the book discussed divertive competition and introduced the topic of the breakeven point (BEP), or the point where total revenues equal total expenses. Let's see how this topic will help us determine whether to join a franchise or stay independent.
Assume that you own a sandwich shop. In looking over last year's income statement you see that the annual sales were $250,000 with a gross margin of 50 percent, or $125,000. The fixed operating expenses were $50,000: the variable operating expenses were 20 percent of sales, or $50,000: and your profit was $25,000, or 10 percent of sales.
In discussions with your spouse, you wonder if joining a franchise operation such as Subway or Blimpie would improve your results. Your research has determined that Subway requires a $10,000 licensing fee in addition to an 8-percent royalty on sales and a 2.5-percent advertising fee on sales. Blimpie, while requiring an $18,000 licensing fee, charges only a 6-percent royalty and a 3-percent advertising fee.
Assuming that you wanted to break-even, what amount of sales would you have to generate with each channel during the first year, since both your fixed and variable expenses would increase?
Remember the break-even point (BEP) is where gross margin equals total operating expenses: in equation form, this is:
Gross Margin =Fixed Operating Expenses + Variable Operating Expenses
Thus, with Subway, fixed expenses would increase from $50,000 to $60,000 and your variable expenses would increase from 20 percent of sales to 30.5 percent (20 percent + 8 percent + 2.5 percent). Blimpie's would increase fixed expenses by $18,000 and variable expenses by 9 percent. Using the equation we can calculate the BEP for both:
50 percent (net sales) = $60,000 + 30.5 percent (net sales)
Net sales = $307,692
50 percent (net sales) = $68,000 + 29 percent (net sales)
Net sales = $323,810
As a result of the increased franchisee expenses, you would have to increase sales over 20 percent just to break even. To make the same profit you are already making, you would have to add that profit figure to the equation.
Gross Margin =Fixed Operating Expenses + Variable Operating Expenses + Profit
Subway's BEP with a $25,000 profit:
50 % (net sales) = $60,000 + 30.5 % (net sales) + $25,000
Net sales = $435,897
Blimpie's BEP with a $25,000 profit:
50 % (net sales) = $68,000 + 29 % (net sales) + $25,000
Net sales = $442,857
Thus, to keep the same profit as you currently have, a franchise would have to help you increase sales by over 75 percent. There is no doubt the image of the franchise will draw additional customers and its management may even help cut some of your other expenses. However, as these numbers point out, joining a franchise channel is not always a surefire guarantee of success.
Now, by using either a franchise directory in the library (e.g., the International Franchise Association at http://www.franchise.org) or a franchisor's home page on the Internet: look up two competing franchise channels in the same line of retail trade. After locating the information about these franchises, do the same cost analysis we just did and determine if, based on these figures, joining a franchise is a good investment. You are required to show your work.
Hint: Start with an income statement.