The franchise business model is widely recognized as a contractual arrangement where an established brand, known as the ‘franchisor,’ grants permission to an independent business owner, or franchisee, to utilize its branding, business model, and intellectual property. While many are familiar with this concept, questions often arise regarding how it generates revenue on a practical level, the process involved in establishing a franchise, and whether it suits individual business aspirations.
This article delves into exploring the inner workings of the franchise business model, shedding light on its revenue-generating mechanisms. It also unravels the step-by-step process of setting up a franchise, providing insights into the strategic decisions involved in making it a successful venture.
What Is A Franchise Business Model?
In simple terms, a franchise business model is an arrangement where an established company (the franchisor) allows individuals or independent business owners (the franchisees) to use its successful brand name, business system, and support in exchange for a fee or royalty.
Franchisees get the advantage of operating under a recognized brand with proven business methods, while the franchisor expands its business through multiple locations without directly managing them. It’s like buying a ready-made business package with ongoing support from the parent company, making it an appealing option for aspiring entrepreneurs who want to run their own businesses with the backing of an established brand and support system.
Types of Franchise Models
There are primarily three types of franchise models
Product Franchise
In this model, the franchisor provides the franchisee with the right to sell their products under their brand name. The franchisee operates a retail location and sells the franchisor’s products.
Business Format Franchise
the franchisor not only allows the franchisee to sell their products but also provides a complete business system, including marketing, operations, and support. The franchisee follows the established business format and uses the franchisor’s brand name and methods.
Manufacturing Franchise
In this model, the franchisee is granted the right to produce and sell the franchisor’s products. The franchisor provides the necessary manufacturing process, technology, and support to ensure product consistency and quality.
Example Of A Successful Franchise Business Model: McDonald's!
One famous example of a company with a franchise business model is McDonald’s.
In the McDonald’s franchise model, individual entrepreneurs, known as franchisees, are granted the right to operate a McDonald’s restaurant under the McDonald’s brand name.
The franchisees receive training and support from the company, including access to the company’s standardized recipes, cooking methods, and quality control procedures.
The franchise model has been a key factor in McDonald’s global success, as it allows the company to expand rapidly into new markets while leveraging the entrepreneurial spirit and local expertise of its franchisees.
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How Does The Business Model of Franchise Drives Revenue?
Every franchise model is different depending on the company and the industry. However, there are three primary sources that will help the franchisor and the franchisees to generate revenue.
Let us go back again to our example of McDonald’s!
McDonald’s is the franchisor.
The business owner that wants to operate under the brand name of McDonald’s is the franchisee.
Now, let us see how the business model of a franchise helps the franchisor and the franchisee.
How the Business Model Of Franchise Helps Franchisors
There are three main payment categories for the franchisor.
- The franchisee pays an upfront fee to acquire the rights and trademark controlled by the franchisor.
- The franchisor may charge for providing essential services like training, equipment, or business guidance.
- The franchisor receives ongoing royalties or a percentage of the sales generated by the franchisee’s operation.
Let’s relate the above to our McDonald’s example. Suppose, you want to open a McDonald’s franchise. You would need to purchase the franchise rights from McDonald’s (first payment). The team at McDonald’s would train your staff and provide you with equipment (second payment). When you are running a McDonald’s outlet, some percentage of your profits will go as royalty to McDonald’s on a regular basis (third payment)
This is how McDonald’s (Franchisor) would earn. But, what is the benefit for franchisees in this model? Let’s find out!
How the Business Model Of Franchise Helps Franchisees
There are various advantages for you as a franchisee in this business model. Let me tell you some of them quickly!
Starting With An Established Brand
Franchisees benefit from the reputation and recognition of an established brand, which can lead to faster customer acceptance and trust.
Proven Business Model
Franchisees receive a well-defined and proven business model that has been tested in various markets, reducing the risk associated with starting a new venture from scratch.
Marketing and Advertising
Franchisees often benefit from national or regional marketing campaigns funded by the franchisor, which can help drive customer traffic to their location.
Reduced Risk
Compared to starting an independent business, franchisees have a lower risk of failure due to the proven track record and support offered by the franchisor.
Let us relate the above with our McDonald’s example. As a McDonald’s franchisee, you won’t need to worry about making decisions on product selection, store layout, or employee uniform design, as these are already determined by the franchisor. The marketing done by McDonald’s would help your franchise outlet as well. And if your outlet generates profits, it would benefit you and McDonald’s both!
Are There Any Demerits Of Operating A Franchise?
As they say, every coin has two sides, and so does the franchise model. This business model may not be feasible for everyone. Let us understand a few roadblocks or demerits of the franchise model of business.
High Initial Investment
Franchisees often need to pay substantial upfront fees and ongoing royalties to the franchisor, making it a significant financial commitment.
Lack of Flexibility
The franchise model may not allow for much flexibility in product offerings, pricing, or business strategies, which can be challenging in dynamic market conditions.
Indirect Effect Of Brand Reputation
The reputation of the franchise can be affected by the actions of other franchisees or the franchisor itself, even if the individual franchisee is performing well.
Bottom Line
In conclusion, the franchise business model is a powerful revenue-generating mechanism that benefits both the franchisor and the franchisee. For the franchisor, revenue comes from three primary sources: upfront fees, charges for services provided, and ongoing royalties based on the franchisee’s sales. This allows the franchisor to expand its business rapidly and leverage the success of its brand through multiple locations.
On the other hand, franchisees benefit from operating under an established brand with a proven business model, which leads to faster customer acceptance and reduced risks associated with starting a new venture. The support and marketing provided by the franchisor further enhance the franchisee’s chances of success. However, the franchise model may not be suitable for everyone due to its high initial investment and lack of flexibility in business strategies.
Overall, the franchise business model has proven to be a successful and mutually beneficial arrangement for many companies and entrepreneurs, allowing them to achieve growth and success in their respective markets. It continues to be a popular choice for those looking to start their own business while leveraging the strength and support of an established brand.