Growth | November 2010 | By John Morell

New-Age Franchising

With the traditional franchise model struggling in the recession, some business people are finding that co-operative efforts are more rewarding.

Some operators are adopting cooperative restaurant models.
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The times are changing for many of the industries that fortified America’s capitalistic society. With banks trying to figure out how to thrive under new financial regulations, quick serves are facing a challenge to their classic business model: the franchise.

Although no one expects the franchise model to disappear any time soon, it’s true for anyone in the industry that it’s been a rocky ride during the economic ups and downs of the past few years. Just around the time when a large segment of the population, including millions of Baby Boomers, was getting set to reach semi-retirement and possibly invest savings into a franchise, the stock market crumbled. While traditionally these individuals may have been able to use real estate equity to make an investment, that, too, was wiped out. 

A drop in potential franchisees hardly marks the demise of the quick-serve industry, but alternative business models that have gained in popularity could pose a big threat to franchising, a model regularly practiced by quick serves. One model that is especially gaining steam is the co-operative business model.

“Speaking as someone who’s owned franchises in the past, this is a much better way to do business. I feel like I’m an owner, not an employee of the franchisor,” says Romil Patel of Milwaukee. Rather than owning part of a franchise, Patel bought into a co-operative business running KaleidoScoops, an Austin, Texas–based chain of 45 ice cream stores around the Southwest and Midwest.

“When you’re a real businessperson, you don’t want to be directed and controlled by a corporate entity that’s often far from your location and which is telling you what’s best for your investment,” Patel says. “I find that this co-op arrangement gives me control. It’s like getting the best of franchising—a national brand—with the best of owning an independent shop.”

Started in 1999 by a group of former Baskin-Robbins franchisees, KaleidoScoops puts a surcharge on the ice cream it sells its co-op members and collects a small quarterly fee, but doesn’t take a percentage of retail sales like many franchise operations. The members work together on advertising and store growth and volunteer their time to help build the brand.

The brand’s website points out that ice cream franchisees should think about making a switch to KaleidoScoops when their contracts run out.

“We’re not a free-for-all where each member can do their own thing,” Patel says. “There are standards we must meet and guidelines to follow. But there’s also flexibility. Many of the big hamburger-chain franchisees have not been happy about corporate installing value menus that cost more than they make. You wouldn’t see that with a co-op. We have a right to make the menu fit our market.”

Expanding a number of outlets through a co-op can be tricky, especially since there can be a fine line dividing franchising and owning co-ops, which gets lawyers involved. “In a traditional franchise model, you have the franchisees buying into the brand and supporting the corporate structure, which handles marketing, R&D, purchasing, etc.,” says David Cahn, founder of the Franchise and Business Law Group in Lutherville, Maryland. “A true co-op really can’t have that kind of corporate support. It has to be the members pitching in to pay for or supply the support functions. In a franchise, you have an entire department devoted to recruiting new franchisees and growing the brand. With a co-op, who takes on that role?”

The biggest attraction for a co-op may be its membership fee. “Start-up costs are between 30–60 percent of what you’d be paying to become a traditional franchisee,” says Boyd Harris, president of KaleidoScoops. “The low investment is a huge factor, especially these days. You can get in on a national brand for little money and retain control all the way through the process.”

KaleidoScoops members aren’t pressured to buy certain equipment or carry particular menu items if they won’t translate into sales in the brand’s markets. 

“We’re very driven by local conditions,” Harris says. “Whenever you talk to franchisees, they say how crazy corporate is in thinking that one product or another will sell in their store. They know their market. If they were in our co-op, they would be in charge of what to offer.”

“This is a much better way to do business. I feel like I’m an owner, not an employee of the franchisor.”

Harris says that many business people getting into franchises are turned off by the control that’s levied by the brand’s corporate office. “There are many people who have become successful in other industries, and they decide they want to invest some of their money into a franchise. But franchisors dictate so many details, down to selecting the contractor who will remodel stores. We know why they do it. It’s because they want to maintain a brand identity, which is very critical. But it can also take away the enthusiasm and creativity of their successful entrepreneurs.”

Respecting franchisees’ large financial investments is what motivated Darryl Gaddis of Farmington Hills, Michigan. Gaddis’ Noah’s Ark Business Group is selling co-op memberships for his Jaws Jumbo Burgers brand. The quick-serve concept charges members $1,200 to join and a monthly fee of $150, not including the rental or purchase of the location, supplies, and equipment. 

“What I’ve seen is that many people interested in the stability of a franchise concept have watched their investment funds dry up the last few years,” Gaddis says. “And the worst part is, banks won’t lend to them, especially for franchise businesses. What I’ve seen is so many franchises have gone out of business the last three years that banks are reluctant to get involved in them again.”

Cahn says co-ops can work in the quick-serve industry, but under certain conditions. “Just like a franchise isn’t for everyone, a co-op isn’t for everyone either,” he says. “It may be a better choice for someone with experience in a particular business segment with lots of connections, and who has the ability to run his store as an independent. However, they join up with others to create a brand and make themselves stronger through the group.”