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Which franchise-friendly industries are most profitable?
Raleigh, N.C., April 22, 2018 – For some people considering opening a business, the franchise business model represents an attractive balance between having the freedom to operate a business as you see fit and having the security of an experienced franchisor backing you with training, marketing and other support.
Figuring out which type of franchise to open takes a lot of legwork, but the Census Bureau recently released statistics on which industries have the most franchised businesses. And Sageworks, a financial information company, examined the profitability of those industries to see which ones tend to generate more profit for every dollar of sales. Franchise-friendly industries with the highest profit margins in recent years include hotels and motels, real estate agents and brokers, beauty salons and janitorial/cleaning services, according to Sageworks’ financial statement analysis of privately held companies, including non-franchises.
Sageworks analyst Libby Bierman said profitability can vary greatly by industry, so anyone looking to open a franchise in a particular industry would be smart to examine industry trends. “Some industries — like gas stations and new car dealers — rely on volume for growth, so you can’t say that in all cases, a higher profit margin is required in order to be successful,” she said. “However, stronger profitability certainly makes it easier to turn sales into income for the owner.”
As an industry, offices of real estate agents and brokers (NAICS 531210) have generated a net profit margin of 14 to 16 percent in recent years, but the profitability jumped to above 20 percent for the trailing 12 months ended April 11, Sageworks’ data show. Common franchise names in real estate include RE/MAX, Keller Williams and Century 21.
Hotels (excluding casino hotels) and motels (NAICS 721110) also saw an increase in profitability in the most recent 12-month period, posting a net profit margin, on average, of 10.5 percent, compared with margins of between 5.5 percent and about 7 percent in the three preceding comparable 12-month periods. Franchise Direct, which matches franchisors and investors, says Marriott International and Wyndham Hotels are the largest U.S. franchises. Janitorial/cleaning services (NAICS 561720) in the psat few years have generated net profit margins of between 5 and 7 percent, although data for the most recent 12-month period is insufficient to determine profitability trends. This industry is quite fragmented; Census Bureau data indicate franchises make up only about 11 percent of all cleaning and janitorial establishments.
Beauty salons (NAICS 812112), another industry where most establishments are not franchised, have been generating profit margins on average of about 4 to 5 percent during the 12-month periods ended April 11, 2015 through April 11, 2017.
Through its cooperative data model, Sageworks collects and aggregates financial statements for private companies from accounting firms, banks and credit unions. Net profit margin has been adjusted to exclude taxes and include owner compensation in excess of their market-rate salaries. These adjustments are commonly made to private company financials in order to provide a more accurate picture of the companies’ operational performance.
Based on the Census data, the most popular industry for franchising is limited service restaurants. There are 122,042 such restaurants (also known as quick service restaurants) that are franchises in the U.S., and they account for more than half of all limited-service restaurants in the U.S. Franchising giants in the limited-service restaurant field include McDonald’s, KFC, Burger King and Pizza Hut. The industry on average has generated net profit margins in the 2 to 3 percent range in recent years, but Sageworks estimates margins were a little stronger in the most recent trailing 12-month period, increasing to nearly 4 percent.
Steve Bickert, CPA, a shareholder of tax, accounting and consulting firm Concannon Miller who works with numerous McDonald’s franchisees, says quick-service restaurants can see different trends in financial performance, depending on the brand and other factors. “The three main items that have the potential for the biggest variability are going to be the labor costs, and some of that depends on where you’re located – the food costs and the rent structure,” Bickert says. “They have the biggest impact” on profitability.
The second-most common industry for franchising is gasoline stations with convenience stores, an industry with 32,845 franchises, followed by full-service restaurants and hotels and motels, according to the Census data. The new car dealer industry has the highest concentration of franchises, with 100 percent of all new car dealers in the U.S. operating as franchises, according to the Census Bureau.
However, Sageworks’ data show that new car dealers have some of the lower profit margins among franchise-friendly industries. Margins can vary by ownership, of course, but on average, the industry has been in the 1.5 percent to 1.9 percent range in recent years, including 1.5 percent in the 12 months ended April 11.
Fitness and recreational sports centers (NAICS 713940) and gas station/convenience store combos also have narrow profit margins, in the 1 to 3 percent range, according to data from Sageworks.
The Federal Trade Commission has a guide for those interested in buying a franchise. It includes tips on selecting a franchise and information you need to know before signing a franchise agreement.
Lending to franchises is big business for many U.S. banks. Bob Coleman, principal of the Coleman Report and an expert on small business lending, said strong economic growth and profit performance, along with tighter lending standards by U.S. financial institutions in recent years, have reduced delinquency rates for all business loans since their peak in late 2009.
Delinquency rates for Small Business Administration-backed loans to franchises, too, have declined. Delinquencies for the 7(a) loan program have fallen from a peak of 3.8 percent in 2009 to 0.7 percent in July, and delinquencies for the 504 loan program have dropped from a peak of 5 percent in 2010 to 0.8 percent in July, according to data from the Coleman Report.
Among the industries with the largest number of franchises, snack and non-alcoholic beverage bars and limited service restaurants had the highest 10-year charge-off rates for SBA-back 7(a) loans, while beauty salons and hotels had the highest charge-off rates for the 504 loan program, an economic development program with a commercial real estate focus.
“Some brands perform very well and some brands perform poorly so [delinquency and charge-off data] helps the lender evaluate them,” Coleman said. “Obviously restaurants are more risky than other types of small businesses, and that continues in the franchise mode, but franchises do perform better than what I call mom-and-pop restaurants, so that is a positive.”