A simple guide to feeding your business
Food franchises are commonly signified as a ‘high margin’ style of business. However, while margins may be high (often 60 to 70 per cent), the transaction value is usually low – say, $5 to $20. This means that for a business to be successful, it needs to generate sufficient volumes to cover the fixed costs such as labour and occupancy.
Consequently, a new food franchisee is faced with learning not just the operational aspects of the business but also the demands of managing the staffing roster, the products and
Ingredients, menu quality and customer satisfaction while at the same time managing
cashflow and developing profitability.
The most crucial time for any new business is the first six to nine months. Our research indicates that while businesses that fail generally do so in their third or fourth year, in most cases the performance issues can be traced back to the first six months. This needn’t be the case if the business owners have a clear understanding of the targets and timelines they need to achieve in order to build a sustainable venture that will deliver an acceptable return on investment.
Unfortunately, while new franchisees may receive comprehensive training on how to operate their new business, they don’t always get the same understanding of the key information they need to manage it.
This article looks at the crucial management components to ensure viability in a food business.
These can be summarised as follows:
Return on investment
Sales drivers
Breakeven
Margins
Spool-up rate
Expenses and productivity
RETURN ON INVESTMENT
Many franchises are granted on the basis of a 5-year term plus one or more renewal periods of 5 years each. Because renewal is not a certainty, and other issues such as lease terms and re-fit costs may need to be considered, as a simple rule we suggest that franchisees should look to pay down the related business debt in the first term of the franchise. In order to accomplish this debt repayment, and additionally to redeem the owner’s equity, the business would need to return an average Return On Investment (ROI) of 30 per cent over the first 5 years.
However, in calculating this figure, it is important to factor in the true and full cost of the venture – in other words, the total funding requirements for the franchisee. As a guide, this could include:
Franchise fee
Fit-out
Training cost
Equipment and furniture
Legal and accounting fees
IT set up
Lending set-up costs
Initial marketing spend
SALES DRIVERS
The first priority of any business is to generate sales and reach the breakeven point in the shortest possible time. Once this level is achieved, the next phase is continuing to grow sales to reach the ROI objectives.
Sales generation is a combination of the following factors:
Customer count
Average yield
Customer satisfaction
Repeat frequency
Upselling
The two major drivers of sales growth are customer count and average yield (how much each customer spends). Using the breakeven formula, sales targets can be refined to calculate monthly, weekly and, in some cases, daily targets for customer count and average yield growth.
BREAKEVEN
The breakeven formula is one of the most powerful management tools for any business. Unfortunately, in our experience, the majority of franchisees (and even many franchise support personnel) often lack a real understanding of the process and its many applications. While franchisees can generally tell you how much trading surplus they require to meet all their obligations, they usually struggle to then translate that number into business targets.
The formula for breakeven is: Fixed Costs = Breakeven Sales
Calculating a sales target based on desired franchisee return is a powerful tool for franchisors to help franchisees manage their businesses better and achieve higher levels of satisfaction.
MARGINS
With most food businesses requiring a high-margin model, any margin leakage can quickly unravel the impact of sales growth and cause significant problems.
Margin is the outcome of a range of factors which mainly include:
Product/menu mix
Discounting
Wastage/spoilage
Add-on sales
Shrinkage/theft
Any menu will contain a range of products and meal options with varying margin returns. Margin distortion can occur when the balance of the product mix is skewed to the lower margin options, or when lower-margin products outsell higher-return products to an unacceptable degree. This can be further compounded by discounting the offers in a mistaken strategy of trying to improve cash flow, rather than addressing the distortion: eg, by changing the mix, better promotion of higher-margin products or training staff in add-on sales.
While most operations can and do measure sales regularly, they find measuring the margin result more problematic. A true margin result should include wastage and shrinkage levels, and can only be obtained if regular (monthly) stocktakes are undertaken. On an ongoing basis, margin leakage can be an incipient factor that left unchecked could significantly reduce profitability.
SPOOL-UP RATE
Once you have worked out the breakeven sales target, the next step is to calculate the spool-up rate - in other words, how long will the business take to build sufficient volumes to achieve first the breakeven and then the profit target? The slower the spool-up time, the more working capital the business will require to fund its operations.
Once the targets are achieved, however, the business should be soundly based; the same calculations can be used to assess any new initiatives or expenditure and keep it on track.
EXPENSES & PRODUCTIVITY
As a general rule, apart from Cost of Goods, the two major expenses in a food operation are occupancy and labour costs. In some cases, these two expenses can represent 40 to 50 per cent of sales. In a business that operates on 70 per cent margins, after allowance for franchise royalties and marketing fees, that would only leave 10 to 20 per cent of sales to meet all other expenses plus profit. Given this type of scenario, owners need to work to maintain high volumes and low costs as well as maintaining margins.
Productivity is the measure of labour efficiency. What return am I getting for the cost I am paying? Most businesses try to relate this measure back to volume or activity; however, we actually pay our staff not only to generate sales but to do so at a target margin. In essence, we want our staff to:
Make the sale
Upsell the sales value
Generate the order quickly
Get the order right the first time without wasting product.
The productivity ratio is calculated as:
Gross Margin Dollars = Productivity ratio Full Labour Costs
Taking the figures in the example above (which have already been reduced down to a per dollar rate), the margin of 65 cents is divided by the labour costs of 25 cents to give a productivity ratio of 2.6.
Each business is slightly different, but the average business seems to produce a result of between 2 and 3. Around 4 is generally peak productivity, while fewer than 2 can indicate efficiency issues. Does it really matter? Well, yes – a recent project we carried out showed that every 0.1 movement in this ratio equated to a profit movement of $10,000.
IN SUMMARY…
Food franchises, perhaps more than any other type of business, require owners to pay close attention to the everyday details of sales, margins and costs. By using the simple tools outlined above to set clear and simple targets and measure results, franchisees can extract the full value from their investment and stay on top of their businesses as they grow. For franchisors, there is considerable value in assisting franchisees to understand these issues and in providing them with the information necessary to benchmark their own performance against others in the system. By doing so, franchisees will be more profitable, more in control and more satisfied. They will also be in a better position to contribute more to the system and their fellow franchisees and to build brand value for the good of all concerned.
Often a holistic business checkup can provide clarity on what areas of your business are performing well and what areas may be causing inefficiencies. Our Business Command Program will put you in the pilot seat with all the right controls at your fingertips while we guide you and keep you on track for greater returns.