Q. WHAT IS FRANCHISING?
Franchising is a method of distributing products or services. At least two levels of people are involved in a franchise system: (1) the franchisor, who lends his trademark or trade name and a business system; and (2) the franchisee, who pays a royalty and often an initial fee for the right to do business under the franchisor's name and system. Technically, the contract binding the two parties is the “franchise,” but that term is often used to mean the actual business that the franchisee operates.
Q. What are the advantages and disadvantages of franchising?
From the Franchisee’s Perspective
(i) The advantages
The franchisee is the owner of its own business and typically owns the tangible assets of the franchise outlet. What it does not own is the goodwill in the business concept. Like any other business proprietor, the franchisee buys materials, pays rent and staff salaries and takes the profit (or loss) of operation, less royalty and service fees. Some franchisors, actually very few, control the real estate from which the franchised outlets operate.
Subject to various restrictions, the franchisee can sell its business when it wishes (usually subject to the franchisor's pre-emption right and on condition that the purchaser is approved by the franchisor). What makes a franchise business different from any other business is that the newly-franchised business gains from the franchisor the entire business concept with full training, assistance in every aspect of setting up and running the business, and access to necessary materials and supplies.
In essence, the franchisee invests in and operates the developed business concept and it is this, and the franchisor's careful selection of the franchisee, that makes failure of the business less likely.
Obviously the franchisee’s start-up costs entail more than paying the franchisor an up-front fee: it must invest in premises, fittings, equipment, materials and provide working capital until the inward cash flow starts. In addition, it must pay continuing fees to the franchisor: typically an initial fee plus ongoing regular payments to the franchisor in the form of royalties or management services fees or, in some cases, an agreed mark-up on supplies obtained from the franchisor. The brand presentation and profile from which the franchisee benefits by joining a franchised network could only rarely be achieved by an individual small business owner.
(ii) The disadvantages
The franchisee is not an entirely independent entrepreneur. The franchisee must adopt the franchisor's business system. In the final analysis the franchisee must follow the franchisor's instructions on how to operate the business and present the brand. The lower risk (of start-up business failure) is off-set by the lower reward for success because of the fees paid to the franchisor. Ultimately, the franchise agreement may not be renewed when it ultimately expires, although franchisees are usually able to realise the value they have built up by selling their businesses during the term of the contract.
From the Franchisor’s Perspective
Every business is different and must assess, with expert help, the pros and cons of using franchising as an expansion or re-engineering strategy. The short summary here is not comprehensive. Please contact us if you would like more information and an assessment for your business.
(i) The advantages
Franchising allows the franchisor to expand its market penetration for the distribution of its products or services with minimum capital outlay and so accelerate the network's growth and profitability. Major global franchisors have thousands of outlets in many countries. Return on investment ratios tend to be high in well-run international networks, which is one reason why corporates sometimes re-engineer using franchising.
Self-employed individual franchisees are generally more highly motivated and incentivised than salaried managers by the profits from their outlets, and are more likely to produce better results for less expenditure of capital than the franchisor would achieve. Franchisees employ their own staff – which means franchisors' staffs and overheads can be kept leaner, with fewer employment issues. As the franchise network grows it will become easier to handle major national or regional customer accounts.
The local market presence and focus of the franchisee can be critically important – particularly in international expansion into new countries, where a major local company may become the country franchisee, and in territory-based domestic services businesses where franchisees are required to focus on their local patch. Franchisees often come up with excellent business development ideas, and the pooling together of marketing funds enables a group of relatively small businesses to punch significantly above their individual weight in terms of brand promotion and advertising.
(ii) The disadvantages
The franchisor has to control and coordinate a network of semi-independent businesses and ensure that they build and maintain a favourable image for the whole franchised operation. This means that the franchisor's own role changes drastically. It is no longer simply an operator of its own business. Its principal role is to recruit, train and motivate the right franchisees and grow and develop the performance of the entire network.
The policing and monitoring of standards by the franchisor is vital, although franchisees will understand the need for excellent brand presentation. The franchisor will sometimes have to resort to the use of both carrot and stick mechanisms to get franchises to try new techniques or improve under-performance.
The dynamics of the franchisor-franchisee relationship are such that a lack of trust can on occasions creep in, making life more difficult than it should be. This may be due to personality clashes between the franchisee and members of the franchisor's team, perhaps where a particular franchisee business is not performing, or because the franchisee does not find it easy to live within the constraints imposed by a franchise.
It is the franchisor's duty to minimise tensions and conflicts and ensure that they are satisfactorily dealt with. Learning best practice franchisor management skills from experts is essential.
While an individual corporately-owned outlet may be more profitable for the franchisor than an individual franchised outlet, the increased number of franchised outlets and reduced corporate overhead will often mean that the franchised business as a whole will be more profitable than one that is entirely corporately owned.
Q. WHAT SHOULD I CONSIDER BEFORE BUYING A FRANCHISE?
Among the points which IFA recommends for investigation are:
- the type of experience required in the franchised business;
- a complete understanding of the business;
- the hours and personal commitment necessary to run the business;
- who the franchisor is, what its track record has been, and the business experience of its officers and directors;
- how other franchisees in the same system are doing;
- how much it's going to cost to get into the franchise;
- how much you're going to pay for the continuing right to operate the business;
- if there are any products or services you must buy from the franchisor and how and by whom they are supplied;
- the terms and conditions under which the franchise relationship can be terminated or renewed, and how many franchisees have left the system during the past few years;
- the financial condition of the franchisor and its system.