Investigating Franchise Failure Rates in New Zealand
Violeta A. Llanes, University of Otago, John Paynter, University of Auckland
André M. Everett, University of Otago
Abstract
Despite the growing interest in franchising, little research has been conducted into the issue of
franchise failure / survival rates. This paper analyses the three-year failure rates of franchise
systems as part of a general survey on franchising performance and practices in New Zealand.
The failure rate of franchise systems was found to be consistently low. Reasons highlighted to
justify the greatly reduced failure rate of franchises relative to non-franchised businesses
include a high quality of franchisor-franchisee relationships (with few, minor conflicts) and
strong support systems (i.e., good communication and education programmes). The findings
have practical relevance to both franchisors and franchisees within the context of New
Zealand’s business environment.
Introduction
This paper explores the survival / failure rates of franchising in New Zealand, and contributes
to the scarce literature on the topic. "Failure" is defined broadly, as the occurrence of any of
the following situations: went bankrupt; terminated due to inability to pay royalties and other
fees, sold back to franchisor, distress sale to third party, inability to earn a profit, cancelled,
reacquired, or abandoned.
The franchising literature was examined but found to deal primarily with growth and
development issues (e.g. Combs and Castrogiovanni, 1994; Floyd and Fenwick, 1999; Frazer,
1998; Glatz and Chan, 1999; Goncalves and Duarte, 1994; Shane and Spell, 1998) and
conflict issues between franchisor and franchisee (e.g., Fock, 2001; Spinelli and Birley,
1998). The literature on franchise failure rates includes a case study of the failure of business
franchising in British forecourt retailing using the rebranding of Shell retail forecourts as a
case study (Boyle, 2002); a comparative study analysing survival rates among franchise and
independent small business start-ups using data from the U.S. Bureau of the Census (Bates,
1995); and factors to arrest franchise failure rates (Stanworth, 1995). The literature is mixed
and inconclusive as to failure rates of franchised vis-à-vis non-franchised businesses.
Overview of Franchising in New Zealand
Franchising in New Zealand (NZ) accounted for over NZ$10 billion turnover in 2001, up
from NZ$6 billion in 2000. As an indication of scale, this represents about 10% of the total
business activity in the country. By the end of 2001, there were an estimated 14,000
franchised and company-owned units, employing about 70,000 individuals. The number of
new outlets for 2001 totalled 768, representing an annual growth rate of 16%. The turnover at
franchises increased by 20% from 2000, almost ten times the growth rate of the economy at
large. In both the 2000 and 2001 surveys, retailing (food and non-food) was the largest
industry group (35%) in the franchised sector. In the 2001 survey, property and business
services (16%) dislodged construction and trade services (15%) as the second largest industry
group, followed by personal and other services (8%). As to "style" of operation used by
franchisees, 21% focused on business-to-business, 67% were based in fixed premises, 36%
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used mobile operations, and 19% were home-based (the sum exceeds 100% because more
than one option could be selected). The large majority (77%) of the franchise systems active
in NZ are of national (domestic) origin vis-à-vis foreign origin systems.
Auckland is NZ's franchise capital, with over half of the franchised systems (51%) located in
the area. During the last two years, 40% of all extant franchise units in the country were
established, and 50% of these were based in Auckland. The remaining franchise units are
scattered throughout the country. The 2000 survey found that of the total franchised units,
27% are in the upper and lower North Island; 10% in Wellington; and in the South Island,
10% in Christchurch and 3% in Dunedin.
In 2000, the median start-up cost for franchisees was $92,000, ranging from $80,000 for a
small business such as lawn mowing to a multi-million dollar cost for a large retail franchise.
In the 2001 survey, the median start-up cost increased to NZ$125, 000. Start-up costs include
the following: royalty (19%), site (15%), plant (30%), stock (11%), working capital (15%),
and other (20%). It is estimated that 35% of the franchise systems started within the last two
years. The average number of years the systems have been operating was eight years, and the
average length of the franchisees’ membership within their system was five years.
Method
Data were obtained from three consecutive surveys, in 1999, 2000, and 2001, conducted for
the. Franchise Association of New Zealand (FANZ). The National Bank of NZ, the research’s
main sponsor, distributed the survey forms. Auckland Uniservices Ltd., the University of
Auckland’s consulting arm, collated the completed questionnaires to maintain confidentiality.
Efforts to improve the response rate included a draw for two mystery weekend trips (1999
survey) or an accommodation package (2000 and 2001 surveys). Follow-up letters as well as
reminder telephone calls were also made. The number of useable returned questionnaires and
response rates for the three-year period are: 1999 - 90 (45% response rate); 2000 - 100 (30%
response rate); and 2001 - 114 (38% response rate).
Results and Discussion
The relevant results from the three annual surveys are presented below, followed by analyses
of the findings. More comprehensive, but less focused, reports on these findings are presented
by Paynter (1999, 2000).
During the previous three years, 14 % of franchised units in NZ had changed their ownership
status. Of these, 67% had been sold by franchisees; 18% had been terminated by either the
franchisee or franchisor. About one percent, where the agreements were terminated or the
term not renewed, were either closed or became independent operations. This is a
conservative estimate, as it is not known how many franchisors had ceased operating over the
past three years and the resulting effect on franchisee numbers.
