What is a 'Franchisee'

A franchisee is a small business owner that purchases the right to use an existing business's trademarks, associated brands, and other proprietary knowledge. In addition to paying an annual franchising fee to the underlying company, the franchisee must also pay a portion of its profits to the franchisor.

BREAKING DOWN 'Franchisee'

When a business wants to increase its market share or increase its geographical presence at a low cost, it may create a franchise for its product and brand name. A franchise is a joint venture between a franchisor and a franchisee. The franchisor is the original or existing business which sells the right to use its name and idea. The franchisee is the individual who buys into the original company by purchasing the right to sell the franchisor’s goods or services under the existing business model and trademark.

An entrepreneur who has little experience within a given industry may choose to enter a franchise, since the franchisor would provide continual guidance and support on business strategies relating to hiring and training staff, setting up shop, advertising its products or services, sourcing its supply, etc. For example, to set up shop, a franchisee is usually given an exclusive area where no other franchises within the same underlying business currently operate in order to prevent internal competition. In return for the advisory role offered by a franchisor, the franchisee pays a one-time startup fee and an ongoing percentage of gross revenues as royalty to the franchisor. Given the financial costs for opening a franchise, a franchisee requires very little capital to start compared to other business startup options, such as starting a company from the ground up.

A franchisee is expected to follow the proven business model that is already in place, as it helps to provide a consistent state of operations within all companies under the same brand name. Using the business model provided, the franchisee is responsible for the growth of the franchise, which can be attained from advertising efforts in its exclusive area of operation. However, all marketing campaigns must comply with and be approved by the original establishment before releasing them to the public. As the manager of the franchise, the franchisee is expected to protect the brand name of the franchisor by offering only approved products and services that are linked to the brand name of the original company.

A great example of a company that has a global presence due to its franchises is the fast food behemoth, McDonald’s. McDonald’s was founded in 1940 in San Bernardino, California, and by 1954, had four franchise locations. As of year-end 2016, there were 36,899 McDonald’s restaurants in 120 countries. Of the 36,899 restaurants, 31,230 were franchised, which means 84% of the McDonald’s food chain is franchised. The company either owns the land and building used by the franchisees or secures long-term leases for the franchised sites. As part of the contractual agreement between the restaurant and franchisee, a franchisee provides a portion of the capital required by making an initial investment in the equipment, seating, décor, and signs in the location that will be provided. For the fiscal year ended 2016, McDonald’s brought in total revenues of $24.6 billion, of which 38% was from its franchised locations. Revenue received from its franchisees comprises of the initial startup fees, rent for the building provided, and royalty payments based on percentage of the franchisees’ gross revenues.

McDonalds’ successful franchise story can be attributed to its commitment to maintaining consistent standards in its menu that resonate across its various chains. So, an Angus beef burger in Los Angeles should have the same quality as one in London. Franchisees manage pricing decisions and staffing matters, while also benefiting from the brand strength and global experience of McDonald’s.

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