A business franchise is the opportunity to buy into an existing brand named business. You buy the right to operate an outlet using the name of the business and the systems that it puts in place for the running of the business.
Let’s clarify a few terms we’ll be using!
What is a Franchise?
In business jargon, a Franchise means the right to operate a business using the branding and product created by another, larger, business.
What is a Franchisor?
Franchisor is the term given to the individual or business which sells a franchise – the seller of a Franchise
What is a Franchisee?
A Franchisee is the term given to the individual or business which buys a franchise – the buyer of a franchise.
Typically the main business or parent business will have already been established and proven to run profitably before it starts selling franchises. It sounds a great idea but is it really?
Should you buy into a business franchise?
The Pros & Cons of Buying a Business Franchise
- Less risk as the business model has already been proven to work
- Existing Branding that is widely known by the public
- All the business systems are already set up for you
- The benefits of technology and management used by the parent company are passed down to the franchisee
- Big advertising budget by franchisor more powerful than could be done by a single operator
- Less experience need by the buyer as training is given as part of the deal
- Cost of buying into the franchise can be very expensive
- The franchisee is usually tightly controlled by rules set by the franchisor
- The franchisee will be tied into the prices charged for product and packaging required for consistent product quality
- If the franchisor business fails you will lose your business and investment
- Extensive training may be necessary for understanding the business systems
- If you want to get out of the franchise you are still constrained as the approval of the franchisor is needed
These are the major pros and the cons of buying a business franchise which you can learn more about in the explanations below. Are you ready to learn a bit more?
Advantage 1 – Less Risk
Some people say that there is less risk in buying into a franchise business instead of starting up your own operation. The highest proportion of businesses fail in their first two years of operation. This is because the business owners may not have enough experience to navigate the minefield of all the things needed to run a business profitably. There are many pitfalls that are easy to fall into.
In the case of buying into a franchise business, there is much less risk because the business model has already been proven to work. The franchisor will also give advice and help to avoid the business failing before it has a chance to succeed.
There are many good points about buying into a proven business model rather than trying to wing it on your own, especially if you have no prior experience of running a business with all that it entails. Also, the main business is usually a household name like McDonalds or KFC and many many more. Some of the global brands are not franchised but are run by the main business itself.
However, a large proportion of global brands are run on the franchise model because it is very profitable and less risky for THEM.
Advantage 2 – Well Known Brand
Most franchise businesses are very well known household names. Their products are almost always identical wherever you buy them. This is because the product quality is very tightly controlled by the franchisor.
The buyer of the franchise is tied to getting almost everything from the franchisor so that the product quality can be consistent for the customer. This is a very important point because it brings a huge benefit to the franchisee.
The fact that the product is so consistent, brings in customers who are sure of the product they are buying and therefore are more sure of their purchase. The franchisee is therefore almost certain to get customers.
If you were to open a shop selling fried chicken for example, would you expect to sell the same quantity of product as a KFC outlet in the vicinity? I don’t think that would be likely.
Advantage 3 – The Business Systems are Already Set Up for You
When you buy a franchise, you are buying into a proven system. The franchisor has already thought through and designed the business systems, and the Chain of Production. Sourcing the component products has already been done and the supply chain secured.
The banks and lenders will be more willing to lend into a business working within a proven model the bank understands as they will have data from their other customers. This can make funding the business easier for the franchisee.
The cost of buying the specialised equipment necessary to run the business will also likely to be cheaper than if it were sourced by the franchisee because there are economies of scale available to the Franchisor because of the quantities they are buying and contracts they are able to secure for their supply. Of course, you can be sure that the Franchisor will be taking their cut of those savings.
Advantage 4 – The Benefits of Technology & Management
The large-scale operation of the franchisor enables them to put in place a more substantial management team. They will have substantial marketing departments and technology to help them gather big data on customer behaviour which will help to maximise sales and profit. This level of customer analysis is not available to a small operator and this is another major benefit for the franchisee.
The technology of the business will also have been tuned to the maximum because of the number of installations that the franchisor has put into place. If you think about KFC for instance, the machines to cook the chicken and chips are all the same in every store. The amount of oil, temperature and cooking times have all been optimised to the extreme.
