If you want to start a business, maybe
you’ve heard of the term “franchising” bandied around, but aren’t really sure
what it means or how it works.
Don’t worry. In this tutorial, I’ll define a franchise business for you, explaining how franchises work and giving examples of famous franchises that you’re probably already familiar with.
Then I’ll take you through the process of starting and running a franchise. If you want more detail at any stage, you can refer to my comprehensive series on Buying and Running a Successful Franchise. But if you just want a quick introduction so that you can get clear on what a franchise is and how it works, this tutorial is for you.
1. What Is a Franchise Business?
Let’s start with a basic definition of a franchise. According to the Oxford English Dictionary, a franchise is:
An authorization granted to an individual or group to trade in a particular area for a stated period, usually in return for royalties, a share of the profits, etc.
Let’s explore what that means through an example. In fact, we’re going to look at two famous fast-food businesses that operate in very different ways: McDonald’s and Chipotle Mexican Grill.
Why those two? Because McDonald’s is a franchise business, and Chipotle isn’t. The difference in how they operate will help you to understand what a franchise business is.
We’ll start with the non-franchise example. Chipotle operates more than 2,000 restaurants worldwide, and it owns those restaurants itself. The company bears all the cost of opening and running each store, and keeps all the profits for itself. The people who run the stores and those who make the burritos are all Chipotle employees.
McDonald’s, on the other hand, only directly owns a minority of its 36,000 outlets. Most of them are franchises. What that means is that someone else owns and operates each McDonald’s restaurant. McDonald’s gives those people the right to use its famous brand, logo, menu, etc., so they can probably attract far more customers than they would if they opened up a new hamburger restaurant in their own name. They also get to use a proven business model rather than trying to invent their own.
In return for all that, the people who run each restaurant pay fees to McDonald’s, usually calculated as a percentage of sales.
That’s the basic tradeoff in a franchising relationship. The franchisor (in this case McDonald’s) lets other people (the franchisees) take advantage of its brand, its business model, and its marketing clout, and it takes a percentage of sales in return.
We’ll look at franchise businesses in more detail later on, but I hope that for now you understand the fundamental difference between the franchise and non-franchise business model.
2. Examples of Franchises
Even if you weren’t familiar with the franchise business model before reading this, you’ve almost certainly had dealings with some franchises already in your day-to-day life.
Take a look at Franchise Direct’s ranking of the Top 100 Global Franchises, and you’ll see plenty of household names. McDonald’s is on there, as we’ve seen, but so are Subway, KFC, Burger King, Pizza Hut, Dunkin’ Donuts, and many more. Every time you go to one of those restaurants, you’re actually visiting an individual franchise under the larger brand umbrella.
But although many of the largest and best-known franchises are in the fast food industry, you’ll also find franchises in many different fields.
There’s Hilton Hotels, for example, or the Carrefour supermarket chain, or Century 21 real-estate agents, or the car rental agency Hertz. And the list goes on: courier companies, gyms, office-supply firms, tax accountants, auto-repair firms, and much more.
In the U.S., franchise businesses employ more than 9 million people and have a gross domestic product (GDP) of $552 billion, 3% of the U.S. economy as a whole, according to the International Franchise Association.
So now that you know what franchises are and have seen some examples of well-known franchises, let’s take a more detailed look at how they work.
3. How Does a Franchise Work?
Let’s say that you want to run a franchise. How does the process work from your point of view as a franchisee?
Keep in mind that there are many different types of franchises out there, and the type you choose depends on what you’re looking for. The initial investment required from you could be anywhere from tens of thousands to millions of dollars. Some franchises may offer different levels of risk (and different levels of potential reward as well).
Some franchisors may offer lots of support to franchisees, while others offer less. Some are very structured, with lots of rules to follow, while others may allow more independence. Some may require you to work longer hours than others. Some may offer locations in your area, while others will require you to move.
All of these things will affect which franchise opportunity is right for you, so it’s important to set your criteria up front and be clear about what you’re looking for.
Then, when you’ve identified some possibilities, you’ll need to evaluate each one. Make sure you understand the business model, and ask questions to find out how much you can expect to earn, how much training and marketing support is provided, and so on. Also make sure you read the detailed prospectus, known in the U.S. as a Franchise Disclosure Document.
I go into much more detail on the process of identifying and evaluating franchise opportunities in the following tutorials:
- FranchiseHow to Find Good Franchise OpportunitiesAndrew Blackman
- FranchiseHow to Evaluate a Franchise OpportunityAndrew Blackman
- FranchiseHow to Decode a Franchise Disclosure Document and Franchise AgreementAndrew Blackman
When you’ve decided on a franchise
opportunity and signed a deal, you’ll typically get a license to run that
business for a fixed term, say ten years, in exchange for an upfront fee and a
commitment to pay royalties of perhaps 5% of revenue every year.
