MUCH BUSINESS LITERATURE characterizes buying a franchise as inherently less risky than starting an independent firm. The franchisor offers a proven concept, recognized name, guidelines and training in return for an up-front fee and a percentage of what the franchisee, the buyer of a franchise, makes each year.

However, new franchise systems don't necessarily succeed more often than non-franchised businesses do, a study by a Georgia Institute of Technology researcher shows. Dr. Scott Shane, director of the Georgia Institute of Technology's DuPree Center for Entrepreneurship and New Venture Development, studied the 1983 crop of new franchisors to determine how many were still franchising 10 years later.

"The failure rate of new franchise systems is roughly the same as that of all new businesses," said Shane, an assistant professor in Georgia Tech's School of Management and director of Georgia Tech's Corporate Venturing Program. "By the end of 1993, less than one quarter of the initial cohort of franchisors was still franchising.

"If you buy a new franchise from a new franchisor, there is a 75 percent chance the person who sold it to you won't be around to support you in 10 years," Shane explains. "So, it's very important that people thinking of buying a franchise outlet differentiate from long-standing franchisors and those that just started this year or last year."

With support from the U.S. Small Business Administration (USSBA), Shane has explored factors that the surviving franchisors have in common. His findings not only offer guidance to potential franchisees; they can help potential franchisors decide when they are ready to grow, as well.

History of Franchising

The word "franchise" is of French origin and initially had meanings similar to "freedom" or "free." It is associated with the granting of a privilege by an individual or group -- a government, for example, providing its citizens a constitutional or statutory right to vote, or a company offering to others the right to sell its services or products.

Franchising first became popular in the United States after World War II, when several gasoline companies adopted this method of doing business. Singer Sewing Machine Co. was the first business in the United States to use franchising.

Today one new franchise outlet opens every eight minutes of each business day, according to the International Franchise Association. Sales from franchised establishments account for a third of all retail sales, the USSBA says -- and that figure is expected to grow to 50 percent by the year 2000.

Franchisees pay initial fees ranging from under $10,000 to $575,000. Once in business, they generally pay monthly royalties to the franchisor of between 1.5 and 12 percent of gross sales, according to the USSBA.

Why are franchises so popular? In addition to the perception, for business people, of carrying less risk, franchises fulfill the wants of the modern consumer by providing consistent goods and services of recognized quality.

Successful New Franchisors

Shane collected data from the 1983 new franchisors' Uniform Franchise Offering Circulars -- documents providing information about a franchisor and its new franchise system to potential purchasers. That data shows that most of the 138 new franchisors in 1983 were eating places -- 17 percent. The rest ranged from lumber and building, computer and camera stores to employment agencies, data processing schools, and grocery, music, retail and photocopying stores. The businesses had operated an average of 3.5 years when they began franchising, and most had 3.5 outlets at that time.

"Interestingly, that decade [from 1983 to 1993] was one of significant growth for entrepreneurship in general, and was one of outstanding growth for franchising," Shane notes. "Employment by business format franchisors increased from 5.2 to 8 million."

Shane found that surviving franchise systems tended to be older and larger than non- surviving systems when they began franchising. They also had higher franchise fees and higher levels of initial investment, although these differences were not always statistically significant.

Franchise systems that survived during the first four years -- when 57 percent of their cohort went out of business -- shared several characteristics that directly influenced their survival:

• Expansion Through Franchising: The surviving businesses emphasized growth via franchises, rather than through company ownership of retail outlets. Emphasizing franchising growth resulted in faster expansion and economics of scale in purchasing, administration and distribution.

• Initial Growth in Company-Owned Outlets: Surviving franchisors opened most of their company-owned, as opposed to franchised, outlets during their first two years. They stopped adding company-owned outlets after their first six years of business. This strategy allowed them to learn the business by operating their own outlets initially, and then concentrate on expansion using franchises and the advantages they offer.

• Knowledge Transfer to Franchisees: Surviving businesses spent more time training franchisees; provided more help in the form of operating manuals, financing and marketing assistance; and required a higher investment from franchisees in signs and equipment.

• Lack of Franchisor-Specific Assets: Franchisors whose advertising fees were higher than the industry average, and who transferred proprietary equipment to franchisees, didn't survive as often as franchisors who avoided these practices. Why? They introduced bilateral bargaining problems -- the franchisor becomes dependent on the franchisee, who can withhold advertising funds or refuse to return equipment, for example, in exchange for what he or she wants.

Five to 10 years into franchising, factors that predict survival of a system were similar to those important during the first four years -- except for one. Knowledge transfer in later years seemed to decrease a franchise system's chances of survival, Shane found.

"Competitors pay significantly more attention to new franchise systems after they have survived for four years," he explains. "[At that point], competitors often become interested in discovering what knowledge the new franchisor is transferring to franchisees, in hopes of copying or offsetting that information advantage."

Among the factors that Shane's study shows do not influence new franchise survival are the amount of royalty rates and franchise fees, and the growth rate of the franchisor's industry.

"High- and low-priced systems were equally likely to be in existence across all periods investigated," Shane said. "Quality and strategy of the franchise system was of such great importance that overall industry growth rates did not matter very much."

Future Study

Franchising is still a relatively new area of investigation -- and it poses its own special challenges, Shane says.

"The biggest issue is that you are studying organizations, most of which are dying," he says. "It's very hard over time to track performance because you have to get people to talk about failure, or get the records of companies that fail, both of which are very difficult to do."

In the meantime, Shane and colleagues in the School of Management are sharing their findings with business people via executive education programs, as well as with Georgia Tech graduate and undergraduate students. Georgia Tech hosted a scholarly conference on franchising research in January, the results of which will appear in a special issue of the Journal of Business Venturing. And Shane notes that findings on franchising may be applicable to other business practice areas, as well. Issues faced in licensing technology, for example, are similar to those franchisors face.

"From our point of view, franchising has contributed to research, community outreach and executive education -- there are practical applications of the research, so it's really quite valuable," Shane notes.

In the future, Shane plans to study additional franchising-related topics: The "appropriateness" of franchising for a particular business, the effects of good and poor management or advice, and the quality of support offered to franchisees. He also is interested in the ability of the franchisor to share knowledge with franchisees while concealing it from competitors; franchisee selection; management of franchisee turnover; the optimum mix of franchised and company-owned outlets; and overseas expansion of franchises.

Further information is available from Scott Shane, School of Management, Georgia Institute of Technology, Atlanta, GA 30332-0520. (Telephone: 404/894-3979) (E-mail:scott.shane@mgt.gatech.edu)

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Last updated: 28 May 1996