Franchising – Evaluation

Advantages of franchising to a franchisor:

1. Very fast expansion. Franchising enables more rapid spread of the business for the franchisor. There will be a guaranteed market as franchisees are selling a recognized product. Since the franchisor’s brand is recognized worldwide, the customers will have more confidence in the product which now will be available in more locations. It gives franchisors a quick and cheap means of expansion.  

2. Increased market share. The market is increased for the franchisor without spending any money on the internal expansion of the firm. It is because the franchisor is leveraging off the assets of multiple franchisees to help grow the market share without actually spending any of its own money. Hence, capital requirements will be lower. It is the franchisees who provide the capital to open each of the franchised outlets.

3. Reliable amount of recurring revenue. Because annual royalties are based on sales turnover, not profits, the franchisor will receive reliable revenue regularly, even if the franchisee loses money. 

4. Specialist franchisees. The franchisor will benefit from using the specialist skills of the franchisees. It will make international expansion easier and faster as each local franchisee possesses the local market knowledge. 

Disadvantages of franchising to a franchisor:

1. Suitability of the business. Not every type of business can be franchised. The franchisor will need to make a study to determine whether the product has a market at the prices charged, and whether competition exists. Restaurants and retail stores are among the most popular types of franchise businesses.

2. Initial costs. Developing a franchise network can be expensive as it demands a significant investment in the form of development costs, management time and initial capital expenditure. The original investment will not be recovered until franchisees are selected and the franchisor starts receiving the license fees and royalties. 

3. Costs of quality control. A franchisor has to ensure, through constant monitoring, that the standard of goods and services are maintained by the franchisee. The franchisor will need to bear the costs of quality control involved in control measures regarding legal documentation, correct revenue collection, maintaining brand image, goodwill, trademarks, etc.

4. Need to carry out administrative activities. Training and support must be provided on ongoing basis for franchising to be successful. The franchisor will need to train others in the use of the systems and procedures. The franchisor is also obliged to carry out administration services regularly.

5. High costs of promotion. Normally, it is the franchisor who needs to carry out the promotion of its products. Usually, the franchisor will launch a national or global advertising campaign. Above-the-line promotion tends to be very expensive overall.

6. Reduced flexibility. There are certain internal and external risks involved in each stage of franchising, so developing a successful business model requires very careful planning, continuous supervision and ongoing support. It is because each decision made centrally at the franchisor’s headquarters will have direct impact on the operations of hundreds or even thousands of franchise outlets around the country and abroad. It will be extremely difficult to reverse any wrong decision once it has been made.

7. Problem franchisees. As the franchisees are independent business people spread across the country and globally, they may sometimes cause troubles and disregard their obligations toward the franchising agreement. They cannot really be fired, if they do not perform up to a certain standard.

Advantages of franchising to a franchisee:

1. Less risky. There is less chance of new business failing for the franchisee because the product and brand that belong to the franchisor are already well-established. Therefore, branch franchising allows an inexperienced franchisee to run a business with higher chance of success than building own business from scratch. 

2. Easier to attract customers. If you buy a franchise from the company that is well-known around the world, then you are going to find it much easier to attract customers, therefore you have a much lower risk of making a loss.

3. Satisfying profitability. The profit margins built into the concept of franchising are great enough that every franchisee who adheres to the franchising system can realize an attractive Return on Investment (ROI). This return should easily exceed 20% before TAXes. The degree of profitability is easily predictable as well.

4. No need to carry out training. The franchisor often provides advice and training to the franchisee as a part of the franchise agreement. Administration services are also carried out by the franchisor.

Example 1: Training is designed and delivered to all McDonald’s employees, so all of the restaurants that belong to McDonald’s franchise operate in a standard McDonald’s way.

5. No need to carry out promotion activities. The franchisor will finance the promotion of the brand through national advertising. So, franchisees do not have to promote the product by themselves which significantly reduces Fixed Costs for the franchisee. 

6. Guaranteed quality supplies. The franchisor has already checked the quality of suppliers, so the franchisee is guaranteed quality raw materials. Usually, the franchisee is not allowed to get any unauthorized products, or any products obtained from unauthorized suppliers. 

Example 2: Quality means fit for purpose. McDonald’s have been able to develop products and processes that meet the needs and requirements of their customers, providing high levels of consumer satisfaction. However, it is important to make sure that these standards are maintained across the whole organization. This is why standardization is so important, so that the quality procedures are in place across the whole of the franchise network.

7. Exclusivity. A franchisor agrees not to open another branch in the local area. So, the franchisee will get the benefits of attracting the entire customer base in his or her territory. Thereby, it will significantly increase his chances of commercial success.

Disadvantages of franchising to a franchisee:

1. High initial costs. The initial cost of paying franchise license fee can be very expensive. If the franchise is very expensive, there will be very few who can afford it. The ideal franchise investment could be around USD$100,000 as there are hundreds of thousands of people who can afford an investment of this size. Often the cost of buying a franchise depends upon how famous the brand is that the franchisee is going to trade under. 

2. Need to pay royalties. The franchisor will take a percentage of the sales revenue made by the franchisee each year. While royalties must be paid even if a loss is made, some franchisors might not offer all of the training and support that is needed.

3. Strict standards to follow. There are very strict controls over what the franchisee is allowed to do with the product. All the operating systems are very polished and efficient. Pricing is very rigid causing inflexibility. Also, strict rules over layout of the outlet reduce owners’ control over their own business. 

Example 3: Standardization is achieved through common products and procedures across the global McDonald’s network. All franchisees must use standardized McDonald’s branding, menus, design layouts and administration systems. If you go to different McDonald's restaurants, you will see that they all look very similar and sell identical products.

4. No choice of supplies or suppliers. The suppliers and supplies have already been chosen by the franchisor, with the quality standards checked and verified. However, franchisees are still responsible for staffing, inventory management, quality management, customer service and the day-to-day running of the franchise which may cause heavy workload in popular locations.

5. Dependence on the franchisor. Franchisees must be prepared to give up some independence. They will most likely act as ‘outlet managers’ rather than being someone who is running own business. Also, the franchisor has all the power to withdraw from the franchising agreement and prevent franchisees from using the premises in the future. The franchisee must also be somewhat ready to spend most of business life with this franchisor, offering its products and services regardless of personal perceptions of the brand.

6. Coattail effect. When others fail, they bring you down too, if you belong to the same group. This can tarnish your reputation.