Should you franchise your business?
By Alex Tanglao, Last updated: 2021-10-07 (originally published on 2017-12-08)
Now that you’ve stabilised business operations, what’s next? One common growth strategy among small businesses is franchising. This is an arrangement where you, the franchisor, sell the right to run the business at a designated location or market to a franchisee. While some business owners regard franchising as a method to expand to new markets, there are also many risks involved.
Here, we lay out the pros and cons of franchising to help you decide whether franchising is for you:
Benefits of franchising
1. Access capital to expand your business
As one of the most common barriers to expansion faced by small businesses is the lack of access to capital, franchising is an alternative form of capital acquisition that allows entrepreneurs to expand their business. The franchisee is the one that provides the capital required to open and operate the unit, and thereby takes on the risk of debt and the cost of equity. As the franchisor, you contribute relatively little capital into adding each location.
At the same time, you are able to minimise the risk of growth. Your risk is largely limited to the capital you invest in developing your franchise company, which is frequently a lower amount than the cost of opening an additional company-owned location.
2. Extend your reach & build your brand
The world’s top franchises – think 7-Eleven, McDonald’s and Dunkin’ Donuts – are household names with instant brand recognition. As an entrepreneur, your most valuable asset is your brand. However, when thinking about which markets or locations to expand into, there will inevitably be some markets where your returns might be marginal. You also may lack knowledge of how to make your brand appeal to a market that you are unfamiliar with.
This is exactly the kind of knowledge and expertise that your franchisee should have. Franchising thus allows you to open and operate successfully in markets that are not high on your priority list for development. By giving a franchisee the ability to represent your brand, you can strengthen your reach and brand awareness.
3. Access better & more motivated talent
A common challenge that entrepreneurs face is finding and retaining good managers. Hired managers are at the end of the day only employees who may or may not have a genuine commitment to their jobs. Your manager could leave the next day or get poached by a competitor.
When you franchise your business, your franchisee in effect becomes not only a manager but also an owner. This will ensure that your franchisee invests long-term commitment into the business. What this means is better operational quality as your franchisees take pride in maintaining the location that they own, as well as greater innovation as franchisees have a stake in the business and are constantly on the lookout for ways to improve their business.
Risks of franchising
1. Brand dilution
That’s right – one of the biggest advantages of franchising also carries one of the greatest risks. When you franchise, you are giving another entrepreneur the ability to represent the brand. Should your franchisee execute branding and marketing in a way that is inconsistent with your approach, this would give mixed signals to your customers and risk diluting, or even threatening, the strength of your brand.
It is thus important that you put in place clear guidelines for the use of all your brand assets. Ensure that your approval is sought before brand assets are used.
Related reading: 7 online marketing tips for your small business
2. Reduced control over how the business is run
As franchisees are independent businesses, you can’t dictate to your franchisees how they should run the business in the same way that you can with employees. You don’t have the same level of control over day-to-day operations and you are not responsible for hiring, training and monitoring employees. If an employee of the franchisee provides poor service to a customer, you may not have the right to fire the employee at will.
Also, as you build your network of franchisees, it can take longer to introduce a new range of products and/or services or a new marketing strategy within a franchise network than in your own chain of company-owned stores. In an arrangement where franchisors collect a percentage of sales as a royalty while franchisees make money from the outlet’s profits, an initiative that boosts sales but not profit may face resistance from franchisees. For instance, offering customers promotional coupons, which would boost sales but not profits, benefits the franchisor but not necessarily the franchisee.
3. Disagreements with your franchisee
The franchise model is one that contains inherent tensions. While franchisees are independent businesses and your franchisee can make decisions on the day-to-day operations of the business, you as the franchisor may still retain control over certain decisions relating to your brand. Given that the franchisor and franchisee each have control over certain aspects of the business, business decisions that benefit the franchisor and franchisee unequally may become contentious and cause friction between both parties.
This is why it is important to have in place a Franchise Agreement that delineates the respective rights and obligations of the franchisor and franchisee in the franchise arrangement. Under a Franchise Agreement, the franchisor’s obligations would be training and providing assistance, while those of the franchisee will be focused on the operation of the business (e.g. the use of intellectual property rights).
Have you ever franchised out your business?
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