Franchise outlook is murky

March 30, 2009
Many small-business owners would be thrilled to simply survive the recession. Not Harold Patrick. Next month, his first Marco's Pizza restaurant franchise will stage its debut.

Over the next six years, Patrick aims to open 37 more Marco's pizzerias in the Indianapolis area.
"We looked at many, many different kinds of franchise and other opportunities, but at the end of the day, Marco's stood head and shoulders above the rest," Patrick said. "For the last 10 consecutive quarters, [they've had] positive growth. Who else is saying that now?"

Franchised businesses aren't immune from the recession. The Washington, D.C.-based International Franchise Association forecasts 10,000 franchised establishments will fail this year, taking with them 207,000 jobs. And those that remain will see their combined sales decline $4.2 billion.

Yet affiliation with a larger franchise offers small-business owners an enticing hybrid of independence and corporate support. Franchisees typically pay parent chains initial startup fees, then remain obligated to shell out ongoing royalty payments indefinitely. In exchange, they enjoy economies of scale on shared purchases of commodities and advertising.

The biggest selling point of franchising is the power of proven brands with well-established store concepts.

"Starting any business is hard. They succeed or fail for a variety of reasons," said Alisa Harrison, spokeswoman for the IFA. "Buying into someone else's success may give you a leg up."

According to the IFA, 11 million people nationally work for franchised businesses. That's more than 8 percent of all private-sector jobs. In Indiana, 19,608 franchise locations employ 265,339 people who earn a collective $5.8 billion. Together, Hoosier franchises produce $18.2 billion in annual revenue.

Affiliation with a larger brand is clearly no guarantee of success. Consider Andrew Gzibovskis, former owner of a chain of five Indiana Ace Hardware stores. Founded in 1976, his sub-chain four years ago had 100 employees and locations in Indianapolis, Greenwood, Columbus and North Vernon.

Last June, Gzibovskis was forced to declare bankruptcy, shutter all his Ace Hardware stores, and auction off every nut, bolt and washer. The souring economy was a factor, but Gzibovskis also blames over reliance on the Ace chain's resources.

"In this day and age, anything retail, you'd better know what you're doing," Gzibovskis said. "The key is really studying your market, and knowing what your customers want."

Franchise finances

Mary Jo Larson, publisher of the Minneapolis-based Franchise Times magazine, said franchises that overextended themselves in better days are now faring worst. But there are still growth prospects. Those offering low prices are coping best, she said. Restaurant customers who normally prefer more upscale dining, for example, are instead shifting to fast food.

"Franchising is definitely not immune to this downturn in the economy," she said. "But there are going to be people who find opportunity and capitalize on it."

Patrick is attempting to be one of them. He's sold on the Marco's concept, with its fresh dough, proprietary sauce and never-frozen blend of three fresh cheeses. Marco's already has three Indianapolis restaurants. Patrick's will be at 7002 Lake Plaza Drive, near the corner of East 71st Street and Binford Boulevard. And he's got the inside track for expansion here. His investment group, Circle City Hospitality, also bought the rights to develop 37 more pizzerias in the Indianapolis territory.

Franchise fees typically start in the low five figures, but can be as high as several million dollars for high-end hotels. Royalty payments, usually based on sales, differ from franchise to franchise. Patrick, for example, paid an initial fee of $17,500 for his Marco's pizzeria, according to Toledo, Ohio-based Marco's Franchising's Web site. As long as his restaurant remains affiliated with the chain, he'll pay it 5.5 percent of his net sales.

Patrick, who once ran a McDonald's franchise in Los Angeles, has a leg up on financing because radio and television personality Tavis Smiley is one of his investors. Smiley's brother Maurice will be the new restaurant's general manager. Patrick said he's known Tavis Smiley for 20 years.

Total startup costs for a new Marco's range from $218,000 to $419,500, according to the company's Web site.

In return, Marco's has already assisted with site selection and construction, and helped plan an ad campaign. The chain also gives guidance on signs, delivery vehicles, computers and insurance. A corporate team will lead the initial training of Patrick's 40 employees. He's already been through brand training himself. Now, anytime he has a question, support is a phone call away.

"You're in business for yourself, but not by yourself," Patrick said. "You have experienced and knowledgeable people who can help you."

Franchise registrations have slowed in the recession, because bank credit is hard to come by. Many franchisees typically tap their home equity to underwrite their startup costs, but declining house prices mean there's less money available these days.

IFA's Harrison said franchising should rebound quickly once the recession hits bottom. That's because many laid-off managers may elect to buy franchises of their own, rather than return to the corporate grindstone.

'The final nail in the coffin'

Oak Brook, Ill.-based Ace Hardware certainly offered all the typical benefits to its franchisees, Gzibovskis said. His father opened the family's first affiliate in 1976. By 2000, they owned two. Both were debt-free and profitable. Gzibovskis said he paid about 10 percent of their annual revenue back to the chain.

According to its Web site, Ace Hardware charges a $5,000 application fee for potential new franchisees. Total costs of a new store range from $650,000 to $1 million.

Gzibovskis said his local stores benefited from Ace Hardware's television ads, which he could never have afforded alone. And without Ace's buying power, Gzibovskis' stores could not have competed against the low prices at Home Depot and other giants.

Still, it wasn't enough in the long run. Gzibovskis said Ace Hardware encouraged him to add stores, with mixed results. Things soured completely after he took their advice to expand in North Vernon, "the final nail in the coffin." Ace Hardware provided market research that showed a great profit opportunity there, since there weren't any big-box stores in the area.

What Ace Hardware didn't consider was the more than 2,000 mobile homes in the community. The brand's standard corporate suite of hardware products had nothing suited for their repair needs. After visiting once, those customers never came back.

Worse, the research also didn't account for local residents' workday commute. Many people in North Vernon have jobs in Seymour or Columbus, and buy their hardware in big-box stores there after they clock out.

Soon, the hardware store was losing $30,000 to $50,000 per month, eating away the profits of Gzibovskis' other stores. His family worked seven days a week to keep their group of stores afloat, but to no avail.

In hindsight, Gzibovskis wishes he'd done more of his own research, and trusted his own instincts. When his stores began to struggle, executives at corporate weren't willing to bend their rules.

"I don't want to bad-mouth Ace; overall, they were OK, he said. But when everything came to an end, and it looked like we weren't going to make it, they didn't want to work with us as much, and it didn't seem like anything was negotiable."

Franchise Times' Larson said some chains are making adjustments to help their affiliates survive the recession, temporarily abating royalty payments, for example. But the best deals available may be from landlords. Desperate to fill space, many are slashing rent and even picking up much of the cost of renovation for new franchises.

As for Gzibovskis, he's still trying to be an entrepreneur. But his days in franchising are behind him. Installation and repair services were always the most profitable part of his Ace Hardware stores, he said. So six months ago, Gzibovskis and his brother founded a new independent company called Handy Repair Guys.

"When we did things on our own with our own product mixes, we were more successful," he said. "When we started relying on others to make our decisions, it didn't
work out."

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