Any franchisee candidate will want to know what sort of returns their franchise investment will yield. Of course, calculating return on investment (ROI) in the franchising industry differs quite significantly from other investments such as those related to property and real estate or the stock market.
If you’re looking for more clarity on what ROI is, what factors are often overlooked when calculating franchise ROI specifically and how to go about making tentative calculations, you’ve come to the right place. Let’s take a closer look.
Table of contents:
What is the return on investment (ROI)?
Return on investment (ROI) is a term that’s commonly used in the business or corporate world to determine what the levels of profitability for a given investment amount are.
In the general sense, ROI is a “yardstick” for profitability and it is expressed either as a percentage or a ratio. The higher the percentage, the better the ROI or levels of profitability are said to be and the opposite is also true.
But when it comes to calculating franchise return on investment, the picture gets more complicated. This is because there are numerous factors that affect the calculation, which are often not taken into consideration.
Factors that are often overlooked when calculating franchise ROI
Prospective franchisees who are looking to determine whether an investment in a franchise business will be worth it over the long run, may have come across different percentage points when it comes to what a good return on franchise investment may be.
Conservatively speaking, some industry experts put a good ROI for a franchise business at 10% to 15%. More optimistic estimates say that a 15% to 20% ROI is favourable.
Meanwhile, there are others who indicate that ROI of between 25% and 50% is reasonable.
These different market performance expectations evidently vary significantly and while some may be possible for one franchisor, they may not be achievable for another simply owing to the nature of the franchise business and the industry it operates in.
However, there are other factors to consider when calculating franchise ROI and although these are often excluded from calculations (which will be discussed later), they should be a must for inclusion in your equation. These include:
1. Fluctuations in the ROI and time factors
It must be remembered that just like most businesses that operate on the marketplace, a franchise business also goes through stages of growth including start-up and zero profitability, break-even and then profitability and growth. As such, ROI for franchises may not be accurate in the early phases of the business start-up phase and time factors should be taken into account because the ROI rate will fluctuate and differ from the first year to the third or fifth year of franchise operations.
2. The type of franchise and the industry it operates in
Not every franchise operates in the same environment, industry and under the same conditions as every other franchise. For example, a coffee shop franchise will be less cost-intensive than one that requires physical buildings and structures such as a hotel franchise.
3. Market demand
Some franchises such as garden maintenance ones may be seasonal whereas a fast-food franchise can be popular all year round.
Therefore, market demand and seasonal fluctuations are a natural part of the franchise life cycle and should be considered in the calculation as well.
4. Self-payment
Many new franchisees often come out of the corporate world where they earned a steady income for their efforts. In terms of calculating franchise ROI, profit calculations often overlook the need to factor in self-payment for time and effort invested in the franchise business.
Even though sometimes these values are hard to quantify, you should attempt to have realistic, conservative and optimistic amounts in mind to ensure you get compensated for your time investment in your franchise business.
How to calculate franchise ROI
At first glance, calculating franchise ROI is simple. The formula is as follows:
Step 1: Work out your total investment
Step 2: Work out your profitability
Step 3: Divide the profitability by the total investment
Step 4: The result is the ROI on your franchise investment
However, if you want to be more detailed and accurate, there are other considerations you need to bear in mind.
Firstly, you need to think about three possible scenarios for your calculation: positive/optimistic, average/conservative and negative.
Next, you’ll need to work out a quantifiable amount that reflects the time and effort you spent on working on your franchise business or the amount you need to essentially pay yourself over a given period of time.
If you are calculating franchise ROI on an annual basis, then work out how much you would need to earn over a one-year period. The same applies if you are calculating it over a two-, three- or longer time period. Then, subtract this from your total profitability.
Also, remember that different franchises operating in different industries will have different ROIs. For example, consider whether your franchise business is seasonal or annual.
With seasonal, you’d have to average out high-season earnings with low-season earnings. With all-year-round franchises, you’d simply take the earnings by summing them up over a 12-month period.
Another calculation you’d need to factor in is your earnings after interest, tax and amortisation. This will give you a much fairer value and accurate estimation of your profits, as mentioned in step 2 above.
There is also the need to consider the opportunity cost of capital. This means considering alternative options of investing in other investment channels, vehicles or enterprises that can offer different rates of return.
The most important thing to remember is that the ROI will differ from franchise to franchise. There is no golden mean or typical ROI across franchising. An ROI of £50,000.00 a year may be a lot for one franchise operation but insufficient for another. So, paying attention to the general calculation and the “hidden” factors discussed above should give you a more realistic outlook.
Concluding remarks
A franchising investment is one of the biggest financial stakes a prospective franchisee will make in their lifetimes. It’s therefore important to ensure that this investment pays off. Calculating your ROI is just one of the aspects of determining whether a franchise opportunity is right for you.
But there are other factors as well.
To make these easier to identify and optimise, our Founder and CEO Dani Peleva has developed the 5 Fs Franchise Marketing Model in her bestselling book, Franchise Fame: An insider’s marketing guide to incremental growth and soaring success for franchisors. Make the most of the opportunity to get your hands on the book to reach incremental growth and soaring success for your franchise business today!
