Franchising is an important part of the American business landscape, comprising about 5% of businesses in America and generating about 8% of all private sector jobs. Franchises like Dunkin Donuts have made huge profits for their private equity investors. They offer grass roots entrepreneurs who lack access to significant capital a chance to get into business for themselves. The franchising model at its best combines a potent mix of capital, brand and initiative. Just as important, it has a lot to teach non-franchised companies-- about incentives for employee performance and how to rationalize, replicate and scale a business model.
Here is the way franchising basically works. A firm that has an established product or service (the franchisor) enters into a contractual relationship with other businesses (the franchisees). Franchisees operate under the franchisor's trade name and guidance--in exchange for a fee.
The contract defines a separation of responsibilities between franchisor and franchisee. The franchisor provides a business model and marketing strategy that specifies:
- Target customer segments
- The product/service menu
- The positioning of the brand (price/quality/value)
- The expected customer experience
The franchisor often also provides advertising, marketing, training and support to help franchisees execute the strategy.
The franchisee is responsible for providing the physical environment (facility, warehouse, equipment etc.), human resources and management of daily operations. A franchisor’s success ultimately depends on the success of its franchisees and vice versa.
In recent years the franchise model has changed, in accord with the overall growth of the services economy. The traditional franchising model was often a way for a product manufacturer or distributor to create or expand a distribution channel. Franchising has expanded from the product-oriented model (for example, fast food) to include more service-dependent businesses like auto maintenance and hotels. The key to the newer model, often called “business format” franchises, is the franchisor’s ability to rationalize complex businesses into repeatable processes that franchisees can execute. Franchisees for their part are expected to use initiative and judgment –to create a valuable customer experience that is consistent with the franchisor-defined model.
Other key aspects of the franchise operating model include:
- Franchisees are typically required to continue to fund advertising even when sales are down. This tends to smooth out the up-and-down spikes in business.
- Franchisees are required by contract to provide a customer experience that is consistent and recognizable by customers.
Franchising is a dynamic business model that offers great opportunities to entrepreneurs--large and small. It also offers lessons to traditional businesses—a point I will turn to in the second part of this article.
For more helpful business advice from Newport partners, see our ebook, "5 Steps to Survive No Man's Land."
About the Author
Mark Street’s executive experience includes extensive background in an industry that offers great opportunity to entrepreneurs: franchising. Contact or learn more about Mark here.
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