A franchise is a business arrangement in which the owner of a business (franchisor) grants certain rights of that business to another party (franchisee) in exchange for financial consideration. It is a common method of expanding a proven business, although it also has specific disadvantages. These primarily include the amount of preparation required to create a franchise, the reduction of income in the short term and the loss of control over the franchisees.
Franchising requires considerable preparation in order to have the best chance of success. You will need to run a pilot operation separately from your main business for a sufficient period to ensure you are using a sound business model. This model must be simple to learn, yet not so simple that competitors can easily copy it. The following problems are common when preparing a franchise:
- The business produces a widely available product.
- The franchisors are not capable of running the business according to your model.
- You incur a moral obligation to ensure the franchisee is successful.
- Insufficient support staff during the franchise’s startup period.
The business must generate sufficient profits for franchising to be worthwhile for both the franchisee and franchisor. A business with low gross profits is usually a poor choice for franchising, unless you are able to generate turnover quickly. The franchisees must earn sufficient income to pay the franchise fee to the franchisor, while still making a profit commensurate with their investment of time and money. The challenges in making a sufficient profit with a franchise include the following:
- Franchisees must remain competitive while still making the franchise fee
- A high franchise fee reduces the pool of possible franchisees.
- The branches of a franchise generally produce a lower income than company-owned chain.
- The growth of the franchise depends on the franchisor’s ability to attract the qualified franchisees.
- A franchise requires startup capital until it begins making a profit.
The franchisor must give up a certain degree of control over the operation of the outlets. This creates the following requirements for the franchisor:
- Conduct regular audits to ensure the franchisees do not underreport the receipts. This is essential, since the turnover determines the franchise fees.
- Develop instruction manuals that describe your business model.
- Engage in regular communcation with the franchisees to ensure they are following those instructions.
- Allow franchisees to use the trademarks and business system of the parent company.
Franchising is most suitable for businesses with a high startup cost, such as Domino’s Pizza, Kentucky Fried Chicken and McDonalds. Small businesses typically have greater difficulty with duplicating their business models when they create franchises. This often means the franchisee spends too much time and money supporting the franchisors.