Franchises are booming

Can small privately-owned businesses compete with the burgeoning number of chain stores?

By ALEX MARGOLIN
aroma 298.88 (photo credit: Yonit Schiller)
aroma 298.88
(photo credit: Yonit Schiller)
Tzion Basheshet, owner of Coffee Time Bagels in Zion Square, keeps a watchful eye on the competition that moves into his territory, wary of the increasing number of big chains encroaching on his small business. Every time a chain moves in, Basheshet says, it takes some business away from the others. "People don't come to downtown Jerusalem cafes from across the country the same way they come to cafes in Tel Aviv," he says, suggesting that profits are limited and each establishment is competing for a share of the pie. "Every new place takes some percentage of the profits from the next one." One block over and across the street, Adam Budwig, manager of the Coffee Bean & Tea Leaf, sees things differently. "Competition is good," he says. "It brings more people to the area because they have more options." Budwig has reason to be confident. He runs Jerusalem's only branch of an international chain that owns 13 other branches across the country. The Coffee Bean & Tea Leaf arrived at Kikar Zion two years ago, joining Neeman Bakery, Café Hillel, Aroma, English Cake and Holy Bagel along a three-block stretch of Jaffa Road. It quickly established itself as a favorite among Anglos and tourists, particularly those who patronized its branches in America. "People are comfortable shopping at chains because they are familiar with the brand name," Budwig explains. "They're coming to a proven place and they know exactly what they are going to get." The different perspectives expressed by Basheshet and Budwig reflect the emerging new landscape for commerce in Jerusalem. Private business owners like Basheshet scramble for customers and worry about cash flow. And increasingly, they are forced to compete with franchises that have built-in name recognition and efficient marketing machines behind them to attract customers. Indeed, the numbers indicate that Jerusalem, like the rest of Israel, is in the midst of an unprecedented boom in franchising that is transforming the city. Of the 5,000 chain-store branches currently operating across the country, more than 1,000 of them opened in 2005. To compete in that kind of environment, Basheshet has skillfully leveraged the advantages of a small business: flexibility and improvisation. While the chains have set menus, prices and presentation styles, Basheshet is free to change anything he likes and to offer the kind of personalized service that creates loyal customers. "We offer a big menu that changes every month," he says. "We have a special menu for children. We cater to all different types of customers. We try to be different from our competitors." But while Basheshet's Coffee Time has managed to compete with the big chains in Kikar Zion, many other businesses across Jerusalem have given way to expanding chains. Neeman Bakery has replaced Art Cake at the Oranim gas station in Talpiot; Aldo Ice Cream took the space vacated by Photo Doron on Rehov Emek Refaim; and Cup O'Joe opened almost a year ago where the Moulan restaurant used to be on Rehov Keren Hayesod, to name a few. WHILE BUSINESSES open and close all the time, franchises are clearly gaining the upper hand. And the numbers suggest the franchise era is only beginning. According to Michael Benin, director of the Israel Franchise Promotion Center, 92 percent of franchises opened new branches in 2005, setting a new record. The statistics for 2006 have not yet been published, but there is reason to believe that franchises are continuing to grow at record rates, says Benin. "If things continue, we will soon reach a similar level to the US, where 40% of all retail is done through franchises." Although there are many reasons to explain the sudden upsurge in Israeli franchising, the biggest factor could be the establishment of the country's mall culture, says Benin. When malls were first opening across the country 10 years ago, he explains, mall managers were happy to fill the spaces with all types of businesses. But with the period of growth coming to an end, competition has increased dramatically for precious mall space. As a result, mall managers have become extremely reluctant to rent space to private businesses, preferring to work with the more stable and often more profitable chain stores. "Today, private businesses have almost no chance of getting into malls or big business districts," says Benin. "The same phenomenon is now spreading to some of the more popular streets as well," he adds. There are currently some 300 franchise chains in Israel employing about 120,000 workers. The largest 85% have an average of 20 branches each. About 87% of all Israeli franchises operate in fast food, clothing and retail. The remaining 13% are spread over virtually every other industry. Although details vary from business to business, a franchise agreement generally refers to a contract between a chain (the franchise) and an independent party (the franchisee), allowing the franchisee to use the franchise's name, logos, products and operating methods in exchange for an upfront payment and a percentage of the profits. Franchises come in different varieties. Some, like Café Hillel or Aroma, own only a small number of the branches under their name. Of the more than 20 branches of Café Hillel, only two or three belong to the franchise itself. Others, like the real estate company Re/Max, don't own any at all. All 77 Re/Max branches across the country are individually owned and operated. The advantage of buying into a franchise is the ability to own a small business that channels with the expertise of a big business. "No one can be an expert in every area - management, sales, marketing, etc.," explains Benin. "But in a big business, there are skilled professionals devoting themselves to only one of those areas. That is obviously difficult to compete with. "Franchises represent the