Definition
Franchising is a business model where a business owner, known as the franchisor, sells the rights to their business logo, name, and model to a third party, called the franchisee. The franchisee pays royalties or a fee to the franchisor for these rights and operates under the brand and business model established by the franchisor. These transactions allow the franchisor to expand their business footprint, while the franchisee benefits from operating a proven business model.
Key Takeaways
- Franchising is a business model where one business owner (the franchisor) allows a separate business owner (the franchisee) to operate under the established brand name. This grants the franchisee access to the franchisor’s proprietary knowledge, processes, and trademarks.
- In exchange for the ability to operate under the franchisor’s name, the franchisee pays ongoing royalties and, often, an up-front franchise fee. These agreements are typically formalized through contracts, which set out the responsibilities and expectations of each party.
- Franchising can offer advantages to both parties; it provides franchisors with a way to expand their brand without incurring high capital costs, while franchisees gain access to a proven business model and established brand reputation. Nevertheless, it also comes with drawbacks such as lack of control for the franchisee and risk of brand dilution for the franchisor.
Importance
Franchising is a significant financial term as it represents a business model that plays a vital role in the global economy.
This business strategy allows a company (the franchisor) to expand its operations, presence, and brand recognition without making significant capital investments, as these responsibilities fall onto independent business owners (the franchisees). The franchisees, in turn, benefit from operating under a proven business model and a recognized brand, reducing the risks associated with starting a business from scratch.
Therefore, this method promotes entrepreneurship, economic growth and job creation.
Understanding the concept of franchising is essential for any potential franchisee or franchisor to grasp how business expansion, risk, responsibility, and profit are distributed within this model.
Explanation
Franchising is a unique business model that allows a company to expand its operations without necessarily having to invest a substantial amount of resources and capital for expansion. This growth strategy has three main purposes: to allow for faster business expansion, to spread risks, and to leverage the skills and labor of others.
Instead of the franchisor building and managing new outlets, it licenses its brand and operational system to independent entrepreneurs, known as franchisees. This allows them to establish their businesses more swiftly across various locations, domestically and internationally, fostering extensive business growth.
The franchising model is used to harness the entrepreneurial spirit and local market knowledge of franchisees, thus spreading financial risk whilst simultaneously ensuring standardization across outlets. The franchisees pay a series of fees to the franchisor to acquire this right.
In return, they can operate under the company’s established brand, enjoying the benefits of a ready customer base, proven business strategies, and ongoing support. Franchising, therefore, offers a middle ground between operating a fully-owned company and independently starting a new business from scratch, making it an attractive proposition for entities looking to invest in an established business model.
Examples of Franchising
McDonald’s: The fast-food giant is one of the most recognisable examples of franchising. The company allows individuals to operate a location of the restaurant with the support, training, and branding of McDonald’s corporation.
7-Eleven: This is the world’s largest operator and franchisor of convenience stores. The person buying the franchise gets access to ongoing support, operating systems and a proven business model.
Marriott Hotels: This popular hotel chain also operates on a franchise model. The franchisee gets the benefit of the brand name and marketing support, while the franchise company benefits from expansion without the cost of building new hotels.
FAQs about Franchising
What is franchising?
Franchising is a business model in which one business owner (the franchisor) grants another party (the franchisee) the right to use his/her business’s trademark or trade-name as well as certain business systems and processes, to produce and market a good or service as per certain specifications.
What are the benefits of franchising?
The primary benefit of franchising is that it allows businesses to expand without the risk of debt or cost of equity. It also enables individuals to own their businesses without having to develop their own concept or systems. Further, franchisees often enjoy support from the franchisors in areas like training, marketing, and site selection.
What are the risks of franchising?
Like any business endeavor, franchising is not without risks. Franchisees are typically required to pay initial franchise fees as well as ongoing royalty fees, and there may be other costs involved. There’s also the risk that the franchise system may not be successful in certain markets or scenarios. Also, franchisees have to operate their businesses according to the terms set by the franchisors, which can be restrictive.
What are some of the most popular franchise industries?
Some of the most well-known franchising industries include fast food, hotels, health and fitness centers, business services, and home services. However, there are franchising opportunities in virtually every industry imaginable.
How can one start a franchise business?
To start a franchise business, an individual typically needs to have a certain minimum amount of non-borrowed personal resources. They must also meet certain qualifications regarding their experience, motivation, and team skills. Once they’ve researched and selected a franchise, they’ll sign a legal agreement with the franchisor, pay necessary fees, and undergo a training program before they can open their own franchise.
Related Entrepreneurship Terms
- Royalty Fee
- Franchise Agreement
- Initial Franchise Fee
- Franchise Disclosure Document
- Master Franchise
Sources for More Information
- Entrepreneur: An online magazine and website that covers topics such as franchising, small business startup, and entrepreneur lifestyle.
- Federal Trade Commission: The FTC provides information on consumer protection and enforcement. They have specific sections dedicated to franchising regulations and rules.
- International Franchise Association: A membership organization of franchisors, franchisees and suppliers that provides a wide range of information and resources about franchising.
- Inc Magazine: An online publication for entrepreneurs and business owners who are interested in franchising, amongst other topics.
