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Buy a franchise, or launch a standalone?

We can begin to manage the decision process surrounding a franchise opportunity by using the PDV exercise in Figure 3-1; this will help us understand the reality of pursuing a franchise by considering the income streams and discounted value of both franchise and standalone opportunities.

We are often asked, “Should I buy a franchise or develop my own store?” While PDV is a pretty straightforward formula, greater nuance is necessary to tease out the issues that affect the calculation.

03fig01.gifFigure 3-1. PDV exercise.

“The present discounted value of an income stream” contains two key concepts—discount and income. The discount rate is the reduction in the future income based on the chance (expressed as a percentage) that we will not achieve expected results. A new business idea is often “discounted” up to 70 percent in pro forma financial statement analysis. The greater probability of success of a franchise lowers the discount rate for the franchise operation because a “proven” business model has less risk than a new concept (i.e., a new standalone operation). Because the success of a franchise rests, to some degree, on the development and beta testing of a business model, positive market response to this business model is what the franchisor is really “selling” when a franchise is sold. The discount rate could be half that of a standalone operation.

An additional benefit to franchising is economies of scale in marketing, purchasing, and property, plant, and equipment (PP&E), which translates into more efficient growth and faster solidification of the brand. In most cases, having a recognized franchise brand versus a new standalone brand results in greater income sooner.

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