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Franchisee vs. Franchisor: Definitions, Differences, and More!
Written by: Parth Parth
Last Updated by
Facundo Bermudez: July 8, 2022
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Franchisee vs. Franchisor
Franchisee vs Franchisor: What is the difference between a franchisee and a franchisor? What is a franchisee? What is a franchisor? If you are thinking about any of these questions, look no further and read on.
Before we get into that, let us try to understand what a franchise is and why companies franchise. Basically, when a company is growing and corporate does not want to handle the complete day-to-day of the company, they franchise the company. What this means is that someone else will use their own real estate and physical equipment and rent the company’s intellectual property. The company or business renting out the intellectual property is called the franchisor. The person or business that rents the company’s rights is called the franchisee.
The franchisor can expand their business beyond just a little local area to nationwide, and potentially international in a very capital efficient manner. So imagine, I’m in Miami Beach and I have a Latin food business, one restaurant is doing $100,000, and the other one’s doing $200,000. I have the opportunity to open up more restaurants, but it’s going to cost me around $300,000 to $450,000 to open up. The alternative to that is franchising, where I can have entrepreneurs open up Latin restaurants throughout the United States and attend to this growing U.S. demographic.
Franchisor
In franchising, the franchisor benefits because it does not have to use its own capital. It’s actually the franchisee who’s, paying a franchise fee, as well as ongoing royalties for me for the brand, the technology system, and everything that the franchisor has built. As I have a profitable business model here in Miami, just with these two restaurants, there is the potential to expand to hundreds of restaurants throughout the United States, and then internationally.
Franchising
Franchising allows you to expand your business in a very profitable, high-margin way where we see franchisors with profit margins of 30%, 40%, and even more. And that can happen quickly.
That said, the franchisor should be more careful, cautious, and responsible with it as there have been a lot of franchisors that go from 2 to 100, 2 to 200, and have major issues. Depending upon the case, it’s better and more responsible to go 2 to 5, 5 to 20. On a yearly basis, the franchisor is growing, but it is not having crazy growth. Also, the growth is more incentivized by the ongoing royalty collected than the franchise fee that it collects for every franchise sold.
The franchisor, then, gives up basically most of the control over the restaurant. Yes, the franchisee has to abide by the rules that the franchisor will set, but the day-to-day is no longer looked after by the franchisor or its affiliates, and it is in the hands of the franchisee. This is different from affiliate-owned stores or licensed stores, where the company owns everything and the “store owner” is basically a salaried or commission-compensated employee of the company. This is good for the franchisor as a company can definitely not manage stores on a level like a lot of franchises have – it is simply not feasible for one company or even multiple satellite offices to manage upwards of 300 or sometimes 30,000 stores.
What do franchisors have to provide?
In many cases, franchisors provide initial training and ongoing support to help their franchisees cultivate a successful business. Some franchisors also offer helpful tools to ensure the long-term success of their franchisees, such as business management software, inventory management systems, and marketing materials.
Franchising brings with it several advantages and disadvantages for businesses wanting to expand into new areas and foreign markets. Their primary advantage is that the firms do not have to bear the development cost and risks of entering into a foreign market on their own, and the franchisee would typically be responsible for those costs and risks. Through franchising, a firm has the potential of building a global presence quickly and also at a low cost and risk. The primary disadvantage to the firm is quality control.
Once the day-to-day is in the hands of someone else, the firm does not have much control over how the final product will look. If the franchisee does not live up to the standards set by the franchisor, it can convey a very bad message about the firm’s brand name and the quality and consistency of the firm’s product. A customer who had a bad experience at one franchise may assume that they will have the same experience at other locations with other services and form a very negative view of the brand.
Franchisee
For franchisees, franchising is an attractive business model, where you do not have to reinvent the wheel, and you can minimize the time and money it takes to break even. Breakeven can happen anywhere from three months to two years plus, so the business never breaks even if you close it. Whereas with a franchise, it generally should happen sometime within the first 12 months. And depending on the business model and the pre-marketing that goes into it, it could happen as soon as the first month, second month, or the third month. Franchisees like the franchise model as they don’t really have to learn from their own mistakes, saving time, and money. Those are two reasons again why entrepreneurs like the franchise system.
