The Franchise Business Model; a win-win relationship

The franchise business model is one of the most amazing models used by business owners. They use it to expand their businesses using other people‘s money and efforts. But it doesn’t only benefit the business owner. The beauty of the model is in making a win-win situation between the mother company (franchisor) and the individual investor entrepreneurs (franchisees).

A franchise enables you, the investor or franchisee, to operate a business even when you don’t have enough experience in an industry or even in business ownership. This win-win relationship gives reason to a successful business owner to support you for his or her benefit. The franchisor who has years of experience in the business, have the best reason to help you become successful because of its success.

But how exactly the franchise business model makes such a relationship? We have discussed it in this article.

Financial relationship in the franchise business model

In the franchise business model, two parties enter into a win-win relationship together. This win-win situation is mostly due to their mutual financial benefit of working together.

Let’s review the most common financial arrangements between them to understand how exactly it works. We have explained what we usually see in a typical franchise agreement:

Costs

Let’s consider how both the franchisor and the franchisee benefit from the financial relationship with each other. We can divide their financial relationship to two different stages: Initial investments and ongoing expenses.

Initial Investments

The initial investment of one unit of a franchise includes a franchise fee and other establishment costs. The franchise fee is usually between $30k to $50k. The franchisee pays this fee directly to the franchisor. But, other than franchise fee, the franchisee will have additional costs anyone would have in establishing a new business.

These costs include but are not limited to:

• the cost of buying equipment
• leasehold improvements
• getting licenses
• buying initial inventory
• paying utility deposits
• establishing the legal entity, and similar expenses.

Other than that, the franchisee will have to spend on marketing, including the grand opening expenses.

Franchisor’s benefit

A good franchisor is not looking for financial gains at this stage. Most of the time, good franchisors almost spend all the franchise fees they get from a new franchisee on the marketing cost of bringing them in! Instead, they are looking for their long term benefit. 

What we just mentioned is one sign of the right franchise. As mentioned in this article, there could be red flags when you want to buy a franchise. One of these red flags is having a very higher than industry norm franchise fee in a franchise.

Franchisee’s benefit

You might think that the franchisees even have to pay more when starting a franchise business compared to starting an independent one. However, the savings of using a proven franchise business model could even save you money when you don’t expect it!

When starting a new independent business, you might not consider several items considerable costs. However, based on experience small business owners, they might turn to be significant.

Some examples of these costs include but are not limited to:

• making a website for the business
• selecting an appropriate name and deciding about the branding of the company
• designing the marketing material
• finding the best specifications that match your business model
• finding the best target market your business wants to serve
• trying different marketing venues to decide on the best marketing strategy for the business
• finding the best product or service that fits the target market and so many other similar expenses.

These are the expenses that a new franchisee saves when they choose to buy a franchise compared to starting their own independent business.

So, even though it seems that you need to pay more when buying a franchise, you may also save money when you decide to start a good franchise business.

Ongoing expenses

After the initial stage, the story will be different. The franchisee will have to pay the franchisor, an ongoing fee, which is called “Royalty.” 

Royalty could be in any of these different formats:

• a percentage of the gross sales of a franchisee’s business
• fixed monthly fee
• a portion of the net profit of the company

While using a percentage of gross sales is very common, using the net profit as base rarely happens due to complications of verifying the net profit in small businesses.

Other than that franchisees, most of the time, have to pay a national or regional marketing fee. Franchisor gathers that money from all franchisees and spend it to the benefit of the franchise.

Although it seems that the franchisor is the only one benefiting in this stage, in reality, again, it could be a win-win relationship.

Franchisor’s benefit

Franchisor’s main advantage, as explained in the above, would be gathering the royalty fees, which is the main reason it started the franchise from the beginning. 

Franchisee’s benefit

The franchisor is not the only one benefiting at this stage. In a credible well-established franchise, different items could benefit a franchisee when compared to an independent business. Examples of these benefits would be: 

• the increase in sales that a franchisee gets because of the brand name of the franchise
•  using the successful business model of the franchise
•  utilizing the benefit of negotiation power of a franchise in buying the raw material and equipment
• getting better terms in different contracts
• being in a better situation when leasing a location
•  using the marketing power of the franchise using the added marketing budgets of different franchisees
• using the result of the research and development of the franchisor

The above are only some examples of what a good franchisor provides for its franchisees. If you can add the benefits of all those items, you understand why a lot of experienced business owners still prefer to be part of a franchise instead of being independent business owners.

Conclusion

In this article, we tried to explained why the financial relationship of a franchisor and franchisee, as defined in the franchise business model, could be a win-win situation for both of them. Through the website, we are trying to help you understand how you can recognize if a franchise has the backbones of being a robust and well-established franchise and how to find a good one if you are looking to invest in one. Read more articles to educate yourself more about the specifications of a good franchise.