Despite the continuing global economic woes that have plagued 2012, franchising has remained one of the bastions of business success globally. While South Africa’s franchise sector has not experienced a stellar performance in 2012 – 5% to 7%, in line with inflation – it’s slightly above par in the global trend of between 3% and 5%.
In fact, South Africa’s franchise sector outperformed the country’s other dominant sectors such as mining, manufacturing and agriculture, contributing 12% to GDP.
Global impact on SA’s franchise sector
The sector has not been without its challenges though. Andre Rosslee, head of Sector Solutions at ABSA outlines the impact of global economic instability by stating that, like most sectors within the South African economy, the franchise sector has seen turnovers coming under pressure, ultimately leading to margins being squeezed.
“The continued turmoil in Europe and the subsequent economic instability it created fuelled uncertainty with investors and potential new franchisees, which led to franchisors taking a more conservative view on expanding their brands and rolling out new stores. New retail developments virtually came to a standstill, limiting the availability of sites for new outlets too,” he explains.
Still, franchising has shown its resilience both in South Africa and internationally. Vera Valasis, executive director of FASA, has stated that franchising appears to be holding its own admirably: “Franchising is healthy and growing in many countries around the world – Brazil experienced 9% growth.
Franchising embodies sound business principles, tried and tested business models, economies of scale and benchmarking, and entrepreneurial spirit, ensuring the flow of new concepts and bright ideas – all these elements are associated with sustainability and longevity.”
Roadblocks of 2012
Morné Cronjé, head of Franchising: FNB suggests that, economy aside, a poor perception of franchising is an issue affecting the growth of the sector: “South Africans tend to have a corporate mentality, meaning that they perceive corporate as the route to making money.
People need to understand that although franchising is not a ‘get rich overnight’ project, there are multi-franchise owners out there who are earning much more than CEOs.” The persistence of this image, says Cronjé, is due to a lack of success stories. “There should be greater emphasis on franchising as a wealth generator in order to encourage growth,” he says.
Other roadblocks, Cronjé says, include the high cost of rentals and shortage of low cost entry opportunities. “In countries like the US, the ‘man-in-a-van’ concept allows for greater participation in the franchise sector. It’s very expensive here, and not many people have R1 million in their pockets to buy a franchise.
On top of that, rent is expensive and set-up costs are very high – basically profits aren’t increasing at the same rate as rent, set-up costs and electricity. But an express store or mobile unit with a set-up cost of between R450 000 and R750 000 is a lot more accessible and offers greater franchise opportunities.”
Improvement through adversity
Despite these challenges, there have been positive developments. According to FASA, franchisors have taken steps to counteract the global recession and economic changes by developing smaller, more cost-effective franchise models with reduced franchise fees, start-up costs, number of employees, and reasonable rents.
New, less expensive alternate locations beyond the shopping mall are also being explored, including stand-alone kiosks, corporate catering, campuses and sporting events. Cronjé echoes this, saying that there is a big drive into rural areas. FASA has also observed that franchisors are investigating alternate markets to expand into by operating in tandem with non-competing brands.
Over and above these adjustments, Cronjé says that more and more professional franchisors have seen the downturn as an opportunity to fine-tune their business and provide additional support to their franchisees.
“In general the outcomes have produced streamlined product or service offerings with added value items, expansion into alternate markets such as breakfast or dinner trade, better negotiated deals with landlords and suppliers, enhanced training programmes to improve customer service, and increased value added promotional marketing,” he says.
Who’s doing okay
Fast food and restaurants. Alongside independent businesses and corporates, some industries have fared better than others over the course of 2012. In Statistics SA’s food and beverage survey released this June, the food and beverage industry grew by 10,8% in comparison to June 2011.
The main contributors to this growth came from quick-service outlets – contributing 6,4 of the percentage points – and restaurants and coffee shops – contributing 3,0 percentage points to the total. Cronjé agrees, saying that while sit-down restaurants have taken a knock due to high set-up costs and the highly competitive nature of the industry that has been battling out the ‘breakfast war’, quick-service restaurants (QSR) have picked up.
Rosslee notes however, that while QSRs have been less affected by the economic downturn, the industry has still experienced serious pressure on margins due to increased food inflation, and operational costs such as electricity, transport and labour costs.
It’s an unfortunate reality that South African education standards are low. In response to this, the supplementary education industry has grown quickly, says Cronje. “Despite people not having
a lot of disposable income, there’s an awareness of the importance of education.
This has led to education focused franchises like Kumon, Master Math and Active English seeing a rise in business. Parents always want what’s best for their children, so they’ll sacrifice other luxuries in favour of their child’s education.”
