Pizzanomics: Would You Rather Have All Of A 4-Inch Pie Or Half Of A 30-Inch One?

Earlier this year, I had the opportunity to attend Franchise Update's annual Multi-Unit Franchising Conference in Las Vegas. I sat on a panel of experts in a session titled "Development Strategies: Accelerating Growth Through Area Representation." During this session, the advantages and disadvantages of area representation (AR) were discussed. As the session concluded, there appeared to be a few franchisors converted to the AR concept.

Throughout the conference, I had the opportunity to talk to numerous franchisors about area representation as a franchise growth strategy. In these discussions, there were always two issues that seemed to emerge:

1. Concern that the costs associated with this strategy in relationship to the revenues generated were difficult to assess.
2. Some franchisors felt the AR revenue-sharing percentages of 40 to 70 percent seemed usurious.

From my perspective these two issues are embedded in the same underlying concern: that the perceived cost of an AR franchise growth strategy outweighs the benefit. This begs the question of whether or not an AR program is worth giving up a significant slice of future franchise revenues.

A number of years ago, I was working with a franchisor to structure an AR program. After a long day of discussions there was an impasse over the issue of revenue-sharing percentages. That evening I went out to dinner with Kevin, the founder of the company. After dinner, the conversation turned to our earlier discussions regarding what percentage of revenue the franchisor was willing to share with the area representatives. I had proposed a revenue-sharing percentage in excess of 50 percent. The franchisor did not want to concede that large a percentage because it could negatively affect the profitability of the company. This was a valid concern. However, I think he missed the entire point of why a franchise company should consider an AR program.

I asked Kevin, "Which is better? All of a 4-inch pizza or half of a 30-inch pizza?"

The question seemed to catch him off guard. He had never thought of revenue sharing with area representatives in that light--the size of the slice compared with the size of the pie.

I have often reflected on that discussion and how franchisors frequently focus on the wrong issues when considering an AR strategy. This is especially true when it comes to the sacred nature of franchise fees and ongoing royalties. For many franchisors, the idea of sharing a significant amount of their revenues with area representatives is just not a part of their franchising DNA.

However, the real benefit for an emerging franchisor in using an AR program as a growth strategy is twofold:

1. The size of the pie can be 10 to 15 times larger than that produced by traditional direct franchising strategies.
2. Critical mass can be reached in a fraction of the time.

Critical mass cannot be underestimated. Using an AR franchise growth strategy not only creates hyper growth in a short time span, but most of the expenses associated with rapid expansion are borne primarily by the area representative. This is because startup and support services provided to franchisees are delivered by the area representative on a localized basis. An experienced area representative generally provides higher-quality support to franchisees. Also, sales revenue tends to be much higher.

When conceptually thinking about implementing an AR franchise growth strategy, it is more important to focus on the benefits that such growth produces, especially in terms of how it relates to five crucial elements of franchisee success.

1. The larger a franchise system is, the more market dominance it creates over its competition.
2. An AR program produces faster growth, which leads to more brand dominance--enabling franchisees to achieve deeper market penetration.
3. Deeper market penetration generates additional revenue, which enhances franchisee profitability. This profitability can be used to fund aggressive marketing and branding strategies leading to even more brand dominance.
4. More brand dominance enables stronger franchise recruitment efforts, which leads to more and better-quality franchisees entering the franchise system.
5. More quality franchisees increase system-wide revenues and profitability metrics.

At the end of the day, franchisees end up being the real winners in an AR program.

When franchisors get too myopic over the issue of revenue-sharing percentages, they often fail to understand the benefits of the growth, momentum, and profitability created through an effectively implemented AR program. They also fail to understand that these benefits are more important than the percentage of revenue shared with highly motivated and talented area representatives.

In terms of economic benefit, the size of the pie always trumps the size of the slice--for everyone in the franchise system.

Marvin L. Storm is Managing Director of Blackstone Hathaway, which specializes in using area representatives as a franchise growth strategy. He can be reached at 925-376-2900 x201 or mstorm@blackstonehathaway.com.