Franchising can be a lucrative business model, but before you make the jump, you need to understand the advantages and disadvantages of franchising.
We talked to Tom DuFore, who has spent over 20 years in the world of franchising. He’s helped brands like Jamba Juice and Massage Envy start franchising. Plus, he’s been both a franchisor and a franchisee.
We’ll explain the pros and cons of franchising from both sides to help you decide whether becoming a franchisor or franchisee is right for you.
Keep reading or click on any of the links below to jump to the section that interests you:
What Are the Benefits of Establishing a Franchise Model?
Let’s start with a simple question: What are the advantages of franchising for franchisors? When asked about the main benefits of becoming a franchisor, Tom explained that he can sum up the advantages in three words: money, management, multiplier.
We’ll cover each part and other benefits in the following sections.
Access to Capital (Money)
Many small business owners cite access to capital as one of the most difficult challenges to overcome. A franchise business owner may still face challenges when converting their business model from a small business to a franchisor.
The need for loans or debt will decrease after the initial conversion because you’ll have new capital coming in from the initial franchise fee and the royalties franchisees pay.
Tom also pointed out:
Check out our interview with Tom below:
Minimal Employee Supervision (Management)
Managing employees becomes increasingly difficult as a company grows. The franchisees are responsible for hiring and managing employees when you use the franchise business model.
Tom explained:
This can be highly beneficial to the franchisor, but it can also be one of several franchise disadvantages to franchisees.
Efficient Growth (Multiplier)
A franchise business model helps a business grow faster and more efficiently. While it’s difficult for a single business owner to open new business locations, when you have a network of independent business owners working together, it increases everyone’s overall success.
The parent company will be able to focus primarily on improving internal practices, brand recognition, and product lines. Meanwhile, franchise owners will focus on opening new business locations, hiring employees, and managing customer interactions. Tom explained:
Better Brand Awareness
One of the benefits of franchising is you’ll increase brand awareness faster by using both national marketing techniques and local marketing strategies. This will help make more people aware of the company and allow you to build from a successful brand operating locally to an established brand on the national level.
Reduced Risk
While most successful business models have risk, a franchising company has reduced risks because the franchise owner isn’t putting up the initial capital for each of the new franchise locations.
What Are the Disadvantages of Franchising?
Loss of Complete Brand Control
While there are many franchising advantages such as increased brand awareness, as a franchisor, you’re no longer solely in control of the brand image. Each franchisee needs to adhere to brand standards to keep the brand image as strong as when you were a small business.
You can create policies, train franchisees, and penalize them if they don’t adhere to brand standards. Despite all this, a single franchisee can do major harm to your organization.
Increased Potential for Legal Disputes
Some franchising disadvantages can be particularly costly. One of the major disadvantages of franchising is the increased likelihood of legal disputes. With more locations, there are more things that can go wrong.
In addition, franchisees can sue franchisors for bad business practices, misrepresenting their financial data, or charging too much. The Franchise Times found that 78.7% of franchisors with more than 500 locations disclosed at least one lawsuit, while over 9% averaged one lawsuit per 100 locations.
Initial Investment
The cost of preparing your small business to start selling franchises will range from $41K to $160K. That includes initial costs and the first year operating as a parent company while accepting franchise owners. Tom told us:
These costs encompass the following:
- Franchise disclosure document
- Operations manual
- Prepared financial statements
- Registration and filing fees
- Franchise brand building
- Franchise website
- Pitch decks
- Public relations
- Advertising
- Broker organizations
- Conferences
While this may seem comparable to opening a new location, this strategy can sell numerous franchises for the same price.
Federal and State Regulation
One of the disadvantages of franchises is the government regulations. Franchising is governed by the Federal Trade Commission. In addition, you’ll have to comply with state regulations in every location you or a franchisee does business.
If you offer franchises internationally, the number of regulatory agencies could expand exponentially.
What Are the Advantages of Operating a Franchise?
Previously, we discussed advantages from the franchisor’s perspective. However, given the target market of a franchising company is other business owners, you’ll want to understand the advantages of owning a franchise so that you can explain them to potential franchisees.
The benefits of being a franchisee include:
- Proven business model
- Business assistance
- Brand recognition
- Lower failure rate
- Buying power
- Profits
- Lower risk
- Built-in customer base
- Being your own boss
Let’s look at the benefits of owning a franchise in greater detail.
Proven Business Model
Business ownership isn’t easy. When you start a new business, there’s a lot you have to plan and figure out. One of the main advantages of buying a franchise is that most of the guesswork has already been done. Tom told us:
People who buy into existing franchise operations immediately gain access to best practices, marketing materials, and established systems. Everything is spelled out in the franchise disclosure document, franchise agreement, operations manual, and onboarding process.
Business Assistance
An entrepreneur might choose to buy a franchise because of the business assistance they receive. As a franchisee, you’ll have both the parent company and other franchisees available to discuss solutions to problems. This built-in network of business owners makes it easier to solve problems you haven’t dealt with before.
Many franchisors also have preferred lenders they work with to make it easier to get business financing.
