Franchising is a special way of structuring a business relationship. For those who find the idea of owning their own business intriguing, but prefer a model to follow, a franchise may be just the ticket. One of the main attractions of a franchise is that it’s really a blueprint — a blueprint for a business.
The word “blueprint” has several dictionary definitions. Under one definition, a blueprint is something “serving as a model or providing guidance.” Another definition of blueprint is “a detailed plan or program of action.”
Both of those definitions do a decent job of conveying, at a high level, how a franchise works. When you purchase a franchise, the blueprint for that business is laid out with all the specifications. You just have to follow the plans.
Read this article to answer the question, how does a franchise work?
The Franchise Business Model
The franchise business model has been called the greatest ever. Today in the 21st century it’s more popular than ever.
What is the franchise business model? For starters, it involves two main parties: the franchisor and franchisee.
- Franchisor: This is the brand or company that creates the original business and then develops the blueprint. The franchisor grants to third parties the right to carry on a business outlet under the brand’s name and trademark, according to an identified system, usually within a specific territory or at a specific location, for an agreed-upon period of time.
- Franchisee: This is the person looking to buy a franchise outlet. Here’s an easy way to remember the difference in terminology: “franchisee” rhymes with “me.” So remember this rhyming phrase: “the franchisee is me.”
As a franchisee, when you buy into a franchise opportunity:
(1) You get to draw upon all the work the franchise has done before you to test, refine and perfect the business concept.
(2) You get to lean on the mother-ship’s brand, buying power, proven franchise systems, advice, training, technology and national marketing.
Those are huge advantages!
According to the International Franchise Association and FranData, there are over 750,000 franchise industry establishments in the United States, employing over 8.5 million employees. There are over 3,000 franchisors to choose from. For more background, see: What is a Franchise?
Fundamentals of How a Franchise Works
There are 5 fundamental aspects to how a franchise works:
- Governed by Federal and state laws
- Long term contract
- Rules to follow
- Independent business owner
- Scalable model
Let’s examine these five fundamentals and some of the franchise terminology you need to know.
1. Governed by Federal and State Laws
The U.S. Code of Regulations, 16 CFR Parts 436 and 437, contains a broad legal framework for the rights and responsibilities of the parties in franchises. The Federal Trade Commission is the agency charged with enforcement and has created the FTC Franchise Rule .
The Rule requires every franchisor to provide every prospective franchisee with a Franchise Disclosure Document or FDD at least 14 days before offering or selling a franchise (unless an exemption exists). The Franchise Disclosure Document contains 23 required types of information including any parent or affiliate companies of the franchisor; existing litigation; fees the franchisee pays; and financial performance requirements.
The FDD is a very important part of the franchisee’s due diligence when buying a franchise. The disclosures also become part of the legal relationship between the parties.
There are also state laws governing franchises.
2. Long Term Contract
While the FTC Franchise Rule and any state laws provide a broad legal framework, many specific rights and obligations between the franchisee and franchisor are based on contract.
Both parties will sign a franchise agreement. The typical length is 10 years to 20 years.
A long-term franchise agreement is as much a protection for the franchisee as for the franchisor. As a franchisee, you will be investing a lot of money and time. You are not going to want to risk losing your franchise fee and investment.
The contract provides many details of franchise ownership, including your territory, the franchisor’s obligations to provide ongoing help and support, and the franchise fee you are required to pay. The franchise agreement also will state any renewal rights as well as any conditions under which the agreement can be terminated.
You will be locked into a long-term contract so it is essential you do thorough due diligence when evaluating franchise opportunities. You have only to read a discussion forum like UnhappyFranchisee to understand some of the pitfalls.
Not everyone who complains is right, of course. For every complainer, there may be a very happy — but silent — franchisee. But keep in mind, there are well-run franchises, and terribly run ones. Laws and disclosure don’t take the place of your own investigation.
3. Rules to Follow
A fundamental part of franchises involves following the rules. The franchise system is highly structured. Franchises have strict operating procedures and standards. The franchisor will provide a business operations manual to follow.
The way a franchise works is that you don’t get to pick and choose. You must do things the way the franchisor specifies whether you agree or not. If you are someone who chafes at being told what to do, franchises will not be right for you.
In some areas there is room to be creative, such as how you staff your business, and advertising in your local neighborhood. But when it comes to the choice of products and services to offer, or pricing or special promotions, you may have no say at all. Colors, signage, even the point of sale system you use — the franchisor may make all those decisions.
