What Is Franchising?

How Franchising Works

Franchising is...

"An arrangement where one party (the franchisor, also sometimes “franchiser”) grants another party (the franchisee) the right to use its trademark or trade-name as well as certain business systems and processes, to produce and market a good or service according to certain specifications.”

Effectively, the franchisee buys the right to set up a particular business in a particular location, usually with some support from the franchisor (particularly in the area of marketing). They are expected to follow overarching rules for the way the business operates.

Example: Maisie’s Music

Maisie’s Music provides music classes for babies and toddlers.

Franchisees gain access to a territory, in which they can provide as many or as few classes as they want. They are responsible for finding and employing suitable teachers, and finding and booking venues for classes. They are also expected to find customers themselves, although the company provides a website with details of each territory’s classes.

The ages and names of the classes are fixed centrally. Franchisees are also supplied with music and song words for each term, and expected to follow the same routine each week. Customers across the country will have very similar experiences in the same class.

There are two types of franchising:

Business format franchising, which is by far the most common form, where the franchisee has the right to use logos and trademarks, and is given a system for doing business; and
Product and trade name franchising, where the franchisee has to buy the product from the franchisor. Examples of this include petrol stations.

As a general rule, franchisees usually have to pay a one-off fee for the franchise, which you could consider a ‘purchase’. They then also usually have to pay a share of their profits to the franchisor, as an ongoing payment for the use of the systems and support available.

Advantages and Disadvantages of Franchising

There are a number of advantages and disadvantages to franchising.

The most obvious advantages are:

Buying a franchise reduces the risk of failure

Franchises are usually established businesses, with tried-and-tested ways of operating. This means that many of the usual risks will have been eliminated. Far fewer franchise holders than other new businesses fail in the first three years of operation, and franchising is therefore a much less risky way of going into business than setting up by yourself.
Franchises tend to have a better competitive advantage

For example, franchisees gain access to economies of scale, because the franchisor can buy across the whole business, and pass on the benefits. Franchises are also trading as a recognised business, which means that franchisees do not have to build brand recognition. This tends to mean that franchisees can ‘punch above their weight’ in terms of competing with other businesses.
Training and support will be provided and little previous experience is necessary

Franchisors usually provide extensive training and support for new franchisees to help them get up and running. Very little experience is necessary. Some franchisors even actively look for franchisees with no previous experience in that area, so that they will be more likely to follow the procedures set out and less likely to want to put their own mark on the business. Many franchisors also provide support for employee training.
The products or services have already been through market testing, and are known to be attractive to consumers

The product development, market testing and initial launch stage are all very risky for new businesses. Businesses often fail at the prototype stage, or in scaling up for production, or the product can simply not be very popular after launch. Franchise products are generally already on the market, and therefore you can assess their popularity before committing to the franchise.
Franchisees often get central support with promotion and upgrading of the products or services

The franchisor has a strong interest in supporting ongoing product development and promoting both products and brands. Franchises therefore often run central marketing campaigns and upgrade products themselves, as well as providing further training on the upgraded products where necessary.

The main disadvantages of franchising are:

There is less freedom to run your business in your own way with a franchise

Franchisors tend to set out very clear guidelines and rules about how the business should operate. You therefore have very little freedom to run the business your own way, or ‘set your stamp’ on it. This can also make it harder to react to local market conditions, or to try anything new.
The risk/reward trade-off may not match your personal appetite

The risk of failure is less with a franchise, but that also means that the reward is likely to be less, too. Like any other small business owner, franchisees have to work hard to build their business, but they also have to pay a proportion of their profits back to the franchisor each year. You may feel that you get less value from these payments over time, as you need less support from the franchisor. Franchisees can often make a very good living from a franchise, particularly an established brand, but probably the only person who is going to get seriously rich from a franchise is the franchisor. Make sure that you are happy with the likely returns and rewards before you start.
You need to pick your franchise and franchisor quite carefully

To put it politely, not all franchisors are created equally. The best franchise opportunities are likely to be supported by franchisors who want to build a brand ethically, supporting franchisees, and who have plenty of experience in the field, so that the business model is tried and tested. There are, however, also more unscrupulous operators who want to take advantage of their franchisees, or those who are simply inexperienced or incompetent. Potential franchisees need to be wary of these, and learn to spot them ahead of making a financial commitment.
The franchise’s reputation can be harmed by a poor operator elsewhere

Reputation is hard to gain, and easy to lose. Franchises may gain a poor reputation as a result of one or two sub-standard operators, and other franchisees may suffer as a result. Doing your research carefully can help to avoid trouble in this area, but there is no real way to guard against it fully.

Other issues to consider

There are a number of other issues worth considering, which some may feel are advantages but others dislike. For example, a franchise is usually bought for a defined period, often five years. After that period, you may have the option to buy an extension. This means that if you do not like the work, you can get out after five years. It also means that you need to be committed to keeping going for at least that period to get full value from your initial spend. You can sell a franchise on, but you will need to discuss this with the franchisor.

Ultimately, franchising can be a very good route into business.

It is, however, not for everyone. Before you embark on it, you should consider very carefully whether you are prepared for the constraints of franchising, as well as wanting to take advantage of its very clear benefits.