intersection between small and big businesses," he continues. "Each branch is essentially a small business in the way it operates. Even the main chain is usually no bigger than a medium-sized business. But taken together the branches constitute thousands of workers and millions in profits. They can harness the power of big business." Since franchises have a vested interest in the success of each branch - both because of the royalties they receive and because successful branches inspire others to open new branches - they tend to offer strong support to their franchisees. The more serious the franchise, says Benin, the more it takes upon itself in the franchise agreement. One Israeli franchise, for example, assumes responsibility for finding a suitable location, finances the interior design and any necessary repairs, works out the menu and negotiates arrangements with suppliers. "All that's left for the franchisee to do is to oversee the cash flow, manage employees and push sales." AS A result, the franchise system presents an option to people who would otherwise never consider opening their own business. Benin refers to the ideal franchisee as an "entrepreneur-lite," the type of person targeted by the franchise industry's slogan, "A business of your own, but you are not alone." Many people who purchase branches, explains Benin, are people who worked for others for a living but wanted to try working for themselves. At the same time, they may not be ready to take on every aspect of running a business - choosing merchandise, creating an accounting system, dealing with distributors, marketing the business - and want to minimize risk by entering a system with proven success. While franchises work hard to help their branches prosper, they also place strict limitations on how business is to be conducted. Franchises usually dictate which products or services can be offered, their prices and often even branch locations. The franchisee is also responsible for maintaining the quality standards of the franchise, and for presenting the product in the manner that customers expect. He or she must keep careful records of all merchandise and practice complete transparency in all accounting. Decisions on hiring, and especially firing, are sometimes made at the franchise headquarters. Because franchisees are expected to begin offering quality service from their first day of operation, even before the branch may have settled in with the local customers, the most successful franchisees are those who have more capital at the start, says Benin. Even if business is slow in the beginning, the franchisee cannot lower prices or cut items from the menu. More capital, he explains, means more time for the business to get rolling. Still, not every individual has the right makeup to excel in the franchise business. Some entrepreneurs who are accustomed to Israel's culture of spontaneity and flexibility in business find it difficult to conform to the guidelines. "Those who fit are people who prefer to work in a framework," says Benin. "They like feeling as though they have support." Uri Scharf, head of MATI, the Jerusalem Business Development Center, agrees. "A person can't suddenly decide he wants to put this new product on his shelf," he says. "And not everyone is comfortable with the level of transparency franchises require." But for those who prefer to work within the confines of the franchise system, the chances of success are often greater than most other businesses, Scharf says. "In a franchise relationship, a person gets more than just the use of the company's name. He also gets his inventory at a cheaper price because the franchise arranges it. In addition, he also benefits from the franchise's experience, what the company learned from earlier mistakes." "A big chain means there is a lot of money behind you," adds Budwig. "There is less risk because you have a proven product that has worked elsewhere. Someone has already done the research. You are buying a finished, or nearly finished product." Benin and Scharf both pointed to a recent study of Israel's café market carried out by Dunn and Bradstreet to show that franchises may well be the wave of the future. According to the study, cafes affiliated with chains had nearly four times as much turnover in an average month as regular cafes. They were also less likely to close during the critical first two years, when 50% of Israeli cafes shut down. The results of the study are discernible in the streets of Israel's cities. Over the past five years, says Benin, the number of cafes in Israel has remained steady at about 1,000-1,100. During the same period, he adds, the number of café franchises has increased substantially, meaning that an equally substantial number of privately owned cafes have closed . One café that seems to be bucking the trend, however, is the Coffee Mill on Rehov Emek Refaim, which is known for its large array of ground coffees and its cozy atmosphere. Co-owners Debbie Katz and Rosie Nathan say their business has been virtually unaffected by the trends on the street, including the arrival of Coffee Shop and the expansion of Aroma at the other end of Rehov Emek Refaim. There will always be a place for a small café that offers something different, they say. "What's good about a small business is that people can really get what they want," says Nathan. For example, if "People say, 'I want my coffee strong but less acidic,' we can make it the way they want it because we have a large selection of coffees." The recent changes on Rehov Emek Refaim, including the influx of restaurants, has had its benefits, adds Katz. "Competition is not bad for business," she says. "It brings a large cross-section of customers to the street." And after 10 years in business, Katz and Nathan say they've established a strong connection with their customers, most of whom they've come to know personally. "People like to go to places where they feel welcome and they can get what they want," says Nathan. "Some small businesses are here to stay."