Franchise Business Model – How Does It Work? (Explained)

What is the Franchise business model?

The franchise business model has existed since ancient times. However, it wasn’t until after World War II that it gained popularity. Its popularity comes from the US due to various multinational companies, especially fast-food chains, adopting this business model. The franchise business model is unique as it contains elements of both a corporation and a sole proprietorship.

The franchise business model allows companies to sell the rights to their franchises. A franchise is a business operated by other businesses. In this business model, there is a legal, commercial relationship between both parties. This business model is mutually beneficial for both parties involved due to reasons discussed later.

The franchise business model allows entrepreneurs to start their own business, especially when entering a highly competitive market. By collaborating with an established brand in the market, they don’t need to make as much effort in making a name for themselves. However, depending on the type of franchise they want, the contract may have complex requirements.

How does the Franchise business model work?

The franchise business model consists of two parties. Firstly, it includes a company that sells the right to its franchises, known as a franchisor. On the other hand, it also consists of another individual or business, known as the franchisee, who buys the rights to operate a franchise under the franchisor’s brand. The part of the business of the company run by the franchisee is known as the franchise.

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In the franchise business model, an individual or business contacts a company to buy the rights to operate a branch or franchise under the company’s name brand. The franchisor may require an upfront payment to allow the franchisee the right to use its brand name. Besides the upfront fee, the franchisor also receives a regular income from the franchise in royalties.

The franchisee, on the other hand, doesn’t only buy the right to use a franchise. The franchisor also offers additional services, such as training, support, raw materials, operations instructions, and much more, to enforce an expected behavior. Similarly, once the franchisee enters the franchising agreement, it cannot sell products from any other brands in its franchise unless allowed by the franchisor.

Franchising contracts are usually temporary and similar to lease or rental agreements. Some companies sell their franchise rights for five years, while some may go as long as 30 years. However, having a franchise doesn’t mean the franchisee gets to own it. Similarly, most franchisors include terms in their contracts to protect against any misuse by the franchisee.

What are the advantages and disadvantages of the Franchise business model?

The franchise business model can have various advantages and disadvantages for both parties involved in it. Some of these are as below.

Advantages

The franchise business model allows franchisees to work in new industries without having the expertise necessary to gain a competitive advantage. The franchisor looks out for the franchisee and provides them with the support to be successful. Therefore, the franchisee has lower risks of entering a new market.

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The franchisee gets to benefit from the brand name of the franchisor. The brand name can bring in customers, thus, resulting in higher profits for the franchise overall. Therefore, franchisees have little to do in the way of marketing or attracting customers.

The franchisor also gets to benefit from the franchise business model. Firstly, it receives money for the right to its franchise, both upfront and in the form of royalties. Similarly, the franchisor can expand its business without needing to invest extra capital assets.

Disadvantages

For the franchisee, there are various disadvantages of the franchise business model. Firstly, it requires a large upfront investment, which may be too high to afford sometimes. Similarly, by working under an established brand, the franchisee business cannot develop a brand name. The franchisees in this model also have to follow any rules or instructions given by the franchisor, limiting them in what they can or can’t do.

For the franchisor, the most crucial disadvantage comes in the form of the franchisee using its brand. If the franchisee misuses the brand name or does anything wrong, the franchisor’s brand has to suffer as a result. However, the franchisee also has to suffer as a result of the franchisor’s negative actions.

Examples

The franchise business model is most common in the restaurants and hospitality industries. Big-name brands such as McDonald’s, KFC, and Pizza Hut have thousands of franchises worldwide. Similarly, hotels such as Marriott International or Pearl Intercontinental International have many franchises around the globe.

Conclusion

The franchise business model is an old model used by many businesses, especially in the restaurants and hospitality industry. There are two parties involved in franchise deals. Firstly, the franchisor is the company that sells the rights to its brand name. Secondly, the franchisee is the business or individual that buys the right to a franchise.

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