The franchisee benefits massively from the franchising system, as they get established brand recognition and standardized products. Suppose there is a town where the closest McDonald’s is 30 minutes away in the next town over. Now, you open a store in your own town and the people can just come to your store. Let’s think about the benefits: you get to manage your own store and be your own boss, people will support your local business not only because it is convenient for them, but you also benefit from McDonald’s brands’ recognition, and much more.
Requirements
Let’s talk about what you give up in exchange for this. Remember, it is not bad to give up these things – you just need to decide if they are right for you. When you rent the brand or its intellectual property, you have to pay an ongoing royalty fee to the franchisor – this might be based on gross sales weekly, monthly, yearly, or things like the number of units sold. You are also required to usually pay an advertising fee to the franchisor, as well as use some money to advertise locally in your area. Remember, all of these trade-offs do also come at the benefit of having a possibly established customer base and benefiting from that brand recognition.
Franchisee
Three important payments are made to a franchisor: (a) a royalty for the trademark, (b) reimbursement for the training and advisory services given to the franchisee, and (c) a percentage of the individual business unit’s sales. These three fees may be combined in a single ‘management’ fee.
Franchisees can almost make money selling their franchises. Once they have put in the work to start a store, or even better a chain of stores for a particular company, there are going to be people wanting to buy it and grow it for themselves. This is an option for people that might want to change business, retire, or just cash out for whatever reason they see fit. If you choose the right franchise, cultivate your customer base right, and build a strong presence for your store in the area, the franchise can sell for a lot of money. Sometimes upwards of millions of dollars, depending upon how many stores you have and how much the revenue and cash flow for them is.
A franchisee also benefits from having an established support network of other franchisees. They can then rely on each other for support. Also, because the franchisor probably does not have as many stores as the franchisee network does or any company-owned stores at all, it might not be able to provide the necessary technical guidance or knowledge of certain things that you will only know if you operate a store or operate a large chain of them. This is one of the biggest advantages over being a small business owner that is not franchised.
Franchisee Responsibilities
One of the biggest responsibilities that the franchisee takes on when they franchise a business is that they train employees and are responsible for maintaining company standards, as well as local laws and regulations and any other safety standards or laws that might exist. The franchisee manages the daily activities that go into keeping a franchise location operational – including opening the store, overseeing sales, and locking up at the end of the day. The success or failure of a specific location ultimately relies on and heavily impacts the franchisee.
Another benefit of being a franchisee is that with some franchises, no prior experience is required. As mentioned, the franchisor might train the franchisee and provide ongoing support for the business. Remember, most franchisors do not want to see their franchisees fail. Yes, they are removed from the day-to-day of the business, but a drop in quality or consistent bad experiences of customers are going to massively impact the franchisor too.
Franchisee Disadvantages
There are disadvantages for the franchisee too. Also, a disadvantage for the franchisee is that a franchise does not last forever. They usually have terms for how long they will last. And while it is very rare, it is possible that the franchisor just does not renew your franchise term after the period is over. In this case, you lose basically everything except the property if you own it. At that point, you just have to start from scratch if you still want to franchise with a company.
A huge disadvantage of franchising a company is that you lose creative control over your location. The franchisor typically specifies how they want their stores to look and feel in order for them to create a standardized experience for their customers. That said, some brands like Mellow Mushroom allow full creative control to franchisees.
This point is not so much of a disadvantage, but something you need to keep in mind: Do your due diligence. There are multiple lawsuits where the franchisee feels that the franchisors lied to them. In some cases, it is true.. That said, you, as a small business owner with just so much capital, are going to have a tough time fighting a lawsuit against a big company that has multiple costly lawyers on retainer. Doing your due diligence as a franchisee/prospective franchisee is always necessary because you do not want to be in trouble later.
Conclusion
The franchising model is perfect and has taken off a lot after World War II. Both parties derive some befit from it when done right. The franchisor gets to increase revenue earned from royalties and other fees and increase its brand recognition and market penetration. This only leads to more people wanting to franchise with them, increasing the cycle.
All this time, the franchisee gets to be the owner of their own business, possibly set their own hours, choose where they want to work, and, if done right, create a network of highly profitable stores that could support their family and multiple families in their local community.
Franchise royalty fees are on average 6.7% with an additional average marketing fee of 2%. However, not all franchise opportunities are the same – many franchise organizations are pioneering new models that challenge established structures.
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