The Untapped Potential of FranchiseTech

Every day, I find myself interacting with franchise businesses, from grabbing a morning coffee and sandwich from the “local” shop to getting the car washed and sending a package via UPS. A franchise is a business whereby the owner licences its operations—along with its products, branding, and knowledge—in exchange for a franchise fee. Not a term that is often thrown around everyday conversations, franchise businesses employ millions of people in the US, contribute billions of dollars to the economy, and have allowed many of our favourite, and least favourite, brands to expand globally from car rentals and pet boarding to our favourite fast food chain and even for those fortunate their wealth managers.?

Franchise business models have also empowered a generation of entrepreneurs, the small business owner who uses the brand of a franchise to start a location in their neighbourhood, and if successful open another and another. However, this business model has a complicated set of needs with additional stakeholders and a slower buying cycle. As such, the technology that supports franchises, either ignores specific franchise requirements, or provides legacy franchise-specific software, reaping profits from a captive customer base. It’s unsurprising that many franchises complain about receiving scraps of innovation and that their vendors are acquired by private equity funds.?

The times are changing: venture-backed startups are dedicated to better serving this segment. FranchiseTech, a new breed of technology solutions designed to enable, streamline, and optimise the franchising process is here, and it is much overdue.

Franchises have breadth and depth across the US economy

To set some context for those newer to the franchise world, the franchising model has a rich history dating back to the 18th and 19th centuries, with early examples including granting rights to represent the church and crown and collect taxes and tolls. The Industrial Revolution spurred further growth in franchising, with automakers and consumer goods companies leveraging the model to scale their businesses. Modern-day franchising experienced a boom in the 1960s, following the Lanham (Trademark) Act, which benefited franchising and preceded an explosion of growth in the restaurant and lodging industries.

Today, franchises are a vital part of the US economy. Franchises employ 8.5M workers in the US (6.4% of the workforce in 2022) and contribute approximately 2% to the GDP. Franchises span industries, with a significant presence in restaurants (70%), hotels (8%), and a long tail of other sectors such as real estate, commercial and residential services, personal services, and business services. Whilst franchises are global and the model works in nearly any economy, the US has proven to be the most attractive location for franchising, ranked as the country with the lowest risk and greatest opportunity out of 131 countries. As a result, 90% of the most successful franchises started in the United States.

Franchises are an efficient business model that outperforms the S&P 500

Franchises are an impressive business model and have shown an ability to allow brands to grow efficiently. They offer a clear path to delineate a popular brand with an operational blueprint from the capital and capacity to operate locally. Look no further than arguably the most successful global franchise: McDonald's. Started in 1940 in San Bernardino, California, this globally recognisable brand has over 40,000 locations and employs almost 2 million employees all operated by 5,000 independent, small and medium-sized businessmen and women: the franchisees.?

These local entrepreneurs, and have empowered this goliath of a business to become worth $200B in market cap, and become synonymous with consistency in food quality, but with innovation in pricing and menu from the corporate level. All in, McDonald’s shareholders gain from franchise revenue for the company of over $15B (~60% of total revenue), and this revenue looks very much like software revenues at over 85% gross margins, highly repeatable with expansion from successful operators. In fact, 90% of McDonald’s total margin dollars come from franchise fees. This model has allowed 95% of McDonald’s restaurants to be locally owned and operated, facilitating quicker growth and an ability to understand the local market.?

That pales to the $200B+ in revenue for the franchisees, albeit at a lower margin, and yet they are willing to pay the 5% franchise fee to McDonald's because of their pervasive global branding, innovative supply system and comprehensive training procedures. The latter allows team members to work in an almost “manufacturing line” style using universal Standard Operating Practices (SOPs).

There is little surprise that as a whole, publicly traded franchised corporations have consistently outperformed the S&P 500 since 2000, with the Rosenberg International Franchise Center 50 Index showing that franchise-based businesses have delivered superior returns compared to the broader market. This index, initially published in 2002 by the Rosenberg International Franchise Center (RIFC), is the first stock index to track the financial market performance of the US franchising sector and includes businesses like McDonald's and 49 others.?

