten other countries in the past four years after establishing there was sufficient money to be made in each country to support the owner/operator model.

The company's having a six-month "tea-break" on further offshore expansion while building up its infrastructure to cope with its rapid growth. The big push will come next year when it heads into the tough US market selling state franchises. It will also introduce cross-border deliveries in Europe.

And you don't need to have franchised your company in New Zealand to look at taking it overseas. Family-owned EC Credit Control is copying the Fastway model offshore (director Matthew Harrison formerly worked for the courier company). Harrison says the debt recovery company has no need to franchise in New Zealand because it is already well established here.

It expanded into Australia three years ago as a pilot franchise and the Australian operation is now much bigger than in New Zealand. The company plans to have appointed a master franchisee for the UK by the fourth quarter of this year and will then look to Canada.

So far, franchising has taken longer and cost more than anticipated - around $500,000 all up, says Harrison. Writing the training and operating manuals is proving an extensive exercise because of the complexity of the business. But Harrison remains convinced franchising will reap benefits. "We can realise some value in the business by franchising over the next two to three years and we will still have a good long-term business in New Zealand that we own 100%." Besides, it's fun to travel, he says wryly.

Once, twice...
The trend offshore is for successful franchisors to have more than one franchise system on the go at once, sometimes vertically integrated. For example, Simon Lord points to a Thai real estate agency that has just set up a franchised cleaning business to clean the houses the agency sells, and a franchised house removal business to shift the same clients into their new homes. All three franchises feed off one client base.

This hasn't happened in New Zealand - yet. One potential is Adrian Kenny, who founded the Green Acres franchise. He recently set up the rival @ Your Request, which has introduced several services under the one umbrella franchise - lawn mowing, home cleaning, commercial cleaning and the newly added home handyman service.

Because of his 14-year franchising experience, Kenny is constantly approached by people wanting help franchising their great ideas. He's currently developing two joint ventures that he will help run in conjunction with his own franchise. "They had the idea and I fit into the puzzle because I know how to franchise and I love getting out there and doing it too."

So, too, with Mike Pero. He's also considering a couple of new franchise systems after being inundated with proposals, but he won't divulge details just yet. His focus outside Mike Pero Mortgages is currently on a ghostwritten autobiography due out in August detailing his business career from motor mechanic to pilot to mortgage broking.

No doubt he'll have full control of these words, and the publicity is all good for the franchised brand bearing his name.

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