A franchise is a type of license that grants a franchisee access to a franchisor’s proprietary business knowledge, processes, and trademarks, thus allowing the franchisee to sell a product or service under the franchisor’s business name. In exchange for acquiring a franchise, the franchisee usually pays the franchisor an initial start-up fee and annual licensing fees.
The franchise business is gaining popularity these days in India. Entrepreneurs choose to own a franchise rather than start a business from scratch. A franchise business or franchising means an already established business grants a license to another business owner to operate with its name and use its expertise for a fee.
Thus, franchising is a process where an established entity grants a license to another entity to use its name, trademark and expertise to run the business. The entity that grants the business license to another entity is known as the franchisor. The entity that buys the business license of the franchisor is known as the franchisee.
Concept of Franchise
A franchise is a business where an individual or an entity known as the franchisee owns a business under the trademark, brand, and business model owned by another entity known as the franchisor. In simple terms, a franchisee runs a business by using the existing brand name and business model of a franchisor for a specific period.
Thus, both franchisee and franchisor have a legal and commercial relationship with each other. In a franchise business, the franchisee uses the trademark and brand name of a franchisor and sells the franchisor’s products or services. A franchisee pays the franchise fee and signs an agreement with the franchisor. A franchisee may also open a new branch of the franchisor business after all the legal formalities are complete.
The relationship between franchisor and franchisee is significant as it forms the base of a franchise business. The franchisor permits the franchisee to use his/her business name, trademark, services, techniques, methods, etc., for an agreed fee. Thus, it helps the franchisor to expand the name and brand to a larger group of people and the franchisee to run a business at a low cost.
For example: A person ‘X’ willing to open a clothes business can approach ‘Raymond’ company and obtain a franchise from them. Raymond will be the franchisor that will provide X with the business plan, trademark, clothes, and necessary documents to start the business and also advertise to get customers to the store. In return, X is supposed to give them an initial amount of profit as a fee. X can earn profits by selling clothes of the ‘Raymond’ brand and operating a clothes business at a low cost.
Examples of Franchise Businesses in India: Subway, McDonalds, KFC, Pizza Hut, Hard Rock Cafe, Domino’s Pizza, etc.
Types Of The Franchise Business
Product franchises
The product franchises are where the manufacturers use the franchise contract to decide how the franchisee will distribute the products. The franchisees distribute the franchisor’s products. The franchisors only provide their brand name to the franchisee. The franchisee will pay a certain amount to the franchisor as mentioned in the agreement.
Manufacturing franchises
In manufacturing franchises, the franchisees are allowed to legally make the products and market them using the trademark and name of the franchisor company. The franchisee will provide a franchise fee and also a certain amount for the units sold to the franchisor.
Business franchise ventures
Business franchise ventures mean the franchisee buys and sells the products from the franchisor. The franchisors provide franchisees with a client base which they need to maintain for future trade.
Business format franchise
In the business format franchise, the franchisor provides the necessary training and helps establish the business. The franchisor also provides the raw materials frequently and gets a royalty fee from the franchisee. In this franchise, the franchise business gets a proper business model made by the franchisor.
Investment franchise
Usually, franchisees invest money in the franchise business and hire their own staff in the investment franchise. The franchisors may also help the franchisees with investment and obtaining benefits.
Job franchise business
The franchisee can run a franchise business from home in a job franchise business. One person usually handles these types of franchises, ensuring the purchasing and selling of the product.
Advantages and Disadvantages of Franchises
Advantages
There are many advantages to investing in a franchise, and also drawbacks. Widely recognized benefits include a ready-made business formula to follow. A franchise comes with market-tested products and services, and in many cases established brand recognition.
If you’re a McDonald’s franchisee, decisions about what products to sell, how to layout your store, or even how to design your employee uniforms have already been made. Some franchisors offer training and financial planning, or lists of approved suppliers. But while franchises come with a formula and track record, success is never guaranteed.
Disadvantages
Disadvantages include heavy start-up costs as well as ongoing royalty costs. To take the McDonald’s example further, the estimated total amount of money it costs to start a McDonald’s franchise ranges from $1.3 million to $2.3 million, on top of needing liquid capital of $500,000.6
By definition, franchises have ongoing fees that must be paid to the franchisor in the form of a percentage of sales or revenue. This percentage can range between 4.6% and 12.5%, depending on the industry.2
For uprising brands, there are those who publicize inaccurate information and boast about ratings, rankings, and awards that are not required to be proven. So, franchisees might pay high dollar amounts for no or low franchise value.
