Franchising is a business relationship where a franchisor (a company or individual who owns the franchise system) grants a license to a franchisee (a company or person who contracts to use the franchise system) the right to use the franchisors brand and operating system for an initial fee (initial franchise fee). In return the franchisee provides a share of the income back to the franchisor (a royalty). The license is contractual and is usually for a fixed period of time. The franchisor selects candidates to become strategic-partners in implementing the business plan and selling products and services to the franchisor’s customers using the proven franchisors business model and/or their proprietary products. A franchise model has in place policies and procedures so as to create consistency from one franchise location to the other.
As a growth strategy it provides franchisors the ability to gain market share by increasing their points of distribution. Increased point of distribution results in greater exposure and brand awareness. Franchisors are able to grow and have committed individuals operating and driving the location. From a franchisees perspective, it allows the franchisee to get into business with support, a brand name and a proven business model. This helps to reduce the risks involved with getting into business.
It has become a part of almost every industry. Although people most often think of fast food when they think of franchising, it is also found in retail, service, automotive, business services, real estate and lodging.
There are several things that one must understand about a franchise. You are not buying the franchise. Instead, you are acquiring a license to operate a franchise. You do not own the name, but instead have a license to use the name. You do not own the business model, but instead have the rights to use the business model for a period of time. It is a little like being a tenant and renting. You don’t own the space you are renting, but instead have the use of the space for a period of time.
Uniformity is a fundamental principal to the success of a franchise. There must be consistency from franchise to franchise within a given business. By having the same product in similar outlets, with consistent levels of service, the franchise is able to build confidence in the mind of the customer and this drives people to the brand. Customers gravitate to what they know, what is familiar and what they trust. The uniformity is created through operating standards and procedures that are clearly documented in operation manuals. Franchisees are required to follow an operating system and use the same suppliers of product, take the same training. The system, suppliers and training are all designed to create a consistent experience to the end user of the product or service and thus create an expectation and impression in the mind of the customer.
The uniformity is enforced through a franchise license. This license gives you the right to use the brand and operating system. The license also comes with obligations, to follow the operating standards and systems, as clearly defined in the business model. If you fail to follow the standards you may loose your license. With compliance to the system it drives the market and enhances your investment. When you first look at a franchise agreement you may find it controlling and very one sided in favor of the franchisor. This is normal and required to allow the franchisor to control the integrity of the brand. As a franchisee, you must understand that you simply can’t do what you want. You are required to conform. The success of the system as a whole to build a brand is dependent upon consistency.
Although you can’t simply do what you want, strong franchise organizations value franchisees input and create advisory groups to provide feedback and input to the franchisor to assist in the strategic direction of the company. They view the franchisee and franchisor relationship as a partnership. A partnership in a strategic sense, not a legal sense. In franchising, it is not an equal partnership. The franchisor takes input but ultimately the franchisor has the final say. The franchisor acts as the senior partner in the strategic partnership. Franchisees are on the front lines and have strong knowledge of the needs of the customer. At McDonald’s it was the franchisees input that led to the development of the Egg McMuffin and the McFish sandwich. Strong franchisors listen and value the input from franchisees.
Franchising provides numerous benefits. Benefits often include;
Franchise fees are typically paid for the use of the brand and the operating system. There is usually a one time initial franchise fee as well as an ongoing fee, called a royalty. The ongoing royalty may be a flat monthly or weekly fee or, more often is a percentage of the gross sales from the business. In addition, most franchise companies charge a fee for an advertising fund where the advertising dollars of the franchisees are pooled together to allow for franchisees to share the costs of national or regional advertising. By pooling the ad dollars together they are able to afford advertising that would not have been affordable otherwise.
The initial franchise fee will vary from $5,000 to $75,000. How much the initial fee is varies depending upon the amount of training and support that is provided to get the new franchised location up and running. In addition to the initial training and support, the initial franchise fee covers the cost of franchisee recruiting, territory analysis, site identification, grand opening launch, and some recovery of the franchise development costs. Typically the more established and recognized the brand of the franchisor the higher the initial fee.
On-going royalty fees will vary from 0% to 20% of gross sales. The amount will vary depending upon the level of on-going support and services that are provided by the franchisors. For example, some franchisors may provide a centralized call center with order taking. This requires a higher cost which is addressed with a higher royalty. Where no royalty is charged, it is basically build into product sales or sale of services in the form of mark-up or rebates on products. Typically the more involved the franchisor is on-going with the business operations, the higher the fee.
Franchisors must make some form of revenues and profit in order to provide on-going support and services. A royalty ensures that the franchisor has a vested interest in seeing you be successful for your success results in their success.
For more helpful tips and valuable guidance on franchising, check out Wayne’s book Franchising Demystified.