There are 2 roles in the franchising business model: franchisors and franchisees. We’ll take a look at each of these roles below, including the pros and cons of the model for each party, as well as why a franchise model is a popular approach to scaling your small business.
A franchisor is…
…a business that allows other businesses to trade under their brand and according to fairly strict operating conditions in exchange for a fee.
By doing this, franchisors are able to expand into new geographical areas quickly, increasing their market share and at the same time, sharing the commercial risk of expansion.
Who’s responsible for what?
While a franchisor will need to foot the bill for specialist equipment, branding and marketing materials and sometimes also staff training, it’s the franchisee who has the responsibility of taking care of the day-to-day running of the business, including recruitment, sales, and logistics.
The franchisee will normally also have responsibility for the costs and upkeep of any premises from which the franchise business is operated and will typically carry the risk in stock, deliveries, insurance and operational liabilities. Complaints are also likely to be the responsibility of the franchisee on a day-to-day basis.
But of course, with this expansion model, comes a lack of control for the franchisor and a reputational risk also – so they need to be able to trust those with whom they start a franchise relationship (and have a strong contract in place, of course, which amongst other things, permits regular auditing and quality control checks of the franchisee’s operations, record keeping and data).
The idea of a franchise is that the branding and customer experience is the same wherever the franchise is – and therefore, customers shouldn’t even be aware that the business is a franchise at all.
Protecting IP and reputation
This is all good in practice, providing that the rules are followed by the franchisee. But if the rules aren’t followed, or if creative license goes a little too off brand, the franchisor’s reputation may be damaged. This is why most good franchise agreements will include robust rights for the franchisor to enforce certain behaviour and include comprehensive audit permissions, which, if not complied with, will result in a breach of the franchise agreement and empower the franchisor to take action to protect itself, including terminating the franchise agreement and seeking compensation for any damage caused.
One more thing to consider is that becoming a franchisor will automatically give you a loosening of your confidentiality, IP and data security. After all, in order to allow others to use your brand, you’ll need to share intellectual property with them and trade secrets. So you’ll need to be comfortable with that, and also have suitable clauses in your franchise agreement that states how that information must be handled and how your IP rights will be protected.
A franchisee is…
…a business who pays a fee to trade under the brand of another business.
As the franchisor already has market share, the franchisee has a head-start on building a positive reputation with both potential customers and business contacts. This can make getting sales easier than it would be if the business started out on its own, and equally, it can help the business get funding easier than if they were to apply without the franchise connection. So, it gives an element of independence, and is a step-change from managing someone else’s business as an employee, but provides the certainty and security of working under the umbrella of a proven brand.
The franchisee does need to pay the franchisor a fee (known as royalties) for the right to use their brand – but, thanks to the franchisor, they don't need to pay for company assets such as equipment, branding and marketing materials. They will, however, need to pay an initial fee for the set-up costs to ensure that they are ready to open up business as a franchisee, and these costs will be largely dictated by what the franchisor requires. The general principle is that the franchisor’s initial services (including training), should be sufficiently comprehensive to establish a previously inexperienced business owner as an effective franchisee from the moment that they he/she starts trading as an authorised franchisee.
After that, fees are usually regularly paid by the franchisee to the franchisor for the ongoing benefit of being part of the franchise. These fees tend to cover the franchisor’s ongoing costs of producing materials, promoting the franchise and running the franchise. They may also include the costs of performance monitoring across the franchise ecosystem, to help maintain standards and profitability, field support to verify compliance with these standards, continuing updates of methods and new innovations and market research and development by the franchisor or those it engages to assist it.
Fees commonly range between 10–15% of the franchisee’s overall revenue. And the franchisee should be just as entitled to verify that these fees are fair and justified, as the franchisor is to audit the revenue reported by the franchisee.
Rules, requirements and obligations
While, as discussed earlier, a franchisor has lack of control with this business model…the same can be said for franchisees. By operating under another business’ brand, there are a whole host of rules and regulations that they will need to follow. Even the franchisee’s ability to sell or transfer the business can be subject to restrictions imposed by the franchisor. And of course – if the franchisor goes out of business – or equally, if they go into debt, or otherwise encounter operational or reputational difficulties – the franchisee will be affected by those circumstances too.
When it comes to the franchise agreement, it shouldn’t come as a surprise to a franchisee of a well-established franchise to hear that the agreement ‘is what it is and is not negotiable’.
This is not at all unusual. Franchise agreements are generally very unilateral in nature. This is because the franchisor will want all franchisees on uniform terms in support of the integrity of the brand and its own quality controls (and it will of course have the greater bargaining power as a result). If you don’t like these terms, you’ll probably need to find an alternative franchise opportunity. In actual fact, a franchisor who is willing to negotiate on key elements of a franchise agreement for an established franchise might well sound a warning alert for a prospective franchisee. An overly willing negotiating stance could indicate that the franchise is not so stable as it should be, or at least, not as well run.
The rules aren’t just for the protection of the franchisor either. Many of them equally protect other franchisees from the potentially damaging actions of a franchisee who ‘goes rogue’. Fellow franchisees would expect the franchisor to have the contractual force to protect their business reputation and revenues in the event of damaging conduct by someone else.
Do your research
Franchisees should do their ‘due diligence’ (background checks) on a franchisor ahead of signing any paperwork, a part of such research being to talk to existing franchisees and understand their experience of the franchisor’s system. You may not be able to change the contract terms, but you can and should understand what signing up to them will really mean for your own business aspirations.
Before you decide on either option…
Becoming a franchisee
If you’re thinking of becoming a franchisee, it's paramount that you check with the franchiser that they’ve provided you with absolutely everything you to weigh up exactly what’s required in running the franchise and decide if it’s definitely something you want to do.
Do talk to fellow franchisees who are already part of the system and check whether the franchise is a member of the British Franchise Association (BFA), which has a code of ethics in relation to franchising operations that are specifically designed to protect franchisees from being unfairly exploited. Whether or not you might be considering contracting with a BFA member, it’s worth taking a look at this best practice guide since it flags up clauses or requirements that the BFA – and wider European laws – consider to be in conflict with good franchise practice and therefore unfair.
Becoming a franchisor
And equally, if you’re looking to become a franchisor, ensure that you give all of this information to any potential franchisees, and ensure the information you give in regard to potential earnings are based on fact.
If a franchisee isn’t provided with correct, comprehensive information in an appropriate way, they’re entitled to make a claim against the franchisor if they fail to make the franchise work. If you’re not already a member of the BFA, you may want to consider registering as it clearly holds a certain credibility and comfort factor for franchisees. You can also gain a fair amount of support from the association, which may be particularly helpful if you’ve not had a franchise arrangement before.
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