Franchising

The essentials

Franchising is an arrangement in which one party, the franchisor, grants another party, the franchisee, the right to sell its products or services, or to run a business under its brand name and system, in return for fees. The franchisee invests in and runs the outlet but must follow the franchisor's standards.

Payments usually include an initial franchise fee and a continuing royalty, often a percentage of sales.

Types of franchising:

• Product or trade-name franchising: the franchisee sells the franchisor's products and uses its name, for example an authorised dealer of a vehicle brand.
• Business-format franchising: the franchisee receives a complete business system, including brand, layout, recipes or methods, training, and marketing support, for example fast-food outlets.
• Manufacturing franchising: the franchisee is allowed to produce goods using the franchisor's formula or technology, such as a soft-drink bottler.

Key points

Advantages for the franchisor: rapid expansion with less of its own capital, income from fees and royalties, motivated local owners. Limitations for the franchisor: less direct control, risk to brand reputation if a franchisee performs poorly, sharing of profits. Advantages for the franchisee: an established brand and tested system, training and support, lower risk of failure than a totally new business. Limitations for the franchisee: fees and royalties reduce profit, little freedom to change products or methods, dependence on the franchisor's decisions.

Exam tips

• Remember who gives (franchisor) and who receives (franchisee) the rights.
• Royalty is a continuing payment; the franchise fee is usually paid at the start.

Common mistakes

• Thinking the franchisor runs the outlet. The franchisee owns and operates it.
• Treating franchising as a merger; both firms remain separate businesses.