Following on from this restraint in luxury spending, industries catering towards maintenance and repairs have seen a marked increase in response to consumers’ frugality, says Rosslee. “A reluctance to make big purchases has seen a change in replacement patterns of vehicles, supporting the growth of franchises operating in the aftermarket, servicing, and out of warranty industries,” says Cronjé.
“Another category to watch could be after-market value adds for cars such as designer wheels, leather interiors, smash and grab protection, alarm and sound systems,” he says.
The road ahead
Rosslee points out that for the foreseeable future funding will remain tight and consumer spending is likely to remain under pressure. “These issues are compounded by ever-increasing input costs such as fuel, electricity and operation costs that place significant pressure on profit margins.
Strikes and labour action in other sectors of the economy may also have significant knock-on effects on the franchise sector,” he says.
Taking these issues into consideration, Cronjé believes that the gap between dominant and small brands will increase as larger brands continue on a merger and acquisition drive. “The major, listed brands, namely McDonald’s, KFC, Nandos, Taste Holdings, Famous Brands, and Spur Group, are growing rapidly by both mergers and acquisitions and brand expansion. This multi-brand position gives them huge advantages that come down to economy of scale,” he says.
These advantages include preference given by landlords and negotiating lower rental terms, suppliers giving major groups favourable terms and conditions because of their bulk-buying ability and perceived low risk, financial institutions more inclined to offer loans based on the brand’s success and calibre of its franchisees, improved profit margins from established distribution centres, large budgets, and aggressive marketing capacity.
Where does this leave the smaller brand? Cronjé believes they have the option of going on their own acquisition drive or merging together, embarking on a rapid growth drive to become a bigger player, dominating an area or province, or expanding into outlying areas.
With recession talks slowly abating, Valasis says it’s expected that franchises will continue to fly the flag of ‘adaptability’. “Franchise is one business sector with its ear close to the ground for picking up consumer trends.
And by the nature of the franchise system, franchises are best suited to effectively make the necessary changes to stay in (and ahead of) the game, start a new trend, identify a niche market, or jump on another bandwagon,” she explains.
Getting in on franchising
If you’re thinking about entering the franchise sector, Cronjé, Rosslee and Valasis offer the following advice:
- Take the time to investigate the opportunity thoroughly, and don’t just accept everything you’re told. Speak to as many franchisees as you can before committing to a specific brand.
- When buying an existing outlet, have a proper due diligence performed by an independent accountant. Consider the long-term viability of the brand – don’t be a sucker for fashion or fads.
- Prepare properly before seeking finance. This means having a business plan that you know and understand (don’t cheat on a consultant), as well as your required contribution.
- Consider and investigate the rate of the brand’s growth as well as any closures.
- Negotiate favourable terms on all costs and expenses, including rent. Profits are often consumed in the hidden admin costs and annual escalation.
- With interest rates very low at the moment, consider the impact of possible future interest rate increases over the period of finance.
- Be fully aware of all relevant regulatory requirements such as the CPA.
- Manage your expectations. It takes time and proper management for a franchise to generate wealth. Can you sustain your lifestyle until such time, or are you prepared to downgrade?
Executive director of FASA, Vera Valasis, explains that legislative changes such as the Consumer Protection Act and the Companies Act are forcing companies to change the way they do business. “Franchisors that aren’t members of FASA should be aware that certain requirements of the CPA, such as the ruling related to Disclosure Documents, could land them in hot water if not adhered to. It’s tantamount to breaking the law,” she says.
“There is a misconception that FASA is the body that requires its members to have a Disclosure Document when in fact it is now law, through the CPA, that all franchise companies, whether FASA members or not, provide prospective franchisees with a Disclosure Document,” Valasis says.
Patch, glue, stitch
A trend emerging from continued economic instability is reluctance by consumers to make big purchases. A typical example is that of new vehicle sales having suffered. Morné Cronjé, head of Franchising: FNB, notes however that the downturn has contributed to the emergence and growth of maintenance franchises for tyres, batteries, gearboxes and general services.
Tracey Fawell, founder of Laundry Dynamics – a wash, dry and iron franchise – echoes this sentiment saying there has been a marked increase in clients looking to preserve items of clothing and shoes instead of replacing them.
“Each of our stores has seen an increase in clientele who want to repair clothes, or dye a pair of faded jeans. We also have a lot of shoe repairs,” she says.
“There is a definite sense that consumers aren’t as quick to throw things out anymore. They’re more mindful of how they spend their money, and they’re interested in the sustainability and longevity of products, so we’ve successfully diversified into avenues like tailoring, dyeing and shoe repairs.”