Franchise v Company
Updated: Jul 7, 2020
Which Business Model Wins
This blog aims to summaries the key advantages and disadvantages of growing a business with a Franchise model. To help explain this I will make some simple comparisons between Franchising and Company ownership models.
As there is such variety in business, the points noted here may not be relevant for some businesses. Think of this article like a "quick list" of pros and cons. It's not a substitute for detailed research related to your actual business and industry.
Advantages of Franchising
Sustainable Growth Structure
There are many Australian businesses who have proven the Franchise structure works for growth. Generally speaking Franchise models require that the legal structure, operations and procedures manuals are established upfront, so the business can be successfully replicated. The preparation specifically addresses replication and sustainable growth.
Attract the Financial Resources of Others
Becoming a Franchise means business owners (Franchisors) can generally raise expansion capital without having to approach banks, sell shares or dip into their own equity. Franchisors invite new Franchisees to contribute their own capital to join the Franchise.
Lower Risk in Growth
When setting up a new Franchisee's site/shop/vehicle, the Franchisor doesn’t generally have to commit their own cash to more stock, leases, vehicles and employees. These expenses would normally be associated with setting up a new company site or service unit however in Franchising, the new Franchisee usually pays for all of these expenses themselves.
Takes Some Weight Off
With Franchising, the Franchisor may become less "top heavy" because the responsibility for local business management usually falls with the local Franchisee. Business functions such as sales, operations, administration, customer service and finance all require more human resources and investment. Franchisees often take a significant load off the Franchisor.
Return On Investment
A Franchisors income is largely derived through royalties and/or ongoing fees, usually calculated as a % of all Franchisees gross sales. This income structure may give a better return on investment when compared with a Company model, and especially over a longer term.
Consider the lesser amount of effort and money the Franchisor may have had to contribute to starting each new Franchise site/unit. When starting a new company site/unit, all the expenses for set up would be incurred by the company. The return may be slower and lower than a Franchise.
A basic equation for calculating % ROI is: (net profit/total royalties) divided by (total investment) x 100.
Skin In The Game
Franchisees pay to receive ownership therefore they have something to loose. Business owners are generally more motivated and dedicated than employees and in theory, they are less likely to throw in the towel if the going gets tough. Most Franchisees envisage a capital return when they decide to exit. Usually through selling their Franchise for a higher price that what they payed.
Better Talent and New Skills
Some of the most motivated, skilled and talented people are those who take reward through business ownership. Franchise ownership will hopefully attract awesome people that will dedicate their strengths to the success of the Franchise.
Recruiting Franchisees who are local to the area gives you some good local knowledge and consumer insight in that particular market. Furthermore, the Franchisees will likely already have contacts and social networks in their area. Because new Franchisees have invested their own money, they are more likely to rally support for their new Franchise business within their local networks. Their networks will usually want to support them in their new venture.
Power of Combined Marketing
Many Franchise systems charge Franchisees a Marketing Levy. As the Franchise group grows so will the Marketing fund. Subsequently the group may benefit from marketing activity that individual companies or individual Franchisees may otherwise be unable to afford themselves. The Franchise industry also hosts events, expos, awards and media which can generate significant brand exposure.
Once systems and procedures are established, tried and tested. Franchising can allow for more rapid expansion as Franchisees can be trained in groups and multiple sites/units, can be set up at the same time. Company models can do this also provided they have the cash to pay for multiple set ups. In Franchising it's the individual Franchisees who pay.
Increased Capital Value
A Franchisors revenue is often based on a percentage of the Franchisees gross (not net) profits. Also this revenue is contractual over terms of 5 years, 10 years or even more. These contracts are valuable assets for the Franchisor. Sustaining business income in this fashion with multiple contracts can significantly increase the capital value of the franchisors business when compared to say a company model that relies on operating profits.
Others To Celebrate With
Leading a growing team can be very rewarding. You will develop lasting business relationships and friendships. This is true for companies too however with Franchising, you get to celebrate successes both with your employed staff, and your many Franchisees. Franchisees are likely to be equally as stoked as you are because they invested themselves and their capital.
Disadvantages of Franchising
Set Up Costs
Setting up business as a Franchise structure can be expensive. Some of the costs include: legal costs such as Franchise Agreements, trademarks, patents, IP, disclaimers, indemnities and confidentiality agreements. No wonder lawyers love Franchising. Add to this operations and procedures manuals, wages, consulting and advisory, sales & marketing, advertising and recruitment. It sure ads up.
