What Are The Advantages And Disadvantages Of Franchising?

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There is no doubt that franchising plays a significant role in most industries across the world.  In many countries the number of franchises opened each year far exceed other types of businesses and it is expected to play a major role in the next few decades here in Asia.

Just like most things, franchising has both advantages and disadvantages, both for the franchisor and the franchisee.  Many brand owners and investors today are choosing to get involved as it is generally agreed that the advantages far outweigh the disadvantages.  Let’s review the main points for both parties, starting with the franchisor, so you can make your own determination.

Franchisor:

Advantages

  1. Promotes rapid multi-unit expansion of your brand

One of the most important factors is by leveraging others resources and market knowledge in their area, businesses can achieve must faster expansion for their brand.

  1. Increased brand awareness

The more cities, countries, or even continents your brand is in, the higher your overall brand awareness is.  As franchisees continue to expand your brand, everyone involved benefits from increased consumer awareness.

  1. Creates capital for expansion

In addition to the speed of expansion, the cost of expansion is reduced.  Many franchisors corporate operations generate income, but organic growth is often painfully slow.  An organically growing brand also risks being surpassed by a well-funded competitor.

  1. Reduced risk

There is risk to any business venture.  Using a franchise model, a franchisor is basically splitting the risk with another company or party.  If it succeeds, both parties win, if it doesn’t both share the loss.

  1. Access to strong managerial talent with minimal supervision

One of the hardest aspects of expanding a business into a new area is that the strong team you have built up and have come to rely on, will have less knowledge in the new territory.  It may be a small obstacle, but as the distance builds so does the obstacle due to manpower.  It is extremely difficult to launch new operations when it is a flight away or across international borders.  The franchisee and their local team have that market knowledge, and at least in the franchisees case, should be quite a high caliber.

  1. Promotes economy of scale

In addition to the rapid expansion mentioned above, the whole process of franchising is focused on economy of scale.  This forces both the franchisor and their team to be focused on growth, which requires things like solid systems, well document processes, and efficient operations.  As there is normally a healthy development schedule for any new franchisee, they also from the beginning are focused on expansion.  Franchising can also increase your purchasing power with suppliers and vendors, and allows pooling of marketing and other resources between franchisor and their franchisees.

  1. New revenue stream

Franchisors don’t share their IP and work hard to support their franchisees just out of goodwill.  They are in business to make a profit and can do so by taking their royalties.  While at the beginning it may not cover the support team and resources required, as the franchise grows, a small percentage over a lot of units can become very profitable.

Disadvantages

  1. Cost

Becoming a franchisor involves opening a new division within your company.  For most companies, it also requires outside assistance with things like franchise develop planning, legal agreements, b2b marketing, and of course business development.  If you are not McDonald’s, Starbucks, or Gucci (or similar) it is very difficult to get your brand in front of the correct companies that are both willing to expand it in their territory but also protect the valuable reputation you have built in your brand.  The franchisee support team also requires ongoing investment of capital and valuable time.

  1. Government regulation

Most countries regulate franchising to some extent or another.  Often franchisors will need legal advice for their FDD and franchise agreement documents.  It is also important you register your trademark in any new countries you expand to.

  1. Reduced control

Compared to your own corporate expansion where you make all the decisions and directly control all locations, when you franchise to others they share in much of the decision making process.  While they must follow certain guidelines and SOPs, and maintain your brand standards, they have a lot of flexibility within their markets.  Similar to a new marriage, there is often many differences of opinion, especially at the beginning until the 2 parties understand each other better.

  1. Takes time

In addition to cost, building a franchise system takes a lot of valuable time.  First you need to get your brand ready internally.  Make sure operations are smooth, supply chain solidified, product is as good as you can make it, and your team is ready to train others.  Then comes the difficult task of getting that first few franchisees.  Not only people with the capital to invest, but also the willingness to follow your system, and the ability to be successful in their local territory.

  1. Increased chance of legal disputes

There can be problems in any company from time to time.  Issues become more difficult though when 2 separate companies are dealing with each other.  As with any business contract, there is a possibility for disagreements.   If disagreements are allowed to escalate and legal action becomes necessary there can be significant costs involved as well as damage to the brand in a certain territory.  For many industries they say “location, location, location”.  In franchising, I like to say “partner, partner, partner”, just like a marriage, it is extremely important to find and chose the right partner from the beginning.

Now it is not only about the franchisor.  For any partnership, there must be 2 parties, and in franchising the other party is called the franchisee.  Some advantages and disadvantages are similar to the franchisor, but sometimes the advantage to one party is the disadvantage to the other.  It is important that any agreement is a win-win for both parties so they are motivated to work hard alongside one another for success.

Franchisee:

Advantages

  1. Brand recognition

You benefit greatly when people already have heard of your brand even before you open in your local market.  Instead of needing months or years to establish your reputation in your area, you may get it instantly in some percentage of the population.  Of course, the larger and more famous a brand is, the more you benefit.  Even when it is a small brand and not well known, at least when people Google it or check it out on social media, there is a history and thus a perception of value.

