What Is a Franchise, and How Does It Work?
by Ankita Tripathy Entrepreneurship Published on: 05 June 2024 Last Updated on: 08 November 2024
We hear the term “franchise” now and then. But what is a franchise business in simple terms?
A Franchise is A Method of Distributing Products or Services Involving a Franchisor and a Franchisee
You can consider it as a license. A franchisee can access proprietary knowledge about the franchisor’s business through this license. It also grants the right to trademark and sell products under the franchisor’s banner.
The Franchisor Has Proprietary Right Over Their Trademark And Business System
You can’t paint the McDonald’s logo blue or make the background yellow instead of red. If you get their franchise, you must use their original trademark.
You must follow the franchisor’s business system, too. You cannot introduce a new item on the McDonald’s menu if you wish.
The franchisee must pay the royalty and often an initial fee. These fees guarantee the right to do business under the franchisor’s name and system
From 2023, you must pay 5% royalty to McDonalds if you are their franchisee.
The royalty payment shares a percentage of the franchisee’s profit with the franchisor.
If you made a $100 monthly profit, you must pay $5 to McDonalds directly.
That’s not all.
If you want franchising rights, you must also pay a one-time fee to the franchisor. In the case of KFC, it is $45,000.
Types of Franchising Relationships
The Federal Trade Commission of the US has its own norms for business franchising. However, there are two broad categories of franchisee business.
- Business Format Franchising: The franchisor provides the franchisee with a complete business operating system.
It includes business-site, training, marketing tools and roadmap for business growth.
- Traditional or Product Distribution Franchising: Larger in total sales, found in industries like bottling, gasoline, and automotive. Here, the franchisee purchases the license to use the franchisor’s trademark.
Franchising Is About Relationships
If you are doing a franchisee business, you must focus on the regulations that define business relationships.
Most people search what is a franchise business and get a vague idea. They promptly start the franchise and may end up losing.
Franchising Focuses on the Relationship Between the Franchisor and Franchisees
The business relationship is more than the governing laws—the participating relationship between the franchisor and franchisee matters.
If you maintain good internal relations, your business will grow. For instance, McDonalds offers a specific support mechanism to franchisees:
- Helping franchisees through hands-on consultation
- Helping franchisees to meet the standard requirements (offering training, consultation, and financial aid, if needed)
Due to such a strong relationship with franchisees, McDonald’s made global sales worth $89 billion.
Franchising Is About the Franchisor’s Brand Value and How They Support Their Franchisees
What is a franchise business?
Ans: A brand can influence others to follow its successful business model with its high brand value. However, you must guide your followers who want to use your model. That’s called supporting franchisees.
Why does McDonald’s have 41.8 thousand restaurants worldwide, most franchised outlets?
Brand relations?
Ans: No.
Brand Value?
Ans: Yes.
You would certainly not bid for a Taco Del Mar franchise if you could get a McDonalds license.
Brand value MATTERS!
At the same time, McDonald’s has a discreet policy to help its franchisees.
Now you know what is a franchise company. But we must dig deep into franchisee relations. Let’s take a brief look at how other brands maintain franchising relationships.
| Name of the Franchise | Relationship Building Strategies |
|---|---|
| Dunkin Donuts | 15 days trainingStrong brand valueRecipes are sure winners Ongoing in-store mentorship |
| Popeyes | Marketing supportExpert help for local and regional level marketing and promotionsManagement training for better leadership of the business unit leaders |
| KFC | Robust brand value of the YUM BrandsTraining to replicate secret product development recipeHigh brand value |
Franchising Is About Brands
You already know what is a business franchise? But what are the most essential elements of that business franchise?
Certainly, the brand value of the franchisor. That’s why there are only 50 franchises of Taco del Mar in the US. However, McDonalds have 14300 franchises within the US.
People decide how frequently they shop from brands based on their perceived value.
The Franchisor Licenses Its Trade Name and Operating Methods to The Franchisee Within a Specific Territory
The franchisor may limit your business to a specific territory. For instance, if there are 5 franchises already existing on Broadway Street, McDonald’s will not allow more franchises to open there.
This is important to manage internal competition.
Mostly, when people search what is a franchise business, they don’t get discrete info about the internal competition.
If there are more stores in the exact location, all of them will compete in the same target market.
Some stores will start losing business when the market reaches its saturation point. It will harm brand equity.
In the end, the overall sales value of the brand will reduce.
At the same time, the franchisor may make other decisions regarding territory. For example, McDonald’s may raise the royalty value for opening a franchise on West 19th Street.
McDonalds may also introduce new menu options for a specific territory. All franchisees within the same region must implement those changes.
There are some other territory-related demarcations, too. For instance, McDonald’s might sell some readymade burgers through local food stores in your territory.
You cannot confront their decision, even if it affects your sales.
The Franchisee Pays an Initial Fee and a Continuing Royalty for the Use of The Franchisor’s Brand and System
Most people search what is franchise business? But they rarely search about the clauses of the business.
They only take an interest in the fundamental model.
However, all franchisees need to pay the initial franchisee fee and royalties to hold their franchise license.
The initial fees are the payment against the authorization to use the brand name and its business model.
However, royalty fees are more common. When people search for what a franchise in business is, they know it is a business right bought against royalty fees.
But how much is the royalty?
Well, it is variable. To clarify, McDonalds charge 5% of royalty. However, KFC may charge 4 to 12% of royalty.
The Franchisee Manages the Business Independently, And Benefits or Risks Are Based on Performance
Maybe you know what is the franchise business. However, you must also know the business risks of a franchisee business. Well, there are many.
A few days back, someone commented what is a franchise business, and how can I start one?
Guess he was not aware of the risk entitlements in this type of business.
In most instances, you operate your business independently.
In other words, your franchisor may guide you on the business model. They may also give training and real-time support. However, the franchisor is not liable for your business decisions or outcomes.
You must pay the stipulated royalty (if determined through contract) and other applicable fees, even if you lose money.
Considerations Before Investing in a Franchise
Now, more of you know what a franchise business is and what factors are liable for its success. So, consider those factors before opening a franchised business.
Before Selecting a Franchise Investment, Thoroughly Research and Understand the Franchise System
You see that all KFC stores near you are doing good business. You are also eager to open one. Thinking that you will make an assured profit, you open a store in haste.
You have agreed to pay 12% or royalty and $45000 as initial fees.
After that, you see that the market is saturated. No more customers want to visit another new KFC store in that area.
After that, you realize it would have been better to launch a new brand franchise, which is not present in that location.
Hence, it is better to research the franchise system and determine the bound costs of opening a franchise. Secondly, you must also research the market. You should ensure you can profit with your selected franchise.
Seek Support from A Qualified Franchise Lawyer Before Signing Any Franchise Agreement
After searching for a franchise business, you are also aware of its risks.
The franchising agreement can have tricky terms that may put your business interests at stake. So, it’s essential to safeguard your interests first. I recommend you contact a franchise lawyer. They can review the terms of the franchise agreement before you sign it.
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