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.
0 comments