  1. Start up and ongoing business assistance

Depending on the type of industry and franchise, the franchisee should be receiving a “business in a box”, something that is fairly turnkey.  Franchisors provide the brand, equipment, supplies, training, marketing plan, and operational instructions.  Plus you get to tap into the knowledge and experience of the franchisors team.  This helps you avoid making those costly and sometimes fatal mistakes.  Support continues to come on an ongoing basis through R&D, QC/QA visits, and ongoing training and marketing.

  1. Systems and training

Any business is difficult to get started.  Two of the ways franchising helps get you jumpstarted faster is with their set systems.  These processes have normally been refined and perfected over the history of the brand, and have often been tested across many outlets and multiple countries.

Franchisor provided training is also invaluable as it means you don’t need to rely 100% on the team you hire to know every aspect of the business well.  The experienced franchisor can train, coach, and guide your team along to success.

  1. Lower failure rate

Any business can fail.  However, franchisees get the benefit of the franchisors history.  The franchisor has done the research and development, learned from experience what worked well and what did not.  They have already adjusted menus, recipes, systems, processes, marketing, location designs, branding, etc. etc. etc. through often many years of trial and error.  You can avoid the costly mistakes common to new businesses by purchasing a franchise.

  1. Buying power

While not a benefit for all franchise industries, many franchises can leverage off of the increased buying power of a brand.  Suppliers obviously give better pricing on equipment, designs, and supplies when the brand has dozens, hundreds, or thousands of locations.

  1. Reduced risk

A franchise isn’t a guarantee of success, however, for the many reasons listed above, there is a much lower chance of failure than a non-franchise start up.  The brand is normally proven to be successful, success or failure then is often decided by your knowledge of the local market, the team you hire, and your marketing efforts.

  1. Established customer base

Many brands have loyal customers.  Even if new to a city or country, travelers may visit when in your territory and visit your location due to brand loyalty.  It also works in reverse.  Locals in your area may have used the brand during their travels, recognize it, and be ready to frequent the brand when you open.

  1. Be your own boss

Being a franchisee is not like being an employee.  You are still working for yourself and much of the success and failures are yours to enjoy or live with.  You are still the boss and make most of the day to day decisions, just with some franchisor restrictions and guidelines.

Disadvantages

  1. Initial cost

While the initial investment of the franchise fee buys a lot of benefits for the franchisee, it can also be costly—especially if you’re joining a very well-known and profitable franchise. While this often translates to larger profits, coming up with this initial money can put a strain on any small business owner. 

  1. Ongoing investment

In addition to the initial investment you’ll have to provide to start your franchise, there are additional, ongoing costs that are unique to franchises. Within the franchise agreement, there may be royalty fees, advertising costs, and other fees.

Another item to keep track of is your development schedule.  Any area or master franchise agreement will have a timetable which lays out a minimum expansion schedule.  While a necessity to growing any brand, it might come at an inconvenient time if you haven’t planned well.

  1. Potential for disputes

Any financial agreement between two parties has a potential for conflict.  Even though a franchisor and franchisee are working towards the same goal of profitability and brand penetration they may have differing opinions on how to achieve those goals.  They also have different priorities.  A franchisor will be more concerned over doing something that might damage their brand reputation or negatively affect other franchisees whereas a franchisee might be more concerned about generating additional revenue.

A business partner of mine often refers to a franchise agreement as being a marriage.  It takes two partners to be successful.  Especially at the start challenges will arise, but picking the right partner in the beginning and being open and communicative with each other can get you through those bumpy times and lead to long term benefits.

  1. Franchisor regulations

A franchise does allow the franchisee to be their own boss.  However, they’re not entirely in control of their business, nor can they make larger decisions without taking into account the franchisor’s guidelines.

For most franchisees, the most frustrating disadvantage that they face is that they must follow the restrictions laid out in the franchise agreement. The franchisor can exert a degree of control over the business and decisions made by the franchisee.

Depending on the franchise agreement, the franchisor can control any of these aspects of the business:

  • Business location
  • Hours of operation
  • Pricing
  • Signage
  • Layout
  • Decor
  • Products
  • Advertising and marketing
  • Resale conditions

These restrictions are put into place to maintain uniformity between the different franchises and the overall brand, but they can also be frustrating and feel limiting for the franchisee.

  1. Lack of financial privacy

Most franchises require some sort of financial transparency.  As there are often royalties to be paid, at minimum a franchisee has to report net sales to their franchisor.  Many franchisors require a lot more detailed info.  Normally this is to make sure their franchisees are profitable and are successful as they can identify problems they see and help address them quickly.  However, it still means your finances are being shared outside your company or investors.

In conclusion

Just like any other business partnership or decision, starting or buying into a franchise has its pros and cons.  It is important to do your due diligence and find the right partner for you and your company.  Look carefully and make sure you understand all the advantages and disadvantages of both franchising in general and the specific one you are considering.

Franchising is so popular because most people agree the advantages outweigh the disadvantages but that may not be true in each and every case.  VF Franchise Consulting has been helping companies form franchises for their brands, and investors to purchase the right brands for their market and their company goals for more than 13 years.  We can help you decide if it is right for your circumstance or not.  Please contact us to learn more at [email protected]

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