The Advantages and Disadvantages of Franchising
Most Canadians engage with franchises daily without giving much thought to the concept. That includes picking up their morning coffee, hitting a local gym, or dropping their children off at daycare. There are currently over 76,000 franchise establishments spanning Canada. Franchises generate trillions of dollars, employ millions of people, and earn higher revenue per location compared to independent businesses.
The franchise business model allows a franchisee to operate a business in an investor role or be more engaged if they choose. After paying a franchise fee, a franchisee has the right to use the franchisor’s name for a specific number of years as part of the venture. Like any business, a franchise comes with a balance of risk and reward. This article will explore the benefits and potential pitfalls of franchising for franchisees and franchisors.
Advantages for the Franchisee
Assistance From the Owner of the Business
When franchisees sign agreements, they attach themselves to established brands with proven business infrastructures. In most cases, franchise brands offer extensive training for new franchisees that covers how to select a location, how to hire employees, how to operate a store, and much more. A number of franchise brands also run mentorship programs that help new franchisees to learn from seasoned ones. This is very different compared to an independent business owner starting their own brand from scratch because the franchisee is getting assistance from a team that is heavily invested in their success!
One of the biggest benefits of opening a franchise location is that a market already exists! When opening a franchise location belonging to a well-established, highly recognized brand, a franchisee is taking a component of the "risk" out of the picture for customers. While customers may be hesitant to try a new business they've never heard of before, a familiar name ensures that they already know what they will be getting. Research shows that familiarity can even trump value when it comes to why customers trust brands. Franchisees still generally need to do some local marketing efforts to spread awareness. However, they often get support from the parent brand. Additionally, franchise brands also do heavy research before allowing a franchise to open in a location to ensure that the demand is there.
Lower Failure Rate Than Startup Businesses
Have you ever heard it said that most new businesses fail? While there is never any guarantee that a business will thrive, franchises have a lower failure rate compared to industry standards. According to the Franchise Brokers Association, the failure rate for franchises may be as low as 20%. The FBA also points out that plenty of franchises have failure rates closer to 2%.
Franchisees generally have opportunities for bigger profits. These bigger profits are driven by a number of things. Yes, the traffic from brand recognition that franchises receive definitely contributes to higher sales numbers. However, it's the often lower cost of doing business associated with franchises that is the true reason behind why many franchisees make bank.
A good franchisor provides its franchisees with efficiency-creating tools and resources. For example, a franchisor will generally provide each location with access to its supply chain and vendor list. Individual franchisees benefit from bulk pricing agreements their parent corporations are able to obtain. As a result, a franchisee may be paying substantially less for similar ingredients, equipment, and supplies compared to the similar independent business down the street. Additionally, franchisors often provide franchisees with management technology, marketing services, and other resources that help locations to maximize profits and efficiency.
While there's no such thing as a no-risk business investment, a franchise opportunity erases a lot of the uncertainty that investors struggle with when assessing the viability of an idea. A reputable franchisor will provide potential franchisees with the information needed to make an informed decision. This includes projections based on internal market research, historical returns from other franchise locations, and operational costs. A better way to describe "low risk" might be "fewer surprises."
Built-in Customer Base
This benefit to franchising ties into "brand recognition." Companies that grow successful enough to evolve into franchising are generally popular, well-known brands. In fact, brands that are franchising are often growing too quickly to keep up with demand on their own. That's why they expand via franchisees. Did you know that researchers have found that seven in 10 shoppers consider themselves loyal to a brand after just three purchases? Researchers have also discovered that an existing customer is 50% more likely to try a new product. For a franchisee, being able to tap into the existing popularity and familiarity of a brand creates an incredible opportunity for connecting with a built-in customer base. In many cases, a customer base is "yours to lose" based on how you conduct operations.
An Opportunity to Be Your Own Boss
While franchise owners have accountability, they essentially act as their own bosses on a day-to-day basis. A franchisee can assemble and hire their own staff. While franchisees oversee everything about a location, they can generally set their own schedule. Many franchisees enjoy the fact that the location can continue to run smoothly under the management team they've assembled while they are traveling.
Disadvantages for the Franchisee
Lots of Regulations
Franchisees straddle a complicated world of running their own business while being subject to a variety of corporate, state, and federal regulations. First, a franchisee must meticulously follow all business guidelines set by the franchisor they are working under. This includes everything from human resources policies to daily procedures for handling waste. Franchisees must also stay current with all state and federal policies regarding hiring practices, accessibility for the public, health and safety protocols, tax reporting, and more.
Not everyone qualifies to be a franchisee. Most franchisors have thresholds for personal net income and wealth that must be met for aa potential franchisee to be considered. Additionally, franchises require startup costs. These costs can range anywhere from a few thousand dollars to a few million dollars. The average franchise fee (a part of the initial investment that grants franchisees access to the franchisor’s brand) for a franchise in Canada is $25,000. Depending on the payment structure used by a franchisor, a franchisee may also pay ongoing franchise fees that come in addition to the percentage of profits shared with the franchisor.
Potential for Conflict
What if you don't want to run your business the way that a franchisor is telling you to run your business? Unfortunately, a franchisee must follow all the requirements outlined in a franchising contract. When researchers examined trends in litigation between franchisees and franchisors, they found that 50% of franchises had between one and fifty lawsuits. Common reasons for franchising lawsuits include:
- Lack of Franchisor Support: Once a location is up and running, a franchisee may feel that the promises made in the franchising contract aren't being fulfilled. One of the biggest sources of conflict is the franchisee’s feeling that the support they were guaranteed isn't being provided.
