A major issue in franchising in recent years, and one which should be carefully considered by any potential franchise owner, is the problem of market saturation.  Market saturation occurs when enough of the same brand franchises operate within a given geographic location that the demand for the franchise’s product is less than the combined supply offered by all available franchises.  This is to say that in any given location there is only a set number of potential customers, and as the market becomes saturated with comparable franchises operating under the same label, business for one franchise means a decrease in business for another.

This problem represent a significant rift between the goals of the franchisor and the franchisees.  Franchisors would most generally prefer to operate at as close to saturation as possible in any given market.  This assures that the maximum amount of customers in that location are being reached by their trademarked product, each sale to which the franchisor is collecting a percentage.   From the franchisor’s perspective, the optimal market situation is one wherein every potential customer is able to receive services from franchisees while maintaining a high enough return on investment at each location to retain the attractiveness of franchise ownership to potential new owners.

For the individual franchisee, however, this saturation means a lower return on investment.  Beyond having to compete with comparable businesses of differing trademarks which offer similar but different products, the franchisee finds him/herself in a situation where it is necessary to compete with other businesses in the same franchising organization.  This means lower sales for the individual franchisee and therefore a smaller return on investment.

To give a very simplified example of what is meant here, let us take a theoretical market in which there are twelve potential customers who wish to purchase hamburgers, distributed throughout a marketing area.  Let us suppose that there is one hamburger stand, operating under a franchise agreement at one end of this marketing area, which is only easily accessible to eight of the twelve potential customers.  For the franchise owner, this isn’t a bad scenario, as he is able to profit off of sales to eight customers, but from the franchisor’s perspective there are still four potential customers unreached and thus a loss of potential revenue.

Let us then suppose that another hamburger stand is opened at the opposite end of the marketing area, able to provide service to the previously unreached four customers and slightly more accessible to several of the other customers as well.  Now either stand receives patronage from 6 customers out of the twelve.  This is the point of market saturation.  From the standpoint of the franchisees this scenario is less ideal because they are each only profiting from six customers instead of the original eight.  From the franchisor’s end, this is the ideal situation because all customers have been reached with their product and each business is still doing well enough to make franchises in other locations appealing to investors.

This scenario can be taken a step further by adding a theoretical third hamburger stand to the market area, over saturating the market .  It is easily seen that such a scenario would hurt both the franchisor and franchisee.  Each franchise would be seeing returns from only four customers, the franchisor would not be garnering any more royalties than they were from two franchises, and the overall attractiveness of buying into the franchising organization would be reduced by the lower earnings of the three franchises.

Obviously the first scenario of operating below the saturation level is preferable to the franchise owner and the second scenario of operating at or just below the saturation level is preferable to the franchisor.  When deciding on the viability of proposed franchise, a potential new owner is wise to survey the landscape and determine the level of market saturation for the area in which he/she intends to open a franchise.  Buying into an nearly saturated market will lead to a diminished return on investment.

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