What is franchising?
The term "franchising" can describe some very different business arrangements. It is important to understand exactly what you're being offered.
Business format franchise
This is the most common form of franchising. A true business format franchise occurs when the owner of a business (the franchisor) grants a licence to another person or business (the franchisee) to use their business idea - often in a specific geographical area.
The franchisee sells the franchisor's product or services, trades under the franchisor's trade mark or trade name and benefits from the franchisor's help and support.
In return, the franchisee usually pays an initial fee to the franchisor and then a percentage of the sales revenue.
The franchisee owns the outlet they run. But the franchisor keeps control over how products are marketed and sold and how their business idea is used.
Well-known businesses that offer franchises of this kind include Prontaprint, Dyno-Rod, McDonald's and Coffee Republic.
Other types of arrangement
Different types of sales relationships are also sometimes referred to as franchises. For example:
- Distributorship and dealership - you sell the product but don't usually trade under the franchise name. You have more freedom over how you run the business.
- Agency - you sell goods or services on behalf of the supplier.
- Licensee - you have a license giving you the right to make and sell the licensor's product. There are usually no extra restrictions on how you run your business.
Some businesses offer franchises that are really multi-level marketing. Self-employed distributors sell goods on a manufacturer's behalf. You get commission on any sales you make, and also on sales made by other distributors you recruit.
Advantages and disadvantages of franchising
Buying a franchise can be a quick way to set up your own business without starting from scratch. But there are also a number of drawbacks.
- Your business is based on a proven idea. You can check how successful other franchises are before committing yourself.
- You can use a recognised brand name and trade marks. You benefit from any advertising or promotion by the owner of the franchise - the "franchisor".
- The franchisor gives you support - usually including training, help setting up the business, a manual telling you how to run the business and ongoing advice.
- You usually have exclusive rights in your territory. The franchisor won't sell any other franchises in the same region.
- Financing the business may be easier. Banks are sometimes more likely to lend money to buy a franchise with a good reputation.
- Risk is reduced and is shared by the franchisor.
- If you have an existing customer base you will not have to invest time looking to set one up.
- Relationships with suppliers have already been established.
- Costs may be higher than you expect. As well as the initial costs of buying the franchise, you pay continuing royalties and you may have to agree to buy products from the franchisor.
- The franchise agreement usually includes restrictions on how you run the business. You might not be able to make changes to suit your local marke.
- The franchisor might go out of business, or change the way they do things.
- Other franchisees could give the brand a bad reputation.
- You may find it difficult to sell your franchise - you can only sell it to someone approved by the franchisor.
- Reduced risk means you might not generate large profits.
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