An additional survey conducted in late 2000 focused on franchisees in the fast food industry.
It asked for an estimate of the failure rate within their system over the last three years. The
average of 7% was similar to that obtained when the same question was asked of franchisors
in the 2001 franchisor survey, which found that the average survival rate was high (Paynter
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and Fong, 2002). When only those (70) who had been in operation for at least 3 years were
analysed, the median rate was 3% (average7%). Considering all systems, the average failure
rate over a three-year period for the units was estimated to be less than 7% (the median was
2%).
Franchisors estimated the failure rate of franchisees in their system over a three-year period at
less than 6%, a low figure suggesting a high success rate. It is also very similar to the 7%
failure rate reported by franchisees in the preceding year’s survey. Taking all of the
withdrawals into account, the rate is estimated to be between 6 and 10.5% for each of the last
three years. (See Table 1). It is significant that almost none of these represent established
systems with well-known franchisee operations; the exception is the Eagle Boys franchise
system that was sold to Pizza Hut. In this case, the franchise was no longer operating because
it was too successful and was purchased by its non-franchised competitor.
REASON
No longer franchising
Sold
Closed Down
Not currently/no longer recruiting
Total
No contact made
Total with No contact made
2001
11
2
5
0
18
2000
20
7
1
0
28
29
47
52
80
1999
12
4
3
2
21
2001
3.67%
0.67%
1.67%
0.00%
6.00%
2000
1999
6.67% 6.00%
2.33% 2.00%
0.33% 1.50%
0.00% 1.00%
9.33% 10.50%
93 9.67% 17.33% 46.50%
114 15.67% 26.67% 57.00%
Table 1: Systems withdrawn from franchise operations.
The high survival rate of NZ franchise systems may be attributed to the quality of franchisorfranchisee relationships. These include the nature of conflicts and the support systems
important to the success of the franchise systems. The number of disputes was found to be
low; of these, only 26% were deemed substantial disputes, but this involves less than 1% of
all franchised units. In the 2001 survey, over 97% of franchisors reported having a very good
relationship with their franchisees, and 94% believed that they offered adequate conflict
resolution methods.
Common causes of disputes cited relate to fees, adherence to the system, and
misrepresentation issues. Franchisors deemed the major problems facing franchising to be
substandard operators, the NZ economy, and finding suitable franchisees. These problems
appear to be inherent in the domestic franchise system, as a study in Portugal (Goncalves and
Duarte, 1994, p. 27) found similar problems, e.g. difficulty of recruiting enough qualified
franchisees; insufficient number of suitable locations, legal restrictions, onerous tax structure,
and insufficient local financing.
Indications are that there is a strong support system for franchisees, including franchise
education. Franchisors provided the following support services to franchisees: pre-opening
training (91%), for a median of 10 days, and on-site start-up support (87%), for a median of
8.5 days. Having franchise manuals also helped. It was found that 92% of franchise systems
provided manuals, with a median length of 250 pages. The maximum number of pages was
2,000. Some franchisors reported that that the manuals were in an electronic form, so the
number of pages could not be determined.
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Franchise education is important in addressing the needs, interests, and concerns of the public
and of related service providers (e.g. accountants, banks, and lawyers). In contrast to
Australia, NZ's Franchising Code of Practice is a voluntary code, although it is compulsory
for members of the Franchise Association of New Zealand. The Code's being compulsory for
members is a major advantage, as it provides guidelines and standards (Llanes, Paynter, and
Everett, 2002).
Conclusion
While the longevity of franchise systems is difficult to measure, the findings showed
consistently low failure rates among franchise units in the first three years after start-up. The
three-year period limits generalisability of the findings, and the findings must be taken in the
context of the NZ business environment. The findings did not support studies such as those by
Bates (1995), Scott and Shane (1998), and Stanworth (1995). However, an empirical study of
franchising in Austria (Glatz and Chan, 1999) obtained similar findings to this study, i.e.,
franchise failure rates in the range of 2-25 per cent during the first five years vis-à-vis
nonfranchised small business failure in the range of 15-40 percent during the first five years.
A number of reasons may account for this high success rate. First, it may be attributed to the
quality of franchisor-franchisee relationships, which was typified by a low level of conflict,
with the gravity of the conflicts deemed to be manageable. Agency theory, as developed in the
information economics literature, highlights the importance of information transfer,
information asymmetry, and associated behavioural and economic costs (Doherty and Quinn,
1999) in the context of principal (franchisor) and agency (franchisee). The strong support
services provided by the franchisor facilitate information transfer, reducing the information
asymmetry in the relationship. The NZ Franchising Code of Practice is also important in
providing guidelines for the conduct of a franchising business and its relationships.
Further research into the critical success factors of franchisee start-ups will provide potential
franchisees some measures useful in identifying practices that will enhance their long-term
survival. Relationship marketing programs involving franchisor and franchisee may be
considered to increase success rates. Given that the demise of the franchise system itself is
highly likely to result in the demise of the individual outlets, it is clear that it is important to
measure the survival rate of the former, given the scale of franchising as an engine for NZ’s
economic growth.
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References
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Spinelli, S., and Birley, S., 1998. An Empirical Evaluation of Conflict in the Franchise
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