What is franchising? Definition and examples

Franchising is an arrangement in which the franchisor gives the franchisee the right to distribute and sell the franchisor’s goods or services and use its business name and business model for a specified period, and possibly covering a geographical area.

The franchisor is the owner of the business that provides the product/service, while the franchisee is the person who receives the rights to use the franchisor’s business name, model, etc.

Franchising exists in several forms. According to the Franchising Council of Australia, the most common way franchising is identified is in the “business format franchising”.

In business format franchising the franchisee has the right to sell the franchisor’s goods or services, but also uses the franchisor’s designs, quality control, training, and also benefits from his/her advertising and promotions, accounting systems, and operating procedures.

Often the supplier of the franchisee’s goods or services is the franchisor. If it is a hotel or travel agency business, the franchisee is also part of the franchisor’s worldwide reservation system.

Franchising offers several benefits for both the franchisee and franchisor.

Examples of franchising relationships include:

  • A manufacturer-to-retailer arrangement – as occurs with car vehicle dealerships. The franchisor supplies the dealership (retailer) with vehicles.
  • A manufacturer-to-wholesaler arrangement – common with soft drinks companies. The franchisor grants the franchisee a license to manufacture and distribute its product(s). This kind of franchise is common when the franchisee is in another country.
  • A wholesaler-to-retailer arrangement – the franchisor (wholesaler) sells products to the franchisee (retailer) who sells them to the general public. This kind of arrangement is common in cooperatives, where the franchisee is, in fact, part of the cooperative (the cooperative is the franchisor).
  • A retailer-to-retailer arrangement – the “classic” business format franchise. The franchisor markets a product (or service) through a network of franchisee retailers.

Franchising is a huge sector of the economy

In the USA, as of 2005, there were 909,253 established franchised businesses. They generated over $880 billion for the national economy and accounted for 8.1% of all private employment (non-farm), a total of 11 million jobs.

According to the International Franchise Association, the franchise industry added 25,060 jobs in the USA in October 2013, representing one-fifth of all new jobs for the month.

What are the top ten franchises?

Entrepreneur lists the following as the top ten franchises for 2013 in the United States:

  1. Hampton Inn – Startup costs, $3.7M – 13.52M
  2. Subway – Startup costs, $85.69K – 262.85K
  3. Jiffy Luve Int’l Inc. – Startup costs, $196.5K – 376K
  4. 7-Eleven Inc. – Startup costs, $30.79K – 1.63M
  5. Supercuts – Startup costs, $103.55K – 196.5K
  6. Anytime Fitness – Startup costs, $56.29K – 353.89K
  7. Servpro – Startup costs, $134.8K – 183.44K
  8. Denny’s Inc. – Startup costs, $1.17M – 2.4M
  9. McDonald’s – Startup costs, $1.02M – 2.18M
  10. Pizza Hut Inc. – Startup costs, $297K – 2.1M

What are the benefits of franchising?

Benefits for the franchisor:

  • The business can expand using other people’s money, which not only provides another income (regular royalty payments) but also allows the franchisor to expand more rapidly.
  • The franchisor may have several sources of income, such as franchise fees, franchise royalty fees, training fees, service fees, advertising and franchise marketing fees, rebates from suppliers, and the sales of products and supplies to the franchisees.
  • Being able to open in multiple locations more rapidly gives the franchisor a competitive advantage over other businesses selling similar products or services.
  • The franchisor brings into the company people (franchisees) who are entrepreneurs, full of motivation to succeed.
  • The franchisor needs a smaller central organization compared to a business that owns all the branches. In other words, he or she does not need such a large head office.

Benefits for the franchisee:

  • A greater chance of succeeding. Franchising businesses have a much higher success rate than others for people who start in business. However, Entrepreneur disputes this.
  • Get things started more quickly. Depending on the arrangement, in many cases the franchisor comes and sets the whole thing up, including decorating, shelving and equipment.
  • Initial training and then ongoing training.
  • Ongoing support.
  • Help in finding the right premises.
  • Being part of a known brand. In many cases, benefiting from regional or national advertising campaigns.
  • Group purchasing usually results in lower costs.
  • Adopting a proven business model.
  • Many franchisors provide customer leads through websites and centralized call centers.
  • Being part of a network of franchisees.

Disadvantages of franchising

Disadvantages for the franchisor:

  • Loss of ownership – the franchisee has put up money and becomes a kind of partner in the business. A business that owns all its branches has not lost ownership.
  • Loss of territory. In most cases the franchisee will be granted an exclusive territory. If it is not fully exploited, there is not usually much the franchisor can do.
  • You may not be suited to be a franchisor. The resources and skills required are not the same as those needed to manage employees in a branch. You have to be able to lead and motivate independent entrepreneurs.
  • Confidentiality – a franchisor will have to divulge more confidential information about the business to franchisees than to employees. Even though a franchisee should have signed a confidentiality agreement, monitoring the provisions of the contract is not easy, and enforcing them can be expensive.

Disadvantages for the franchisee:

  • Lack of independence – goods usually come just from the franchisor, the premises can only be decorated in a certain way, the range of products available for sale are restricted, etc.
  • Lack of control over prices – the company may decide on a nationwide discount on products that may not work in the franchisee’s market.
  • Generally being at the mercy of the company regarding virtually everything.
  • Long-term growth – the franchisee’s ambitions regarding to become large business one day may be limited by the franchise setup and the franchisor’s aims.