Franchise

A franchise refers to the license to produce or sell a licensed product, subject to certain conditions imposed by the owner of the product rights. A franchise can easily be learned as the ‘right’ to operate an already established business or to produce and sell already introduced products.

The owner of the business grants this right against a licensing fee.

Definition

A franchise is a license by the virtue of which, a franchisor (the owner of the license rights) grants franchisee (the acquirer of license rights) access to a business’s intellectual property, processes, proprietary knowledge, trademarks, etc.

Simply put, a franchise license grants the franchisee the right to use the intellectual property of the franchisor’s business, make products using its confidential processes and ways, and using its copyrighted names. Granting franchise rights is an easy way of spreading businesses across the world. It helps to widen the reach of products and services, establishing the brand name.

Examples:

1. McDonald’s was found in California, USA. But there is hardly a region or country where McDonalds’ local outlets are not found. Not each of these outlets belong to McDonald’s, but most of these are the franchises of McDonald’s operated by local businessmen.
   
   

Against all these rights, the franchisee pays an annual licensing fee, or any other fee as agreed between both the parties. No restaurant can call their ice-cream McFlurry, until they have obtained franchise rights from McDonalds.

2. Dominos has more than 17,100 stores around the world. More than 94% of Domino’s US stores are franchised. For these franchised stores, Domino only receives an annual franchising fee, while the rest of the business operates independently.

Against this franchising fee, the franchisees acquire the right to use the brand name “Domino’s”, Domino’s intellectual property (recipes), branding items (pizza boxes, food packaging, etc.), trademarks, and other copyrighted properties.

Franchisor and Franchisee

The two main parties involved in a franchise agreement include a franchisor and a franchisee. 

Franchisor

A franchisor can be an individual or a corporation that owns a business model, trademarks, and all copyrights of the concerned business.

A franchisor licenses the use of his business properties (business model, trademarks, copyrights, brand name, etc.) to the franchisee. He usually charges the franchisee with an upfront payment and regular royalty payments in return for these rights.

Franchisee

A franchisee is an individual or a corporation that acquires business rights from the franchisor. He owns and is responsible for his business operated under the business model, business name, trademark, and copyrights licensed by the franchise agreement. 

A franchisee is usually entitled to training and ongoing support from the franchisor. This helps the franchisor to ensure that his brand’s message is well communicated to the audience. In addition to the license fee and regular royalty payments, a franchisee is also responsible for the well-being, goodwill, and prosperity of the franchised brand within his region.

Example:

Healthy Shakes (Pvt.) Ltd. is a well-known brand with a huge clientele, multiple outlets, and franchises around the world. They deal in smoothies, shakes, and other fresh fruit juices. A local corporation is planning to establish its Smoothie shop but instead of branding from a scratch, they wish to acquire the franchise rights of Healthy Shakes (Pvt.) Ltd.

Upon submission of the business plan and feasibility report, both the parties have reached an agreement for an upfront fee of $20 million and an annual licensing fee of $5 million. 

In this example Healthy Shakes (Pvt.) Ltd. assumes the role of a franchisor as it franchises its business rights. The local corporation, whereas, acts as the franchisee as it acquires the franchising license of Healthy Shakes (Pvt.) Ltd. Against this fee, the local corporation shall be entitled to the following rights,

• Operating a smoothie shop under the brand name of ‘Healthy Shakes’.
• Using the smoothie, shake, and juice recipes of Healthy Shakes.
• Using their trademarks, and brand packaging (glass, cups, etc.)
• Materials and resources essential to start up and run the franchise, such as operation manuals, SOPs, KPIs, etc.

Basics of a Franchise Business

A franchising contract can vary from company to company. Generally, a franchising contract contains several payments that must be made by the franchisee to the franchisor. Also, some services must be provided by the franchisor to the franchisee under a franchise agreement. Here are some basic terms usually included in the franchise contract.

• A franchisee must buy the trademarks and controlled business rights by paying an upfront fee.
• A franchisor provides the franchisee with a proper operating manual, brand standards, marketing strategies, quality control procedures, and site selection support. It helps the franchisor to personally look after the outlook of his brand.
• A franchisor typically receives a fee against the provision of trainings, advisory services, equipment, and all the necessary products for the establishment of a franchise. For example, Dunkin Donuts may charge a fee for conducting initial trainings of the chefs to perfectly comply with the Dunkin Donut’s special donut recipe.
• In addition to the licensing fees, a franchisor is usually entitled to receive a specific percentage of the annual business sales or profits (ongoing royalty payments).
• In return for all these payments, a franchisee enjoys access to an already established business and a loyal customer network. Starting up a Mcdonald’s franchise is not the same as establishing a Pop Rock restaurant. McDonald’s has a huge clientele, a trusted brand repute, sufficient marketing, and many loyal customers. Paying for a franchise saves all these costs and efforts.
• A franchise agreement is always for a specified period and does not award the franchisee with permanent business rights. Typically, franchise agreements last from five to thirty years. In case of early termination of a franchising contract, both the parties may face legal consequences.
• As the franchisee owns and operates the brand of the franchisor, he can expect any kind of business help from the franchisor. Assisting the franchisee is in the interest of the franchisor as any unaddressed act of the franchisee may damage the brand repute. Such help may include business advisory, operating strategies, or financial assistance in some cases.
• In certain cases, a franchisee enjoys the right to full disclosure by the franchisor. Before signing the franchise agreement, a franchisee must have access to the earnings, business performance, and the financial status of the company. This can greatly influence the franchising decision of the franchisee.
• A franchisee is legally obliged to strictly adhere to the set brand standards, policies and procedures. Any act in violation of the standard operating procedures that affect the brand’s goodwill may lead to legal implications.

