Latest / Franchise Conversations with Fexingo: Buying, Running, and Scaling Franchise Businesses / How Franchisees Use Unit Economics to Decide on Multi-Unit Growth
Transcript
- Lucas: So the last time we talked about expansion, we focused on pop-ups and mobile units as a way to test the waters. But today, I want to talk about the decision that comes after that test — when you're ready to commit to a permanent second location, or even a third or fourth. Luna: And I'm guessing the answer isn't just 'well, my current store is making money, so I'll double down.' Lucas: Exactly right. And that's the trap I want to dig into. I've been talking to a franchisee who runs three sandwich shops in the Midwest — let's call him Dan. He's doing about one point two million dollars in revenue per store, and his margins are decent. He's thinking about a fourth unit, but he's not sure if the math actually works. Luna: What's the hesitation? If the first three are performing, you'd think the fourth is a no-brainer. Lucas: Well, that's the thing. Dan's stores are doing fine, but when you break down the unit economics, the picture gets murkier. He's got one store that's a clear winner — it's doing about one point five million. But the other two are more like one point one million each, and they're cannibalizing each other's sales a bit because they're only a few miles apart. Luna: Cannibalization — that's a word you don't hear enough in franchise conversations. Lucas: Right. And it's one of the reasons why average unit volume, or AUV, can be a misleading metric. Dan's average looks great on paper, but when you strip out the outlier store, the median unit is doing about one point one million. That's a different starting point for underwriting a new location. Luna: So what's a better way to think about it? What metric should someone look at when they're considering adding a unit? Lucas: The metric that really matters is contribution margin — the revenue from that specific unit minus all the variable costs that go toward running it: food, labor, utilities, the small stuff. It tells you how much that unit contributes to covering your fixed overhead — the franchise royalty, your rent, the general manager's salary. Luna: And that's different from your total profit, right? Because you have shared costs across the portfolio. Lucas: Exactly. And that's the key. Too many franchisees look at total net profit across their portfolio and think, 'Great, I'm making money.' But they don't allocate the shared costs — like a district manager, or a delivery van, or the extra accounting — down to each unit. When you do that, you often find that one of your units is actually a drag on the whole system. Luna: So the fourth unit isn't just about whether that store can make money on its own. It's about whether it can carry its share of the extra overhead you'll have to add. Lucas: Yeah, and that's where I find most people underestimate the jump from one unit to two, or from three to four. There's a step change in complexity. When Dan adds a fourth store, he's probably going to need a district manager. That's a hundred grand a year, easy, before you even think about payroll taxes and benefits. Luna: And a district manager might add a hundred thousand dollars in cost, but they also free up Dan's time. So the question is, is that time better spent on the new store or on improving the existing ones? Lucas: That's a really good framing. And it's one that Dan is wrestling with. He's currently in the stores more than he'd like, doing shifts when someone calls in sick. He wants a district manager so he can step back. But he's also aware that a district manager is a cost that has to be covered by the new unit — or by the increased efficiency of all four. Luna: I've heard that phrase 'you can't manage a store you're not in' — but is that really true once you have multiple locations? Lucas: That's the old-school thinking, I think. The better operators build systems and hire managers who can run the place without them. But that's a skill in itself — and it's one of the reasons why so many franchisees stall at two or three units. They haven't built the management bench. Luna: So what's the practical test? How do you know if you're ready to handle a fourth unit without spreading yourself too thin? Lucas: There's a rule of thumb I've heard from a veteran franchise operator who runs about twenty fast-casual locations. He says, 'One strong unit beats two mediocre ones.' And by 'strong' he means a unit that hits a certain cash-on-cash return — he likes to see at least fifteen percent, but he'll accept twelve if the growth trajectory is there. Luna: Fifteen percent cash-on-cash — that's the return on the actual cash you put in, right? Not the total investment, but your out-of-pocket. Lucas: Correct. And for Dan, the question is whether that fourth unit can deliver that kind of return after you allocate the incremental overhead. If the new store does one point one million in revenue, with a twelve percent EBITDA margin, that's about one hundred thirty-two thousand dollars in operating profit. But then you've got the district manager salary, the new delivery truck, maybe some additional training costs. Suddenly that one hundred thirty-two thousand is down to ninety or eighty. And if you had to put in two hundred thousand of your own cash to open the store, you're looking at a cash-on-cash return of around forty percent. Luna: Forty percent is pretty good, though. That's not a bad return on a new store. Lucas: It's solid. But here's the catch — that's assuming the store ramps up to one point one million right away. In reality, a new store takes time to build a customer base. Dan's first store took almost eighteen months to get to a profitable run-rate. His second store took about a year. If the fourth store takes two years to hit that revenue, the return over the first couple of years looks a lot less attractive. Luna: So it's not just about the unit economics at maturity — it's about the ramp-up period and how that affects your cash flow and your ability to cover the new overhead. Lucas: Exactly. And that's why the smartest multi-unit franchisees underwrite each new location as if it were a standalone acquisition. They look at the projected revenue, the costs, the ramp-up time, the working capital needed — and they stress-test it. They ask, what happens if revenue is twenty percent below plan for the first year? Does the district manager still make sense? Luna: And I imagine that stress-testing is where a lot of deals fall apart — which is a good thing. Better to know now than after you've signed the lease. Lucas: Absolutely. And that brings me to another concept that's really important: the second-unit trap. It's this idea that your first unit succeeded because of your personal involvement — you were there every day, you knew every customer, you fixed problems before they became disasters. When you open a second unit, you can't be in two places at once. And if you don't have a manager who can run the