Franchisees also lack control over territory or creativity with their business. Financing from the franchisor or elsewhere may be difficult to come by. Other factors that impact all businesses, such as poor location or management, are also possibilities.
Ready-made business formula
Market-tested products and services
Established brand recognition
Large decisions already made
List of approved suppliers
Training and financial planning provided
Success not guaranteed
Large start-up costs
Ongoing fees
Lack of territory choice
Lack of creative control
Franchise Models in India
FOCO – Franchise Owned Company Operated
The franchisee invests in the property and other additional capital expenditures in a FOCO business model. The franchisor takes care of the operations and running costs. The franchisor gives the franchisee a fixed percentage or share of the return.
FOFO – Franchise Owned Franchise Operated
In FOFO, the franchisee owns and operates the franchise business according to the franchisor’s directions. The franchisor decides the prices and merchandise for the outlet. They provide the brand name for a franchise fee for a pre-agreed period. The franchisee bears the operational costs and should pay some percentage of revenue (royalty) to the franchisor.
COFO – Company Owned, Franchise operated
In the COFO model, the franchisor invests in the franchise business, but the franchisee operates it according to the franchisor’s directions. However, this franchise business model is rare and not common in the industry because most companies (franchisors) investing in expanding their business operations prefer to run it on their own.
COCO – Company Owned and Company Operated
In COCO, the franchisor owns and operates the business. The franchisee does not have anything to do with franchising. As a result, the franchise is funded entirely by the franchisor, and its employees run the franchise.
Franchisor-Franchisee Relationship
A franchisor and franchisee should have a solid relationship in a franchise business to ensure the brand’s success. Initially, the franchisor will help the franchisee by providing the marketing, training and product development. As the relationship grows, the franchisor will give enough support to develop the franchisee’s business.
The franchisor-franchisee relationship benefits both of them. The franchisee runs the business while getting the benefits of support from the franchisor. The franchisor gets a new branch and expands its business to a new area and location. It allows franchisors to benefit without investing in the business expansion at a new location. The franchising business also helps the customers since they get a famous brand’s services and products in their local area.
The franchisor is the parent business allowing the franchisees to operate using its products or services, techniques, trademarks, etc., in return for an agreed-upon fee. A franchisor generally has many franchisees, while a franchisee can have only one franchisor. The franchise agreement governs the franchisor and franchisee relationship.
Franchise Agreement
The franchise agreement is a legal written document between the franchisor and franchisee. The franchise agreement is the basis of the franchisor-franchisee relationship. Both the franchisor and franchisee must sign this agreement. The following are the significant aspects covered in a franchise agreement:
- Details of the franchisor and franchisee
- Franchisee appointment and license grant
- Franchisee location
- Development and maintenance of the franchisee location
- Proprietary marks or trademarks which the franchisee can use
- Permissions or licenses the franchisee should obtain or can use from the franchisor
- Operation and quality standards
- Assistance and training from the franchisor
- Consideration (specific amount) to grant the franchisee
- Franchise license fee
- Marketing assistance from the franchisor, if any
- Services or products that the franchisee can offer
- Franchisee obligations
- Franchisor responsibilities
- Terms and tenure of the franchise agreement
- Renewal of the franchise agreement
- Termination of the franchise agreement
FAQs
What Are the Advantages of Franchises?
Some of the widely recognized advantages of franchises include a ready-made business formula to follow, market-tested products and services, and, in many cases, established brand recognition. For example, if you’re a McDonald’s franchisee, decisions about what products to sell, how to layout your store, or even how to design your employee uniforms have already been made. Some franchisors offer training and financial planning, or lists of approved suppliers; however, despite these benefits, success is never guaranteed.
How Does the Franchisor Make Money?
Typically, a franchise agreement includes three categories of payment to the franchisor. First, the franchisee must purchase the controlled rights, or trademark, from the franchisor in the form of an upfront fee. Second, the franchisor often receives payment for providing training, equipment, or business advisory services. Finally, the franchisor receives ongoing royalties or a percentage of the operation’s sales.