Brand Recognition
A franchise network already has an established brand. They know how to reach customers and control advertising costs. This will help you grow faster because you reap all the benefits from their previous mistakes.
Higher Success Rate
We’ve all heard the statistic that starting your own business has an 80% failure rate. Did you know that franchise opportunities often have failure rates between 10% and 20%?
In other words, one of the advantages of a franchise is a higher probability of success.
Buying Power
Franchise businesses are often treated as a single account by vendors. That means you have more purchasing power because every franchised location increases the amount of money spent with vendors. Learn more about volume discounts.
Profits
Profits tend to be higher for franchise owners than independent businesses, but every franchise is different. Franchised businesses often have franchises at varying levels of success and longevity.
According to FranNet, the top 20% of franchises tend to make about 80% of the profits. Tom explained:
Built-In Customer Base
Franchise advantages include a built-in customer base. Many franchises have national accounts that local franchisees provide a service for. You might not make as much from these accounts, but they are a source of revenue if there are clients in your area.
Lower Risk
As you’ve already discovered, franchises generally have higher success rates. That means lower risks. The reduced risks come from many of the other advantages such as brand recognition, business assistance, an existing customer base, and more purchasing power.
Like any business, franchises still have risks. Some of the risks are unique, such as another business owner damaging your reputation because you all operate under the same branding.
Being Your Own Boss
Another advantage of franchise ownership is the ability to be your own boss. As long as you stick within the terms of the franchise agreement, you can control your hours, when you take off, and how much you make.
Despite all the advantages of franchise operations, there are some disadvantages of franchise operations that we should talk about as well.
What Disadvantages of Franchising Do All Franchisees Face?
Disadvantages for a franchisee include:
- Franchise agreements restrict decision-making.
- The initial cost is more than an independent business.
- Ongoing investments are required.
- There’s the potential for conflict between the franchisor and franchisees.
- Franchisors and franchisees lack financial privacy.
Next, we’ll take a closer look at the disadvantages of owning a franchise.
Franchise Agreement Restricts Decision-Making
Franchise agreements are one of the biggest disadvantages for business owners who like being able to experiment and make their own decisions. You’ll have limited creative opportunities to try a new marketing campaign or management style because the franchisor has limits on what the day-to-day operations are allowed to involve.
Some existing brands might have beta testing occasions where you can experiment a bit, but if you object to limited control of major decisions, then you might want to start your own business instead.
Initial Cost Is More Than an Independent Business
Opening new locations as a franchisee is often more expensive than starting your own business or buying an established one. Some of the costs that bootlegged startups might scrimp on that you have to pay as a franchisee include:
- Business insurance: It’s common for business owners to get business insurance only when required by law. Franchisees are required to have it.
- Marketing and advertising: Many small businesses put in time as opposed to throwing money at marketing and advertising. Franchises tend to have requirements for marketing to ensure the business grows.
- Systems: A small business commonly starts as a one-person operation and doesn’t need many systems. Most franchises are meant to grow to employ people.
- Initial fee: Franchise fees are unique to franchises. These upfront costs add an average of $45,000 to the cost of starting a business. You may be able to negotiate deals to reduce these costs if you’re a veteran, minority, disabled, or LGBTQ.
While this is one of the most glaring disadvantages of starting a franchise, remember that you’re far more likely to meet your business goals. I would also make the argument that you should have most of these costs to start business operations. Foregoing things like legal protections and marketing are a surefire way to struggle.
Ongoing Investment
The ongoing costs of franchisees are another downside of this business format. You’ll typically have:
- Royalties: A major disadvantage of franchises is that you have to share a percentage of your revenue with the parent company.
- Marketing fees: There are typically required marketing fees to reach potential customers and make the brand name more well known.
- Technology fees: Franchisees commonly have to pay a fee to the franchisor for the use of company systems.
- Ongoing training: Most franchises have training standards you have to follow. These can cost thousands per year between remote training and annual conferences. You might be fined if you don’t attend.
Tom explained:
All these ongoing costs are both advantages and disadvantages of owning a franchise. While they are costly and reduce the franchisees’ take-home pay, they’re the costs associated with working alongside an experienced team with a strong track record.
Business Owner and Franchisor Conflicts
Conflicts and even legal disputes are not uncommon between a business franchise and franchisees. As we discussed earlier, nearly 80% of franchising organizations have outstanding lawsuits. Many of them are with the franchisees.
Lack of Financial Privacy
When you buy a franchise, financial information isn’t under your complete control. A good franchisor should provide financial representations in Item 19 of the franchise disclosure document. These may include:
- Revenue
- Gross profit
- Operating profit
- Net profit
- Full financial statements
- Financial information by franchisee
- Financial information by age
- Averages and medians of franchise performance
This data can help you write a business plan and access loans, but if you own locations as a franchisee, it means you’re sharing financial information you may not want to disclose.
Closing
We’ve discussed many of the franchising pros and cons. Franchising is a great way to expand business opportunities, but you have to consider whether the advantages and disadvantages of a franchise are worth it to you.
What are the advantages and disadvantages of franchising that most concern you?