This applies to every part of the business such as packaging, sauces, the product itself and so on. Some of those savings are then passed onto the franchisee which can result in cheaper prices that make competition difficult for others looking to enter the same market.
Advantage 5 – Advertising Budget
The advertising budget available to the franchisor is often quite huge. This enables high-cost advertising such as illuminated billboards, television advertising, and mobile offers and apps to promote the business.
A sole trader will be most unlikely to be able to afford that level of costs in their advertising budget. By pooling the resources from all the franchisees, they benefit from the much higher exposure of advertising, branding and customer acquisition.
Advantage 6 – Lack of Experience is not an Obstacle
In most businesses, if an investor or entrepreneur has little experience then the chance of business success is very low.
With all the systems, manuals and information available by the franchisor, and the requirement for training, there is a much lower threshold of experience required to start up the business.
The franchisee will be hand help along the way and will be provided with contacts for other franchisees to assist with any issues and problems that may be faced whilst the business is new.
This opens up an opportunity for investment and profit from being a franchisee.
Now for the Disadvantages!
Disadvantage 1 – Cost can be Very Expensive
The parent company invests a huge amount of capital in setting up and branding the business.
At its core, a business is a set of processes. There are the legal processes, marketing from testing the product idea is viable and saleable through to the advertising and customer acquisition stages. There are the processes of securing the raw materials needed for production and the supply chain and acquiring the human resources necessary to produce the product. There is the process of finding real estate and the optimum locations for stores as well as the equipment needed to produce the business. There is the modelling of the entire business system and testing of the production labour and equipment. There are other systems but these are the main ones and as you can see it is a complicated compendium of component parts.
The franchisor is in the business for profit. It, therefore, uses all the knowledge gained in setting up the business and getting it off the ground, along with all the benefits to the franchisees buying in set out above, to extract as much in the way of buy-in premium as possible. This si the initial profit to the franchised business.
That process in itself requires management. Not just anyone is accepted. The product brand name and quality have to be monitored and maintained. Therefore wannabe franchisees are vetted for suitability.
Do they appear to be financially stable? Are they responsible and diligent people? Will they likely abide by the rules of the franchise being sold? Do they fit the franchised business and add value?
I’m sure there are many other points of consideration but you get the idea, right?
So the buy-in price is usually very high and not all comers are accepted despite that high price. The price will be several multiples of setting up in business yourself, but then we are not comparing apples to apples since you could not match the market power of the franchise business with a startup.
Protecting the brand is paramount.
Disadvantage 2 – Constraining Rules on the Franchisee
We have discussed the capital bonus to the franchisor from the sale of each individual franchise. Once the business is set up the capital expended in that process is rapidly recovered through the initial sales to franchisees. So okay, you have bought into the expertise and processes already set up as a turnkey business, what now?
Sadly, for the franchisee at lease, that is not the end of the story. The franchisor will contract for all the materials and equipment used in the business to be bought from them. This will always be at a premium to cost to the Franchisor but may not be much of a premium to the cost you would pay sourcing the same product from elsewhere.
The Franchisor can still make a profit by selling at a competitive price because of the economies of scale in purchasing. Of course, cheaper alternatives might be available for purchase elsewhere but you are prohibited from those savings.
You cannot go and source the equipment or items in the supply chain from elsewhere. This ties the franchisee into paying the price set by the franchisor. It does have the benefit of maintaining the business processes though of a consistent product line and consistent method of production. This is a customer benefit that the franchisee benefits from in the way of more sales as well as a con from the point of price fixing.
Disadvantage 3 – Franchisee is Tied into Prices for Products & Raw Materials and Packaging
As explained in the previous paragraphs, the franchisee is tied to paying the prices set for the product, machinery, raw materials, point of sale recording method and packaging. All of this is supplied by the franchisor and at prices set by them.
Depending on the franchise bought, the same product may be available for purchase from an alternative source if the product is made by a third party as part of the inventory sold by the franchisor. This means that the franchisee is tied to paying above market price for the product he then has to sell at a profit.
If you think of 7-11, the franchisee has to buy the regular items for sale from the parent company even though it may be available locally in exactly the same form, at a lower price locally. If you consider KFC then the chicken pieces are part of an extensive supply chain and again may be available locally at a cheaper price.