first unit as well as you do, the second unit can actually drag down your entire portfolio. Luna: So it's a risk not just to the new store, but to the existing one that was doing fine. Lucas: Right. And that's why Dan is smart to be cautious. He's seen friends open a second location and watched their first store's sales dip because they couldn't give it the same attention. It's not just about cannibalization — it's about management bandwidth. Luna: You know, this reminds me of something I read about a franchisee who was opening a new unit and used a shadow management program — we talked about that in an earlier episode — to train a manager for the new store while still running the old one. That seemed to work well for them. Lucas: Shadow management is a great tool for exactly that. It gives you a manager who's already experienced in your specific operation before day one. But even with that, you still need to make sure the economics work. And that's where I think a lot of franchisees get seduced by top-line growth. They see the total revenue of their portfolio going up, and it feels great. But if the profit per unit is going down, they're actually worse off. Luna: I mean, I've seen that happen. Someone opens a bunch of locations, and they're doing millions in revenue, but they're barely breaking even. It's like they're running a charity. Lucas: Exactly. And that's why I love the concept of profit per unit. It's a simple number — take your total net profit and divide by the number of units. If that number is going up as you add units, you're scaling well. If it's going down, you're just adding headaches. Luna: So what's a realistic profit per unit for someone like Dan? Is there a benchmark? Lucas: It varies by industry and brand, but for fast-casual restaurants, a healthy profit per unit is often somewhere between eighty and one hundred fifty thousand dollars. And when you add a new unit, you want to see that number stay stable or improve. If it drops significantly, you need to ask why. Luna: And that ties back to the contribution margin conversation. If your fourth unit has a lower contribution margin because it's cannibalizing your third, your profit per unit will drop even if total revenue goes up. Lucas: Exactly. And that's why I think the best franchisees think in terms of return on invested capital, not just revenue. They ask, 'What's my return on the total capital I've put into this portfolio?' And they compare that to what they could get elsewhere — maybe a stock market index fund, maybe a real estate investment trust. If your franchise portfolio can't beat a passive index fund on a risk-adjusted basis, you have to ask yourself why you're doing it. Luna: That's a tough question. And I think a lot of franchisees don't ask it because they love the business. But it's a fair one. Lucas: Yeah. And I'm not saying you should only look at the numbers. There's a lifestyle component, there's pride in building something. But if you're going to invest hundreds of thousands of dollars and years of your life, you want to make sure the financial foundation is solid. Luna: So before we wrap up, let's talk about the practical steps someone can take this week if they're considering a new unit. What's the first thing they should do? Lucas: The first thing is to pull together your last twelve months of financial statements for each of your existing units. And I mean each unit separately, not just the total. Then calculate the contribution margin for each one. That will tell you how much each unit is truly contributing to your fixed overhead. Luna: And then what? Compare those margins to what the new unit is projected to be? Lucas: Right. And make sure you add in the incremental costs — the district manager, the additional insurance, the extra marketing. And then stress-test it. Assume revenue is fifteen percent lower than projected for the first two years. If the store still delivers a positive contribution after that, you're in okay shape. If not, you might want to wait. Luna: And also look at your own bandwidth. Do you have a manager who can run your best store without you? If not, that might be the bottleneck, not capital. Lucas: Yes, that's a great point. And that's why I always tell franchisees: hire for the role you need, not the role you have. If you're going to open a fourth unit, you need a district manager — even if you don't have the fourth unit yet. That person can help you prepare for it. And if the fourth unit doesn't work out, you've still got a better manager for your existing stores. Luna: That's actually a really smart approach. Hire the DM before you need them, and let them be part of the decision-making process. Lucas: Exactly. And it's also worth remembering that the best franchisees are constantly in learning mode. They read, they talk to other franchisees, they attend conferences. There's a reason why the most successful operators are always asking questions. Luna: Speaking of learning — I know we don't run ads on this show, and that's a deliberate choice. If you're finding these conversations useful, and you want to support that ad-free approach, there's a way to do it that doesn't cost anything but a bit of your time. It's buy me a coffee dot com slash fexingo. Lucas: Yeah, that's something we really appreciate. It keeps the show clean and focused on the content. No interruptions, no sponsored segments. Just the conversation. And every little bit helps cover the production costs. Luna: Okay, so back to the topic — let's say Dan decides to move forward with the fourth unit. What are the biggest mistakes he should avoid during the launch? Lucas: The biggest mistake is probably undercapitalizing the ramp-up period. A lot of franchisees think they have enough cash because they've budgeted for the buildout and the initial inventory. But they forget about working capital — the money you need to cover payroll and rent while the store is still building its customer base. I'd say you need at least six months of operating expenses in reserve, and preferably a year. Luna: And that's on top of the buildout costs, right? So it's a double whammy of cash outlay. Lucas: Exactly. And that's why I always advise franchisees to do a full cash flow projection for the first two years, not just the first few months. You want to see when you hit break-even, and how much cash you need to get there. If that cash requirement feels scary, that's a signal that you might be overreaching. Luna: So what's the final takeaway? What should someone thinking about a fourth unit remember? Lucas: I think the core message is: add units only when they add to your profit per unit and your return on invested capital, not just your revenue. And that starts with a clear-eyed look at your current unit economics. If you can't explain how much each unit contributes to your bottom line, you're not ready to add another one. Luna: I love that. And maybe a final question for our listeners: what's one metric you're not tracking today that could change your next expansion decision?