How does a franchise work?

When a business intends to increase its share value and expand its geographical approach at the same time, it can opt for selling franchise rights. Establishing a franchise helps a franchisor expand his business without having to look after several outlets, stores, and regional customers. It also helps startup businesses to reach heights in no time.

If starting a business from a scratch is not a viable option and acquiring a business isn’t affordable, the only remedy is to acquire franchising rights. Under a franchising agreement, a franchisee is allowed to sell the products or services of an established business.

A potential franchisee makes a proposal manifesting his interest, financial and marketing capability, and regional feasibility to launch a franchise. After negotiations, if the franchisor finds it viable to allow franchising rights to the franchisee, then both the parties sign a franchising agreement.

Under this agreement, the rights and responsibilities of both parties are mutually decided. It generally includes the upfront fee and annual licensing payments, the tenure of license activation and terms and conditions to operate the business, etc. Both parties may face serious penalties in case of early termination of the license rights. Also, violation of the agreed terms may lead to legal charges.

A franchisor generally supplies the equipment, necessary guidance, and trainings to the franchisee. Under a franchising license, a franchisee can make and sell exactly similar products of the franchised brand using the supplied equipment and trainings. Franchising rights may be granted to one or several businesses. In case franchising rights are granted to a single person, he may assume the role of an exclusive seller of the franchisor’s products.

Example:

Thinking of the wide-spread network of food chains like KFC, Subway, Dunkin Donuts, etc. amazes us. All the 1000s of stores under these brand names are not owned by the original business, but most of them are franchises.

KFC owns the licensing rights to its processes, distribution network, recipes, and product names. No other restaurant can call its burger as the ‘Mighty Zinger’ without copyrights from KFC. By franchising, KFC can expand its global network with fewer new investments and easy profits.

Such franchises are typically privately owned and pay their franchisors an agreed amount each year to continue operating under the established brand name. KFC franchises all around the world are obliged to adhere to the KFC brand guidelines, quality checks, and production processes. No wonder, why KFC Zingers taste the same in the USA, UK and everywhere around the world.

Pros & Cons of a Franchise

To every activity there are pros, and some cons too. While generally, the idea of franchising seems perfectly good for both the parties, there can be some problems too.

Pros:

• Franchisee enjoys an already well-established business name and model.
• A franchise includes a built-in successful business formula, products, services, designs, and an established brand name.
• Depending upon the franchise agreement, the franchisor offers full support to the franchisee to successfully adopt the brand strategy, standards and procedures. 
• Establishing and overseeing several outlets across the globe requires too much investment and effort. Dealing with so many outlets is likely to cause mismanagement which may damage the brand goodwill. Franchising not only opens opportunities for new businesses in different areas but also ensures a proper management of the business. Local businessmen are well-acquainted with the regional preferences of people and can thus lead to a better business campaign.

Cons:

• The franchisee may have to bear heavy start-up costs in addition to ongoing royalty payments.
• Also, the franchise agreement may require the franchisee to pay a certain percentage of the annual profits yielded by his business to the franchisor.
• The franchisee has lesser control over the site selection, business operations, other operational activities. He cannot introduce new creative ideas but has to stick to the brand guidelines.
• Lack of management and personal, financial, and marketing abilities of the franchisee may cause severe damage to the brand’s repute.

Conclusion

Franchising is a broad topic with several examples that can be easily found everywhere around us. Some key points to remember when referring to a ‘Franchise’ are as follows.

• A franchise is the license to operate a business and produce or sell copyrighted products under the brand name of the franchisor. It allows the franchisee with the access to the business model, processes, brand names, and all other intellectual properties.
• Against the franchising rights, a franchisee buys the trademarks (for a specified period) and pays an annual licensing fee. Common examples of franchises include the world-wide outlets of Burger King, Dominos, Subway, Baskin Robbins, etc.
• A franchisor is the license owner who grants these rights to the franchisee. Whereas, a franchisee is the person who acquires these license rights from the franchisor.
• A franchisor may grant the franchising rights of his business to one or several franchisees, around the globe. He is also responsible for supplying the franchisee with the necessary training and equipment to operate in adherence to the brand rules.
• Franchising helps a business grow around the world without the need for substantial investment and maintenance by the business owner. The franchisor, in return, earns regular licensing fees and sometimes, a share of the local franchise profits. On the other hand, it helps the franchisee to earn substantial profits under an already established brand name.

FAQs

1. What is a franchise?

A franchise is the license to operate a business and produce or sell copyrighted products under the brand name of the franchisor. It allows the franchisee access to the business model, processes, brand names, and all other intellectual properties.

2. How does a franchise work?

When a business intends to expand its operations, it can do so either by setting up a new business or acquiring an existing one. Franchising offers a third option where the business owner grants license rights to operate under his brand name and trademark to another party in exchange for a royalty payment. The franchisee gets access to all the processes, systems, and procedures of the franchisor and is usually given some training to help get started.

3. What are examples of a franchise?

Some well-known examples of franchises include the worldwide outlets of Burger King, Dominos, Subway, Baskin Robbins, etc.

4. Who can own a franchise?

Any individual or business entity can own a franchise as long as they meet the eligibility criteria set by the franchisor.

5. Is franchise an asset?

Yes, a franchise is an intangible asset that goes on the balance sheet and is recorded as a current asset.