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. “In the Middle Ages, the local titled landowner would grant rights to the peasants or serfs, probably for a consideration, to hunt, hold markets or fairs, or otherwise conduct business on his domain. With the rights came rules, and these rules became part of European Common Law, explained FranChoice.
Modern-day franchising is believed to have started with Benjamin Franklin, who 1731 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 after Singer 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. According to a U.S. government report, the franchise industry employed 21 million people and generated $2.3 trillion of economic activity as of 2018.
Franchising has contributed greatly to the overall US 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? Understanding the Franchise Business Model and How Does It Work
A franchise is a type of business operated by an individual(s) known as a franchisee using the trademark, branding, and business model of a franchisor. In this business model, there is a legal and commercial relationship between the company’s owner (the franchisor) and the individual (the franchisee). In other words, the franchisee is licensed to use the franchisor’s trade name and operating systems.
In exchange for the rights to use the franchisor’s business model — to sell the product or service and be provided with training, support, and operational instructions — the franchisee pays a franchisee fee (known as a royalty) to the franchisor. The franchisee must also sign a contract (franchise agreement) agreeing to operate per the terms specified in the contract.
A franchise essentially acts as an individual branch of the franchise company.
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The Franchisor and Franchisee Relationship
The Franchisor is the parent company that sells the rights to franchise its brand to prospective franchisees. The franchisor has developed the company, brand, and operating systems. Upon the decision to franchise their business, the franchisor offers franchisees the rights to its proven business model, recognizable trademark, established business systems, and training and support.
The Franchisee is the individual who buys the rights to sell the products or services and utilize the proven and established business systems mentioned above. Although the franchisee is, in essence, buying a pre-established business, franchisees must work hard to gain loyalty in their market, attract talent, and grow their franchise business. After all, it is the franchisee that runs the day-to-day business.
The franchisor/franchisee relationship should be one built upon mutual respect, understanding, and support. Of course, as with all relationships, no two are the same. Although relationships between franchisee and franchisor will differ from brand to brand, one thing always remains the same: the franchisee/franchisor relationship matters.
What Franchisees Can Expect from Their Franchisor
The FDD
When a franchisee is serious about a franchise opportunity, the franchisor will share their Franchise Disclosure Document (FDD), which contains information about bankruptcies, various fees, franchisee obligations, and more.
Financing Options
Some franchisors offer financing programs for interested and serious buyers, which can assist franchisees in finding a loan servicer or alternative methods of payment.
Location Assistance
If the franchise requires a physical location, the franchisor usually assists in site selection and finds a local contractor to construct the approved architecture.
Training and Operational Guidance
Franchisors also provide franchisees with an operating manual and in-person or online training to understand how the business runs. The operating manual includes all employees’ roles, performance standards, management operations, and other specifications. The training tends to take place either at the franchisor’s corporate headquarters or online and in-person training.
Marketing and Advertising
Franchisors also supply their franchisees with marketing and advertising. This could be through television and radio ads or social media and email campaigns. Franchisees are usually charged a marketing fee to cover this cost. Some franchisors also lend administrative services to their franchisees, like human resources and accounting services.
Support
As a franchisee gets their business up and running, questions and concerns are bound to arise. The franchisor will provide varying levels of support throughout the life of the franchise agreement. Franchisees also have access to an entire network of fellow franchisees, who may be able to offer advice or offer a solution to a common problem.
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Types of Franchising – Two Primary 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.
Different Types of Franchise Ownership
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
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.
What’s the Difference Between Licensing and Franchising? Learn More!
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.
Not All Franchises are Created Equal
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 research the opportunities they are 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 list.
