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Franchising

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Business Studies

A franchise model is great because most people who are entrepreneurial want flexibility and time to do what they love. A lot of home business entrepreneurs struggle because they have to do everything."

- Rory Vaden

Some might consider franchising an optimal form of business as it comes with fewer risks than setting up your own venture from scratch. On the other hand, others might want more freedom in running their business. Let's examine these two perspectives in more detail.

What is franchising?

Franchising is a two-party contract. The franchisor provides a set of information to the franchisee on how to run the business. The franchisee essentially receives the whole 'business package' from the franchisor.

A franchise is a form of business. Franchising happens when a franchisor provides a license to the franchisee. Franchising allows the franchisee to operate their business using the same business model and brand as the franchisor. The franchisor is the business owner who sells the franchising rights to another business. Upon purchasing this right, the franchisee can operate their business under the same name and brand as the franchisor.

Once the franchisee has bought the franchising rights, they have to pay a portion of their profits to the franchiser. These are known as royalty payments. For instance, the franchisor could ask for five percent of the franchisee's yearly profits. The franchiser may also provide training for the franchisee and their employees. The franchisee is usually trained on how to run the daily operations of the business, marketing and management.

For a quick refresher on this concept, check out Profit.

Franchising examples

Franchises can be distinguished based on certain characteristics.

  • The franchisor owns a trademark and sells it to franchisees. The franchisee, in return, pays royalty payments to the franchisor.

  • The franchisee pays for their rights to be part of the franchising system.

  • The franchisor provides its franchisees with a set of business tasks that outline how to run the business.

Fast food restaurants are commonly franchised. As you may have already noticed, restaurants like McDonald's, Burger King, Papa John's, or KFC look the same almost everywhere. Their branding, operations, menus, exterior, and interior are designed in a very similar way. This is because most of them are owned and operated under a franchise. Although these restaurants are all franchises, the requirements and costs of owning and operating different franchises vary.

KFC is one of the most expensive franchises to set up as a franchisee in the UK. KFC's UK website (2021) says "aspiring franchise owners must have £5 million in assets and £2 million in liquid capital", in addition to paying the franchise fee which is around £38,000.

Advantages of franchising

Franchising benefits both parties in a lot of different ways. Buying a franchise is a good way for an individual to set up their business. The benefits of franchising to each party are outlined below.

Benefits to the franchisor

  • The franchisor gains the motivation of entrepreneurs who really want to set up and run the franchise. This can be beneficial for the franchisor as they do not need to select a new manager from job listings, etc. The franchisees chose to run the specific franchise themselves.

  • The franchisor is able to grow and expand rapidly with the help of eager franchisees.

  • The franchisor gains local business knowledge from the franchisee, as the franchisee is more likely to be familiar with local communities and practices.

  • It requires relatively lower investment for geographical growth and expansion of the business.

  • The franchisor still has control over where and how the new franchises open.

  • The financial investment by the franchisees is a source of capital for the franchisor.

Benefits to the franchisee

  • They do not have to establish themselves in the same way a sole trader would.

  • They buy into a well-established business with a known brand name.

  • The franchisee might find it easier to borrow money from financial institutions, like banks.

  • The franchisee receives support in most areas of the business like marketing, advertising, employee training, staffing, and operations. There is less experience required.

  • They are supported by a business model that is proven to work. The franchisee does not need to come up with their own business plan or business model.

  • Less investment is needed in starting up the business, as the business already has established processes.

  • There is less risk involved than with a start-up business that has no established foundations.

  • There is a lower chance for failure, as the product or service has already proven profitable in the market.

Benefits to franchisorBenefits to Franchisee
Motivated workers.Known brand name.
Quick growth and expansion.Easier to borrow money.
Local business knowledge.Proven business model.
Lower investment.Lower chance of failure/less risk.
Control.Support of franchisor.

Disadvantages of franchising

On the other hand, franchising can also have its downsides. As with all business ventures, it is not guaranteed that your business will be successful.

