How to Evaluate the Return on Investment and Profitability of a Restaurant Franchise
For the majority of restaurateurs, the objective is not to earn a Michelin star, and more often than not it is a question of survival. It’s no secret that most restaurants operate on pretty slim profit margins (2-6%), and the external factors that affect fixed costs can sometimes be volatile. So how does a franchisee assess their restaurant’s ROI and profitability? There is a proven formula to apply, but as we will see, franchising to become a restaurant owner has some inherent advantages.
Related: So you want to open a restaurant?
Determination of gross and net profit margins
Determining an establishment’s gross margin is not as complicated as one might think. There is a simple formula that gross profit equals total sales minus cost of goods sold (COGS).
Gross Profit = Total Sales – COGS
In catering terms, this means that gross profit can be determined by the difference in value between the sale price of a menu item and the combined cost of the ingredients and materials needed to create it. For successful sites, the gross profit is around 70%. However, this is before taking into account the net profit. It is the remaining amount of gross profit margin after the owner has deducted operating expenses. These typically include payroll, commercial rent, utilities, materials, and any equipment leases.
Net profit = [Total Sales – COGS – Labor)/Total Sales] x100
Related: Why Your Franchise Depends On A Strong Unit Economy And 5 Ways To Strengthen Them
Benefits of Restaurant Franchising
Most franchise restaurants provide owners with name recognition and a track record of success. Provided the establishment remains consistent with brand standards, overall risk is reduced through experience and repetition – this is the inherent value of buying from a turnkey operation.
Franchisees receive training, where they learn brand industry trade secrets and gain access to established supplier relationships. Every aspect of the day-to-day operation of the restaurant is spelled out in the Franchise Operations Manual. If any difficulties or questions arise, franchisees can count on integrated support systems. Of course, the level of this support varies, but it’s not uncommon for brands to offer high levels of field support assistance. This support network also extends to marketing, advertising and promotions designed to attract customers, often all handled by the brand’s cooperative programs.
For franchised food establishments, owners can usually count on lower inventory prices. This is largely due to the collective bargaining power of the brand, which uses reputation and name recognition to negotiate favorable terms on the fixed costs of goods and services.
Profit margin range by type of restaurant
Franchised catering establishments come in many forms. There are full-service restaurants (FSR), quick-service restaurants (QSR), quick-service restaurants, mobile truck and fast-food operations, and even restaurant concepts. Their profit margins vary, but the averages look like this:
Full service 2% to 6%
Quick service 6% to 9%
Street trucks 6% to 9%
There are two basic ways to increase profit margins: increase sales volume and reduce overhead. Strategies and tactics to achieve these goals are always on the franchisor’s mind, as their goal is to give franchisees the best possible opportunity for their return on investment and profitability.
Like any business venture, a successful operation requires hard work, excellent leadership and ongoing operational support. Restaurant owners are responsible for the first two, but the third factor comes from the built-in support that is integral to the franchise business model.
As for the best franchise concepts by category, Entrepreneur got you covered. We have business opportunities to share in over a dozen industries. Everything from automotive, home services and childcare to food, health and beauty, and everything in between. To see what’s in our franchisor database, be sure to check out Entrepreneur Best of the best rankings.