What Is a Franchisor?

A franchisor sells the right to open stores and sell products or services using its brand, expertise, and intellectual property. It is the original or existing business that sells the right to use its name and idea. The small business owner who purchases these rights is called a franchisee and the branch business, itself, is called a franchise.

How Franchisors Work

The franchisor company generally receives an initial start-up fee, an annual fee, and a percentage of the branch’s profits. It may also charge for other services. Well-known corporate franchisors include Hertz (NYSE: HTZ), Marriott International (NASDAQ: MAR), McDonald's (NYSE: MCD), and Subway (privately held).

Becoming a franchisor is generally a good business alternative, especially for large, already-successful companies, though there are both advantages and disadvantages.

A chain store is one of a series of stores owned by one company; if Starbucks (NASDAQ: SBUX), for example, were to franchise some of its stores, then those would be owned by outside investors—not by the original company—and Starbucks would become a franchisor.

Advantages of Franchising

Expansion Opportunities

A corporation often will use franchising as a way to expand its global presence because it enables them as franchisors to benefit from the local knowledge of their franchisees. The franchisor company grants the franchisee the responsibility of expanding in an area or country and grants them the right to sub-franchise. In exchange, the franchisee assumes the financial burden of building a unit and pays the franchisor royalties for access to its time-tested business model, market power, and brand name.

Heightened Market Share

In addition to extending its geographical reach, franchising is a good way for a company to increase its market share while minimizing capital expenditures (CapEx). Franchises can be more profitable than corporate-owned chains, because as business owners franchisees are motivated to maximize their outlets' profitability and are responsible for their own overhead, such as staff. Less overhead can make franchises more profitable than corporations, even when its outlets are less profitable than they would be if they were run as chain stores.

Scalability

Depending on a franchisor's needs, resources, and production goals the company can customize its franchise agreement to focus on large-volume national growth or low-volume regional growth.

Additional Sources of Revenue

A franchisor receives additional income in the form of on-going royalties paid by its franchisees. Royalties typically include a startup fee, a monthly fee that includes a percentage of the franchisee's gross sales, and it may contain other payments depending on the franchise agreement.

Disadvantages of Franchisors

Some may think—partly because of the steep cash outlay—that franchisees assume more risk than franchisors; but, there are potential disadvantages for franchisors, too.

Capital Investment

Establishing a franchise requires a large investment of both time and money. At a minimum, a franchisor should plan to spend on business development, a flagship store, legal document preparation, marketing, and packaging plans, and recruiting and training franchisees.

Franchise Failure

Even with scrupulous vetting on the part of the franchisor, a franchisee could turn out to be a poor choice—irresponsible, difficult to work with, or incapable of running a business for whatever reason. Or the franchise could become unprofitable for other reasons. Even with a proven business plan, there is no guarantee that a franchise will succeed.

Less Control

At the outset, franchisees will, of course, agree to follow their franchisors' training, deportment, and other instructions. But after the honeymoon is over, that might not be the reality. Franchisees are human beings with their own ideas and temperaments, so disagreements can always occur: a franchisee could become stubborn or difficult, or might not be able to effect changes as easily as the franchisor had hoped.

Costly Legal and Regulatory Fees

In the event that a franchisee refuses to cooperate, or proves to be a poor choice in other ways, legal action may be necessary; this can be both expensive as well as damaging to a franchisor's reputation among other franchisees. Moreover, franchises are regulated by state and federal laws that require a Franchise Disclosure Document (FDD) and other regulatory documents entailing an attorney's services.

Understanding the Role of a Franchisor

The relationship between a franchisee and franchisor is inherently one of advisee and advisor. The franchisor provides continual guidance and support concerning general business strategies such as hiring and training staff, setting up shop, advertising its products or services, sourcing its supply, and so on.

The franchisor's advisory role is not free, however; it is part of the entire package that the franchisee purchases. Even when the relationship is solidified, and the two have been working together successfully, the franchisor still acts as a mentor. A franchisor's parental role is an ongoing commitment. In fact, franchisors generally police their franchises constantly—albeit some more than others—to ensure that they are maintaining the parent company's standards, product quality, and brand values.

Key Takeaways

  • A franchisor sells the right to open stores and sell products or services using its brand, expertise, and intellectual property. 
  • Becoming a franchisor is especially viable for already-successful companies.
  • All franchisors assume the risk that a franchise could fail.

Various Store Types Available for Franchisees

  • Freestanding store: A restaurant, either newly constructed or an existing structure that does not share any common walls with a third party
  • Shopping center storefront: A restaurant that shares a common wall, or walls, with third parties
  • Gas/ convenience restaurants: A restaurant that is a sub- or-shared tenancy within a gas/ convenience host environment
  • Special distribution opportunity (SDO): Cart or kiosk locations that are referred to as special distribution opportunities and may be located within another host establishment, such as a stadium or another retail facility

An Example of a Franchisor: Dunkin' Brands Group

Dunkin’ Brands Group (NASDAQ: DNKN), which used to be called Dunkin' Donuts, began operations in 1954 and has been franchising since 1955. With more than130 years of franchising experience, Dunkin' is home to two of the world's most recognized franchises: Dunkin' and Baskin-Robbins. According to its most recent count, Dunkin' boasts approximately 12,870 locations in more than 45 countries.

As a franchisor, Dunkin’ licenses stores and restaurants that sell Dunkin’ coffee, donuts, bagels, muffins, compatible bakery products, sandwiches, and other food items and beverages compatible with the franchisor’s concept.

Most companies that offer franchising opportunities post how-to information for prospective franchisees on their websites. Generally, this is comprehensive, voluminous, and often written in legalese or boilerplate. In its franchisor role, Dunkin's text speaks to its would-be franchisees clearly and understandably, as the following sample shows.

Training Overview

  • Franchisees must at all times manage their network with at least two individuals, one of whom must be the franchisee or another partner, shareholder, or a designated representative. But both must successfully complete the required training program.
  • It takes a minimum of 20 days to complete the classroom/ instructional phases of the Dunkin’ Core Initial Training program—not including online training, in-restaurant practice, or travel time; this is offered a minimum of 25 times a year at Dunkin’ Brands University in Braintree, Massachusetts.
  • The classroom and in-restaurant time are based on 10-hour days. Some of the franchisor’s required classes are only offered on the internet and are referred to as online training. These classes will require approximately 65 hours to complete.

Obligations and Restrictions

Franchisees must devote continuous best efforts to the development, management, and operation of their business. This means devoting sufficient time and resources to ensure full and complete compliance with their obligations to the franchisor, their customers, and to others.

Franchisees may not conduct any other business or activity at the restaurant without the franchisor’s prior written approval. They may sell only products approved by the franchisor and they must offer for sale the full menu prescribed by the franchisor.

Franchisees are not permitted to sell or distribute goods or services via the Internet or other electronic communications.

Financial Assistance

Dunkin' typically does not offer financing. However, from time to time, it may, at its discretion, offer voluntary financing to existing franchisees for specific programs such as the purchase of specialized equipment or accelerated development in specified markets.

The franchisor has facilitated certain third-party lending arrangements that may provide financing for qualified franchisees. The amount of financing and repayment period varies by program, circumstances, and creditworthiness of the applicant.

Estimated Initial Investment

Dunkin' estimates that the cost to open one of its franchises—not including real estate costs—is approximately $95,700 at the low end and $1,597,200 at the high end.

You may find a complete breakdown of the fee schedule on the franchising page of the company's website.