Updated on April 24, 2020
What’s a franchise?
What’s a franchise? How does the franchise system work? Here are the answers, and you can find out what this contract between two independent entrepreneurs, franchisor and franchisee consists of, and what it is for.
What is a franchise?
Franchising is a type of commercial contract between two independent entrepreneurs, franchisor and franchisee, whereby the first entrepreneur, called the franchisor, grants the second, called the franchisee, the right to exploit exclusively in a market and for a period of time a business model, using his brand to distribute his goods or services under the guidelines of the brand, in exchange for a series of economic considerations.
Franchising is the least risky method of creating a successful business:
- It allows the franchisee entrepreneur to establish a business, taking advantage of an already proven business model, reducing the risk of failure and the investment of openness.
- It allows the entrepreneur to have the help of a service center that helps him to compete in better conditions, achieving lower costs and higher sales thanks to joint advertising.
- The franchisee, in turn, finds local partners who contribute with investment and work, operating the business with greater commitment and profitability than if he opened his own centers. A franchised organisation is more competitive than an organisation based on labour agreements.
Main features of franchises
If you are opening a franchise or franchising a business, you should know:
- Does franchising reduce the risk of starting a business, but doesn’t eliminate it? Statistics show that 80% of independent businesses close before they have five years in business. In franchises, this percentage is reduced to 60%. In other words, although there is risk (inherent in any business activity), this risk is reduced.
- Did you know that there is no franchise law? Franchising is the most flexible contract to create business in the world because legislators decided not to create a franchise law. Thus, each contract is the law that regulates each franchise relationship, and can be adapted to many different business sectors and companies.
- Don’t franchises always earn the same in every location, not every year, nor are they run by different people? The same business can produce very different results depending on who manages the point of sale, its location or the market in which it develops.
- The content of each franchise can be very different.
- Did you know that the most important factor for the success of a franchise is the management of the franchisee and the place where you open the business?
- One person is not good for each franchise. Each person has different skills and abilities, as well as personal affinities and preferences.
- Not all franchises are equally good for everyone. There is no best franchise, only the best franchise for one person in one place.
- Did you know that the best franchises only have 5% of the locations that lose money?
- And not-so-good franchises have up to 40% of the locations that aren’t doing well.
- There are brands that make a million euros in one place and in the same city another place loses money just because of the change of location and management.
- Did you know that the concept of ongoing support that defines the franchise allows for very important differences in services? You should ask and evaluate in each case what you will be able to compare.
- Many franchises copied the conditions and contract of others without their offer making commercial sense or justifying their royalties.
- The value of a franchise is in selling more and having less costs within the franchise than if you set up the business yourself.
- A good franchise should be concerned with opening good projects, not opening many projects.
- Did you know that the entry fee avoids the cost of creating an image and the risk of designing and creating a business?
- Franchising is not inventing, but applying the model that has already worked.
- New franchises have more risks, but you can take advantage of opportunities in better markets and locations.
- Franchises are the professional outlet for people who will not find jobs, but who do not have the ability to create and lead the strategy of a business on their own.
- Did you know that a franchised entrepreneur has at his service head office executives who are experts in strategy, marketing, purchasing, IT? This allows them to have their business, but compete in the marketplace with a good team.
- Did you know that a franchisee’s attitude towards headquarters has a big influence on how well or how badly their franchise develops?
- If you think you can do better than the franchisor, you should not create a franchise.
- The best franchises need to manage a lot of problems. For it to work well, you need a good fit between the franchisor’s style and that of the franchisee.
- As an entrepreneur, you need to be proactive and attack priority issues every day, even if you don’t feel like it. Since you have no boss, no one will tell you what to do, but if you don’t solve it, you pay for the result.
Why do you franchise a business?
Franchise business to grow. Growth allows you to build a notorious brand, thanks to your presence in many locations in a country or even the world. Growth also allows them to buy cheaper and earn more. Growth also allows unit costs to decrease. There are many functions that headquarters does and that need not be duplicated in successive centres. These functions allow the franchisee to have access to economies of scale and improve their profitability.
