Franchising

What is franchising?

A franchise is a form of business. Franchising happens when a franchisor provides a license to the franchisee. Franchising allows the franchisee to operate their business using the same business model and brand as the franchisor. The franchisor is the business owner who sells the franchising rights to another business. Upon purchasing this right, the franchisee can operate their business under the same name and brand as the franchisor.

Once the franchisee has bought the franchising rights, they have to pay a portion of their profits to the franchiser. These are known as royalty payments. For instance, the franchisor could ask for five percent of the franchisee's yearly profits. The franchiser may also provide training for the franchisee and their employees. The franchisee is usually trained on how to run the daily operations of the business, marketing and management.

Franchising examples

Franchises can be distinguished based on certain characteristics.

• The franchisor owns a trademark and sells it to franchisees. The franchisee, in return, pays royalty payments to the franchisor.

• The franchisee pays for their rights to be part of the franchising system.

• The franchisor provides its franchisees with a set of business tasks that outline how to run the business.

Fast food restaurants are commonly franchised. As you may have already noticed, restaurants like McDonald's, Burger King, Papa John's, or KFC look the same almost everywhere. Their branding, operations, menus, exterior, and interior are designed in a very similar way. This is because most of them are owned and operated under a franchise. Although these restaurants are all franchises, the requirements and costs of owning and operating different franchises vary.

Advantages of franchising

Franchising benefits both parties in a lot of different ways. Buying a franchise is a good way for an individual to set up their business. The benefits of franchising to each party are outlined below.

Benefits to the franchisor

• The franchisor gains the motivation of entrepreneurs who really want to set up and run the franchise. This can be beneficial for the franchisor as they do not need to select a new manager from job listings, etc. The franchisees chose to run the specific franchise themselves.

• The franchisor is able to grow and expand rapidly with the help of eager franchisees.

• The franchisor gains local business knowledge from the franchisee, as the franchisee is more likely to be familiar with local communities and practices.

• It requires relatively lower investment for geographical growth and expansion of the business.

• The franchisor still has control over where and how the new franchises open.

• The financial investment by the franchisees is a source of capital for the franchisor.

Benefits to the franchisee

• They do not have to establish themselves in the same way a sole trader would.

• They buy into a well-established business with a known brand name.

• The franchisee might find it easier to borrow money from financial institutions, like banks.

• The franchisee receives support in most areas of the business like marketing, advertising, employee training, staffing, and operations. There is less experience required.

• They are supported by a business model that is proven to work. The franchisee does not need to come up with their own business plan or business model.

• Less investment is needed in starting up the business, as the business already has established processes.

• There is less risk involved than with a start-up business that has no established foundations.

• There is a lower chance for failure, as the product or service has already proven profitable in the market.

Disadvantages of franchising

On the other hand, franchising can also have its downsides. As with all business ventures, it is not guaranteed that your business will be successful.

Disadvantages to the franchisor

• The possibility of certain franchisees tarnishing the reputation of the franchise. For instance, if a franchisee sets up their business - a restaurant - and it is known to be one of the worst restaurants in the area for customer service, the franchise could get a bad reputation in the local community.

• A lot of resources are required to help the franchise set up their business.

• The franchisee will have access to a lot of information on how the franchise works. This comes with a risk that the franchisee will disclose the information to third parties. For example, if the franchise's signature dish involves a secret recipe, the franchisee could technically disclose this information to a competitor. However, there are usually contracts in place to avoid events like this from occurring.

Disadvantages to the franchisee

• The cost to buy a franchise. It could be very expensive to buy the rights to a franchise. Depending on the franchise, it could also be quite costly to set up (see KFC example above).

• There are also certain restrictions when operating a franchise. The franchisee has to stick to the business plan as outlined by the franchisor, with little to no room for changes.

• The franchisee also has to stick to a prescribed model for marketing and advertising which can be quite costly at times.

• The franchisee has to pay a certain percentage of its revenues to the franchisor.

• The franchisee can only operate in a specific area. If they want to expand their operations, they will most likely have to buy additional rights or pay additional fees.