Inspection Business Model Choice Depends on Franchise Fees
by Nick Gromicko, CMI®
It is always better for home inspectors to charge more than less, obviously – that goes without saying. But, mathematically, it is particularly important for the marketing campaigns of franchise home inspection companies to target higher-paying inspection jobs. I'll explain why.
Franchisees pay their corporate franchisor a percentage of their total gross revenue. This is often paid as a monthly fee based on the total amount charged for all the inspections performed each month. However, for financial analysis purposes, we can look at this franchise fee as a percentage of the fee paid by the inspector for each inspection.
I'll call the first business model the "Take Every Inspection You Can Get" model. In this model, our inspector targets all types of clients and homes, not just the high-paying, great profit-margin inspections. Under this model, the inspector will land some high-fee inspection jobs that generate large profits, some that generate modest profits, and some low-priced, low profit-margin inspection jobs.
I'll call the second business model the "Go After the Gravy Only" model. In this model, our inspector targets, bids, and accepts only the highest paying inspection jobs with the greatest profit margins. Under this model, the inspector bids all inspections high, refuses to compete on price, and thus lands fewer but higher-profit inspections.
Now, for purposes of illustration, I'm going to make up some numbers. They might not be accurate for your market area, but that doesn't matter, as I'm only using them to highlight the effects of franchise fees on two opposing business models.
They are as follows:
- Franchise fee = 12% of gross revenue
"Take Every Inspection You Can Get" Model:
- Average fee of the "Take Every Inspection You Can Get" model = $360
- All costs to the inspection company to perform a home inspection, including operations, marketing, risk management, inspector's pay, etc. = $270
- Average profit per inspection of the "Take Every Inspection You Can Get" model = $90 per inspection (total fee minus costs)
- Number of inspections performed per year using the "Take Every Inspection You Can Get" model = 400
"Go After the Gravy Only" Model:
- Average fee of the "Go After the Gravy Only" model = $575
- Average profit per inspection of the "Go After the Gravy Only" model = $305 (total fee minus costs)
- Number of inspections performed per year using the "Go After the Gravy Only" model = 200
(You might have noticed that I have decided to give the "Go After the Gravy Only" model only half as many inspections per year as the "Take Every Inspection You Can Get" model. I did this intentionally. Again, it matters not that my made-up numbers aren't representative of your experience. I'm only using them to demonstrate an effect.)
Now, using these numbers, we'll look at the effect on both non-franchise and franchise inspection companies that adopt the "Take Every Inspection You Can Get" model first.
The non-franchise company that tries to land every inspection they can will have a yearly gross revenue of $144,000 (400 inspections at an average of $350 per inspection), and a net profit (after paying for operations, marketing, risk mitigation, inspector's pay, etc.) of $36,000.
The franchise company that tries to land every inspection they can will also have a gross revenue of $144,000. But the franchise company's net profit will be reduced by $17,280, or 12% of $144,000, which is the franchise fee on the gross revenue, leaving the franchise company with an annual net profit of only $18,720 ($36,000 - $17,280 for the franchise fee).
Despite doing the exact same number of inspections for the same fees, the franchise company only makes about half (52%) of the net profits that the non-franchise company makes. This is because the franchise fee of 12% is charged on gross revenue, not on net profits.
The franchise company can do something about this inequity, though. It can adopt the "Go After the Gravy Only" model. Let's plug in the numbers and look at the effect on both non-franchise and franchise inspection companies that adopt the "Go After the Gravy Only" model.
The non-franchise company that goes for the gravy only will have a gross revenue of $115,000 (200 inspections at an average of $575 per inspection), and an annual net profit (after paying for operations, marketing, risk mitigation, inspector's pay, etc.) of $61,000.
The franchise company that goes for the gravy will also have a gross revenue of $115,000. But here is where it gets good for the franchise company: The franchise company's net profit will be reduced by only $13,800 (12% of $115,000), which is the franchise fee on the gross revenue, leaving the franchise company with a net profit of $47,200 ($61,000 - $13,800 for the franchise fee).
Despite doing the exact same number of inspections for the same fees, the franchise company makes almost the same 77% of the net profits that the non-franchise company makes.
So, what does this all mean? It means that although it might be more profitable for all inspectors to do fewer inspections for more money... it is especially much more profitable for franchise inspection companies to do fewer inspections for more money.
What franchise inspection companies should do is avoid chasing low profit-margin inspections. Such inspections only increase gross revenue, thus increasing the franchise fees, but without increasing net profits much.
As a proof by extreme, if a franchise inspection company paying 12% of its gross revenue to the corporate franchisor is operating at only a 12% profit margin, the inspection company isn't making any money at all. It could do $10,000,000 in inspections and still wouldn't make any money.
The fact that the franchise fees are a percentage of gross revenue and not net profit compels all franchise inspection companies to adopt the "Go After the Gravy Only" business model. The lesson? Raise your prices.
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