Analysis of Survival Rates among Franchise and Independent Small Business Startups

Abstract

recent ad in Business Week succinctly states the conventional wisdom on the risk involved in entering self-employment by purchasing a franchise: A franchisee has a four times greater chance to succeed than an entrepreneur who launches a new independent business. The franchise, we are told, is a safe bet. However, findings of this study indicate that young franchise startups exhibit both higher rates of firm discontinuance and lower mean profitability than cohort independent business startups. When owner and firm traits are controlled for statistically in logistic regression, the franchise characteristic is found to be negatively related to firm survival prospects. These findings are based upon analyses of approximately 20,000 young small businesses, utilizing nationwide data compiled by the U.S. Bureau of the Census. The findings of this study are consistent with the hypothesis that popular franchising niches have become saturated, leasing diminished prospects for newcomers. Net income in 1987 among firms formed during the 1984 to 1987 period, for example, averaged -$4,102 for retailing franchises and $14,572 for cohort independent business startups. For these same retailing firms that were operating in 1987, 45.1 percent of the young franchises had gone out of business by 1991, versus 23.4 percent of the independent young retail firms. Relative to all small business startups, franchises are heavily concentrated in retailing, and it is the retail franchises that most often fit the high risk, low return profile. Note that firms sold to a new owner, merged, or otherwise altered are not counted as discontinued in this study if they continued to operate. Franchise discontinuance rates reported in this study differ dramatically from those cited by various franchisors and franchisor associations. According to research sponsored by the International Franchise Association, for example, 96.9 percent of the franchised units opened nationwide within the past five years are still in operation (Arthur Anderson and Co. 1992). Significantly, this survival rate information was compiled by surveying franchisors - the corporations that sell franchises - rather than the actual franchisee owners of the operations whose survival is at issue. In contrast, the approach of this study is to rely upon franchisee owners to self-report information about the continuity of operations in the small businesses that they own and operate. Most evidence on franchise survival rates comes from sources other than scholarly journals, so that peer review monitoring of research quality is not present. The February 1994 issue of McCalls magazine claims that 50.7 percent of Decorating Den's franchisees terminated operations during the three-year period ending in December 1992, as compared to the Anderson number quoted above. Thus, claims about franchise survival rates have often tended to extremes. The purpose of this study is to raise the debate to a higher plane by using nationwide data from the Census Bureau on business survival and to conduct appropriate statistical analyses on these data. CHARACTERISTICS OF FRANCHISE AND INDEPENDENT YOUNG FIRMS The presence of a large new nationwide small business database compiled by the Census Bureau - the Characteristics of Business Owners (CBO) database - makes it possible for issues of franchise survival to be analyzed comprehensively. The CBO database is described in detail in Bates (1990a), Nucci (1992), and in Appendix B: Nature of the Database. Of the roughly 90,000 small businesses surveyed to create the CBO database, over 72 percent responded. All of the reported statistics in this study are weighted to adjust for both survey non-response and the Census Bureau's non-random sampling in the creation of the CBO. The firms described in this study are representative of young firms that grossed at least $5,000 in total revenues in 1987 and filed a small business income tax return. This study covers only firms formed over the 1984-87 period, and the unit of analysis is firms, not persons. …