Franchises: Opportunities and Challenges

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  • 0:06 Franchise - A Proven…
  • 0:56 Advantages of Franchises
  • 2:08 Disadvantages of Franchises
  • 3:27 Diversity in Franchising
  • 3:51 Globalization - A…
  • 4:30 Lesson Summary
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Lesson Transcript
Instructor: Shawn Grimsley
Franchises offer a way for a person to start a proven business. In this lesson, you'll learn about franchises, including their advantages and disadvantages. You'll also learn about diversity and global challenges in franchising.

Franchise - A Proven Model for Success

Meet Francine. She wants to start a business but doesn't have any experience in running a business and doesn't really have a killer idea for a business. While she's willing to take a degree of risk in starting a new business, she doesn't want to go too far out on a limb.

Francine decides to purchase a franchise. A franchise is a type of business arrangement where a license is granted to a person or business to use the name, business process and products that have been successfully developed by another company. The party giving the license is called the franchisor. The person that purchases it, like Francine, is called a franchisee. The most well-known franchise in the world is probably McDonald's. Other well-known franchises include Subway, Hertz, Days Inn, and Century 21.

Advantages of Franchises

A franchise offers some important advantages to an entrepreneur like Francine. One of the biggest advantages to Francine is that a franchise is as close to a turnkey business as it gets. This means most of the work in developing the business has already been done and all the steps and processes are laid out for Francine. All she has to do is follow the instructions.

A good franchise will have all the steps needed to make your business a success laid out in black and white for you. It will show you how to market, how to budget, how to produce the product or service, and how to manage.

Another advantage of a franchise is that the business has already been proven to be successful. If you buy a McDonald's franchise, it's pretty likely that you'll stay in business. Keep in mind that the franchisor doesn't want you to fail. It wants to get paid its share of the profits, and more importantly, failure hurts the value of its franchise brand. If the franchisor doesn't think your proposed location is going to be successful, or the demographics of the area don't match the franchise's target customers, it probably won't grant you a franchise license.

Disadvantages of Franchises

Francine does face some challenges if she chooses to go the franchise route. Good franchises are not cheap. Start-up costs can range anywhere from less than $10,000 to over $1,000,000. Most franchisors will not only charge a franchise-licensing fee but also a royalty on your profits.

Francine may have to fork over a typical royalty of 4% of gross sales. Keep in mind that gross sales are not Francine's profit, but just the amount of sales she makes in a given period of time. Her profit is what is left over after paying all expenses - including the franchise royalty.

Franchisors often are very strict in how their franchisees run their franchises. The franchise agreement may require that Francine operate her business in a particular way, and she will have no choice but to comply unless she wants to risk losing her investment in the franchise. Thus, her independence is constrained when operating a franchise.

This makes some sense because the value of the franchise is consistency. Customers can walk into any McDonald's and see a familiar menu with food that tastes the same no matter where you are. If Francine is able to change things up, she would diminish the predictability and advantage of the franchise brand.

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