realonomics

In the post “Unlocking Franchise Economics,” Part 1, we opened the door to asking relevant questions that will help owners analyze the economics of real estate franchising.

In this series of posts REALonomics has one primary objective it would like to accomplish on behalf of owners and that is as follows:

…to help owners unlock the door to franchise economics so that gain an understanding of the substantive value propositions that exist and how a franchise name and associated promises can be quantifed in real dollars that are converted to a profit equation that is greater than it would be if the brokerage firm operated without the franchise.

Franchising is an Add-On Toolkit, with Limitations

At its most fundamental economic level a real estate franchise is a brokerage toolkit. Yes, there are all sorts of issues such as marketing, relocation, referrals, training, conventions, etc. But for now, we are setting those aside. A real estate franchise is an economic toolkit, at least it should be. Franchisors spend a great deal of time butter-balling brands, numbers of offices, growth, name recognition, relocation, referrals, etc., and that is how most franchise sales people will present their proposition to an owner. It’s the owner’s responsibility to translate the presentation into real economic reality and performance and to insist that the franchisor do the same.

As a toolkit, there are some things a franchise can do, there are many things it cannot do and there are more things it does not want to do for a brokerage firm because to do them will harm the franchisor’s bottom line. Let me be clear on this last point. At some point in the franchise relationship, an owner may find the franchisor a competitor for market territory, referrals, relocation and even local business.

As owners, it is important to enter your franchise considerations with both feet firmly planted on the ground and your eyes wide open when you begin to consider both the limitations and the benefits of the franchise toolkit. Converting the tool kit into a quantifiable economic model is entirely another thing and in the end will prove to be the true test of the value to your brokerage.

When an owner considers franchising his/her brokerage firm, one of the highest considerations is the impact on agents and operating overhead. Make no mistake about it; a franchise decision will change the economic structure of the real estate company before it ever delivers a single penny of economic value. Overhead is going to increase immediately and not all agents and employees will perceive and measure value as an owner might. - Donald Teel, Realonomics

Bottom line: the tools provided by a franchisor should fill voids in the brokerage firm with real solutons that can be measured. The brokerage firm must know with certainty how the tools produce NEW ROI (more on this later) and finally, how the implementation of the franchise enlarges the company’s market position and growth opportunities. It is entirely possible that becoming a franchise may in fact diminish a firm’s market potential.

Understanding Owner & Franchisor’s Motivational Schemas

As with any business arrangement, understanding the motivations of the parties is critical so that each can build a workable blueprint. Franchisor are in it for the money. Since franchisors are in it for the money, so should the owner be! Business is conducted with a profit motive, although some brokerage firms are not necessarily profit driven.

If you franchise, you will spend a lot of time (perhaps years) in continued negotiations with the franchisor over myriad operating issues (we will get to this later, as well). Therefore, coming out of the chute, the owner needs to have a pristine understanding of what drives the franchisor’s model.

The Owner’s Schema. I never met an owner that didn’t love transactions. Typically, when an owner considers incorporating a franchise brand into his/her market model, transaction are a key motivator. The Franchisor knows this and the presentation is designed to convey a perception that once franchised, transaction counts will increase.

In addition, broker/owners want more market opportunities in terms of their ability to provide agents with services that will enhance recruiting. However, recruiting is a somewhat dying art and most metro markets are saturated with brokerage firms and agent, reducing the recruiting message to a simple message, “We pay you more.”

Some owners want and desperately need networking opportunities with other owners where they can exchange information, create idea forums and discover new ideas to improve the efficiency of their company. Franchisors can meet this need and most do a good job at creating opportunities for Broker/Owner exchanges.

Today technology and the Internet play an ever increasing roll in real estate brokerage business operations. This was not so true just 14 scant years ago when the first property listings found their way to the Internet and pagers found their way into the hands of agents.

Many brokerage firms are looking for technology solutions and the implementation and maintenance of these solutions can be incredibly expensive. Franchisors are finally beginning to see how technology can provide them with a lock on brokers. When considering a franchise Broker/Owners should have a complete understanding of what a particular technology solutions will create in terms of not only opportunities, but operating costs, maintanance, training and obsolescence. After all, it won’t be included in most franchises.

