Are franchise dreams turning into MLM? The ground reality seems to be completely different

India is ranked as the second-largest franchise market, next to the USA, which has the potential of 1.4 billion middle-class customers. It is also expected to grow to about $140bn by 2028, according to the Business to Sales report

It's a dream for middle-class families to start their own business. Even working-class professionals are aspiring to work independently post-pandemic. The reason could be that jobs have increased uncertainty in the security of the job significantly since the origin of AI. Apart from this, People who want to be safe and start doing something today are often confused about the venture's setup process due to the lack of an initial setup.

For such people, a franchise seems like a Pandora's box, offering them numerous options with a guaranteed return on paper and minimal risk. Our economy provides a range of franchises, available for as little as Rs 50,000 to over Rs one crore. India is ranked as the second-largest franchise market, next to the USA, which has the potential of 1.4 billion middle-class customers. It is also expected to grow to about $140bn by 2028, according to the Business to Sales report.

It's quite natural for a working professional to feel upset and frustrated. They often say, "Let's start a tea shop and earn more income peacefully than a salary." Even if they observe and believe that small street food vendors with a larger crowd are making a profit, they think that the owner is making a significant return on a minimal investment and will start putting the calculation and conclude that the shop owner will get a minimum guaranteed profit of fifty per cent. But in most cases, they fail to consider the actual costs involved.

These days, more families are seeking to generate passive income and earn high returns by entering franchise businesses, which are often advertised as appealing and attractive, promising more Return on Investment (ROI) with minimal investment in a short time. However, these opportunities are similar to Multi-Level Marketing (MLM) or a Ponzi-like investment scheme.

Many franchises on paper sound optimistic. No one could imagine how it could go wrong as well. In reality, many franchises crash even before reaching break-even. Even a big-name franchise may go down to dust. Without knowing anything about the risks involved, just by seeing the high ROIs and success mentioned in the brochure, they tend to take up the franchise and burn their savings.

Post-pandemic, the trend of acquiring franchises was steadily increasing, as discussed in Ginesys' report. The report further says that 4600 active franchisors operate nearly 2 lakh outlets, and more than 300 companies are starting as a franchise every year.

It's easy to set up these franchises, so people can easily buy into the dream of starting on their own and forget to do the rest of the homework. The numbers appear glossy in the franchisor's presentation, but in our country, it is not always a copy-paste of the business model. A business model that is successful elsewhere cannot be successful here. It should be tailored to each location and its specific demographics.

According to the Indian franchise association as of 2023, the failure rate is more than 50% for new franchises. Many franchisors advertise on various social media platforms through influencers, claiming you can make a monthly 1 lakh by investing just 1 lakh to start the franchise, and show very colourful pictures of people minting money. But on the ground it is very different. So it's leading to an important question: Is the franchise turning into an MLM?

Many franchises are failing because getting a franchise is not a golden ticket to success. Skin in the game is required to understand. For any business to succeed, the founder must have a comprehensive understanding of the business model, from suppliers to customers. If someone opens a hotel in a location, it's essential to understand the demographic base and the affordability of the people living there. Further, if a Kitchen Order Ticket (KOT) is not present on any day, the founder should create a KOT to sustain. Even in cases where chefs are unavailable, he must take on the role of a chef to fulfil the order. Business can never be just a white collar job due to increasing uncertainties. Indian Franchise Association says only 40% of franchises make it to second year.

People often overlook whether it is rational to accept the franchise at the franchisor's specified cost. Can it break even within the stipulated timeframe at the incurred cost? Would that franchise fit in the location where one is going to start? Some franchises rarely admit when the area is overcrowded or oversaturated. Never depend on the brand value alone. Basic math and homework should be completed before starting. A soft ice cream brand charges Rs11 lakhs to set up their franchise in a 100-200 sq ft place in Chennai. Similarly, pani puri franchises cost Rs. 70,000, while tea shop franchises range from Rs 15 to 25 lakhs. The real question is how many days it will take to break even? What is the USP? Suppose taking a tea shop franchise for Rs 15 lakhs and selling tea at Rs. 10 does not seem viable unless the shop has an extraordinary daily footfall.

In any franchise, the franchisor is safe and gets their return in multiple ways. Most franchisors mandate that ingredients be procured only from them, which is higher than the regular market price. The same product can be purchased in a local market with the same or superior quality at a lesser price. However, many franchisors insist on buying from them only, which unnecessarily escalates working capital and dents the pocket of franchises.

There are very few data points available about franchises. According to the best available data, Entrepreneur magazine has analysed the pattern of multiple franchises over 5 years in the US market, and the report indicates that the franchise failure rate is directly proportional to the cost of investment made. A franchise that is set up between $10,000 and $25,000 tends to fail more often than one that is set up for more.

The primary reason is that low-cost franchises target middle-class and low-net-worth people with less experience. Also, there lies risk tolerance. When people invest a high amount, say 30 to 40 lakhs, versus 1 to 2 lakhs, they take a larger stake in it. This indicates that the owner might have done more research and groundwork, as they put sweat equity into it.

Another reason for failure is the perception. Many people believe that a franchise generates revenue from the outset, but they often overlook the need to budget for the working capital required to operate. This misconception stems from the idea that taking a franchise is a one-time investment. The time they realise it is too late.

As the MACJ CEO says, franchise business is more like a marriage, which requires trust, transparency, and long-term commitment. It is not just signing an agreement and leaving it. It is like growing together. The franchisor should oversee the franchise until it achieves success. They have to provide regular feedback and suggestions to improve the business volume.

We researched several franchise opportunities, focusing on their business models, required investments, and day-to-day operational requirements. We found these details to be beneficial/profitable for the franchisor, even if the business didn't take off, which would leave a massive hole in the investor's pocket. This needs to be addressed by the regulator to keep both sides profitable.

Many franchises, such as McDonald's, Subway, Jockey, Aavin, and Delivery, are successful in India due to their effective business models. It is not just a transaction; it is about the trust. The Indian franchise has just started growing.

It cannot be a plug-and-play model here. It is an evolving relationship that strongly depends on shared goals, transparency, and commitment. Like marriage, when both parties are in sync, the results are breathtaking.

(Authors are Associate Professor, Institute of Public Enterprise & Area Credit Manager, SMFG India Credit Limited)