Disadvantages to the franchisor

  • The possibility of certain franchisees tarnishing the reputation of the franchise. For instance, if a franchisee sets up their business - a restaurant - and it is known to be one of the worst restaurants in the area for customer service, the franchise could get a bad reputation in the local community.

  • A lot of resources are required to help the franchise set up their business.

  • The franchisee will have access to a lot of information on how the franchise works. This comes with a risk that the franchisee will disclose the information to third parties. For example, if the franchise's signature dish involves a secret recipe, the franchisee could technically disclose this information to a competitor. However, there are usually contracts in place to avoid events like this from occurring.

Disadvantages to the franchisee

  • The cost to buy a franchise. It could be very expensive to buy the rights to a franchise. Depending on the franchise, it could also be quite costly to set up (see KFC example above).

  • There are also certain restrictions when operating a franchise. The franchisee has to stick to the business plan as outlined by the franchisor, with little to no room for changes.

  • The franchisee also has to stick to a prescribed model for marketing and advertising which can be quite costly at times.

  • The franchisee has to pay a certain percentage of its revenues to the franchisor.

  • The franchisee can only operate in a specific area. If they want to expand their operations, they will most likely have to buy additional rights or pay additional fees.

Disadvantages to the franchisorDisadvantages to the franchisee
Potential problems with reputation.Costs and fees.
A lot of resource input.Restrictions.
Risk of information disclosure.Loss of a percentage of revenue.

Franchising - Key takeaways

  • Franchising is a two-party contract. The franchisor provides a set of information to the franchisee on how to run the business.
  • The franchisee buys the whole 'business package' from the franchisor in exchange for royalty payments.
  • In a franchising system, individual business owners are a tight-knit group, whose operations are directed and controlled by the franchisor.
  • Common examples of franchises are fast food restaurants like McDonald's or KFC.
  • There are many advantages and disadvantages to franchising for both the franchisor and the franchisee.
  • Advantages to the franchisor include the possibility to expand quickly with relatively low investments.
  • Advantages to the franchisee include buying into a well-established business with a known brand name, where they are being supported by a business model that is known to work.

Franchising

A franchise is an established business that sells the rights to its company name, brand and trademark to a franchisee. Franchising happens when a franchisor provides a license to the franchisee. Franchising allows the franchisee to operate their business using the same business model and brand as the franchisor. The franchisor is the business owner who sells the franchising rights to another business. Upon purchasing this right, the franchisee can operate their business under the same name and brand as the franchisor. 

A franchise is a business, which has an established owner, that sells the rights of operating the business to a franchisee. Franchising is a two-party contract. The franchisor provides a set of information to the franchisee on how to run the business. The franchisee essentially receives the whole 'business package' from the franchisor. 

International franchising is a system in which a franchisee is granted the right to replicate a successful business in a foreign market. In a franchising system, individual business owners are a tightly knit group, whose operations are directed and controlled by the franchisor. The franchisee is granted the right to use the franchisor's brand name, logo, appearance and operations in exchange for royalty payments.

Final Franchising Quiz

Question

What is a franchise?

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Answer

A franchise is a business, which has an established owner, that sells the rights of operating the business to a franchisee. Franchising is a two-party contract. The franchisor provides a set of information to the franchisee on how to run the business. The franchisee essentially receives the whole 'business package' from the franchisor.

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Question

What is a franchisor?


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Answer

A franchisor is an established business that sells the rights to its name. The franchisor also provides training and input to the franchisee on how to run the daily operations and manage the franchise. The franchisor receives royalty payments from the franchisee.

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What is a franchisee?


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Answer

The franchisee is the party that purchases the rights to the franchise. Upon purchase, they receive the right to the business name and are allowed to operate their business with the same business model as the franchisor. The franchisee is also granted the right to use the name, branding and marketing as the franchisor.

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What is a royalty payment?


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Answer

A royalty payment or royalty fee is a fee the franchisee must pay to the franchisor. This fee is usually calculated based on a percentage of the franchisee's yearly sales and profit. They must pay this fee in order to continue operating as a franchise.

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What is a franchising system?


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Answer

In a franchising system, individual business owners are a tightly knit group, whose operations are directed and controlled by the franchisor.