The Internet is separate from technology, in our opinion, and there will be a whole set of operating and branding requirements for the owner and his/her agents when it comes to utilizing the Internet. Do not assume that your website will automatically comply with the franchisors requirements…read that fine print. Franchisors are doing a much better job today with their technology and Internet delivery than were even five years ago. Most owners want more Internet traffic. Find out how the franchisor delivers Internet presence AND traffic.

The market is paramount to an owner. Almost every owner I have known in nearly 25 years shared the desire to see their company grow in size and market share. What owners may not realize is that “market” is a very important word to the franchisor and it is here where the greatest potential for conflict between owner and franchisor might arise.

Owners want to capture and control more market area horizontally whereas, many times, the franchise will contained highly defined and rigid definitions of “market area” that the owner may find restrictive. Will entering into the franchise agreement expand or contract the owner’s market opportunities? This is an all important question needing to be answered.

Owners are increasingly discovering that market definition in the franchise relationship can make or break them. Any and all attempts to block an owner’s legitimate rights to horizontal growth should be negotiated out of the franchise agreement. Retrictions and control of horizontal market expansion is a key to the franchisor’s economic model. Franchisors typically exercise control over expansion by denying use of marks, brands and branch offices unless they approve. - Donald Teel, REALonomics

Finally, profit is the end game for owners. Although the franchisor will state its strong support of owner profitability, what will happen to the relationship when losses mount for the owner. What specific economic support does the franchisor provide to failing brokerage firms in terms of fee reductions or set asides?

Franchisors should be required to specifically demonstrate with empirical data how the franchise will pay for itself and how long it will take before the relationship brings profit to the Owner when measured against all related expenses. In the opinion of REALonomics, this should be a warranted performance item, with franchisee recource. If they can’t or won’t do it, show the franchisor the door. After all, profit is the end game of business.

The Franchisor’s Schema. Real estate franchisors measure things with a different stick than do most broker/owners.

The king pin in the franchise economic model will always be the brokerage gross commission income (GCI). It is the primary calculator for the franchise payment stream. Franchisors are interested in GROSS as the number against which their multiplier is applied, whether it be 3, 6 or 8 percent. This is their great motivator. Forget the franchise fee of $15k, $25k, $30k or $50k because this number will pale over the long haul of 5-10 years (typical initial franchise term).

How an owner thinks about and treats the franchise effective fee rate in the accounting process is paramount to quantifying the franchise value. If you think of franchise fees as a cost of sale, that’s one thing. If you treat is as an expense item, that’s another. But if you view it and treat it as a business development and capital expansion cost, that’s entirely another matter.

Definitions do count and calling a franchise cost a “selling cost” may be a giant investment error. After all, what did the franchise have to do with the selling cost of your transactions and if it did contribute, how did it contribute? Can you specifically account for it as a selling cost? An expense? Franchising is a market and development cost. Think of it in terms of research and development.

Franchisors are also motivated by the durability of the brokerage firm when they award a franchise to and owner. This has to do with the history and good will of the company in the local market(s). From this a franchisor can deduce predictability and replication of fee payment.

Referrals and relocation leads are a huge part of any franchisors presentation. But, be careful, because most of the major franchisor are running the relocation and referral businesses under not so evident agreements and as separate profit centers. This is a political and economic playing field that is continually tilted by franchisors. It is not uncommon for one franchisor’s relocation lead to be given to a direct competitor operating in the same market as its franchisee.

Watch out when you weigh relocation and referrals as a part of your decision-making. Our advice, based upon your market location, is to consider whether these should be taken off the table as considerations in the value proposition. You’ll only be able to do that if you ask for and receive the referral and relocation statistics with detail. Do not predicate your decision to franchise your firm on empty promises relocation and referral leads.

An owner should explore franchise training programs, business planning and the host of other fringe benefits as well. These are a part of the toolkit…but will they be used and are they, in fact, cutting edge or shop worn?

Stay tuned for “Unlocking Franchise Economics: Part 3.”

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