Franchising as a business model is not new. Franchising dates back to the middle Ages and ancient China. “In the middle ages, the local titled landowner would grant rights to the peasants or serfs, to hunt, hold markets or fairs or otherwise conduct business on his domain. With the rights came rules, and these rules became part of European Common Law.
Today, there are thousands of franchises across hundreds of industries and sectors. As of 2018, the franchise industry employed 21 million people and generated $2.3 trillion of economic activity, according to a U.S. government report.
Franchising has significantly contributed to the overall world economy, and has proven to be a profitable venture for those seeking both freedom and financial stability. But what exactly is a franchise?
- Are there different types of franchise models?
- How does it all work?
- And is owning a franchise right for you?
What is a Franchise?
A franchise business is a business in which the owners, or “franchisors,” sell the rights to their business logo, name, and model to third-party retail outlets, owned by independent, third-party operators, called “franchisees.” In other words, the franchisee is licensed to use the franchisor’s trade name and operating systems.
Franchises are an extremely common way of doing business. In fact, it’s difficult to drive more than a few blocks in most cities without seeing a franchise business. Examples of well-known franchise business models include KFC, McDonald’s, Subway, UPS, Chicken Republic, MTN, Health Plus, and ETC.
In exchange for the right to use the franchisor’s business model – to sell the product or service and be provided with training, support, and operational instructions – the franchisee pays a franchise fee (known as a royalty) to the franchisor. The franchisee must also sign a contract (franchise agreement) agreeing to operate by the terms specified in the contract.
A franchise essentially acts as an individual branch of the franchise company.
There are two primary franchise business models: The Product Distribution Franchise Model and The Business Format Franchise Model.
Product Distribution Franchise – In this franchise model, the franchisor manufacturers the product, and the franchisee sells the product. Examples of product distribution franchises include Coca-Cola, John Deere, and Ford Motor Company.
Business Format Franchise – This is the most common franchise model. Here, the franchise is allowed to use the brand and trade name of the franchisor, like in the product distribution model they are also granted access to the product distribution model. Examples: Domino Pizza, Chicken Republic, McDonald’s, are business format franchises.
Different Types of Franchise Ownership
Single Unit Franchisee – When a franchisee purchases the first franchise, they are considered a single-unit franchisee.
Multi-Unit Franchisee When a franchisee owns more than one franchise unit, it’s considered to be a multi-unit owner.
Multi-Unit Area Developers – Similar to multi-unit franchisees except that they agree, upfront, to develop a certain number of franchise locations within a specified period and area. This approach is best for franchisees who are looking for market exclusivity and have the resources to secure that exclusivity with the franchisor.
Master Franchisee – Similar to a multi-unit area developer in that they are obligated to open a certain number of locations in a specified period and area. The difference is that the master franchisee is also able, and sometimes bound, to sell franchises to other prospective franchisees. The master franchisee then acts as a middleman for the franchisee and the franchise company.