Advantages and disadvantages of Franchise

There are two primary advantages to franchising. First, early in the life of an organization, capital is typically scarce, and rapid growth is needed to achieve brand recognition and economies of scale. Franchising helps a venture grow quickly because franchisees provide the majority of the capital.13 For example, if Comfort Keepers were growing via company-owned outlets rather than fran- chising, it would probably have only a handful of outlets rather than the more than 700 it has today. Many franchisors even admit that they would have rather grown through company-owned stores but that the capital requirements needed to grow their firms dictated franchising. This sentiment is affirmed by an executive at Hardee’s, who wrote the following about the growth of this fast- food chain:

Hardee’s would have preferred not to have franchised a single location. We prefer company-owned locations. But due to the heavy capital investment required, we could only expand company-owned locations to a certain degree—from there we had to stop. Each operation represents an investment in excess of $100,000; there- fore, we entered the franchise business.14

Second, a concept called agency theory argues that for organizations with multiple units (such as restaurant chains), it is more effective for the units to be run by franchisees than by managers who run company-owned stores. The theory is that managers, because they are usually paid a salary, may not be as committed to the success of their individual units as franchisees, who are in effect the owners of the units they manage.15

The primary disadvantage of franchising is that an organization allows others to profit from its trademark and business model. For example, each time Comfort Keepers sells a franchise it receives a $32,500 initial franchise fee and an ongoing royalty, which is 3 to 4 percent of gross sales. However, if Comfort Keepers had provided its service itself in the same location, it would be getting 100 percent of the gross sales and net profits from the location. This is the main reason some organizations that are perfectly suitable for franchis- ing grow through company-owned stores rather than franchising. An example is Darden Restaurants Inc., the parent company of Olive Garden, Bahama Breeze, LongHorn Steakhouse, The Capital Grille, Seasons 52, Eddie V’s, and Yard House. With over 1,500 locations, the firm employs more than 150,000 people and serves more than 320 million meals a year.16 All of Darden’s units are company owned. Starbucks is another company that is suitable for fran- chising but has only a small number of franchise outlets. We provide a more complete list of the advantages and disadvantages of franchising as a means of business expansion in Table 15.3.

When a company decides to investigate franchising as a means of growth, it should ensure that it and its product or service meet several criteria. Businesses that fail to satisfy these criteria are less likely to make effective franchise systems. Before deciding to franchise, a firm should consider the following:

The uniqueness of its product or service: The business’s product or service should be unique along some dimension that creates value for customers. Businesses with a unique product or service typically have the best potential to expand.

The consistent profitability of the firm: The business should be con- sistently profitable, and the future profitability of the business should be fairly easy to predict. When developing a franchise system, a company should have several prototype outlets up and running to test and ensure the viability of the business idea. Remember, a franchisee is supposed to be buying a way of doing business (in the form of a business model) that is “proven”—at least to a certain extent. Franchisors that learn how to run their businesses through the trial and error of their franchisees have typically franchised their businesses prematurely (especially from the franchisees’ point of view).

The firm’s year-round profitability: The business should be profitable year-round, not only during specific seasons. For example, a lawn and garden care franchise in North Dakota should be set up to provide the franchisee supplemental products and services to sell during off-peak seasons. Otherwise, owning the franchise may not be an attractive form of business ownership. This issue is particularly problematic for some ice cream and smoothie franchises in northern states, which experience a sig- nificant decline in sales during winter months.

The degree of refinement of the firm’s business systems: The sys- tems and procedures for operating the business should be polished and the procedures documented in written form. The systems and procedures should also be fairly easy to teach to qualified candidates.

The clarity of the business proposition: The business proposition should be crystal clear so that prospective franchisees fully understand the business proposition to which they are committing. The relationship between the franchisor and the franchisee should be completely open, and communication between them should be candid.

After determining that the firm satisfies these criteria, the entrepreneur should step back and review all the alternatives for business expansion. No single form of business expansion is the best under all circumstances. For any entrepreneurial venture, the best form of expansion is the one that increases the likelihood that the venture will reach its objectives.

One franchise organization that started fast but is now faltering is Curves International, as depicted in this chapter’s “What Went Wrong?” feature.

Source: Barringer Bruce R, Ireland R Duane (2015), Entrepreneurship: successfully launching new ventures, Pearson; 5th edition.

One thought on “Advantages and disadvantages of Franchise

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