Beyond the fees, you’ll have to budget for the usual setup costs of a business, like rent, equipment and inventory, so make sure you know exactly what you’re getting into and have the funds to make it work.
When you’ve started, you’ll run the business yourself, but within the guidelines established by the franchisor. If you’ve ever visited McDonald’s, for example, you’ve probably noticed that each restaurant is pretty much the same. There may be some minor variations in store layout or menu items, but you don’t get any big surprises.
That’s because McDonald’s, like any other franchisor, has a list of rules designed to keep the customer experience consistent in each store. If you run a McDonald’s franchise, you’ll have some leeway in the day-to-day management, but you won’t be able to double the price of a Big Mac or decide to offer mashed potato instead of fries. Some things have to remain consistent with the brand.
In terms of the finances, it’s pretty much like running your own independent business. You have to make all the investments and take the risks, but you get to keep any profits you make after paying the royalties and other fees to the franchisor.
4. How to Run a Successful Franchise Business
As you’ve seen, running a franchise can be a great way to go into business while taking advantage of an existing firm’s brand recognition.
But that doesn’t mean that you should run out and invest in the next franchise opportunity you come across. There are good franchises and bad ones, good locations and bad ones. To make it work, you’ll need to do a lot of research and follow the right process.
In this section, I’ll cover some of the key points of running a successful franchise. I went into this process in depth in my series Buying and Running a Successful Franchise, so feel free to read that if you want more detail on any of the steps.
As I mentioned in section 3, it’s important to do the research early on and decide on the right franchise for you. Once you’ve done that and started running the business, the key thing to remember is that, although a lot of support is provided for you, it’s still your business, and you’ll need to plan and strategize for success just as you would if you were starting your own business from scratch.
Many of the steps in the How to Start a Business tutorial, for example, also apply to franchises. You won’t need to come up with an idea or create a name and a brand, because that’s been done for you. But you will need to take other steps, like identifying and understanding your target market, creating a business plan and a financial model, hiring employees, and setting up your accounts.
And although many franchise agreements include some marketing support, that doesn’t mean you don’t need to do anything by yourself. If you run a McDonald’s franchise, for example, you’ll benefit from all the ads the company runs on TV and elsewhere, and from the general brand recognition. But those ads aren’t telling people about your particular restaurant. So what can you do to get the word out locally? Maybe you could run contests or promotions, or get a spot on local radio.
As you’re making your plans, of course, you’ll need to consult your franchising agreement at all times to make sure you’re not violating any of the terms. But as long as you’re staying within the franchisor’s guidelines, do everything you can to get the word out and attract a loyal customer base. View the support you get from the franchisor as a bonus, not as the be-all and end-all.
Also remember that, as Theodore Roosevelt once said, “The most important single ingredient in the formula of success is knowing how to get along with people.”
Getting along with people doesn’t mean going along with things you don’t want to. If you have concerns, you should definitely raise them with the franchisor. But maintaining a good relationship is important.
With an independent business, you can stay in business for as long as you want, as long as you’re profitable. But a franchise agreement runs for a fixed term, and there’s no guarantee of being able to renew it. And if you violate any of the terms, it could even be terminated early. So although doing a good job, following the rules and paying your royalties are most important, maintaining a good relationship can certainly help.
And, on a more positive note, keeping on good terms with the franchisor can lead to more opportunities. For example, your store may be chosen to be featured in a special promotion or an advertising campaign. And if new franchises become available, you may be given the chance to buy one.
It’s also important, of course, to build relationships with your customers and your employees. Customers are the lifeblood of your business, and employees are responsible not only for working efficiently but for dealing with customers and being the face of your business.
These two tutorials give a useful framework for identifying your target customers and giving them what they want. They’re aimed at freelancers, but many of the lessons also apply to franchises.
- FreelanceHow to Identify Profitable Clients: A Step-by-Step GuideCeline Roque
- FreelanceHow to Find Out Exactly What Your Target Clients Want—Then Sell It to ThemCeline Roque
For more on hiring and managing employees, see the following tutorials:
- ManagementHow to Hire Your First EmployeesAndrew Blackman
- ManagementThe Strategic Guide to Managing Difficult EmployeesLisa Jo Rudy
- BrandingHow to Encourage Brand Advocacy Through Employee EngagementBrenda Barron
- CreativityHow to Bring Out Your Team's Creative BestDavid Masters
In this tutorial, you’ve learned what a franchise business is and how it works. We’ve looked at some examples of franchises, and we’ve seen how a franchise business like McDonald’s differs from a predominantly non-franchise business like Chipotle.
You also now have an understanding of some of the research you need to do in order to find and evaluate franchise opportunities, and you’ve got some tips on running a successful franchise.
If that’s all you were looking for, then I hope it’s met your expectations. If you’re still looking for more details, the next step is to work through my comprehensive series on Buying and Running a Successful Franchise.