What is Franchising?

What is Franchising?

Franchising is an arrangement where one party (the franchisor) grants certain rights and privileges to the other party, i.e., franchisee. These rights usually include franchisor’s proprietary knowledge, processes and trademarks. Franchisee is authorized to sell the products, goods and services offered by the franchisor. In exchange, the franchisee pays an annual licence fee to the franchisor. It may also have to share certain part of its revenue with the franchisor. This arrangement is usually done through a contractual agreement between both parties, known as Franchising Agreement. Common examples of franchising are outlets of fast food chains like KFC, McDonalds, Burger King, Taco Bell and many more.   

There are different types of franchise models for entrepreneurs to choose from, but FOFO and FOCO models have been the most prevalent models. The models are as follows:

  • FOFO: Franchise Owned Franchise operated
  • FOCO: Franchise Owned Company Operated
  • FICO: Franchise Invested Company Operated
  • COFO: Company Owned Franchise Operated

To learn more about these topics, please review our article on franchising models.

Benefits of Franchising-

For Franchisee-

  • Risk of failure is very less as the market for that product already exists and the business model for selling is already well proven and established in the market.
  • Franchisee get benefitted from established brand name, trademark and design.
  • Franchisee doesn’t have to worry about skills and expertise of employees as the training is provided by the franchisors themselves. Franchisors also provide technical assistance, if required.
  • Market research and advertising are also usually done by the franchisor, so franchisee won’t doesn’t have to expend their resources on marketing of the product. The existence of a market of the product/service has been established by the franchisor.
  • Entering into franchising agreement with a big company often ensures easy access to capital as these companies have tie-ups with banks and other financial institutions.
  • Since most of the supplies will be done by franchisors or by suppliers recognized by franchisor, purchasing efficiency will be higher for franchisee.
  • Franchisee often gets exclusive right to sell that product in that geographical area, which is a huge advantage.
  • Franchisor company provides assistance in every step of running of business as their interests are also connected to it.

For Franchisor-

  • Franchising arrangement is useful for the companies who are facing the problem of lack of capital because in most cases, investment is made by the franchisee. Therefore, the franchisor is able to expand his business without applying more capital.
  • Franchisee arrangement is of great advantage to companies who want to quickly expand their business and outperform the competitors in terms of business growth.
  • Franchisor receives annual fee and share in profits from the franchisee which is of great advantage to companies with low capital.
  • Investment Franchising agreement reduces the risk for franchisor also as plenty of responsibilities are shared by franchisee also such as hiring of employees, buying inventories, managing of operations etc.
  • Franchisor is able to supervise the activities of franchisee without having to be worried about day to day affairs.
  • Franchisee are likely to be efficient and better performing because then own stakes are involved in the business.
  • Hiring and managing part of the staff is usually the responsibility of franchisee therefore franchisor company won’t have to worry about keeping large staff and their business could be more cost effective.

What are the Possible Disadvantages of Franchising?

For Franchisee-

  • Initial cost of buying the franchise can be quite high, especially for the more reputed and well-established companies.
  • Franchisee will have to share part of its profits with the company.
  • Franchisee is not independent in operations and decision making. It will have to abide by the rules agreed upon in the franchising agreement.
  • Business and profitability will also depend on the overall reputation and quality of the parent brand. In some cases, the franchisor may go out of the business as well.
  • Selling the franchisee to anyone will be subject to approval by franchisor.

For Franchisor-

  • Franchisor has less control over the affairs.
  • Franchisee don’t have incentive to advertise on their own. They may rely on advertising by company or by other franchisee.
  • Franchisors will have to spend on training of the staff hired by franchisee.
  • An inefficient franchisee may adversely affect the reputation of the brand.

Things to remember before entering into Franchising Agreement-

Anyone willing to enter into franchising agreement should keep following things in mind-

  • Whether the franchising agreement is negotiable or not? Most brands use a standard form of franchising contract which are non-negotiable in nature.
  • Whether exclusive right is being given to the franchisee within a certain geographical area? How large is the area of exclusive operation within which other franchisee couldn’t open their stores?
  • How much license fee is to be paid and whether it is permitted to pay it in installments?
  • For how long will the franchising agreement remain valid?
  • Specific permissions regarding use of trademarks, designs and other intellectual property of the Franchisor company.
  • Whether any guarantee is required for franchisee?
  • Procedure of renewal of franchising agreement and what are the conditions on which franchise could be terminated.
  • Specific obligations and liabilities of the parties.
  • Operational and Quality standard to be adopted.
  • What technical assistance and training will be provided by the franchisor company?
  • What contribution will the franchisor have to make to the advertising and marketing expenditure, if any.
  • What will be the mechanism of resolving disputes?

It is prudent that both parties fully understand the nature of their commitments as per the franchise agreement before execution of the same and make relevant financing arrangements before entering into such a commitment.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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