In Chapter 4 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:

Subway’s BEP:

50 percent (net sales) = $60,000 + 30.5 percent (net sales)

Net sales = $307,692

Blimpie’s BEP:

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.

Please cite any outside sources. APA Format is required.

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