Understanding the franchise model

June 10, 2015
The franchise model is very different from the approach of the Big 4 consolidators and is increasingly becoming an alternative to grow a business.

Some of the most iconic and prolific businesses on the globe are franchises. Think McDonalds, Starbucks, H&R Block, Snap-on Tools, etc. Although the term franchise is thrown around quite a bit, there is often confusion about the franchise model, and the collision industry is no exception. Many may wonder how the franchise model works from an economic and financial standpoint and if the franchise model is a viable option given the industry's rapid change. 

The franchise model has been around many years and continues to gain traction in the collision repair industry. Major franchise operators in the collision repair industry include CARSTAR and FIX Auto. CARSTAR — with more than 400 stores and $700 million-plus in sales last year — is the largest pure play collision repair franchise network (excluding MAACO). FIX Auto is a close second with 318 stores across the U.S., Canada, the U.K., France and Turkey. Smaller up and coming franchises include Carsmetics of Florida and California and 1Collision in the midwest. There are also groups like MAACO that traditionally focused on fleet, refinishing and cosemtic repairs that are now entering the collision marketplace.

The franchise model is very different from the approach of the Big 4 consolidators — The Boyd Group, Caliber Collision, ABRA and Service King — that predominately buy and sometimes build locations. In general, franchisors do not actually own or operate individual locations, instead relying on franchisees to run the day to day.

 For many individual collision repair businesses, the franchise model is increasingly an alternative to grow a business. Rather than standing pat or attempting to compete one on one with other large players in the market, the franchise model allows independent owners to retain ownership of their business while also taking advantage of the scale and experience of a much larger organization

I had the opportunity to sit dow with both David Byers, CEO of CARSTAR and Paul Gange, president and COO of FIX Auto USA, to discuss the costs and benefits of the franchise model, industry consolidation, the opportunities available to collision repair business owners and the role of private equity in the collision industry.

What is a franchise?
A franchise is essentially an agreement between two parties, where one party agrees to confer the right to proprietary knowledge, processes, trademarks, brand, etc. in order to allow the other party to sell a product or provide a service in exchange for a fee. There are two parties to every franchise agreement — the franchisee and franchisor. The franchisee is the one selling the product or service (i.e. the operator), whereas the franchisor is the company behind the scenes that owns the brand.

Another way to think about it is the McDonald’s commercials you see on TV are the franchisor and the drive-through is the franchisee. Franchisors own the intellectual property and brand assets of a business, whereas franchisees tend to own the physical infrastructure like buildings and equipment. Or, as a marketing professor once said to me, “You can SEE the franchiSEE.” A bit corny, but you will probably never forget now.

How does it work financially?
Joining a franchise requires a significant investment, both up front and ongoing. The premise of entering into a franchise agreement is that a smaller business pays for access to the brand and operational expertise (intellectual property) developed by a larger institution. In order to even sign a franchise agreement, the franchisee must pay an up front fee to the franchisor. This gives the franchisee rights to license the franchisor’s assets, and also ensures that the franchisee has skin in the game, minimizing the franchisor’s risk of not being compensated for access to proprietary processes and procedures.

Bothe FIX and CARSTAR charge an up-front franchise fee, and fees start at a minimum of $10,000. Both organizations are not shy about this, as they are looking or owners who are deeply involved in their business. Gange says FIX seeks out "very successful, very competitive, driven, engaged, passionate collision repair shop owners who want to stay in the business and compete."

Byers echoed that statement. "We have very specific guidelines for what stores should become CARSTAR stores in our network. We clearly are working at larger stores that are a bit more sophisticated."

In addition to the upfront franchise fee, most agreements include an ongoing franchise fee. Fees often are structured essentially as royalty agreements where the franchisee pays either a fixed monthly fee or a percentage of sales directly to the franchisor. Other agreements require the franchisee to purchase certain items (i.e. paint and/or allied products) directly from the franchisor, contribute to marketing budgets, or commit facility upgrades and capital improvements. Every agreement is unique, so it is important to read the fine print. In CARSTAR’s case, they do not require direct purchases and have one of the lowest ongoing fees in the entire franchise world at 1.5 percent of revenues according to Byers. 

While the fees are low on a relative basis, a franchise fee is a significant financial commitment. Because the fee is a percentage of sales, not profits, the franchisor gets paid first, regardless of the profitability of the franchisee’s business. This is often an overlooked and under appreciated aspect of entering into a franchise agreement. Even if a business is losing money, the franchisor still gets paid.

However, in return for those fees there are often a lot of perks to belonging to a franchise group. CARTSAR delivered $6.5 million in rebates to its members in 2014, or about 1 percent of sales, according to a recent press release. Many franchisors tout their buying power. Because the franchisor is able to negotiate on behalf of the entire network, they can drive discounts and rebates for their members. "In most cases, CARSTAR is the largest purchaser of major parts, or paint or products within the industry. So we are negotiating national discount levels that would not be available to an individual operator," says Byers.