Franchisees and franchisors are becoming more tech-centric

It would be a mistake to assume that the image of an aging franchisee, stuck using manual processes, is the future of the industry. These brands face increased pressure to keep prices low to hold market share, and to stay relevant and competitive. More than ever, franchises must embrace technology and innovate their processes. A few trends from the past years point to an ongoing revolution in how franchises, guided by their own franchisees, will have to embrace cutting-edge technology from AI to automation, and not just be content with being “digitised”. These trends include:

1. The rise of a new generation of younger, tech-savvy franchisees who demand more advanced tools and platforms to manage their businesses. Millennials and Gen Z are eager to launch businesses, with a focus on SMBs and technology. They want to run their business from a phone or tablet and expect to have data on demand. They see business ownership as a way to gain freedom both financially and from a set schedule, and for the upcoming great transfer of wealth to these groups, many will inherit franchises, They will expect their franchisors to be technology-driven and will supplement with their own solutions.?

2. The growth of creator-led franchises built on the foundation of social media and digital marketing. These franchises leverage their vast subscriber bases and social media presence to drive growth and engagement. The next Ray Kroc may indeed be a YouTuber and it isn’t hard to see how PRIME, a hydration drink company co-founded by YouTubers Logan Paul and KSI, and MrBeast Burger, a virtual restaurant brand, could have easily expanded through a franchise model in the future. Imagine that when they do, these franchisors will be based on digital-first brands and will operate their businesses as such.

"I think that creator-led franchises are going to be very powerful going forward. Maybe each one not at the scale of these giants, but very profitable businesses, if they can take a little bit more risk, own their IP, own their creativity and apportion it the right way" James Murdoch

3. Increasingly fragile relationships between franchisors and franchisees, with many franchisees considering switching to more efficient, tech-enabled brands. The days of a franchisee “lifer” are over, as despite high switching costs only 5% of franchisees are satisfied with their current agreements. Disputes over royalty fees and excessive control have caused a backlash. Technology will be a way that new franchises or competing incumbents will differentiate to help prove more efficient tech-enabled operations that improve economics. Remember that franchisee margins are tight, and success here is defined by saving costs and maintaining quality.

4. Persistent labour challenges that began during the pandemic, forcing franchises to turn to technology to supplement their workforce. The pandemic-induced shutdown led to a challenging labour market for franchises, with many workers leaving the industry permanently. It isn’t uncommon for coffee shop chains to provide fertility benefits or fast food to pay for child care. Franchises have had to boost incentives to attract and retain talent, and approximately 80% of franchisees can't fill open positions. This has increased the dependency on technology to streamline operations and maintain profitability.

Franchise tech stacks are complex with many stakeholders

Like every business, franchises need a plethora of technology solutions from CRMs to payroll systems. However, adding in a dual ownership structure can split the technology stack into centralised solutions (like CRMs or POSs) and disaggregated solutions such as workforce incentives. This also differs by size of franchise, given that mid-market franchises (<1,000 locations or 10,000 employees) will provide a lot more technology discretion for franchises, whilst enterprise franchises have an established tech stack with any changes going through an advisory council in a franchisee association. This overall makes an overtly complicated sales cycle for tech vendors and startups.

To make matters even more complicated, franchises need their own management systems that can manage franchise operations, including royalty payments, compliance, and performance tracking. Also, as franchises succeed off co-marketing locally with their franchisees, and by finding new franchise owners and coaching them, you need another set of marketing and training tools between these stakeholders.

Prior, PE-backed solutions filled the market for franchisee and franchisor interaction tools. For the rest of the tech stack, from CRMs to workforce management systems, tools were force-fit for franchises, with the exception of enterprise clients where budgets allowed for white labelling and customisation. However, this approach is changing, as more and more startups actively target franchises and understand their business model and pain points. The FranchiseTech market map below highlights the now increasing breadth and depth of the ecosystem. As more startups enter it is only a matter of time before franchises get to see the latest and greatest solutions and not just settle for “good enough”.?

Note: This market map was compiled from conversations with some fascinating startups including Wefranch (Gregory Ugwi), FranShares (Kenny Rose, CFE), Workweek ( Adam Ryan ), Transitiv (Christian Pillat), Delightree (Tushar Mishra, CFE), Kickfin (Justin Roberts) and Incentivio (Rajat Bhakhri) and many others. If you are a FranchiseTech startup and we aren’t connected, please let me know. This is an iterative process.

