What is franchising?
Buying a franchise is a complex process that should be undertaken in a logical order. You need to make sure you do your research thoroughly including finding out the basics of what franchising is, before looking at whether it is the right route into business ownership for you. Once you understand this, you are able to evaluate and find out more about the franchise opportunities available.
Our Franchise Guide takes you step-by-step through the franchise buying process. In this first stage we will look at what franchising is including the two different types of franchise methods, and the advantages and disadvantages of buying a franchise.
What is a franchise?
In simple terms, a “franchise” is an agreement between two parties which allows one party i.e. the franchisee, to market product or services using the trademark and operating methods of the other party i.e. the franchisor.
There are two types of franchise methods - 'Business Format Franchising' and 'Product and Trade Name Franchising'.
1. Business Format Franchising
The most common method in the UK is Business Format Franchising. By using this method the franchisor grants the franchisee the rights to use their logos and trademarks, as well as a turn-key system for doing business.
A franchisee often received help from the franchisor in regards to site selection, store layout and design, recruiting and training staff, marketing the business, preferred supplies contacts and more.
The franchisee in return has to pay an upfront franchise fee as well as ongoing royalties to the franchisor. The franchisor uses this money to help further develop the system through marketing, product and market research, and ongoing support.
2. Product and Trade Name Franchising
The other franchise method is Product and Trade Name Franchising. This type of franchising does not involve royalty fees.
The most important thing that the franchisor provides is the product; the franchisee is required to purchase the product or range of products exclusively from the franchisor. The franchisor also provides national marketing and advertising campaigns, logos and trademarks.
This type of franchising is mainly associated with industries such as petroleum, soft drink distribution and automotive.
Product and Trade Name Franchising has 3 distinctive characteristics:
- The franchisee sells goods which are supplied by the franchisor or a person affiliated with the franchisor
- The franchisor helps the franchisee to secure accounts or, depending on the type of business, locations or sites for rack displays or vending machines
- Within 6 months of opening the business, the franchisee must pay the franchisor or a person affiliated with the franchisor
Advantages of franchising
In this article, franchising expert, Manzoor Ishani, Sherrards Solicitors, discusses the advantages of franchising and the top 7 reasons reasons you should consider buying one.
1. Less risk
In a nutshell, the greatest advantage of a franchise system is that it reduces risk of business failure. This is due to the fact that an ethical franchisor will have a tried, tested and proven business concept in the market place. Therefore, most of the wrinkles will have been ironed out and the risks to the franchisee minimised.
It is a well known fact that less than 7% of franchise owners fail within the first 3 years, as compared to over 90% of new business start ups.
2. Competitive edge
Franchising enables a small businessman to compete with big businesses and a franchisee can take advantage of the economies of scale. All franchisees acting together can buy more cheaply and on better terms than an individual small business.
Add to this the franchisor’s reputation in the industry, the franchisee can trade under a recognised brand and should have a distinct advantage over any independent small business competitor.
In theory at least, the products, equipment and system will have been previously market tested and therefore they come to the franchisee with a certain degree of 'ready acceptance' by the consumer.
3. Training and Support
Through training imparted by the franchisor, the franchisee climbs a very steep learning curve in a shorted period of time, thereby increasing their chances of succeeding considerably.
For example, someone who wishes to set up a dress hire business would find it very difficult to get the stock mix right at the outset. A franchisee, however, should have the benefit of his/her franchisor’s experience and should receive advice on the range and mix of the stock to carry etc.
The franchisee has the benefit of the management and administrative experience of the franchisor in addition to which most franchisors provide back up and support including trouble shooting services to assist franchisees in their daily endeavours.
This support includes managerial and administrative services, product information and marketing support
4. No previous experience needed
No previous experience in a particular business is necessary for a franchisee to operate it. All deficiencies of know-how are made good, again, by training imparted by the franchisor.
Indeed, one of the proudest boasts of franchisors is that they have the ability to turn a butcher, baker or candlestick maker into a fryer of chicken, dry cleaner or quick print shop operator.
Any lack of knowledge on how to run a business is not a problem as a franchisor will provide the necessary training to the franchisee.
5. Hit the ground running
Franchisees “hit the ground running” when they open a franchised outlet as they enter the market with a recognised brand name, proven business system and products and or services which have been market tested.
6. Pooled resources
A franchisee has the ostensible backing of a large organisation and this is achieved by the pooling of resources, particularly in the field of advertising, marketing and promotions where each franchisee, by contributing a little, can have the benefit of a large fund for this purpose.
Franchisees are therefore able to have their goods and services promoted through media which would otherwise be closed to them.
In a well-run and structured franchise business, the franchisee is left to concentrate on selling the goods or services while at the same time receiving the benefit of continuous market research and development to improve the business and the franchised system.
7. Exclusive territory
In many cases franchisees are given exclusive territorial rights and this, in effect, gives them a monopoly over the area allocated to them, certainly in terms of doing business under the franchisor’s trade name.
