The term 'Franchise Model' is included in the Corporate Finance edition of the Financial Dictionary. Get your copy on Amazon in Kindle, Paperback or Audio edition. Choose your edition here...
Franchises are businesses where the owners sell the rights of their business to third parties. The owners of the franchise are known as franchisors. The third party operators who buy the rights are called franchisees. The franchise model is the precise way the business is run to insure uniformity among the different regional or national franchise outlets.
This model of business offers advantages to the sellers and the buyers of the franchise. Franchisors who sell their rights gain the ability to grow their business brand faster than they might with their own capital or by using the help of lenders or investors. They are able to harness other individuals’ money to build up the business footprint faster than they can alone. They still maintain control over the brand.
Franchisors receive both an upfront franchise fee and continuous royalties. They avoid the deadlines of loan repayments with this model. With the royalties and fees that the franchisors gain, they are able to run the corporate headquarters operations, advertise and market the business brand, support and train their franchisees, build up their brand in the industry, and make improvements on the service or products that their business provides.
Franchisees also gain many benefits. Their franchise has a greater likelihood of succeeding than if they start up their own business. This is evident in many ways. They receive upfront training and continuous support. The time to open is less. Buyers also receive the recognition of a brand that is known, help in finding the best site for the new location, lesser costs because of group purchasing power, and better advertising exposure through regional and national campaigns.
Besides this, they receive leads that are generated by call centers and websites, the established franchise model, and moral support and counsel from fellow franchisee peers. A more recent benefit for franchisees pertains to help getting funding secured for startup and ongoing operation costs.
The model has been wildly successful particularly with nationally known franchises such as McDonald’s, Subway, and Panerra Bread. Yet there are still downsides to the franchise model. These disadvantages apply to franchisees. Most importantly, they have little independence. This is evident from their services and goods they provide to franchise wide promotions that might not be effective in their own individual market.
Franchisees will have to utilize the company colors and approved paint colors on their walls. They can be made to redesign their units at significant expense. Most dangerous of all is the possibility that the franchise transforms after the franchisee signs a 10 to 15 year long contract. The ownership or management could completely change and force the brand to go in a different direction that the franchisee does not like or at all want.
The franchise model is all about following the system. This idea is central to the success of a franchisee’s efforts. The reason that a franchisee purchases the franchisor’s model and system is because they have confidence in it. Franchisees feel they can succeed and make money if they follow the system perfectly.
A good franchisor considers appropriate regional variations and suggestions for some changes. They also know that if they leave the system without gaining approval from the franchisor first, they may violate the franchise agreement. This could cause them to have their rights to use the franchisor’s name and business model revoked.
Franchisees are also required to keep confidential any trade secrets or proprietary methods of business. They are also made to sign and abide by a non-compete clause agreement.