Winning as a FranchiseTech startup

As startups pour into serving franchises, soon FranchiseTech will become an acceptable acronym (quote me on that). The natural next question is what are some guiding principles that startups should follow when attempting to sell a solution to franchises? From our research and conversations, a couple of themes came out:

Go after the mid-market first: While enterprise franchises may be attractive, there is also opportunity in the mid-market segment, where solutions can gain traction efficiently. Startups should target the mid-market franchise first, then expand to enterprise deals. Mid-market franchises, with 50 to 1,000 locations, have a shorter sales cycle, followed by a rollout in corporate locations and then franchisees. Franchisors in this segment often source tech through their CTO, pay to launch at corporate locations, and then work with vendors to sell to franchisees, sometimes passing on the cost as a "tech fee." For larger enterprise franchises, they can offer large contract sizes, but be prepared for a 6-month pilot with corporate locations, then an evaluation by the ownership association which may lead to tech implementation exemptions, followed by a geo-by-geo rollout held to high standards. It is worth it, but not a great starting point.

Be “franchise-focused”: Solutions must prioritise the needs of franchises, adopting a franchise-centric approach. It can’t be an afterthought. Invest the technology resources to understand features needed, permissions requirements, and desired views of data. Don’t assume that these needs are secondary, as with the prior themes, franchises expect better solutions than have been targeting them before. Remember that franchised businesses are a favourite acquisition target for PE funds. Figuring out distribution through these funds can help you expand into thousands of locations, especially if you can focus on increasing their EBITDA.

Scale across industries: Unless your company is focused specifically on the restaurant or hotel industry, which is highly franchised and huge, any startup going after franchises, should think across industries. FranchiseTech solutions should be scalable across multiple industries as needed features aren’t always as diverse as expected. My research shows it’s common to see tip management, workforce incentive providers, and even data warehousing solutions sell to franchises in 4-5 industries. A horizontal franchise-focused SaaS solution targeting franchises across sectors can reach $100M+ ARR without expanding into restaurants and hotels.

Prioritise your efficiency and minimise burn: All startups should follow this advice, in my opinion, but anytime you are selling to an industry on legacy solutions, you need to think about your CACs and payoff periods. Don’t assume that a cutting-edge AI solution will sell itself, and that convincing won’t be required. This is a business model whereby the additional stakeholders create risk for the brand. If the CTO of a franchisor is too hasty in changing the tech stack and this causes outages, or issues, reputationally or amongst team members, that person may not last. Corporates are cautious and concerned with making sure that their customers, the franchisees are happy. Also, exits of franchise-focused technologies aren’t as common as we may think, especially as most FranchiseTech solutions have been snapped up by PE. I expect this will undoubtedly change, but it may take true disruption or time.

Consider tech-enabled alternatives to Franchises

Franchises are the ultimate way to borrow the business model and brand of a parent company. However, the advent of more and more branded marketplaces, like Uber or even Thumbtack, raises the question of whether that will be a credible alternative in other industries. These marketplaces help owners to outsource all functions except for their service or product, including demand generation, making it easy for employees to become business owners.

Additionally, verticalised software solutions are now enabling brand building and automated marketing, whereby an SMB business owner can easily rely on technology to help guide their business model. This raises the question: will technology enable business models to become a tech-enabled service, and not just depend on franchises?

These alternatives offer SMBs the ability to outsource various aspects of their business, from branding and marketing to logistics and property development, without the strict requirements and higher costs associated with traditional franchising. In essence, that begs the question, “Do I even need to be a franchisee or can I do it myself, with the help of solution X?”. Remember taxi franchises used to be very common and profitable until ridesharing dominated.

However, I want to caution against those who will come to the natural conclusion that franchises are going away. They are not, but to overcome antiquated technology they must adopt new solutions and not stagnate. One way is to engage Vertical SaaS solutions as an enabler and not a competitor for franchises, so they can white-label platforms and provide a best-in-class CRM initially with features for franchisees. As these SaaS solutions become broader in their capabilities, this will help to upgrade franchises tech stacks and give them back their lost advantage.

About Conductive Ventures

Conductive Ventures is a venture capital fund with $450M in assets under management. Our investment focus lies in capital efficient, post-product expansion stage companies in the software, hardware, and technology-enabled services sectors. We believe that capital efficiency leads to optimal outcomes for CEOs, fosters sustainable businesses that add value to the world, and stands the test of macroclimates. FranchiseTech aligns with our thesis and will build many efficient and sustainable businesses.

If you are an early-stage startup CEO or an investor who shares our belief in treating venture dollars as finite resources, please reach out to me at arif (at) conductive (dot) vc.