The business model of franchising

Jan 11, 2012
The business model of franchising

It’s been called the best business model ever developed. And it’s at least 150 years old.

The franchise model provides a proven formula to follow for people that want to get into business for themselves. These people are called franchisees. Payment for this formula comes in the form of a one-time, up-front franchise fee.

Then, in order to keep using this formula, payments are collected from the franchisees by the franchise company (the franchisor), on a regular basis (usually monthly), in the form of royalties. The royalties that franchisees pay are usually based on a percentage of gross sales.     

A Little History

The modern franchise model can be traced back to Isaac Merritt Singer. He founded I. M. Singer & Company and patented an easily workable sewing machine. They sold for around $125, which was really expensive for the time.  

Since most people couldn’t afford to buy Singer’s amazing machines, he needed to come up with a way to make them more affordable without dropping the price. It was actually one of his partners who came up with what turned out to be a great idea: a “payment plan.” This plan required customers to pay around a $1 a day until the machines were paid in full. This pay-per-day method allowed more people to buy his sewing machines. It was actually the first-ever installment plan.

Singer also came up with a licensing arrangement. Singer and his business partners would find people who were interested in owning the rights to sell their sewing machines in specific geographical areas, and then ask them to pay an up-front license fee. This arrangement allowed the partners to use that money to build more sewing machines … which they did.

Henry Ford was another entrepreneur who needed to speed up production of his products, and he decided to approach businesspeople in cities around the country and ask them to be dealers … franchises, really. Today, there are thousands of franchised automobile dealerships all over the country, selling and servicing our cars and trucks.

Some Specifics

Here’s how a franchise is defined by the U.S. Small Business Administration:

“A franchise is a legal and commercial relationship between the owner of a trademark, service mark, trade name, or advertising symbol and an individual or group wishing to use that identification in a business. The franchise governs the method of conducting business between the two parties. Generally, a franchisee sells goods or services supplied by the franchisor or that meet the franchisor's quality standards.”

Basically, you’re buying the rights to use everything that the franchisor offers. Examples include:

  • Training
  • Operations manuals
  • Business systems
  • Recipes
  • Software
  • Marketing plans
  • Signage

The Pros and Cons of Franchising

Pros:

1. Systems. Systems are already in place for you to use every day.

2. Training. You’re provided with formal training; you’ll learn everything you need to run your business.

3. Technology. A good portion of a franchisor’s budget is used for technology. These days, small independent businesses located near you probably won’t be able to compete with the arsenal of tools you’ll have as a franchisee.

4. Marketing/Advertising. Franchisors have marketing plans in place that should give you a nice jumpstart when your franchise business launches. In addition, you’ll be provided with ongoing marketing and advertising support.

5. Support. Franchisors have dedicated support systems in place; you’ll have support from in-house personnel and possibly even field reps that visit your location to help you solve problems.

Cons:

1. You’ll pay a hefty up-front fee for the right to use the franchisor’s formula.

2. You’ll be expected to pay the franchisor a percentage of your sales, every month for the life of your contract (around 10 years on average).

3. You may have to pay a percentage of your gross sales into an advertising and marketing fund that’s been set up by the franchisor.

4. You must agree to follow the system, and all the rules that go along with it.

5. When you decide to sell your franchise, the franchisor needs to approve your buyer.



Joel Libava
Known as The "Franchise King", Joel Libava is one of the nation’s top franchise experts. His book, Become a Franchise Owner! The Start-Up Guide to Lowering Risk, Making Money, and Owning What You Do , gives prospective franchisees a road map for pursuing franchise ownership. Libava regularly provides his expertise and straightforward advice in national media interviews. The resident franchise expert at Small Business Trends, he also writes about franchising for the SBA.gov Community. As president of Franchise Selection Specialists Inc. in Cleveland, Ohio, he offers personalized franchise ownership advisory services for budding franchisees. For more information, visit www.thefranchiseking.com