How the Franchise Model Works

Every year the number of new businesses that start up increases. According to Statista, one of the leading providers of market and consumer data, over 785,000 of those new start-ups were franchise businesses. 

The franchise business model in the U.S. can be traced back to the Colony era when Benjamin Franklin and Thomas Whitmarsh entered into a franchise agreement with a printing business. But what exactly is a business franchise? Let’s understand this type of business model by analyzing:

• What is a franchise?
• What advantages exist from entering the franchise industry?
• How does it work?

What is a Franchising Model?

Franchising in the United States is a business model that allows a business to put licenses on their brand, which they can later distribute to a separate company. The best example of the franchise business model, and the most successful company in the franchise industry, is McDonald’s.

The franchise business owner is known as a franchisor, while the third party that enters into the franchise agreement is the franchisee. The franchisor owns the rights to the trademark, branding, and business model of their business. Under the franchise business model, the franchisee can operate their own business by having access to the franchisor’s rights. 

How Does a Franchise Model Work?

When two individuals (or entities) enter into a franchise agreement, the franchisee buys the rights to a license to operate under the franchisor’s business name. As part of this agreement, the franchisee pays different fees that include:

1. Franchise fee. Also known as a license fee, this is an initial amount paid to the franchisor upfront. According to the U.S. Small Business Administration, “today’s franchise fees range from $20,000-$50,000”.
2. Royalty fees. A franchise royalty fee is usually paid to the franchisor monthly based on the revenue you generate. These ongoing royalties can range anywhere from 4 to 12 percent of your total revenue.
3. Marketing fees. Also calculated as a percentage of your revenue, this fee is charged by franchisors to assist them with the thousands they spend on advertising their business brand. The portion of the monthly marketing fees is usually less than the percentage of royalty fees.

Note: Any fees should be clearly stated in the franchise disclosure document (FDD).

Advantages of a Franchising Model

While there are many different types of business models out there, the franchising model has a few advantages that include:

• Costs. Purchasing a franchise will make it easier to get business loans since they are considered less of a risk. Some banks will also offer franchisees expert advice from a specialist franchise advisor for your financing options. Overall, starting a new business can be more costly than buying a franchise.
• Established market and demand. The idea of becoming a franchise business is that you operate your new business under a well-established and well-known brand name. The brand name’s popularity will promote monetary rewards based on your efforts to manage the franchise and not start from scratch. When buying into a franchise that sells products, the franchisor usually has access to bulk discounts to pass on to your business.
• Franchisor perks. Some franchisors might offer the option to pay the initial franchise fee in installments over time instead of upfront. Franchisors, in some situations, might assist you with site selection and setting up the new franchise business. You can count on some franchisors providing training and knowledge from past mistakes.
• Advertising. Paying for marketing fees might seem like a negative, but as a franchisee, you will be able to benefit indirectly from advertising done by other franchisees.

What are the 4 Types of Franchising Ownership?

The way a franchise model works is pretty straightforward. But prospective franchisees must understand that there are four types of franchise owners to enjoy the franchise model benefits.

Single Unit Franchisee

The most common type of franchise is known as a single unit franchise. Franchising establishes a franchise agreement where the franchisee is granted rights to start up and operate only one franchise unit.

As with any new business, there is always the fear of your business not working out. That’s why any prospective franchisee will start with a single unit and see how profitable the franchise will be. 

Multi-Unit Franchisee

When a single unit franchise proves to be a successful franchise, this will open the way to negotiating with the franchisor the opportunity to become a multi-unit franchise. The new franchise agreement will allow the franchisee to open other units. Sometimes there will be a schedule as to when it’s expected for the other units to begin operation.

Multi-Unit Area Developers

A multi-unit area developer franchise is very similar to the previous type of franchise ownership because it will allow the franchisee to open multiple franchise units. While a multi-unit franchisee will start as a single-unit franchise, the multi-unit area developer franchise will agree from the very beginning that they will develop a certain number of units within a specified time.

With this type of ownership, the franchise agreement will provide exclusive rights to the franchisee for that specific franchise within a particular territory.

Master Franchisee

A master franchisee can be considered a step up from a multi-unit area developer franchise. Under this type of franchise business, the agreement allows for multiple units and exclusivity over a specific area. The difference is that as a master franchisee, you will receive permission to sell franchises to other prospective franchisees.

Being a master franchisee will, in a way, make you a franchisor. The perk of providing franchise opportunities to others is that you will benefit from receiving franchise fees and ongoing royalty fees from those franchisees you sell to in the territory.

A Different Type of Franchise

As people spend more time online, the eCommerce franchise model is beginning to become the 5th type of franchise opportunity. eCommerce franchising refers to a franchisee opening a single online store. eCommerce franchises will start to increase as the ability to work from home increases as well.

The Relationship Between the Franchisor-Franchisee

We mentioned that one of the many franchise benefits is receiving help from your franchisor. When you decide to buy into a franchise, your unit will represent that brand name (or trade name). For this reason, a special relationship is created between the franchisor and franchisee because a successful franchise equals success for the brand.

Throughout this partnership, the franchisor will provide ongoing support by providing help with any questions or concerns you might have along the way. You can also count on help from an entire network of fellow franchisees. The owners of these other franchises will be the perfect people to offer advice and solutions to common problems.

A solid franchisor-franchisee relationship will make the franchise business model a benefit for its loyal customers who are guaranteed to receive the same product selection and quality they expect. The franchisee will also be able to provide customized service with the personal touch of a small business.

Why Franchise?

With a hefty percentage of new businesses failing within their first year, the franchise model benefits make this the best business model to choose. Why Franchise understands the fear of stepping into entrepreneurship which is why we strive to provide you the guidance and resources for your franchising journey.