Regulation and Scrutiny
Franchising has come under some scrutiny and the Franchising Code of Conduct has been significantly tightened up. This means more regulation and some more reporting especially with regard to marketing funds and disclosure. It is expected the tightening will continue. Some of this reporting is not required for companies.
Less Control Over Personnel
You can’t easily sack a Franchisee or employees of a Franchisee for that matter. Don't misconstrue this. Employees have rights under fair work legislation. The point is Franchisees are independent business owners. Whilst there are areas of compliance, and reasons for termination, you don’t have the same ability to tell them what to do.
In comparison with a company model, you employ managers and staff who are required to do what you tell them. If they don't perform you can terminate them. You can only terminating a Franchisee if there are serious contract breaches and processes must be followed properly. It's not as simple in Franchising.
Recruiting is Tough
It is not as easy as it may seem to recruit good franchisees. Consider you are recruiting business investors not job applicants. The field of suitable candidates is far more narrow especially for new "Greenfield" Franchises which have greater perceived risk.
Conversion rates are often low and lead generation can be expensive. This can be disheartening and a test of your commitment and patience. You can attempt to counter this if you have the cash. Consider opening company owned sites/units where there is demand and look to find investors once the units are fully operational and profitable.
If the Franchisor is rewarded through royalties on gross sales, and the Franchisees are rewarded through net profit, this can create conflicting objectives. Franchisors may favour activity that increases gross sales but not necessarily net profit. Activity such as promotions and discounts may not appeal so much to Franchisees as they increase sales, but not profit. This increases royalty at no apparent benefit to the Franchisee.
Slow to Adapt and Innovate
New ideas and innovations can be difficult to implement as they usually have to be negotiated with Franchisees to get their buy in first. This can also mean Franchises are slower to adapt to competitors and sudden changes in the market. Company's can usually make swift decisive changes when they please.
More Legal Issues
Franchisors may have more contracts to manage than a company model. As a Franchise grows, you increase your likelihood of having more legal matters to deal with and, the general headaches and sleepless nights that can come with them. Most common of these being if Franchisees underperform, or get behind in their fees.
Franchising has gotten some bad publicity and some people simply don’t like Franchises. This can dampen your enthusiasm and also, your team moral. You may have to grow a thick skin and accept the fact that some good opportunities may slip through because of this negative stigma.
Not So Private
Franchising has laws that require disclosure and this includes some personal information about Franchisors and key management. Furthermore the Franchising sector has developed into somewhat of a community with events and media publications, all focusing on the businesses and people in Franchising. Whilst this can equate to good exposure, it can also be a little problematic for Franchisors who did not expect or desire any limelight, critique and scrutiny. As the name implies, private companies are a little more private.
Everyone Is Doing It
When you have a minute, Google the keywords “Business Opportunity” or “How to Franchise.” Your browser will be flooded with a multitude of Franchise opportunities and sales pitches. It all sounds so positive and inspiring. You may wonder why isn’t everyone doing it. These days it feels like everyone is doing it. New Franchises a popping up left right and centre. This increases the competition for business buyers and subsequently puts added pressure on your Franchise recruitment efforts.
With modest success in Franchising comes the temptation for Franchisors to set very ambitious targets with regards to the number of outlets/units to be sold. This can lead to over saturation and in the worst cases, local Franchisees essentially competing amongst themselves. Another symptom of over saturation is where Franchisees claim they need more than one franchised unit to make the business model viable.
Multiple Business Relationships
Some franchisors are simply not good with people. A good leader will usually be naturally well suited to managing people. Think of the multiple business relationships that inevitably come with Franchising. Some Franchisors take a do it yourself approach and are either unaware, unwilling or can not afford to employ and empower people who are good relationship managers. If this is the case, there will be trouble in their business relationships.
And the winner is........ The model you choose.
This is not a cop out. The fact is both models can work for mosts business if it's done correctly. If you carefully consider your options, weigh up the pros and cons, run some budget forecasts, draw up a business plan, do some market research and pilot testing, seek professional advice, debate and deliberate. You have a very good chance at making the best choice for you.
It can be more complex and expensive to change an existing Franchise model into a company model therefore it may be wise, if you can afford it, to start with a company model and in good time, create additional outlets/units which remain in your complete control.
This should give you good insight into your market and the challenges of running multiple sites. You can always Franchise these sites later if you choose to go down that path..
Get in touch
If you need some help or guidance in planning and implementing growth strategy in your business please get in touch. http://www.raddadconsulting.com/contact