A franchise is a form of independent undertaking based on an agreement or license between a franchisor and a franchisee.
It usually consists in the lawful use of a trademark, brand name or business model by a third party (the franchisee). The franchisee has to pay a financial counterpart to the owner of the trademark or business model (the franchisor).
As a general rule, the franchisee pays a fee between 2 % and 10 % of his turnover in return for assistance from the franchisor which can take several forms:
- distribution network;
- structural support.
The franchisee is hence not left on his own as he is granted the right to benefit from the franchisor's experience and proven operational model.
He will also benefit from the brand's reputation and the franchisee's fame.
An independent undertaking in the form of a franchise can be particularly interesting for persons who:
- do not wish to start up a conventional independent undertaking;
- do not have the financial means to start up an independent undertaking on their own;
- wish to benefit from the know-how, image and experience of an established partner.
As a large well established company, the franchisor usually:
- offers the use of his know-how, his suppliers and/or his brand to the franchisee;
- supports the franchisee when setting up his business;
- provides advice to the franchisee with regard to business management.
The assistance provided can be limited to the start up phase of the collaboration or take the form of continued advisory services or training for the franchisee.
The franchising agreement is usually concluded for a period between 3 and 7 years, but it generally includes the possibility of a renewal.
The franchisee will usually be granted "territorial exlusivity" within a given geographical area where no other franchisee can operate as a competitor.
In exchange, the franchisee has to pay for the support received. The payment can take the form of:
- a flat fee;
- or a percentage on the turnover of the franchise.
Depending on the details of the franchising agreement, the franchisor can decide how the franchisee should run his business, which providers to use and even how to fit out the commercial premises. The franchisee may even have to adapt specific stages in the operational process according to the instructions from the franchisor.
These strict conditions serve the purpose of guaranteeing the quality but also maximising profits.
Forms of franchising
In the case of a production franchise, the franchisor offers his expertise concerning the production of a certain good. The franchise is usually based on the use of a patent or the transfer of a licence required to produce certain goods protected by intellectual property rights. This means that the franchisee himself is manufacturing and selling goods under the franchisor's trademark and according to his instructions.
A distribution franchise is based on the distribution of products in the name of the franchisor. This type of franchise is often seen in the cosmetics industry or the retail trade. The franchisor is responsible for the production of the goods whereas the franchisee is responsible for their sale.
The services franchise is the best known form of franchise. This type of franchising agreement is often used by fast food chains or ready-to-wear clothing companies. The franchisee uses a business model which has been developed by the franchisor in the services industry and obeys certain strict rules.
Details of the agreement
A franchising agreement must include the following information:
- the type of product or the name of the services concerned;
- how the required expertise is to be provided;
- the rights and obligations of the franchisee;
- the rights and obligations of the franchisor;
- the franchising fee and other costs;
- the brand name and company name;
- the duration of the contract;
- the start up fee of the franchise (entry fee);
- an estimate of the prices used in the event of a short-term promotional sale;
The franchisee can not dictate a minimum sales price. He can indicate a recommended sales price.
- the area of the territorial exclusivity;
- the provisions in terms of renewal or cancellation.
Advantages and disadvantages
Advantages for the franchisee
The franchisee can:
- benefit from the name of the franchisor and does not have to create his own brand;
- benefit from costly and large scale promotional events organised by the franchisor and does not have to invest in marketing;
- access bank loans more easily as banks usually consider that a franchise has less entrepreneurial risks.
Disadvantages for the franchisee
- is required to make concessions with regard to the management of his business because he must comply with the requirements of the franchise concerning the production, presentation or preparation of the products;
- has to deduct the franchising fee (royalties, percentage on the turnover) from his profits;
- only has a limited choice of suppliers as he is bound by the agreement with the franchisor ;
- could suffer from a deterioration of the image of the brand through no fault of his own.
Advantages for the franchisor
- benefits from the development and increase in the awareness of his brand with no investments needed;
- achieves a stronger negotiation position with his suppliers due to increased sales which in return allow him to receive better volume discounts without needing to increase his annual turnover as an independent undertaking;
- benefits from reduced liability with regard to sound business management as the franchise does not operate under the control of the franchisor.
Disadvantages for the franchisor
- will only be paid a fee by the franchisee as the latter has the status of a self-employed worker and is not an employee of the franchisor;
- might suffer from a deterioration of his brand image due to the actions of the franchisees;
- has to face an increase in his operating costs as he must implement costly control mechanisms (quality control systems, control of sales, enforcement of branding rules and respect of the brand name).
Costs for the franchisee
The franchisee must cover all expenses related to:
- the fees for the use of the brand name;
- investment costs (e.g. for business premises);
Following the provisions of the agreement, the franchisor directly or indirectly contributes to these expenses by giving the franchisee the opportunity to obtain a bank loan with favorable interest rates.
- all other expenses in accordance with the provisions in the franchising agreement.
Costs for the franchisor
Most of the time, the franchisor has to meet administrative expenses, namely with regard to the implementation of monitoring systems which are necessary for the protection of his brand name.
A franchise represents a certain loss of earnings for the franchisor as he gives up earnings he would have had if he had managed his business on his own.
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