The franchisors can grow by taking advantage of the economic resources of the franchisees, since they are the ones who invest in the franchises they set up, and also have a very committed team, the franchisees, who generally get better results than the centers managed by the staff themselves. The franchisee is the key to the success of a franchise.
The companies that franchise achieve the following results:
- Sell more: Thanks to the opening of more units, franchisees obtain more income and can obtain greater benefits.
- Buy more cheaply: Thanks to the growth of franchises as shopping centers, they can buy more cheaply, improving the profitability of all units, both their own and franchises.
- Lower your unit costs: There are many functions in a job that do not need to be done in all units, for example, marketing. If I have a marketing manager who costs 60,000 euros and I have 10 stores, I get 6,000 euros per store. On the other hand, if I have 100 stores, the cost per store will drop to 600 euros per store. This increases the profitability of all units.
- Franchises create brand: The networks of units create brand, through the repetition of their facilities that the public sees on the streets and the possibility to gather the marketing budget of all their units. Thus, if an independent store spends 3,000 euros a year on advertising, it will be able to do few actions. On the other hand, if a network accumulates 3,000 euros for 100 facilities, with a budget of 300,000 euros it can do advertising. Advertising increases the sales of all stores and at the same time increases the profitability of stores and franchises.
- Improve your profitability: Businesses that use franchises have a higher profitability than independent businesses. This is the result of higher revenues thanks to superior advertising and marketing on the one hand, and lower costs on the other. If a franchise is well established, which not everyone is, a franchisee should sell more and have less costs than an independent business in its sector.
- A more committed team: Franchisees, as entrepreneurs owning their franchises, make the units work better because they take more care of the business. They sell more and manage costs better.
Why do franchisees establish a franchise?
Setting up a business has risk and the franchise reduces it, although it does not eliminate it.
Creating a business that has already worked significantly reduces risk.
Moreover, creating a business within a franchise network offers some advantages: being able to use a known brand and sell more, in addition to having lower costs thanks to the central purchasing and economies of scale.
If a franchise is well set up, the franchisee will set it up for less investment than it would cost to start from scratch and should have lower costs than if they were on their own.
The franchisor also trains the franchisee, provides the products and services and provides ongoing support services.
Franchising is a formula, which if well thought through, should benefit both the franchisor and the franchisee.
The advantages of franchising to the franchisee
- Reducing investment: If the franchise is properly assembled, the franchisor works to reduce the investment in assembly. On the one hand, there are many cost items that only need to be made when creating the first pilot store(s). Once the model is defined, there is no need to recreate an image, a decoration, or to refine the business. Furthermore, as a franchisee, he can optimize materials, prices and processes, and he can open the new units for less money. The first unit does not cost the same as the number 20, nor 20 as the number 100. If the franchise is good, the investment must be less than creating a plant independently.
- Reduce business risk: Franchises reduce the risk of a new business, although they do not eliminate it. They reduce the risk of creating the business, but location and management risks remain. The risk is reduced from 80% mortality in independent businesses to between 40% and 5% for the most optimized franchises.
- Access to better profitability: Franchise businesses should provide the franchisee with higher revenues and/or lower costs than if the entrepreneur set up the business on his own. Be careful, this only happens if the franchise is well set up, there are many cases where the franchise has not been well designed and this is not the case. The entrepreneur who is looking for a franchise should look very carefully at this point.
Keys to the success of the franchise system
Franchising is a worldwide success because it allows small companies to compete with big companies. It allows the entrepreneur who wants to start a business to do so with the support of a brand and a central organization behind it. They can have better prices and less risk.
At the same time, it allows the franchisor to grow through the investment made by the franchisees so that a small business can compete with the strength of a large one, gaining the size of the franchise network.
This dual benefit franchisor – franchisee is the key to the success of the franchise around the world.