- Breach of Agreement: When the terms of the franchising document aren't fulfilled on either end, the franchisee or franchisor may feel that their ability to maintain profits is being stifled. If a brand feels that a location owner isn't providing products or services to the specifications outlined in the contract, they may be able to bring legal action against the franchisor for noncompliance.
- Fee Disputes: Payment issues can sour the relationship between a franchisee and franchisor. It's not uncommon for franchisees to feel that the franchising fees and sales royalties being paid to franchisors are excessive. While these fees may seem reasonable when the contract is being signed, a franchisee may begin to feel like the parent company isn't providing the support needed to justify the fact that they are taking as much of a cut. When franchise brands raise fees in response to higher costs for doing business, franchisees can feel like they are being squeezed. Unlike independent business owners, franchisees do not have the ability to adjust their business practices to cut costs based on their own assessments.
- Poor Communication: Franchisees invest 100% of their time and energy into making their locations successful. That's why feeling like they are being "kept in the dark" by the franchisor can be frustrating. It's important to remember that a single franchise location is ultimately just one cog in a much larger machine. A franchisee may not be kept in the loop when it comes to changes in direction with marketing, procedures, growth figures, and other core details that affect their operation.
Franchisees are limited in just how creative they can be when it comes to marketing. While franchise locations get to piggyback on the visibility of larger regional or national campaigns from their parent company, most franchisees are paying marketing fees as part of overhead costs that help to feed those large campaigns. This can frustrate local franchisees because they often feel that they aren't provided with the support needed to drive local marketing efforts. For franchisees who feel like they know their local markets better than a big marketing department, there is the added frustration of not being able to design their own marketing campaigns around the interests and trends of the local community. What's more, they may feel like the national marketing campaign of the parent company is a bad fit for their local market. That means that they are stuck paying marketing fees for initiatives they don't feel will benefit their sales.
Lack of Financial Privacy
While a franchisee feels like "their own boss" during day-to-day operations, there's no question about the fact that franchisees are accountable in front of the franchisor. Franchisees must be accountable for every dollar, receipt, and piece of inventory at the end of the day. A franchisee may feel like their finances are being micromanaged by a corporate staff that doesn't have experience with running day-to-day operations.
Advantages for the Franchisor
Access to Capital
Many larger brands that offer products or services in "storefront" settings find that the franchise model is the best way to open new locations. While franchisors do invest money in every new franchise location, they are essentially able to raise capital through the franchisee. This is why franchise brands have such stringent financial requirements for franchisees. Under the franchise model, larger corporations can open a large number of locations in new markets by charging startup costs and franchising fees instead of raising capital through traditional investors or lending institutions.
Efficient Growth with Minimal Work
For franchisors, the franchisee doesn't just provide the capital investment needed to get a new location up and running. The franchisee is also a key component of growing the location successfully. Nobody is as motivated as a franchisee who is investing their savings and time into opening a new location. Franchisees handle essentially the work that needs to be done "on the ground" at the location with very little help from corporate employees. What's more, the franchisee is also typically responsible for paying franchise employees.
Increased Brand Awareness
The franchising model is how so many brands that everyone knows and loves suddenly start "popping up everywhere." By increasing its presence at a rapid pace through this model, a brand is able to strike while the iron is hot instead of waiting for traditional funding for establishing new locations. The brand-awareness angle in franchising works in two ways. First, a brand that has created a product or service that people love is able to replicate the customer experience in a way that allows it to be delivered by trained franchisees. Second, the rapid growth of a brand helps to create the perception of popularity because the public assumes that the rapid rise of this brand is owed to the fact that there is demand.
Disadvantages for the Franchisor
Loss of Complete Brand Control
When a brand goes with the franchising route, it is placing its reputation in the hands of individual franchisees. Of course, franchising contracts are in place to help set guardrails for how a franchisee can and cannot conduct themselves when it comes to brand representation. However, a franchise brand simply can't be "everywhere at once" when it comes to managing day-to-day operations at franchised locations. They must place their trust in a franchisee's ability to follow brand guidelines, follow all local and federal guidelines, and train the right people to run a location. The risk is that the public isn't generally knowledgeable about the difference between a corporate-run location and a franchise location. That means that any sort of "scandal" or bad experience that happens at one franchise location affects the reputation of the entire business.
Increased Opportunity for Legal Disputes
Unfortunately, franchisees sue franchisors every single day. A franchisee-franchisor relationship often goes smoothly up until the moment that a franchisee perceives that they are being wronged in some way. According to legal experts, some common causes of litigation include:
- Disputes regarding disclosure documents.
- Disputes regarding compliance violations.
- Territory and encroachment disputes.
- Termination disputes.
- Antitrust violations.
- Alleged discriminatory practices.
- Liquidated damages.
- Supply chain and sourcing issues.
Each legal dispute costs a franchise time and money. In fact, being a franchisor generally requires an in-house legal staff capable of responding to legal actions immediately. The funds budgeted for legal action represent money that could have been reinvested back into the business. What's more, franchisors can be on the hook for large payouts if they are found to be at fault in a lawsuit.
Getting to the point where a brand is able to sell franchises is no small task! In most cases, it takes years of work and millions of dollars in overhead costs to get to a point where a brand is recognizable enough to thrive within the franchising model. A franchisor must also invest in the development of an extensive financial disclosure document (FDD) in collaboration with a legal team. Additionally, a franchisor is responsible for handling all filing and registration fees for incorporating. The cost to build the corporate infrastructure needed to support franchisees can be sizable. It takes a team of financial experts, accountants, marketing specialists, distribution specialists, legal experts, construction experts, and real estate professionals to support franchisees in opening their own locations.
Risk and reward accompany every business venture. Knowing the advantages and disadvantages of starting a franchise is important so that there are fewer surprises. Running a franchise can be incredibly rewarding and profitable.