Franchising is a model to expand your business. There are several advantages to franchising your business and making money using other people’s money, but there are also significant risks.
Advantages to franchising
- Faster growth: Franchising typically requires less money and personnel to set up the franchise system and sell franchises than it takes to open and operate even one new outlet by the franchisor. The cost to set up a franchise system can be recovered over time through franchisees paying initial franchise fees, royalties, and other fees to the franchisor. With franchising, you can make the most of your existing assets (e.g., your system, brand, and know-how) by developing a system that can be duplicated in other locations.
- Allocate risk: Risks that are a normal part of opening and operating an outlet—such as the market demand in the area, permit and license issues, capital needs, employee and supplier issues, etc.—are passed on to the franchisee. The franchisor is left with system-wide risk, such as setting up the franchise system and maintaining the brand.
- Revenues off the top: In most franchise systems, in addition to other fees, the franchisor receives a portion of the gross revenues from each franchised outlet each week or month as a royalty, right off the top of their income statement. Note that the royalty is based on gross revenues, and not profits. So, in general, the franchisor is sharing in the successes of the franchised business but not in its losses.
- Franchisee motivation: Typically, the franchisee is the owner and operator of the franchised outlet, meaning the individual buying the franchise is the one managing the outlet. Given the franchisee’s initial and ongoing investments in the business, the franchisee-manager is usually very motivated to make the business work—many times more motivated than an employee of a company-owned outlet that has no vested interest in the business.
- Less supervision: If the franchisee is properly trained, the day-to-day operations of the business are handled by the franchisee, and the franchisee normally requires less supervision than, for example, an employee in a company-owned outlet.
- Buying power: Suppliers are more likely to grant discounts for volume buying than if you buy products or services for only one location. Some franchise systems require franchisees to purchase products and services necessary for the business from authorized suppliers. As the franchise system grows, franchisors can leverage their increasing buying power to obtain these products and services at lower prices and, in some cases, to receive rebates or commissions from suppliers.
Disadvantages to franchising
- Less per-unit revenues: The franchisee keeps more of the gross revenues from the business, after paying you only a small percentage as a royalty and other fees, than you would have received had you opened and operated that outlet yourself.
- Loss of control: Granting a franchise is a business transaction governed by binding contracts (as well as state and federal laws aimed at protecting franchisees). While a franchisee must operate their franchised business as directed by the Franchise Agreement, ancillary contracts, and the operating manual, ultimately the day-to-day decisions are left with the franchisee. Terminating a franchisee is usually more complicated than terminating an employee, and you must follow a specific statutory process that takes time and money, and that could adversely affect the franchise system and brand.
- Brand contamination: A franchisee that fails to adhere to the Franchise Agreement, ancillary contracts, or the operating manual may adversely affect the brand as a whole. Customers generally view an independent and franchised-owned business as being owned and operated by the franchisor (because the brand name is the same). So, other outlets in the franchise system could be contaminated by any adverse actions by one franchisee (such as the commission of crimes or unsanitary facilities).
- Regulation: Franchising is a highly regulated area, governed by state and federal laws. Before a franchisor can sell franchises, the franchise system must be registered in certain states and the franchisor must provide mandatory disclosures in all states. The ongoing relationship with franchisees, including renewing franchisees and terminating franchisees, is subject to state franchise relationship laws. Any misstep can result in repercussions. These franchise laws are in addition to the business laws that apply to your business, such as health and safety laws and municipal ordinances.