In the case of 7-11 there really is no benefit from buying from the parent company at a higher price because the product is no different and not made by 7-11 with the exception of own brand items. There is no argument for maintaining product quality for them, you just have to like it or lump it. The shop layout expertise, mechanical installation an marketing efforts are still substantial benefits though.
For KFC though, the case can be made that the chicken sourced from other places may not be the same quality and the cuts may be different and inferior. This would affect the quality and mess up the carefully crafted systems in place for the business. That would be bad for the brand, other franchisees, and the customer because product consistency is affected.
There is a myriad of different factors at play here depending on the franchise. The buyer of a franchise needs to look at each franchise opportunity and carefully weigh what is being offered under what conditions and whether the franchisor is price gouging or providing value for the ongoing tie-in to the franchisor.
Disadvantage 4 – If the Franchisor Fails then you Lose your Investment & Business
I guess this is obvious and you may think this is a small risk.
With some franchise opportunities, the risk may be small but for others, it may be a substantially higher risk.
Maybe you will remember the issue with food poisoning which affected a number of stores of a well known fast food franchise in the USA. The franchisees were tied into the food supply chain put in place by the franchisor and had no control over where they purchased. The quality control in the supply chain was not good enough and food containing bacteria which caused the food poisoning was distributed widely.
The fall out when the issue was publicised was huge and affected franchisees not only in the area where the problem reared its head.
An interesting aside here is the issue of the defamation laws in Thailand. Had the same issue occurred in that country the brand name involved would be protected by those draconian laws. There have been several cases in the recent past where companies at fault have sued the people raising the issue for attention. That is not a good law for the benefit of society but one made for the powerful by the powerful for their own selfish interests.
Disadvantage 5 – Expensive Systems Training Required
The systems and machinery used by the franchisor and imposed on the franchisee require some skill and understanding to run.
Although a franchisee may not be experienced in the market entered, you would still need to be trained to develop the skillset to operate profitably.
This training may come at a cost or be included as part of the initial purchase price. If it comes at a price then the price may well be quite expensive for the training provided but is in any case necessary for the successful operation of the business.
In fact, this is a pro to con because the benefit of the training will be clear and necessary but the cost of that training may be a price gouge by the franchisor. Every cloud has a silver lining huh?
Disadvantage 6 – Restrictions on Who you can Sell to if you Decide the Franchise is not or you
If and when you come to sell, there is a further issue in that the franchisor has to approve any buyer you may find. You are controlled even at this point which gives a margin for shenanigans to be played by the franchisor.
I did at one stage consider buying a 7-11 franchise. My research into that went into some detail. The franchise is only sold for a set period of time and on expiration has to be purchased again. The issue with this is that the length of granting of the franchise is barely enough to be able to start making a profit after recouping your investment before you are faced with buying in all over again. Then there is the particularly distasteful fact that 7-11 run its own stores, in Thailand at least, as well as the thousands of stores it sells to franchisees up and down the country.
So if you happen to run your store very well and be lucky enough to make a success of it, then the parent company is quite within its rights to open its own stores right next door to yours. Instant competition because they know very well the outcome since you have paid for the privilege of testing the market for them. Hardly fair!
I see this everywhere, and the parent company stores always seem to be bigger and better than the poor guy who worked himself to a frazzle to prove the success of the market and then giving the benefit up to the franchisor. There should be a law against this really.
This is, of course, good business for the franchisor but really a terrible idea for its franchisees if the parent company goes into competition with its franchisees store locations directly. The parent company is doing little more than making people pay to test out market locations and then reaping the benefit for itself.
If you are considering buying a franchise opportunity then at least make sure the parent company is not in a position to compete against you with its own outlets unless some distance away. Whatever you do ensure you carry out extensive due diligence and understand the small print. Think about each clause, why that clause is in the contract, whether it is fair and even-handed and any way the parent company can neutralise what will be a significant investment in time and money for you.
The Main Pro: A ready-made turnkey business with less risk of initial failure, marketing benefits of scale and support systems for a successful outcome – depending on the ethics of the Franchisor.
The Main Con: It IS sometimes a real con where the franchisees are abused by the franchisor, more common in developing countries with insufficient legal safeguards and it is usually very expensive to buy in with little hope of any short-term ROI. It needs to be a long-term contract to be valuable to a franchisee in nearly every case.
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