From time to time franchisees make headlines when they revolt against the rules — but with mixed results. A few years ago some McDonald’s franchisees were very unhappy with a special low cost menu, as reported by CNBC:
“Franchisees also complained about McDonald’s new value menu. They said the $1 $2 $3 Dollar menu, which launched this month, will drive sales in the first part of the year, but they fear it will drive checks lower, diminish their ability to control menu prices and raise their food costs. *** Several operators said the company has created a policy of ‘say yes or leave’ when it comes to adopting these new protocols.”
How would you feel if put in the position of being required to offer a product at prices you didn’t agree with, like McDonald’s franchisees? Yet it happens everyday.
Read more in: Pros and Cons of Franchising.
4. Independent Business Owner
A franchise is not a replacement for being a savvy small business owner. Rather, think of the franchise as making your job easier. Buying a franchise means buying yourself a head start in business.
In business there are no guarantees. Just because your business is based on a franchise, doesn’t mean you have a 100% chance of success. No franchisor would ever make such a claim. If they did, run the other way!
But franchise ownership removes some of the uncertainties of building a business.
Make no mistake. At the end of the day a franchisee is still a small business owner. As a franchisee business owner it’s up to you to:
- Put in the time and energy to run your operation.
- Recruit, hire and train a great team.
- Have the confidence to take calculated risks.
- Hit your sales numbers to grow the top line.
- Keep your expenses in check, for a profitable bottom line.
- Overcome obstacles and problems.
- Make sure your business delights customers.
- Pay your taxes and comply with regulations and licenses.
- Articulate the vision and be an inspiring leader.
A great small business owner does all of this. Every. Single. Day.
But, as a franchisee you get to operate your business without the energy-sucking and money-sucking work of starting from scratch. You avoid a lot of trial and error. As a franchisee, you avoid:
- All the painstaking work to create goods, products and services.
- The years and expense to build trademarks, logos and brand recognition.
- The effort finding, evaluating, choosing and implementing technology and systems.
- Hours of time developing standard operating procedures and methods.
As a franchisee, you are in business for yourself — yet you are not alone.
5. Scalable Model
When we think of franchises, most of us think of a single unit franchise. We picture ourselves owning and operating a sandwich shop, restaurant, retail outlet or other franchised business with a single location.
One of the beauties of the franchise business model, however, is its scalability. You can grow. And adding additional outlets is one of the main ways to grow a franchisee business.
Owning multiple units of a franchise is the path that many wealthy franchise business owners have taken.
Prospective franchisees who are growth-oriented will keep the future in mind from the start. Chances are you will want more than one individual franchise outlet — after you get your arms around running your first unit.
When you buy a franchise, look for franchise opportunities that are not saturated in the market. Find one that offers the potential for you to acquire multiple franchise locations, i.e., multi-unit franchises.
There’s also something called a master franchise. In a master franchise one buys the rights to an entire area, and it’s usually based on population. One example of this is Jan-Pro Cleaning Systems.
As a Master Franchisee you have the right and obligation to sell multiple franchise units in your designated territory. When you are a Master Franchisee, you bring on other sub-franchisees under you. In effect you become the regional franchisor for an entire region.
Area Development Contract
A related concept is the area development contract. In an area development contract, you acquire the rights to develop multiple locations in a geographic area, although you typically do not have sub-franchisees. An example of an area development contract is Buffalo Wild Wings. At one point it required each new franchisee to commit to opening at least two franchise units and develop an area.
A Master Franchise and an Area Development contract will be more expensive to acquire than a single unit franchise, because of the greater area you have rights over. You will need more financial backing and a higher net worth to qualify. (Calculate your net worth.)
Compared with a single-unit franchise, there’s more complexity. If you have sub-franchisees you are required to support them just like a franchisor.
You have greater obligations, too. The franchisor is not going to simply give you protected rights over a territory without also requiring the obligation to develop units in that territory on an agreed-upon schedule. If you do not open up franchise locations on schedule, you will be in breach of contract.
Most of us are not equipped to jump into a multi-unit, master franchise or area development contract as our first foray into franchise ownership. We should take it slow and learn to walk — before trying to run.
In summary, becoming a franchisee can be very rewarding. It’s a big step but you must choose wisely and understand generally what’s involved for success.