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Franchising - What is franchising?

Definition: franchising occurs when the owner of a business (the franchisor) grants a license to another person or business (the franchisee) to use their business idea - often in a specific geographical area.

A parent company (franchisor) allows entrepreneurs (franchisees) to use their company's business model, brand, strategies and trademarks and in return the franchisee pays an initial fee and continuing royalties based on their revenue.

The parent company also provides the franchisee with support, including advertising and training, as part of the franchising agreement.

The franchising model therefore provides benefits to both the franchisor and the franchisee.

Benefits for the franchisor

Creating franchises can be a good alternative to building 'chain stores'. Franchises allow a company to distribute their goods in many locations while at the same time avoid large investments and liability over their chain stores.

Franchising provides company's with a faster, cheaper form of expansion, because it costs the parent company far less when new branches are owned and operated by a third party.

There are two payments initially made to a franchisor:

  • A royalty fee for the use of the trade-mark
  • Compensation for training and any other services given to the franchisee

Though franchising has many benefits for franchisors, the potential for revenue growth is more limited because the parent company will only earn a percentage of the earnings from each new store.

Benefits for the franchisee

Franchising offers franchisees the advantage of starting up a company quickly based on a proven trademark, and is provided with the tools and infrastructure to succeed as opposed to having to develop them.

The franchisee has a greater incentive than a direct employee of the franchisor because they hold a direct stake in the business.

Types of franchises

There are product franchises – e.g. Chanel and other cosmetics – but most commonly frachises are created for service firms - e.g. restaurants, convenience stores, etc. Some of the most famous chains include McDonalds, 7-Eleven, and Subway, among others.

Businesses for which franchising works best have the following characteristics:

  • Businesses with a good track record of profitability
  • Businesses which are easily duplicated