Franchising is a halfway house between being an entrepreneurial business owner and taking a job with all the certainty and uncertainty that entails.
Franchising is a common next-step for managers who leave their safe employment and want to set up and operate their own business. But they don’t have the ideas or the appetite for a wholly new business of their own. As a business model, franchising offers significant benefits to:
- the person granting the franchise (franchisor)
- the person operating the franchised business (franchisee), and
But with benefits come inevitable costs and risks. So, in this article, we’ll look at the Big Idea behind franchising, what it is and what it means for business people on either side of the transaction.
What is Franchising?
Franchising is a business structure where one person (the franchisor) grants a license to another person (the franchisee) that entitles the franchisee to own and operate their own business (the franchise). They operate that franchise under the franchisor’s business model, using their processes and systems, and brand.
Franchise businesses range from mass-market ubiquitous restaurant chains, like Subway, Pizza Hut, and McDonalds to toddler music classes, care businesses, and high-end business services.
Some Statistics about Franchising
There are around 1,000 franchise brands in the UK, according to the trade body, The British Franchise Association, with nearly 50,000 businesses operating them. Their turnover in 2018 was over £17 billion.
In the US, there are around 3,000 brands, with around 900,000 franchise businesses, generating over $2 trillion (thousand billion). Franchises account for around half of all US retail sales.
The Franchise Agreement
The biggest single component in franchising is the ‘Franchise Agreement’. This is the master legal contract that sets out the obligations and rights of the franchisor and the franchisee. The only discretion the franchisee has in how they operate the business they have bought is the latitude the franchise agreement grants them – either explicitly or by omission. It also determines how long the franchise lasts, which is usually 5 years in the first instance but can be longer, depending on the nature of the business and the scale of the investment (and therefore the time needed to recoup it).
The agreement also sets out the renewal options: when, how, and under what terms.
A big part of the franchise agreement is the commercial terms. The charges the franchisee pays to the franchisor are in return for any rights, assets, intellectual property, and services the franchisor grants them.
The costs are usually in two parts:
- An initial fee (the buy-in), which can be a few thousand pounds or dollars, up to well over a million for capital intensive premium brands, like the big restaurant franchises.
- A recurring fee (or royalty) for continuing the operation, which covers the ongoing costs for the franchisor to support the franchisee and provide any consumable materials. This can be made up of:
- a fixed component
- a component calculated from the franchisee’s financial performance
We’ll look at what the franchisor provides to the franchisee below.
Why Should You Get into Franchising?
Franchising is an increasingly popular business model herein the UK, and globally. Let’s see what’s in it for both parties.
…As a Franchisor
The principal benefit of franchisng a business idea, rather than growing your own business and expanding yourself is reducing the capital costs and risks associated with them. Your franchisees provide you with capital and also fund the big asset purchases like premises. They also take on the staffing risks.
Yet the franchisor gets to retain control over quality standards, product ranges, and marketing messages: they own the brand. And that also means they own the goodwill that the brand can earn.
Finally, as well as earning a revenue from signing up new franchise holders, the franchisor will receive some form of revenue share from each franchisee, and on-going fees (royalties) to pay for:
- Initial setup
- Support services
- Marketing and advertising
And these will inevitably have a profit margin attached to each.
…As a Franchisee
With franchising, the franchisee gets to own their own business, without the time, work, and risk associated with creating something from nothing. That means they get:
- An existing brand – and so, security
- Some certainty of demand – and so, lower risk
- Tested operational processes, methods, and systems
- The training to use them
- Benefits of scale in purchasing supplies, insurance, and services
- Infrastructure and support, typically:
- Materials and consumables
- Product development and new IP
- Management services
- Template documents and legal forms
- IT systems
- Fellowship from other franchisees
- Franchisee conferences, ongoing training, and business development events
Franchisees never fully own their business. They have an asset they can sell, but to continue to operate their business beyond the term of the Franchise Agreement, they will need to renew. And that means, ultimately, agreeing to the franchisor’s terms – which can have changed since the start of the previous agreement.
And, if they don’t choose to renew, they don’t own the intellectual property behind their business. They would need to repurpose the assets they do own (like premises and the contracts with their staff) to a new business. And that may resemble their franchise, but must not impinge upon the franchisor’s intellectual property.
What is Your experience of Franchising?
We’d love to hear your experiences, ideas, and questions. Please leave them in the comments below.
Here’s a fascinating fact…
Here’s a fascinating fact or two that I couldn’t fit organically into the article. Our word ‘franchise’ comes from the old French word ‘franc’, which means ‘free’. Voters have the franchise – they are free to elect whomever they choose (for good or for ill). Commercial franchisees do have some freedom – but only that granted by their franchise agreement. In other ways, they are constrained by it.
And… the Franks were not the free folk and neither were French Francs free money. The Frankish races are names after their spear, or ‘franca’, and French (pre-Euro) currency was named for the Frankish Kings whose names they bore.
But, Chaucer’s Franklin was free and not Frankish. He was a landowner who was born in freedom, but not of nobility.