Franchise Failures Found to Be Higher Than Was Thought

A franchise seems like the perfect business to many budding entrepreneurs worried about venturing out on their own. After all, the International Franchise Assn. for years has cited government statistics showing that less than 5% of all franchise outlets fail each year.

But a recent study of 138 franchising chains that began operations in 1983 found that only a quarter of them were still in business 10 years later.

Another recent study found that while large corporate franchises tend to be successful and profitable, smaller ones usually aren’t. These fail at a higher rate than independently owned businesses.

Women who go into franchising are even more likely to fail, according to the studies.

The findings are contained in two reports recently released by the Small Business Administration Office of Advocacy in Washington.

“There’s a perception that you’re much more likely to succeed out there if you buy a franchise,” said Jere W. Glover, chief counsel for the advocacy office. “I think our studies clearly indicate that that perception is wrong. You’re no more likely to succeed in a franchise than in your own business.”

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The SBA commissioned the studies after the appearance of a 1993 report predicting that franchise sales would account for 38% of all retail sales by 2000. That forecast has already been topped: Franchises account for 40% of all U.S. retail sales and employ more than 8 million people.

The SBA wanted hard data to learn whether small-business owners are benefiting from the franchising trend and if they are satisfied with this form of business, Glover said.

The agency turned to Timothy Bates, a professor at Wayne State University in Detroit. Bates used U.S. government data from 1986 to 1991 to compare newly created small franchises with independent businesses nationwide. Besides looking at small noncorporate franchises such as limited partnerships, he also examined large corporate franchise chains.

Small start-up franchises found the going rougher than did independent establishments, the study shows: 62% of these franchises survived, compared with 68% of the independent small businesses.

On average, profit was nonexistent for small franchises of every type. The average annual net loss for them was $4,500, contrasted with an average profit of $15,500 for nonfranchise businesses. The losses were even greater for small retail franchises: On average these lost nearly $16,000, contrasted with a profit of $10,000 for nonfranchise retail businesses.

The franchise path was even tougher on women, Bates found: Only 49% of franchises owned by women started in 1987 still existed in 1991, compared with 67% of independent firms started by women.

Bates found that large corporate franchised businesses tended to do much better than independent businesses. Well-known national franchise restaurant chains such as McDonald’s and Burger King had closure rates of just 4.5%, compared with 17.1% for independent restaurants. Hotel and motel franchises reported closure rates of 7.6%, compared with 13.2% for independent ones.

The report gives no explanation for most of the findings, but Bates speculated in the study that smaller franchises, especially restaurants, did poorly because they were entering a heavily competitive market dominated by corporate giants.

The study by Scott Shane, at the Georgia Institute of Technology in Atlanta, found that franchises started in 1983 had a survival rate of 25% 10 years later. Those lasting four years had a much greater chance of making it to 10 years, Shane found.

Glover said the studies point to a need for those considering franchise ownership to evaluate not only their own potential for success but also that of the franchise chain itself.

Don DeBolt, president of the 32,000-member International Franchise Assn., said the studies do not give franchising a black eye but that they do underscore warnings that the association itself issues about risks in franchising or any independent business.

DeBolt also said the studies’ findings support the association belief that the name recognition of large franchises gives them an edge over independent businesses.

Carl Chase, 47, a 7-Eleven franchise owner in San Diego who also owns an independent liquor store and an independent produce store, said a nationally known franchise logo makes a “dramatic difference” in store sales.

“I could put the logo on a store and sales would increase by 20%,” he said.

Chase said that large franchise chains allow operators to concentrate on customers and the individual store. Operators in smaller, start-up franchise chains are at a disadvantage, Chase said, because the new chain is in a learning curve, still refining its operations and staffing as it adds stores.

DeBolt added that a recent report in Franchise Times, a franchise industry publication, found that 73% of franchise owners surveyed nationwide, both large and small, were satisfied with their business. The median personal income of the 1,000 franchisees surveyed was $87,000.