Q: I'm developing a new business proposal, and mentors have recommended that I use a franchising model. What factors should I consider?
A: In a franchise system, the owner/creator of the franchise (franchiser) offers outside parties (franchisees) the opportunity to purchase unit(s) of the franchise and to use the franchise methods and brand name. The franchiser may also provide training and other assistance to the franchisee.
Most franchisers also charge an initial franchise fee, which covers training and support from the franchiser to open the unit. Fees vary greatly, reflecting the value of the franchise brand and level of support offered to the franchisee.
Franchising offers the franchiser several advantages over operating their own corporate system. First, franchisees are responsible for building their own unit(s) using their own operating capital. That frees the franchiser from raising capital required to build and run multiple units or retail outlets. Since franchisees have an ownership stake in the business, their return is based on how well they manage their unit's costs and revenue.
The franchising model also has drawbacks. The franchiser loses some control of the business. While the franchise agreement specifies the rules and processes franchisees must follow, they may have their own ideas about running the business. Those different ideas about how something should be done can cause conflict in the relationship between the franchiser and franchisee.
Another potential problem: Ensuring compliance with a franchise contract can be expensive and difficult for the franchiser. Furthermore, it is not possible to write a contract that anticipates every situation and contingency, so gray areas may still exist in the rights and responsibilities of both parties. Finally, if market conditions change, and the franchiser wants to revise the contract, the franchisee may refuse to change the terms of the current contract, which may run 10 years or more.
A key decision franchisers must make is how to monetize their franchise units — whether in the form of a royalty or other fee. The most common method charges franchisees a percentage of revenue. Charging a flat royalty rate is less common.
Mark Spriggs is an associate professor with the Schulze School of Entrepreneurship at the University of St. Thomas.