Disadvantages of franchising
Understanding the disadvantages to franchising could help identify any issues which may not be obvious to someone new to franchising. The drawbacks fall into 3 categories:
1. Lack of independence
An important feature of franchising is that every aspect of the business format is defined and each outlet is operated strictly in agreement with this format. Not everyone would be happy to operate a business under such constraints and you must consider how well you can accept this aspect of the franchising system when looking for a franchise to buy.
- Discipline: Buying (licensing) a franchise means working within a system in which there is little freedom or scope to be creative. Almost every aspect of operating the business is laid down in the manuals.
- Franchisor Monitoring: Regular field staff monitoring visits are welcome initially, but as time passes you will feel able to do your own trouble-shooting and you may come to regard the franchisors interest as an intrusion - it is after all your business.
- Service Charges: At first these services are necessary and franchisees do not mind paying for them. However as time goes on, if less use is made of the franchisors services then franchisees can resent making the continuing payments.
- Reputation: Each franchisee affects the reputation of the whole system depending on their performance and ability. In many franchises there is a wide gulf in the quality of product or service between the best and the worst franchisees. Thus any franchisee can harm the reputation of all outlets in the chain, even internationally.
- Responding to the market: Franchising tends to be an inflexible method of doing business as each franchisee is bound by the franchise contract to operate the business format in a certain way. This can make it difficult for a franchisor to introduce changes to the business format, refit outlets, or introduce new types of equipment. In some franchises it can be difficult for a franchisee to respond to new competition or to a change in the local market.
- The job itself: What may seem an attractive challenge now could become boring after a few years so it is important that you choose a franchise to buy in which you will enjoy the work, or which has potential for growth.
3. Risk associated with franchisor performance
It is important to recognise that not all franchise businesses are soundly based or well run. In signing the franchise agreement you are formally binding yourself to a particular franchisor and it is, therefore, vital to select one which is competent and ethical.
There are 4 different categories of franchisor; some should be avoided at all costs, while others will vary in attractiveness according to the level of risk you are prepared to take.
1. The Established franchisor: This represents the least risky type of franchise opportunity. The business format will have been fully tested in a number of locations, most likely abroad too, and although the initial cost of opening such a franchise may be relatively high, a franchise with this type of company will be highly attractive to anyone for whom security is important.
2. The New Franchisor: There is nothing intrinsically wrong with a new franchise but great care must be taken in deciding to invest in any particular franchise. As franchisors incur high initial costs, they need a minimum number of franchises to break even. When a franchisor has fewer than the break-even number of franchises it is likely that
- More effort will go into selling franchises than into providing support services.
- There will be some deficiencies in services in order to keep costs down.
- Financial resources will be strained.
In this start-up phase the franchisor is vulnerable to financial problems if franchises cannot be sold quickly enough. Franchises in this take-off phase are potentially those, which will earn the highest returns, for example if the product or service is outstanding in some way a large territory can be covered. With a franchisor you are in a position near that of an independent business - greater return. Depending on the risks you are prepared to take, this type of franchise may be attractive, or one to be avoided.
3. The Unethical Franchisor: Unfortunately some franchisors have no intention of entering a long-term support relationship with the franchisee, instead they have heard that franchising is a way to make money quickly out of gullible franchisees. This is done by setting up a shell franchise - lots on offer but nothing to back it up, then selling such franchises to those who are so keen to become a franchisee that they fail to make a thorough appraisal of the business on offer. Make sure that you spot this type of franchise, take time to investigate different opportunities.
You cannot afford to learn from your mistakes.
4. The Incompetent Franchisor: These are franchisors who are not offering franchises to perpetrate fraud but who are incompetent in one or more of the following ways:
- The basic business is unsound
- The franchisor is under-resourced and may not be able to fund the initial running of the business
- The franchisor has not run a pilot test so cannot confirm that the business is actually franchiseable
- They have not used experience or accredited franchise consultants or lawyers
- Their manuals and start-up assistance and support if of poor quality
How long is a franchise term?
When you buy a franchise, you are not buying the rights to own that franchise for unspecified period of time, instead a franchisor will grant you a license to run your franchise for a specific period; this is known as the Franchise Term.
The franchise term can vary between franchises, this is usually between 5-10 years, with the option to renew made available if you are a franchisee in good standing. The period and the terms of renewal, such as the payment of a renewal fee and whether you are obliged to refurbish or update aspects of the business, will be outlined in the franchise agreement.
In general, the period needs to be fair and hence long enough for you to recover your investment and loans associated with the purchase of the franchise.
Franchisees are able to sell their business before the end of their franchise term. If doing this you must contact the franchisor and work with them to make sure that you take the correct legal steps.
It would be worthwhile seeking legal advice from a franchise specialist lawyer when looking to sell your business or renew, especially if the certain areas of the agreement need renewed also.