Last Updated on March 9, 2021 by Filip Poutintsev
‘Franchise’ can be defined as a right to sell a company’s products in particular areas using the company’s name. In some cases, it gives the business owners the right to use the franchisor’s already tested business products and their established name and brand.
Wendy’s, McDonald’s, and Burger King are some popular examples of franchises.
Franchising is a business relationship; wherein the owner authorizes another party to use their brand, product, business system and process in return for adequate consideration. Franchising should not be confused with the equal partnership, especially due to the preponderance of the franchisor over the franchisee.
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History of Franchising
The concept of franchise dates back to the mid 19th century. The most famous example is Issac Singer. In 1851, Singer successfully created a franchise for his sewing machine to distribute it to a larger area. This experiment proved to be a failure.
In the early 1890s, Coca-Cola successfully franchised the rights to bottle its beverage to a large number of independent businessmen who received exclusive territories in which to distribute the product.
Franchising was not so widely practiced until the 1960s and 1970s. Even though the concept intrigued people with the entrepreneurial spirit there were serious pitfalls for investors, which almost ended the practice before it became truly popular.
How Does Franchising Work?
When a business decides to expand by franchising, they allow other franchisees to open up an identical business. The franchisor provides an existing business model, brand, marketing strategy, and ongoing training. There might be site selection and lease negotiation, mentoring through the network of the master agreement. There are three ways in which franchisees make money.
- When the franchisee buys the right to open up a business.
- The franchisee agrees to buy all the products from the franchisor.
- The franchisee also agrees to pay a fee according to the master agreement.
Pros of Franchising
1. Reduced Risk
Franchising can provide a high growth rate for a minimum amount of risk. Unlike in adding your own company outlet you put relatively less money when you franchise. The franchises are one who executes on leases and it is itself responsible for what happens inside the unit. So you don’t have any liability for what happens inside the unit (such as employee litigation).
2. Improved Valuations
It is no surprise that franchisers are often valued better than other businesses because they have a faster growth rate, increased profitability, and increased organizational leverage. So when it comes to your company’s valuation successful franchising with a scalable growth rate and a good business model can be a big advantage.
3. Discover Better Talent
Franchising is a great way to find new talented people to manage your company’s outlet by giving them an incentive to work hard. This way you are going to get a better talent that will work very hard for your company rather than hiring one yourself.
Hired managers are only employees who may or may not have a genuine commitment to their jobs, which makes supervising their work from a distance a challenge. Your franchisee will be an owner, often with his life’s savings invested in the business. And his compensation will come largely in the form of profits.
4. Increased Profitability
Franchisors do not have to worry about site selection, lease negotiation, training, and human resources function. All these are done by the franchisees themselves, this allows ease of supervision in the franchise organization to run in a highly profitable manner.
Franchising allows entrepreneurs to expand without the risk of debt or the cost of equity. Since the franchisee provides all the resources required to open, it allows companies to run largely without debt.
Moreover, since the franchisee signs various contracts, it allows them to expand with a greatly reduced risk to the franchisor. The risk of the franchisor is largely limited to the capitol the company invested in, the amount is much less than the company had to open its own outlet. The franchisor can also have a steady cash flow from royalties.
Cons of Franchising
1. Less Control over Managers
Your franchisees are not your employees. You cannot tell them how to run their business. Sometimes they may have different goals than yours which can even lead to legal troubles. You may have a different management style than the franchise owners and that may sometimes lead to disagreement between the parties involved.
2. Restricted Innovation
In the case of your own stores, you can innovate new designs and products with much freedom in decision making. But in case of franchising, you have to have a formal agreement and negotiate your innovation before you can finally put up.
3. Risk of Bad Reputation
Sometimes, the franchisees may not operate and function smoothly giving your brand a bad reputation. This bad name can cost you your customers. In order to mitigate this, the recruitment process needs to be thorough.
4. A Weaker Community
It may be very difficult to get franchisees to get to work together unlike the managers of company-owned stores. This may result in a weak community core in the brand.
Franchising isn’t a silver bullet for business expansion. You have to know what is right and wrong for your business. If the pros outweigh the con, it can be a great way to grow your business.