What do Subway, Dunkin' Donuts, UPS, Domino's Pizza, Jiffy Lube, McDonald's, Burger King, and RE/MAX all have in common? They are all highly successful businesses and they all franchise their operations. If you have ever considered becoming a franchisee, read on for some insight into the benefits and pitfalls.
- A franchise is a business whereby a company licenses its operations along with its products, branding, and knowledge to a franchisee.
- A franchisee pays the franchisor an initial franchise fee, licensing, marketing, and royalty costs, along with a percentage of its gross profits.
- Purchasing a franchise allows an individual with instant expertise and an established business plan.
- Although franchisees may see a healthy profit, franchises require a sizeable initial investment and ongoing costs.
- As with any business, it's important to do your research before opening a franchise, including the location, market, and costs.
What Is a Franchise?
A franchise is a popular business model used by an established business to expand its reach. The concept dates to the Middle Ages when a king would grant rights for activities such as running a market or brewing ale.
The business, which is referred to as a franchisor in the relationship, licenses its proprietary business knowledge, processes, and trademarks to a franchisee who sells the company's products under its name. Put simply, the franchisee purchases the right to use the franchisor's name, idea, and products to the general public.
The company and the franchisee enter into a franchise agreement, setting down the terms, conditions, and financial details of the relationship. The franchisor gains access to a (new) geographic market while the franchisee pays a series of fees to run the business, including:
- An initial sum, known as the franchise fee or startup costs
- Ongoing royalty costs, which are usually paid on a monthly basis based on your revenue
- Advertising charges
- Licensing fees
- A percentage of the franchisee's gross profit
Buying into a franchise provides instant expertise and leaves out all the guesswork of having to set up a brand new business. As such, the required business model, systems, and processes that you need to run a business are already established. You simply pay the associated fees as per the contract and keep the business running.
In some sense, franchising is akin to a business in a box. That's because it comes with a recognized brand name, consistent advertising, branding, and presentation—think uniforms, store colors, signage, and products. Just open the box, take out the components, and you are ready to go. The materials you need to run your day-to-day operations are delivered to your door by reliable, time-tested suppliers.
As noted above, franchisors get paid for their ideas, expertise, and assistance. The payment includes a lump-sum franchise fee, a percentage of the franchisee's gross sales, and other costs, such as royalties, advertising, and licensing fees.
For example, Dunkin' Donuts charges franchisees approximately $40,000 to $90,000 for the initial franchise fee, 5.9% in royalties, and 5% for advertising. The initial investment ranges between $109,700 to $1,637,700.
A store that does $900,000 in annual sales would owe nearly $100,000 to the company. If you add in about $200,000 for the cost of materials, the franchisee would be left with about $600,000. From this, the franchisee must pay rent, utilities, labor, taxes, and other expenses. However, even in the most expensive markets, the franchisee of a successful brand is likely to be left with a healthy profit.
Even though franchisees pay startup costs and ongoing fees, the franchisor controls many of the aspects of the business like design standards, site approval and maintenance, operational methods, and the area where you can sell.
What to Keep in Mind
Franchising is an expensive proposition. Like every new business, franchising comes front-loaded with startup costs. Ongoing costs often also add up, particularly since the trade-off for reliable suppliers is higher costs.
It is also important to remember that you need to follow the rules. When you purchase a proven business plan, you are expected to use it. This means that the franchisor doesn't want you to try and change or deviate from it.
As with any other business, operating a franchise is not easy. You have to work to succeed and, despite the merits of franchising, some businesses end up failing.
Before you invest in your own store, make sure you do some extensive research. Talk to at least a half dozen current franchisees. Take a long, hard look at the numbers. Make sure you thoroughly understand the startup costs, ongoing costs, and the amount of money you can expect to earn.
Find out how far away the next closest franchise location is and where the next new location can be built. You don't want to be in competition with another store over which you have no control.
Be sure to find out about any opportunities that may arise your way to expand if your location is a success. Finally, develop an exit plan in case you can't handle it and decide to call it quits.
Should You Franchise?
The franchise economy was hit especially hard by the COVID-19 pandemic. According to the 2021 report from the International Franchise Association, roughly 20,000 franchise locations and 900,000 jobs were lost in 2020. That being said, if you are considering opening a franchise, you are not alone. In fact, franchising contributed $670 billion of economic output to the U.S. economy and still represented 3% of the total nominal gross domestic product (GDP).
But the report is optimistic about the rebound of franchising as the economy recovers from the damage caused by the pandemic. In fact, it cites the fact that in past recoveries, franchising has expanded faster than overall GDP. Furthermore, the rise of vacancies in retail real estate may make this an enticing time for potential franchisers.
The Bottom Line
If you are not the type of person that's going to dream up the next big idea, but you want to run your own business, franchise opportunities may be exactly what you are seeking. Like any business endeavor, find the right business for you, do your research, and make sure that you are comfortable with the processes and limitations that come with operating a business that somebody else created.