What Is Franchising?
A franchise business is a business in which the owner(s), or "franchisor", sell the rights to use their business logo, name, and model to third party retail outlets, owned by independent, third party operators, called "franchisees". Specifically, the franchisor "sublicenses" the use of the trademark along with propriertary techniques often referred to as their business system. The licensee of these is referred to as the franchisee. The franchisee through the franchise agreement agrees to pay an initial franchise fee and ongoing fees referred to as royalties for the right under the franchise agreement to do business using the franchisor's trademark, and proprietary operating system.
A report from Price Waterhouse Coopers found that franchised businesses are responsible for:
$2.3 trillion in total economic output
11.4% of the U.S. private sector economy
1/3 of all retail sales in the United States
15% of all private sector jobs
Based on information provided by the International Franchise Association (IFA) at www.franchise.org, (6-15) the estimated economic impact of franchising to our economy includes;
781,991 operating franchised establishments
Estimated employment in franchised businesses of 8.8 million people
Economic output of $890 Billion
Economic output represents 3% of total US Gross Domestic Product (GDP)
Additionally, it has been previously estimated that franchising represents over 300 different business lines.
Do you have a proven track record of growth and profitability?
People buy franchises to learn from those who are successful. Growth and profitability are the standards that franchisees buy into. As a matter of fact, the first question a franchisee prospect usually asks is, “How much can I make?” If you’re not profitable, why would someone else want to buy your franchise? Depending on your situation, it may make sense to continue focusing on increasing your profitability before franchising.
Does your business have broad consumer appeal?
Not every business has the same appeal everywhere. Have you determined the market for your business and are these markets available for growth outside of your area? If your business is geared toward your local college campus, will it have the same appeal at other campuses? If you are providing a business service, do businesses in other regions have the same needs? Not every franchise needs to grow nationally to be successful, but they do need to have at least a regional appeal or a specific market appeal. Is your market segment large enough for your business to flourish on a regional or national scale?
Is It Easy To Replicate Or Duplicate?
Is your business repeatable? A key to successful franchising is having a proven system in place and being able to teach others this system. Through hard-work you and considerable expense, you have created something successful, but to take the next step in franchising you must be able to teach it to others. Is your operation complex? Does it require a large number of employees to manage day-to-day? Are there special skills or licenses required? Answering these questions will help you determine whether you have the ability to duplicate your operation, which is critical to the success of future franchisees.
What is the role of the Franchisor?
It is important to understand that not every business should be franchised. It is equally important that, when you decide to become a franchisor, you do so in a way that maximizes the unique character of your business. Successful franchisors are rarely the product of a packaged approach, as each element of your franchise system should be developed in a way that supports your franchisees so that they can deliver consistently to your Brand Promise.
What is a Franchise Fee?
The franchise fee (also called the “initial franchise fee”) is the payment made by a franchisee to the franchisor for joining the franchise system. While the definition of a franchise may differ at the state level, under the Federal Trade Commission (“the FTC Rule”), which defines franchising throughout the United States, a business relationship qualifies as a franchise if three criteria are met:
The franchisor licenses its trademarks, service marks, trade name, logo, or other proprietary marks to the franchisee.
The franchisor has “significant operating control” or “significant operating assistance” over the franchisee’s business.
The franchisee makes a payment to the franchisor of at least $500 (annually adjusted) either before or within six months of opening the business.
What is a Royalty Fee?
A royalty fee is an ongoing fee that the franchisee pays to the franchisor. This fee is usually paid monthly or quarterly, and is typically calculated as a percentage of gross sales. These payments are collected by the franchisor to fund the franchisor entity’s actions, which include both corporate and franchise-related expenses. The ongoing royalty payments are how the franchisor makes its money, which it uses to support its franchisees and further build the business. Additionally, all the administrative costs of running the franchisor’s headquarters and staff are funded from the royalty payments. Lastly, the franchisor’s efforts to further expand and develop the brand through recruiting and bringing in new franchisees to the system is in part funded by royalties.
How are Royalty Fees Calculated?
There are a number of ways that franchisors establish what their ongoing royalty fee will be. The most common is a percentage of the Gross Sales that the franchisee earns. Typically this ranges from between five and nine percent. So, essentially, the franchisee is taking in 91-95% of their gross sales with the rest going to the franchisor. Gross Sales is the amount of revenues from the sale of services, goods, and any other products or merchandise by the franchisee, and is not reduced by any discounts given to employees or family members, taxes, or returns, credits, allowances and adjustments.
Successful franchisors will take great care in determining what their required royalty payments will be, whereas some franchisors will just use whatever their competitors are requiring, or just pick a number with little to no basis for it. Ideally, the franchisor will set the royalty amount at a level that will allow the franchisee to take home a healthy enough profit, after all expenses, such that the business will be able to succeed both initially and ongoing.
Different industries and revenue models lead those industries to specific strategies for setting royalty amounts. There is no one way that is required, so franchisors can get as creative as they’d like.
What attributes do successful franchisors share some common?
They are motivated to share their experience and know-how with their franchisees.
They are committed to their franchisees' success.
They provide their franchisees with the tools needed to operate their businesses to brand standards.
They are focused on ensuring that each franchisee operates to system standards.
Great franchisors have all made their share of mistakes, and have survived them. It is their hands-on knowledge of the business they are franchising that is of the greatest value to franchisees. Franchisees benefit from the franchisor's proven experience, which hopefully allows franchisees to avoid some of the minefields that plague many start-up businesses.
Great franchisors provide initial training to new franchisees and their management, and also provide support in the training of members of the franchisee's staff. Great franchise systems provide their franchisees with a library of systems manuals, field consulting, consumer marketing and other support, and provide each franchisee with the tools needed to operate their businesses to system standards.
Franchise Your Business
The Stanwood Group, LLC provides the services to establish and organize a franchise system as well as ongoing representation for day-to-day needs. Please contact us for a free consultation at (610) 660-7773 and ask about whether franchising is an appropriate vehicle for expanding your business. For over 20 years the firm's management have gained substantial expertise in helping companies with strong unit economics and good concepts to use franchising as a means of exploiting market opportunities. We have worked with over 150 franchisors in the retail and service businesses sector, and have considerable expertise in identifying those business model structures that have potential to scale through franchising. We will help you analyze whether franchising is the appropriate growth strategy for you and your business.