What Is Franchising?
Franchising is a business strategy where an established business, known as the franchisor, grants an individual or group, the franchisee, the right to operate a business using the franchisor's proven business model, brand name, and intellectual property. This arrangement falls under the broader category of Business Strategy and Expansion. In exchange for these rights, the franchisee typically pays an initial franchise fee and ongoing royalty payments to the franchisor. Franchising allows for rapid market penetration and leverages the capital and entrepreneurial drive of independent business owners, while offering franchisees a structured framework and established brand recognition. This model provides a systematic approach to growth, enabling a company to expand its presence without directly investing its own capital in every new location.
History and Origin
The origins of franchising can be traced back centuries, with early forms involving exclusive rights granted for trade or resource extraction. However, the modern concept of business format franchising, as it is largely understood today, began to take shape in the mid-19th century in the United States. One of the earliest documented examples of a franchise-like agreement in America is attributed to Benjamin Franklin in 1731 for a printing business partnership.24
A pivotal moment occurred in 1851 when the Singer sewing machine company developed a franchise system to market and repair its machines due to a lack of capital and an emerging market for sewing technology.22, 23 This model allowed Singer to expand its reach significantly. In the early 20th century, companies like Ford franchised dealerships, and oil companies similarly franchised gas stations.21 The post-World War II era saw an explosion in franchising, particularly with the rise of fast-food chains and service-based businesses in the 1950s and 1960s, a period marked by significant suburbanization and increased automobile travel.19, 20 As the industry grew, so did the need for regulation, leading to the Federal Trade Commission (FTC) adopting the FTC Franchise Rule in 1978, which became effective in 1979.18
Key Takeaways
- Franchising involves a franchisor granting a franchisee the right to operate a business using an established brand and system.
- Franchisees typically pay initial fees and ongoing royalties for the use of the brand and support.
- The model allows franchisors to expand quickly with less direct capital investment.
- Franchisees benefit from a proven business model, brand recognition, and operational support.
- The FTC Franchise Rule provides regulatory oversight, requiring franchisors to disclose crucial information to prospective franchisees.
Interpreting Franchising
Understanding franchising involves recognizing the symbiotic, yet distinct, relationship between the franchisor and franchisee. For the franchisor, it represents a scalable growth mechanism, transforming their business model into a repeatable, revenue-generating system. The value for the franchisor is in expanding brand footprint, increasing market share, and generating recurring revenue through fees and royalties without incurring the full operational costs and liabilities of owning every outlet.
For the franchisee, interpreting franchising means entering a business venture with a pre-existing blueprint. This often includes access to proprietary systems, training, marketing strategies, and established supply chains. The interpretation of success for a franchisee hinges on their ability to adhere to the franchisor's standards while effectively managing their individual unit for profitability. They operate as independent business owners, albeit within strict operational guidelines set by the franchisor.
Hypothetical Example
Consider a hypothetical fast-casual restaurant chain, "Green Bowls," known for its healthy, customizable salads. Green Bowls, the franchisor, decides to expand through franchising. An aspiring entrepreneur, Sarah, is interested in owning her own business but wants the security of a proven concept.
Sarah researches Green Bowls and decides to become a franchisee. She pays an initial franchise fee of $50,000 to Green Bowls. In return, she receives a comprehensive operations manual, training for herself and her staff, assistance with site selection and store layout, and access to Green Bowls' proprietary supply chain and recipes. Green Bowls also provides her with marketing materials and a license to use their well-known brand name and logo.
Sarah then invests her own capital to build out her restaurant location, purchase equipment, and hire employees. Once open, she pays a weekly royalty fee equal to 6% of her gross sales to Green Bowls. In addition, she contributes 2% of her gross sales to a national advertising fund managed by the franchisor. By following the established Green Bowls system, Sarah benefits from immediate brand recognition and a tested menu, allowing her to focus on local operations and customer service. This structured approach helps Sarah mitigate some of the risks associated with starting an independent new business.
Practical Applications
Franchising is widely applied across various sectors of the economy, proving its versatility as a growth strategy.
- Retail and Food Service: Perhaps the most visible application, franchising dominates the fast-food industry (e.g., McDonald's, Subway) and extends into retail (e.g., convenience stores, auto repair services). These systems leverage strong brand recognition and standardized operations.
- Service Industries: Franchises are prevalent in personal and business services, including fitness centers, cleaning services, real estate agencies, and educational programs. The repeatable service delivery model lends itself well to franchising.
- Healthcare: Certain segments of the healthcare industry, such as urgent care clinics or home healthcare services, also utilize the franchise model to expand reach and provide standardized care.
