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No one invests to lose money. We invest to win, to succeed, and to make even more money. And we measure this in a few different ways. One is analyzing the return on our investments, or ROI. ROI is a relative measurement of how much profit was generated as a percentage of how much was invested to get started.
When deciding whether a smaller franchise investment is worthwhile, consider this: smaller franchise investments have excellent potential for showing a high ROI because it’s easier to maximize profit when the initial expenses are low.
Franchise investments under $50,000 tend to forego brick and mortar locations and the build-out and cash demands that such locations require. Rather, they are often home-based businesses that provide a remote service or go to another location to provide the service. Think online and internet services, tutoring, property management, and repair services. The franchise fee is lower because less overhead is needed in the form of commercial office space, equipment, inventory, and physical signage.
For franchises with a smaller initial investment, the early ROI can be significantly higher than one that has more money invested. We use ROI as one way to measure how successful a new franchise endeavor might be. So for a smaller investment, the actual numbers may be smaller, but the ratio as a measurement of success will likely be higher. And since we all want to earn the money back as soon as possible, smaller franchises might be the perfect investment for you.
What is ROI?
For the purpose of initial franchise investments, the ROI ratio is calculated by projecting net income and then dividing that by the initial investment. For example, if a sports camp franchise projects net income of $100,000 in its first year, and the initial franchise investment is $35,000, the projected ROI looks like this:
ROI (%) = $100,000 / $35,000 x 100 = 2.8
or a 280% return on the initial investment
ROI can be used to measure the value of investing in other things too. An ad campaign, for example, can be measured by looking at the total of new sales generated by the campaign. If it exceeds the advertising campaign’s costs, then the advertising was worth it.
While ROI does not show everything, it is a simple and easily understood measurement of success, whether of an ad campaign or your initial franchise fee.
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Calculating a return on your initial investment is easy after you’ve been in business for a while, but using it as a way to determine which smaller franchise to purchase is a bit more challenging. To get an idea of what you might expect, speak to current owners, and plan your business development with some reasonableness. Allow for time to build your customer base, and plan on making revenue your priority.
In addition to speculating your projected ROI, consider the time it will take to get the return you want. Earning back your franchise investment fee in two years presents a very different scenario than if it takes five years. Be sure you are comparing the same time periods when you evaluate potential ROI’s on your franchise investment.
And lastly, understand that ROI might be manipulated and misleading. The formula is real, but there might be hidden costs. In the ad campaign example, the campaign costs might be earned back through new business, but the campaign costs might not take into account the additional labor needed to service the increased business.
A high ROI is desired by all businesses, but for franchises with a lower initial fee, the upside is more likely with solid sales and lower overhead expenses. Do smaller investments yield less? Dollar for dollar, they probably do. But measured by ROI, smaller investments can be more successful than larger ones.
Anne Daniells is a co-owner of Enterprising Solutions, a professional services firm specializing in corporate communication and financial improvement for businesses where she shares decades of corporate and entrepreneurial experience—including franchise ownership—in her writings on business culture. She has authored hundreds of articles for publications including AllBusiness.com, TweakYourBiz.com, and MSN.com. Reach out via her website for more on where corporate culture, communication, and human architecture collide.