Gange continued, "We absolutely have a robust buying program and we continue to enhance that. It is fun for me when we run those calculations and see the types of savings that we profice to our franchisees. But I honestly don't think that is the end al and I choose not to promote our business based on that."

Another benefit of belonging to a franchise is the brand strength that being part of a larger organization brings. Both organizations have an insurance relations team that builds brand awareness with key insurance carriers at a national level. "We maintain large MSO agreements that we negotiate at the national level," says Gange. "I'm very involved with that."

Gange went further. "And then we have a marketing fund that everyone pays into. The minimum payment is 0.75 percent of sales with a cap of $950 per month. But the owners by market can vote that up. And in every one of our markets they have because it sia share of resources. One hundered percent of those dollars are spent in advertising."  

"We even do sports advertising with the Portland Timbers and the San Diego Padres. Every dollar in goes back out on behalf of the franchisees. But the beautiy, of course, is my $1 is combined with many others that have much more buying power."

Byers added, "We meet with almost all the big national carriers on a regular basis. We make recommendations about which stores should be added based on the performance criteria of that individual carrier. We measure the stores that come in to our network across a whole host of measures. On the DRPs, the first year they hoin us, they have an average of two DRPs, on the fourt year, 11."

Additionally, many franchisors offer operational insight in the form of education and training to assist owners in running more efficient and profitable businesses. CARSTAR takes operational performance seriously. "What I think is most beneficial for CARSTAR is we have some of the very highest KPIs of any of the MSOs. I think our customer satisfaction scores are the very best of any of the MSOs, period," says Byers. In order to drive high performance, franchisees attend national meetings and have access to proprietary best practices, training platforms, SOPs, as well as KPI reporting.

FIX also takes operational performance very seriously. "We're very concerned with consistent performance. We are very transparent. But to be honest, the wood behind the arrow is really our fixed claim solutions group. We have built a model that delivers on efficiency, that reduces the cost associated with settling a claim. That doesn't mean that we are a lower-cost provider in terms of severity. What it means is that we are more efficient in how we work with carriers."

Other considerations
Both CARSTAR and FIX have very specific guidelines for what stores can become part of the network. There are revenue guidelines as well as operational resources that both evaluate prior to acceptance into the network. Both organizations want to ensure that individual stores are set up for success and have the resources to achieve the success. Byers states, "We are working with stores that are looking for help across the wide range of elements in the industry."

Gange agreed, stating, "Most of the shops that join FIX have just come up with a record year. These folks recognize that there are new market segments that have been created in the industry, and they want to re-position for success in the longterm."

It is important to keep in mind that a franchise agreement is a legally binding document. In signing a franchise agreement, you are bound to run your company according to the rules and provisions contained within that agreement. A franchisor will do everything possible to improve the operations of their franchisees, but according to Byers, "You're only as good as your weakest link. There is no doubt that we will remove stores if a store is not performing. And we have done that."

Ultimately the franchisor has the legal authority to remove an underperforming member for the benefit of the other franchisees or levy other penalties as warranted. Signing up for a franchise is not as simple as paying a company for the right to slap their brand name on your store.

Gange continues, "I tell people very candidly, "You trade off some of your individual liberty to gain the benefit of being part of a group. Joining a franchise is a very strategic decision and FIX makes sense to those kinds of operators who are thinking strategically and thinking longterm. The thin about FIX is we rarely talk to people who need us today. And frankly, most of the folks that come in to FIX believe it to be the best decision they've ever made."

A franchise is also not a fix-all solution. Both FIX and CARSTAR takes KPI management and operations seriously, as do most franchises. Although a franchisee will have the support of a big brand name, it does not mean the business owner can sit back and relax. The structure and control of a franchise may mean as a business owner you are working harder than you ever have previously. But franchisors counter that the business owner will have more support and be making more money than ever before. "We bring on stores in our network that have the financial and operational resources available to implement our plans, our programs and they're going to be set up for success," Byers said.  

Franchise agreements are a great way to focus on improving operations, but tend not to offer as much support in financial management. Both franchises have some tools to help manage your P&L and compare performance across peers. However, actively managing your income statement, cash flow, working capital, CAPEX investments and arranging financing is still up to the individual business owner. While both groups will assist with site selection, managing inorganic growth through acquisitions or brownfields predominately falls upon the franchisee. Cultivating resources that assist individual business owners in developing financial core competencies, as well as operational excellence, is a significant opportunity for franchisors in the industry.

Read the fine print of the agreement. While a franchise can offer a great opportunity to partner with a well-known brand, the franchisor is under no obligation to guarantee any increase in revenues or profitability. While they provide the tools, marketing, and support to improve your business, ultimately it is up to the business owner to drive change. And growth will require the development of core competencies not only in operations, but also in marketing, finance, acquisitions and integrations.

Brad Mewes is the founder of Supplement!, which provides financial insight for automotive industry professionals. If you would like to discuss how you can better position your company for success in this rapidly changing industry, contact him directly. You can see his extensive writing on similar trends in the collision industry and email him directly at www.supp-co.com

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