- Financing: For prospective franchisees, Small Business Administration (SBA) loans are a significant practical application. The SBA does not directly lend money but guarantees loans made by approved lenders, making it easier for small businesses, including many franchises, to obtain financing. To be eligible for an SBA loan, a franchise must often be listed in the SBA Franchise Directory.16, 17 This directory ensures the franchise agreement meets SBA standards, providing a layer of due diligence for lenders and borrowers.
Limitations and Criticisms
While franchising offers numerous advantages, it also comes with notable limitations and criticisms for both franchisors and franchisees. For franchisees, a primary drawback is the lack of independence. Franchisees operate under strict rules and guidelines set by the franchisor, limiting their ability to innovate, adapt to local market conditions, or make independent decisions regarding product offerings, pricing, or marketing.14, 15 This can lead to frustration if decisions made at the corporate level negatively impact a specific franchise unit. The ongoing management service fees and requirements to purchase products from the franchisor can also lead to higher overall costs than an independent small business.12, 13
For franchisors, a significant risk is the potential loss of control over brand consistency and reputation if a franchisee fails to uphold standards or engages in problematic practices.11 Recruiting suitable franchisees can also be a slow and resource-intensive process. Concerns have also been raised regarding franchise failure rates. While the International Franchise Association (IFA) has historically reported high survival rates for franchises, independent research, such as a 1995 study by Dr. Timothy Bates, found that franchise failure rates could exceed 30% and that franchises often yielded lower profits than independent businesses.10 Furthermore, some studies suggest that franchisor communication processes focusing solely on adherence to standards can lead to higher franchisee failure rates, highlighting the importance of a supportive relationship.9 The perceived lower risk of franchising compared to independent startups has been a subject of debate, with some research indicating that failure rates between the two business forms are more similar than often portrayed.7, 8
Franchising vs. Licensing
Franchising and licensing are both business arrangements involving the use of intellectual property, but they differ significantly in scope and control.
| Feature | Franchising | Licensing |
|---|---|---|
| Relationship | Ongoing, comprehensive, and highly regulated. | Generally simpler, transactional, and less regulated. |
| Business Model | Provides a complete business system, including operations, marketing, and training. | Grants rights to use specific intellectual property (e.g., trademark, patent, copyright). |
| Control | Franchisor exerts significant control over franchisee's operations to ensure consistency. | Licensor typically has less control over how the licensee operates their business. |
| Fees & Payments | Involves initial franchise fees, ongoing royalties, and often advertising contributions. | Usually involves a one-time fee or ongoing royalty payments based on sales of licensed products. |
| Support & Training | Extensive training, operational support, and ongoing guidance provided by the franchisor. | Support and training are usually limited to the specifics of using the licensed intellectual property. |
| Regulatory Oversight | Heavily regulated (e.g., FTC Franchise Rule in the U.S.) to protect prospective franchisees. | Less extensive regulatory oversight compared to franchising. |
The key distinction lies in the depth of the relationship and the extent of operational control. Franchising offers a complete, integrated business system, whereas licensing typically provides access to a specific piece of intellectual property without dictating the entire business operation.
FAQs
What is the primary difference between a franchisor and a franchisee?
The franchisor is the original business owner who grants the rights to use their brand and business system. The franchisee is the individual or entity that purchases these rights and operates a unit of the franchised business.
What are the typical costs associated with buying a franchise?
The costs typically include an initial franchise fee, which is a one-time payment for the right to use the system, and ongoing royalty fees, usually a percentage of gross sales, paid to the franchisor. There may also be advertising fund contributions and initial setup costs for the business unit.6
Is franchising a safer investment than starting an independent business?
Franchising can reduce some risks by offering a proven business model and established brand. However, it's not without its own risks, including significant upfront costs, ongoing fees, and a lack of operational independence. Research on business failure rates suggests that the perceived safety of franchising compared to independent startups may not always hold true.4, 5
What is the Franchise Disclosure Document (FDD)?
The Franchise Disclosure Document (FDD) is a legal document that franchisors are required to provide to prospective franchisees in the United States, typically at least 14 days before signing any agreement or taking payment. It contains 23 items of information about the franchisor, the franchise system, and the contractual obligations, enabling the prospective franchisee to make an informed investment decision.2, 3
Can a franchisee sell their franchise unit?
Generally, yes, a franchisee can sell their unit. However, the sale is typically subject to the franchisor's approval, and the new prospective franchisee must often meet the franchisor's criteria and undergo their training. This ensures continuity and adherence to the brand's standards.1