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Question

Which one of the following statements is true?


a. The franchisee grants a license to the franchisor, who then has the right to operate under the same business name. 

b. The franchisor must pay royalty payments every single year. 

c. The franchisor must cover all advertising costs.

d. A certain percentage of the franchisee's profits are due for payment to the franchisor.

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Answer

D.

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Question

Imagine you are about to open a McDonald's franchise. What would be one of the expectations the franchisor would have of you?

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Answer

That you provide the same experience to customers as other McDonald's restaurants.

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Question

Which one of the following statements is correct?


  1. When it comes to international expansion, franchising is the best option. 

  2. As a franchisee, you buy the right to the franchise's name and branding. 

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Answer

Only statement II. is correct.

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Question

One of the advantages of franchising is that: 

  1. The franchisor buys into a well-established business model. 

  2. The franchisee receives support in most areas of the business. 

  3. The franchisee provides training on how to run daily business operations. 

  4. The franchisor pays royalty payments every year. 

Show answer

Answer

B.

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Question

Name two benefits of franchising for the franchisor. 


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Answer

  • Possibility to expand the business rapidly.

  • The franchisor gains local business knowledge from the franchisee.

  • The financial investment made by the franchisee is a source of capital for the franchisor. 

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Question

Name two benefits of franchising for the franchisee.


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Answer

  • Buying into an already well-established business.

  • The rights to a successful business model. 

  • Less risk involved and a lower chance of failure.

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Question

One of the drawbacks of franchising is that: 

  1. The franchisor's business model is constantly changing. 

  2. The franchisor could refuse to help train staff. 

  3. The franchisee could tarnish the reputation of the franchise. 

  4. The franchisee could refuse to pay advertising costs. 

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Answer

C.

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Question

Name two drawbacks of franchising for the franchisor.

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Answer

  • The franchisee could harm the franchise's name or reputation. 

  • A lot of resources are required to help the franchise set up their business. 

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Question

Name two drawbacks of franchising for the franchisee.


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Answer

  • Can be very costly to buy the right to a franchise.
  • Loss of autonomy when it comes to running the business. 
  • The franchisee has to stick to prescribed business models and marketing strategies which can be costly. 
  • The franchisee has to pay royalty fees to the franchisor.

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Question

Franchising is a two party contract

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Answer

True 

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Question

A franchiser is the......

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Answer

Business owner

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In a franchise, profit is given to a franchisor by a ..........

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Answer

Franchisee

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What type of business is commonly franchised?

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Answer

Fast food restaurants 

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Question

Royalty payments are also known as a percentage of profit paid to franchisor 

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Answer

True 

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A franchise can only take place when another business buys franchising rights from the business owner

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Answer

True 

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Question

A franchise gives a business the right to operate using another business model, brand and recipe 

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Answer

True

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A franchisor gains the ability to grow and expand rapidly 

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Answer

True

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Question

Subway is a fast food restaurant with lots of franchise stores, from the diagram below. Do you agree that all franchises of subway will have this exact brand logo?

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Answer

Agree 

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Question

Diagram A below is a standard Burger made from a recipe curated and sold at McDonald, another business buys franchise rights of McDonalds. Is this business allowed to change the recipe for the standard burger as seen in diagram B?

a. 

b. 

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Answer

Yes

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The diagram below is a pictorial representation of what a business store and its franchise store is expected to look like?

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Answer

True

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Franchising is a low investment strategy for growth and expansion

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Answer

True

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Franchise is a source of capital to......

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Answer

Franchisee

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A franchise is a form of business

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Answer

True

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A franchise is a form of business

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Answer

True

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A franchise is a proven business model sold to buyers

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Answer

True

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An example of restriction a franchise experience is all except

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Answer

Follow business plan

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What would happen if mr A. a franchisee of KFC operating in London, decides to operate in Manchester, United Kingdom?

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Answer

Pay additional costs as the initial contract and franchise rights sold only cover one location

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Cost of buying a franchise is a disadvantage of franchises 

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Answer

True

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Question

Do you agree from the diagram below, that franchising has been explained?

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Answer

True

Show question

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