Why is franchising important in retail?

Click here to get more.

What Is a Franchise?

A franchise is a type of license that grants a franchisee access to a franchisor's proprietary business knowledge, processes, and trademarks, thus allowing the franchisee to sell a product or service under the franchisor's business name. In exchange for acquiring a franchise, the franchisee usually pays the franchisor an initial start-up fee and annual licensing fees.

Key Takeaways

• A franchise is a business whereby the owner licenses its operations&#;along with its products, branding, and knowledge&#;in exchange for a franchise fee.
• The franchisor is the business that grants licenses to franchisees.
• The Franchise Rule requires franchisors to disclose key operating information to prospective franchisees.

• Ongoing royalties paid to franchisors vary by industry and can range between 4.6% and 12.5%.

Understanding Franchises

When a business wants to increase its market share or geographical reach at a low cost, it may franchise its product and brand name. A franchise is a joint venture between a franchisor and a franchisee. The franchisor is the original business. It sells the right to use its name and idea. The franchisee buys this right to sell the franchisor's goods or services under an existing business model and trademark.

Franchises are an effective way for entrepreneurs to start a business, especially when entering a highly competitive industry such as fast food, or an industry that is established and requires time to develop its operating processes from scratch. One big advantage to purchasing a franchise is you have access to an established company's brand name, management knowledge, processes and procedures, financial toolbox, and metrics. You won't need to spend time and resources building them and getting your name and product out to customers.

The franchise business model has a storied history in the United States. The concept dates to the mid-19th century when two companies&#;the McCormick Harvesting Machine Company and the I.M. Singer Company&#;developed organizational, marketing, and distribution systems recognized as the forerunners to franchising. These novel business structures were developed in response to high-volume production and allowed McCormick and Singer to sell their reapers and sewing machines to an expanding domestic market.

Before buying into a franchise, investors should carefully read the Franchise Disclosure Document, which franchisors are required to provide. This document contains information about franchise fees, expenses, performance expectations, and other key operating details.

The earliest food and hospitality franchises were developed in the s and s. A&W Root Beer launched franchise operations in . Howard Johnson Restaurants opened its first outlet in , expanding rapidly and paving the way for the restaurant chains and franchises that define the American fast-food industry until this day.

There were 790,492 franchise establishments in that supported the U.S. economy, with an expected 805,436 for . These franchises contributed over $500 billion to the economy. In the food sector, franchises included recognizable brands such as McDonald's, Taco Bell, Dairy Queen, Denny's, Jimmy John's, and Dunkin'. Other popular franchises include Hampton by Hilton and Days Inn, as well as 7-Eleven and Anytime Fitness.

Franchise Basics and Regulations

Franchise contracts are complex and vary for each franchisor. Typically, a franchise agreement includes three categories of payment to the franchisor. First, the franchisee must purchase the controlled rights, or trademark, from the franchisor in the form of an upfront fee. Second, the franchisor often receives payment for providing training, equipment, or business advisory services. Finally, the franchisor receives ongoing royalties or a percentage of the operation's sales.

A franchise contract is temporary, akin to a lease or rental of a business. It does not signify business ownership by the franchisee. Depending on the contract, franchise agreements typically last between five and 30 years, with serious penalties if a franchisee violates or prematurely terminates the contract.

In the U.S., franchises are regulated at the state level; however, the Federal Trade Commission (FTC) established one federal regulation in . The Franchise Rule is a legal disclosure a franchisor must give to prospective buyers. The franchisor must fully disclose any risks, benefits, or limits to a franchise investment.

This information covers fees and expenses, litigation history, approved business vendors or suppliers, estimated financial performance expectations, and other key details. This disclosure requirement was previously known as the Uniform Franchise Offering Circular before it was renamed the Franchise Disclosure Document in .

Advantages and Disadvantages of Franchises

Advantages

There are many advantages to investing in a franchise, and also drawbacks. Widely recognized benefits include a ready-made business formula to follow. A franchise comes with market-tested products and services, and in many cases established brand recognition.

If you're a McDonald's franchisee, decisions about what products to sell, how to layout your store, or even how to design your employee uniforms have already been made. Some franchisors offer training and financial planning, or lists of approved suppliers. But while franchises come with a formula and track record, success is never guaranteed.

Disadvantages

Disadvantages include heavy start-up costs as well as ongoing royalty costs. To take the McDonald&#;s example further, the estimated total amount of money it costs to start a McDonald&#;s franchise ranges from $1.3 million to $2.3 million, on top of needing liquid capital of $500,000.

By definition, franchises have ongoing fees that must be paid to the franchisor in the form of a percentage of sales or revenue. This percentage can range between 4.6% and 12.5%, depending on the industry.

For uprising brands, there are those who publicize inaccurate information and boast about ratings, rankings, and awards that are not required to be proven. So, franchisees might pay high dollar amounts for no or low franchise value.

Franchisees also lack control over territory or creativity with their business. Financing from the franchisor or elsewhere may be difficult to come by. Other factors that impact all businesses, such as poor location or management, are also possibilities.

Pros

• Ready-made business formula

• Market-tested products and services

• Established brand recognition

  THE MIDI. supply professional and honest service.

