Entering the world of franchising requires a dual approach. On one hand, you’re searching for a brand in alignment with your goals and values. On the other, you’re stepping into a rigorous financial ecosystem where a number of factors determine whether your business will thrive or even survive. 

Unit economics are the fundamental financial building blocks of a single franchise location. While brand recognition in the broader scheme is enticing, the health of the individual unit is where the real story lies. 

The Foundation: AUV and the Top Line

The starting point for any unit economics discussion is Average Unit Volume (AUV). This represents the average annual sales generated by a single franchise location. While a high AUV is often used as a primary marketing tool by franchisors, it’s merely the top line.

“We're driving top-line sales through a variety of strategies, including doubling down on innovation while maintaining best-in-class prime costs,” said Sunny Street Cafe President, Mike Stasko. “That has resulted in a record-breaking AUV that we’re very proud of this year.”

AUV tells you how much money is coming through the door. But it doesn’t tell you how much is staying in your pocket. To properly assess that, one must look at the costs required to generate those sales.

The Variables: COGS and Labor

The two heaviest hitters in a profit and loss statement are cost of goods sold (COGS) and labor.

• COGS: This includes the raw materials needed to create your product (from pizza dough to cleaning supplies). In a healthy franchise model, COGS is managed through the franchisor's supply chain power.
• Labor: This is often the most volatile variable. It includes wages, benefits and payroll taxes.

“We are leveraging buyer relationships, negotiating good contracts and really fine-tuning the model,” Stasko said. “We own many of the restaurants, so we have a vested interest in driving food costs down – not only for franchisees but for ourselves. That's pretty unique. As a result, we’ve seen our lowest food and labor costs in the history of the company.”

In today’s economy, labor efficiency is critical. If a brand requires a high headcount but offers low margins, the business can become fragile. As brands are evaluated, one must ask: is the business model designed to absorb rising wage costs, or will those costs eat the bottom line?

Finding the Breakeven Point

The breakeven point is the moment your total revenue equals your total expenses. Every dollar earned after that is profit. Knowing how long it takes to reach this stage, and how much capital it takes to get there, is vital to proper financial planning.

However, the math is only half the battle. Jim Stapleton, strategic sales advisor and vice president of development for Caring Transitions, suggests that starting with the spreadsheet might be the wrong first move.

"The first question they need to ask is: what is their why? People buy from their heart, not from their head," he said. "If they’re just focused on the numbers themselves, it's often not enough. With Caring Transitions, it's not so much about the money. What are you looking for? There are some franchises out there that are just focused on the monetary payoff. But it should also be about the heart behind the brand."  

The Valuation Trap

When looking at franchising as an investment to one day sell, the way a brand scales matters just as much as its current revenue. Rapid expansion through selling many units quickly can be viewed skeptically by buyers (potentially leading to a discounted valuation). Waiting to open these units before selling can increase the franchise's value. The ultimate goal is a business that works for the owner, rather than the owner working for the business. 

We are confident that our prime costs are among the best in the breakfast segment,” said CEO Scott Moffitt.

“This is essential to us perfecting the business model to align with our franchise growth plans.

Five Tips for Evaluating Franchise Unit Economics

1. Look Beyond the AUV: Always ask for the net figures. A $2 million AUV is impressive. But if the COGS and labor are $1.8 million, your margin for error is quite thin.
2. Verify the "Why": Ensure the mission of the brand is something you can deliver with passion. "The money shouldn't be the most important thing,” Stapleton said. “It should be your love for the business."
3. Audit the Labor Model: Ask current franchisees about their turnover rates (and former franchisees why they left). High labor costs are often driven by hiring and retraining.
4. Analyze the Breakeven Timeline: Calculate your timeline for return. How many months of operating losses can you actually sustain before the business reaches a sustainable point?
5. Watch the Growth Velocity: Be cautious of franchisors who are selling territories faster than they’re opening stores. A brand’s value is tied to its operational success (not just its contract signings).

The Takeaway

Success does require a certain mastery of the spreadsheets. And ensuring that AUV supports labor and COGS is important. But successful franchise owners are the ones capable of embracing the concepts of financial discipline and personal purpose. Because it’s important to maintain the human element. It can drive a business forward at the local level. 

By balancing an embrace of unit economics with a passion for the business opportunity, it’s possible to create a franchise that’s not only profitable but sustainable over time.

Growing and selling franchises is difficult. Want to learn more about how 1851 helps franchisors grow their franchises with confidence? Visit www.1851growthclub.com and see what we can do for you.