First of all, let's define what we mean by the term: franchising refers to an arrangement in which a party, the franchisee, buys the right to sell a product or service from a seller, the franchisor. The right to sell a product or service is the franchise.
Primary Types of Franchises
- product and trade-name franchises
- business-format franchises
Business format franchises generally include everything necessary to start and operate a business in one complete package. Business format franchises provide the product, trade names, operating procedures, quality assurance standards, management consulting support, and facility design. Many familiar convenience stores and fast-food outlets, for example, are franchised in this manner.
People are attracted to franchises because the best ones have proven to be extremely successful over the years, and they combine many of the benefits of business ownership with the brand name, experience, and economies of scale provided by the established corporate franchisor. In fact, good franchises generally have a higher success rate than other types of businesses. Let's take a look at the advantages and disadvantages of franchising:
Advantages of Franchising:
- Risk minimized. A reputable franchise is a proven business method.
- Name recognition. A well-known name can bring customers into the business and provide a competitive advantage for the franchisee.
- Training. A franchisor can provide a regimented training program to teach the franchisee about the business operation and industry even if the franchisee has no prior experience.
- Support. A franchisor can provide managerial support and problem-solving capabilities for its franchisees.
- Economies of scale. Cost savings on inventory items can be passed on to the franchisee from bulk purchase orders made by the franchisor.
- Advertising. Cooperative advertising programs can provide national exposure at an affordable price.
- Financing. A franchisor will generally assist the franchisee in obtaining financing for the franchise. In many instances, the franchisor will be the source of financing. Lenders are more inclined to provide financing to franchises because they are less risky than businesses started from scratch.
- Site selection. Most franchises will assist the franchisee in selecting a site for the new franchise location.
Disadvantages of Franchising
- Franchise fees. Franchise fees are required to be paid to the franchisor at the inception of the franchise agreement. These fees can range from a few thousand dollars to hundreds of thousands of dollars depending on the franchise.
- Royalties. The cost of many franchises includes a monthly royalty (fee) based on a percentage of the franchisee's income or sales, and you pay even if the business is not profitable.
- Loss of control. Franchise agreements usually dictate how the franchise operates. The franchisee must adhere to the standards in the franchise agreement, which thereby leaves the franchisee with little control over the operation.
- Required purchases. The franchise may require the franchisee to purchase certain materials for the purpose of producing uniform franchise products.
- Termination clause. The franchisor may require that it retain the right to terminate the franchise agreement if certain conditions are not met. The franchisor may then terminate the agreement and offer the franchise location to another.
If you think that franchising might be right for you, you'll want to consider the following:
- franchising vs. starting a business
- franchising vs. buying an existing business
- finding a franchise
- investigating the franchise
- deciding whether to buy