• Large decisions already made

• List of approved suppliers

• Training and financial planning provided

Cons

• Success not guaranteed

• Large start-up costs

• Ongoing fees

• Lack of territory choice

• Lack of creative control

Franchise vs. Startup

If you don't want to run a business based on someone else's idea, you can start your own. But starting your own company is risky, though it offers rewards both monetary and personal. When you start your own business, you're on your own. Much is unknown. "Will my product sell?", "Will customers like what I have to offer?", "Will I make enough money to survive?"

The failure rate for new businesses is high. Two-thirds of businesses survive just two years, and 50% survive just five years. If your business is going to beat the odds, you alone can make that happen.

To turn your dream into reality, expect to work long and hard hours with no support or expert training. If you venture out solo with little or no experience, the deck is stacked against you. If this sounds like too big a burden, the franchise route may be a wiser choice.

People typically purchase a franchise because they see other franchisees' success stories. Franchises offer careful entrepreneurs a stable, tested model for running a successful business. On the other hand, for entrepreneurs with a big idea and a solid understanding of how to run a business, launching your own startup presents an opportunity for personal and financial freedom. Deciding which model is right for you is a choice only you can make.

What Are the Advantages of Franchises?

Some of the widely recognized advantages of franchises include a ready-made business formula to follow, market-tested products and services, and, in many cases, established brand recognition. For example, if you're a McDonald's franchisee, decisions about what products to sell, how to layout your store, or even how to design your employee uniforms have already been made. Some franchisors offer training and financial planning, or lists of approved suppliers; however, despite these benefits, success is never guaranteed.

What Are the Risks of Franchises?

Disadvantages include heavy start-up costs as well as ongoing royalty costs. By definition, franchises have ongoing fees that must be paid to the franchisor in the form of a percentage of sales or revenue. This percentage can range between 4.6% and 12.5%, depending on the industry.

There is also the risk of a franchisee being duped by inaccurate information and paying high dollar amounts for no or low franchise value. Franchisees also lack control over territory or creativity with their business. Financing from the franchisor or elsewhere may be difficult to come by and franchisees could be adversely affected by poor location or management.

How Does the Franchisor Make Money?

Typically, a franchise agreement includes three categories of payment to the franchisor. First, the franchisee must purchase the controlled rights, or trademark, from the franchisor in the form of an upfront fee. Second, the franchisor often receives payment for providing training, equipment, or business advisory services. Finally, the franchisor receives ongoing royalties or a percentage of the operation's sales.

The Bottom Line

A franchise can be a great way for an individual to enter the world of entrepreneurship, as the majority of the groundwork has already been laid and you are leveraging off an established, successful, and well-known business and brand name. There are also many businesses with franchises to choose from.

For a fee and start-up costs, you can be on your way to being your own boss and entering a possibly lucrative career. Though it must be noted that success is not guaranteed and franchises require a lot of work to be profitable.

Franchising a retail business allows you to see greater success faster than starting from scratch.

The benefits of franchising a retail business are tenfold. When franchising with an established well-known brand, you get a loyal customer base, brand recognition and much more. Below are the top five benefits of franchising a retail business. 

No Industry Experience Needed

One of the greatest benefits of franchising a retail business is that little to no industry experience is necessary to get started. Many retail franchisors have built-in models with a step-by-step process to follow when starting their business, making getting started almost foolproof. 

&#;Franchising provides a consistent and well-thought-out business structure in a box, which greatly reduces the risk of failure,&#; said Doug Payne, serial franchise owner and founder of OHM Fitness. &#;Franchisees can leverage the ready-made processes and the support of the franchisor to operate their businesses successfully.&#;

Franchisor Support

In addition to built-in models, many retail franchisors offer support for franchisees. Some retail franchisors have networks where franchisees can talk to each other and can reach out if they run into problems unlike starting an individual business from scratch. 

&#;The biggest benefit is that the brand has a proven track record of success, and provides me with training and support to set my location up for success, while still allowing me to have flexibility and freedom,&#; said Courtney Florence franchisee of The Birthday Suit waxing spa. &#;The Birthday Suit's retail product line component is an easy upsell that supports the longevity and success of our services while allowing us another revenue stream to profit off of.&#;

Scalability Opportunities 

When starting a retail business, you have a greater opportunity to scale your business sooner than you do when starting your own business. Retail franchises allow you to start earning a profit faster because you already have an established customer base, making it easier to scale your business. You may also be able to secure financing for your franchise, allowing you to pay off your loan faster and reduce the amount of your own investment funds.

&#;Franchising creates brand awareness at a scale that is difficult to achieve as a stand-alone mom-and-pop business,&#; added Payne. &#;As more and more franchise locations open, the brand value increases.&#;

Low Failure Risk 

Since franchisees are getting a step-by-step, startup guide and an established customer base, the risk of failure is much lower. Franchisors are also there to provide you with support and assistance, which makes it more difficult for you to fail. Many franchisors offer marketing assistance and ready-made marketing kits, which takes the guesswork out of how to market your business. Some franchises also provide franchisees with data from their previous stores so you get a background of what works and what doesn&#;t, and allows you to better help your business succeed. 

Brand Recognition 

When opening a popular retail store, you get automatic brand recognition. This reduces the amount of marketing you have to do because everyone already knows the business. When opening your store, you have to come up with a name that sticks in people&#;s minds and also explain what your business is and what it sells. 

For more information, please visit retail franchise opportunities.