Franchising Meaning Types Business Examples Advantages

Franchising Meaning

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This method enables big companies to branch out and expand while enabling individuals to run the franchise with a proven formula for success. In many cases, A franchise reaches the break-even point faster than an independent business because of the established brand name. In addition, there are different franchising relationships, like business format, product distribution, and manufacturing.

Key Takeaways

Franchising definition refers to an arrangement between a franchisor and franchisee wherein the latter acquires the rights to market and distribute the franchisor’s products or services using its business plan, brand name, and trademarks.A significant benefit of franchising is that franchisors can proliferate while controlling where and how new franchises are established. At the same time, franchisees bear a low level of risk as they work based on a successful business model. There are various types of franchising relationships. Two popular ones are product and business format.This arrangement is less risky than joint ventures.

How Does Franchising Work?

Franchising definition refers to a license or an agreement between two parties, which gives an individual or an organization (the franchisee) the right to market goods and services using the trading techniques and brand name of another organization known as the franchisor.

Technically, the contract binding the franchisor and franchisee is the ‘franchise.’ That said, it commonly refers to the business operated by the franchisee. Both parties must adhere to the agreement’s terms and conditions for a specific duration. Besides paying the initial fee to purchase the franchising rights, franchisees must pay a part of the profits to the franchisor through royalty payments.

The franchisee is responsible for managing the daily operations of the franchise. Moreover, depending on its capabilities and performance, it earns profits or incurs losses.

Characteristics

Some of the main features of franchising in business are as follows:

Two Parties: This method involves the franchisor and the franchisee. Both of them sign a written agreement.Exclusive Right: The franchisor grants the franchisee the right to use their brand name, trademarks, and techniques under specific guidelines.Assistance: The franchisor supports the franchisee in critical areas like marketing, technology, recordkeeping, staff training, etc.Policies: Franchisees must operate the business according to the policies designed by the franchisor. The former gives an undertaking not to engage in any competing business. Moreover, per the terms of the agreement between the two parties, the franchisee must not disclose any confidential information regarding the business.Limited Period: Franchisees can use the franchisor’s brand name, trademarks, and techniques for a period mentioned in the agreement, for example, seven years. Upon the expiry of the contract, both parties may agree to renew the contract.Payments: The franchisee pays an initial fee to the franchisor to acquire the license. In addition, the former pays royalty fees to the latter.

Types

The following are the most common types of franchising relationships:

#1 – Product Franchises

In the case of these agreements, the franchisee has the right to use the franchisor’s brand name, products, trademarks, etc. Manufacturers allow third-party operators to market and distribute their products via this contract. Moreover, they control the way the retailers carry out the distribution. In return, the franchisee pays the franchisor an initial fee and royalties.

#2 – Business Format Franchises

Business format franchises involve following a particular business format and the best processes and practices associated with it. The franchisor expands its operations by providing its well-established business concept or format. It guides the franchisee on how to launch and operate the business.

#3 – Manufacturing Franchise

In this arrangement, the franchisor gives the franchisee (a manufacturer) the right to produce goods under its trademark and brand name. This type of agreement is common among food and beverage companies.

Examples of Franchising

Let us look at a few franchising business examples to understand the concept better.

Example #1

Franchising is expected in the case of fast-food restaurants. Individuals can observe that the appearance of restaurants such as Papa John’s, KFC, McDonald’s, and Burger King in different places is almost the same. Since these restaurants are all franchises, their owners use a similar design for menus, exteriors, interiors, and branding. However, the cost incurred to own and operate the franchises vary.

Example #2

Soft drink bottlers often acquire a license from soft drink companies to produce, bottle, and distribute soft drinks. The franchisor provides the franchisee with the concentrate; the latter distributes it to the regional production franchises after processing and packing.

Advantages & Disadvantages

Before acquiring franchise rights, individuals or organizations must be aware of the benefits and limitations of franchising in business.

Advantages

This system expands franchisors’ network, thus increasing their goodwill.This method allows franchisors to get valuable feedback regarding customer choices, requirements, and product popularity.Franchisors can expand their distribution chain quickly.Franchisees do not have to promote a product that much as they sell products under a well-established brand name.The risk for franchisees is low as they sell products under a well-established brand name.The franchisee’s financial investment is a source of capital for the franchisor.Franchisors can acquire local business knowledge from franchisees as the latter is usually more familiar with the local practices and communities.

Another vital benefit of franchising is that franchisees operate on a business model with a proven formula for success.

Disadvantages

There’s a possibility that individual franchisees may tarnish the franchisor’s reputation through poor customer service or substandard product quality.Franchisors require a lot of resources to help franchisees set up their business.Franchisees gain access to a lot of information regarding the franchisor. As a result, there’s a risk that the latter may disclose some confidential details to a competitor. That said, the contract between the parties prohibits franchisees from doing so.Franchisors impose various restrictions on franchisees; the latter must stick to the business plan.Typically, one requires a substantial amount to acquire the rights to a franchise, especially if the brand is trendy.Franchisees must stick to a fixed marketing and advertising model; there’s little room for changes.

Another noteworthy disadvantage of franchising in business is that a franchisee can operate only in a particular area. If it wishes to expand its operations, it has to purchase additional rights.

Franchising vs Joint Venture

Let us look at the critical differences between franchising and joint venture.

Meaning: Franchising involves an arrangement wherein a party signs an agreement with an organization to sell goods and services under its brand name and trademarks. In contrast, a joint venture involves an agreement between two parties to collaborate for mutual profit, typically by introducing a new service or product in the market.Self-Determination: Joint venture Partners have a higher level of self-determination than third-party operators owning a franchise. The former identifies market demand for a new good or service. Then they combine the established organization’s stability with the novel offering of an organization new to the location. That said, franchisees sell the product and services of a franchisor using the latter’s brand name and techniques.Risk: Franchising is less risky than joint ventures as the former does not involve introducing a new concept.