Photo credit: Pizza Factory
The franchise business model is not new. In fact, franchising is an ancient distribution model that dates back to the Middle Ages and ancient China. Modern-day franchising is believed to have started with Benjamin Franklin. In 1731, he entered into the first franchise agreement with Thomas Whitmarsh to provide printing services in Charlestown, South Carolina. In the early 1850s, Isaac M. Singer again looked to the franchising model to distribute the Singer sewing machines. But it would be another century before franchising became truly popular, thanks to Ray Kroc and his discovery of the McDonald’s hamburger stand.
Today, there are thousands of franchises across hundreds of industries and sectors. Franchising has contributed greatly to the overall U.S. economy and has proven to be a lucrative avenue for those seeking freedom and financial stability. But what exactly is a franchise? Are there different types of franchise models? How does it all work? And is owning a franchise right for you?
What Is a Franchise?
A franchise is a business that an individual (called the franchisee) operates using the trademark, brand, and business system of an established company (the franchisor). Instead of starting from scratch, the franchisee licenses the right to use the franchisor’s name, products, and proven operating methods.
In simple terms, a franchise location is like a branch of a larger company, run by an independent owner but following the franchisor’s rules and standards.
How Does the Franchise Business Model Work?
The franchise business model is built on a partnership between franchisor and franchisee:
- The franchisor provides the brand name, operating systems, training, and ongoing support.
- The franchisee invests in the business, runs day-to-day operations, and agrees to follow the franchisor’s standards.
In exchange for these rights and support, the franchisee pays the franchisor:
- Initial franchise fee to buy into the system.
- Ongoing royalties, usually a percentage of revenue, paid regularly.
- Other possible fees, like marketing contributions.
This agreement is formalized in a franchise contract (franchise disclosure document + franchise agreement), which spells out the responsibilities of both parties.
At its core, the model allows a franchisor to expand their brand quickly, while giving franchisees the advantage of running a business with an established reputation, proven processes, and ongoing support.
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Understanding the Franchisor and Franchisee Relationship
The Role of the Franchisor
The franchisor is the parent company that owns the brand, trademarks, and operating systems. When a business decides to expand through franchising, the franchisor grants franchisees the right to use its proven business model in exchange for fees and royalties.
A franchisor typically provides:
- A recognizable brand name and trademarks
- A proven set of business systems and processes
- Initial and ongoing training
- Marketing and operational support
By offering these resources, the franchisor helps franchisees launch faster and operate more effectively than if they were starting from scratch. There are also many other expectations required from a franchisor that can either be industry standard, or specific to that franchise.
The Role of the Franchisee
The franchisee is the individual or group who invests in the franchise and operates it on a day-to-day basis. Franchisees sell the franchisor’s products or services while following the company’s established systems.
Although franchisees benefit from a pre-established brand, success is not automatic. They are responsible for:
- Building customer loyalty in their local market
- Hiring and managing staff
- Delivering excellent service
- Growing the business over time
In short, the franchisee is the hands-on operator who brings the brand to life in their community. Ready to get started? Here’s what to expect in your first year as a franchisee.
The Franchisor-Franchisee Relationship
A successful franchise business model depends on a strong relationship between franchisor and franchisee. While each brand’s approach may differ, the foundation should always include:
- Mutual respect for each other’s roles
- Clear communication about expectations and goals
- Ongoing support to help franchisees succeed
Ultimately, the franchisor provides the system, and the franchisee executes it. When both sides work together, the partnership creates long-term growth for the brand and the individual business owner.
Types of Franchise Business Models
Two primary franchise business models exist today: the Product Distribution Franchise Model and the Business Format Franchise Model.
Product Distribution Franchise
In the product distribution franchise model, the franchisor manufactures the product, and the franchisee sells the product. This relationship is similar to the supplier-dealer relationship but with a few differences. One major difference is that in the franchise relationship, the franchisee may distribute the products exclusively or semi-exclusively. In contrast, a supplier-dealer relationship may allow the dealer to sell several brands simultaneously. Examples of product distribution franchises include Coca-Cola, John Deere, and Ford Motor Company.
Business Format Franchise
The Business Format Franchise is the most common franchise model. In this model, the franchise is allowed to use the brand and trade name of the franchisor, like in the product distribution model, but they are also granted access to the product distribution model. Most of the franchises that immediately come to mind, like Wendy’s, Dunkin Donuts, or McDonald’s, are business format franchises.
What Are the Different Types of Franchise Ownership?
Before investing in a franchise, it’s important to understand that ownership can take several different forms, each with its own risks, rewards, and responsibilities. Exploring these options helps you choose the structure that aligns with your resources, growth ambitions, and long-term vision.
Single Unit Franchisee
When a franchisee purchases their first franchise, they are considered a single-unit franchisee. This is the most common form of franchise ownership.
Multi-Unit Franchisee
If a franchisee finds success with their first franchise venture, they may choose to open a second, third, or even fourth franchise from the same franchisor. When a franchisee owns more than one franchise unit, they are considered to be a multi-unit owner.
Multi-Unit Area Developers
Multi-unit area developers are similar to multi-unit franchisees except that they agree, upfront, to develop a certain number of franchise locations within a specified time period and area. This approach is best for franchisees who are looking for market exclusivity and have the resources to secure that exclusivity with the franchisor.
Master Franchisee
A master franchisee is very similar to a multi-unit area developer in that they must open several locations in a specified period and area. The difference is that the master franchisee can, and sometimes obligated, sell franchises to other prospective franchisees. The master franchisee then acts as a middleman for the franchisee and the franchise company.
Licensing vs. Franchising: What’s the Difference?
One common area of confusion for prospective franchisees is understanding the difference between franchising and licensing.
Licensing is a broad term that businesses use for contracting purposes. Licensing gives the licensee a right to operate in cooperation with a brand, gaining access to the brand’s intellectual property, brand, design, and business programs. In exchange, the licensee pays royalty fees to the licensor. The licensor may have a say in how the intellectual property is used but not how the licensee operates their business. A licensor will grant a licensee the right to use their intellectual property. Still, the licensor will not provide support or training or exert any control over how the licensee uses that intellectual property.
On the other hand, a franchise is a legal and commercial relationship between the owner of a company (the franchisor) and an individual (the franchisee) starting a branch of that business using the business’ trademark logos and business model. Essentially, a franchise is an independent branch of the franchise company. The franchisee sells the product or service that the franchisor supplies.
Franchise Opportunity vs. Business Opportunity
Another common area of confusion is franchise opportunity versus business opportunity. While they may sound very similar at first glance, there are some major differences. For instance, a franchise opportunity includes licensing trademark rights, offers robust training and operational assistance throughout the contract’s life, and can often cost more than a business opportunity due to the ongoing required fees.
While all business opportunities are different and can be hard to define, the main difference is that when someone pursues a business opportunity, they are unlikely to receive the same level of support, training, or guidance that a franchisee receives from their franchisor.
It’s important to know that each opportunity is only suitable for the right individual. If you’re not quite sure, ask yourself: should you buy a franchise or start a business from scratch?
How to Evaluate a Franchise Opportunity
There are thousands of franchise opportunities for eager entrepreneurs who see the appeal in the franchising model. However, not all franchises are smart investments. That’s why prospective franchisees should evaluate each franchise opportunity they’re interested in.
To help prospective buyers find the best opportunities, Franchise Business Review surveys thousands of franchisees across hundreds of brands each year. Based on this research we can determine the best franchise opportunities on the market today based 100% on franchisee satisfaction. Details on this year’s top-rated franchise brands can be found on our Top 200 Franchises list.
