Definition
In a financial context, a franchise refers to a legal and commercial relationship between the owner of a trademark, brand, or business model (franchisor) and an individual or company (franchisee) authorized to operate a business using the same brand. The franchisee pays an initial fee and ongoing royalties to the franchisor for the use of the brand and support services. This model allows the franchisee to sell a product or service that already has established brand recognition and operating systems.
Phonetic
The phonetics of the word “Franchise” is /ˈfranˌCHīz/.
Key Takeaways
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- Franchising is a business model that involves one business owner licensing trademarks and methods to an independent entrepreneur.
- It offers plenty of room for growth without the business owner having to manage multiple locations or outlets themselves.
- While it provides the franchisee with an established business model and brand, it also comes with strict rules and constraints set by the franchisor.
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Importance
The term franchise is essential in business/finance as it refers to a powerful business model whereby one party (the franchisor) grants another party (the franchisee) the right to operate under their established brand and business system. This setup offers several advantages: it provides the franchisee with a proven business format and strong brand reputation, reducing business risk and potentially accelerating profitability. Likewise, the franchisor benefits by expanding their brand presence and earning continuous royalty fees without making the same level of investment as creating and running new outlets independently. Thus, franchises play a substantial role in economic growth by encouraging entrepreneurship and generating employment opportunities.
Explanation
A franchise serves as a contractual agreement between two parties: the franchisor, who is the established business owner, and the franchisee, who is granted the rights to operate under the business’s trademark or trade name. This purpose is to allow the franchisee to capitalize on the established brand and business system of the franchisor. The franchise model benefits both parties – the franchisor can expand its business footprint without incurring the associated costs, and the franchisee gains access to a proven business model, ongoing support, and brand recognition.Franchising is used to enable rapid expansion of business. By attracting investors who use their capital to start branches of the business, a franchise allows the franchisor company to grow more quickly and at a lower capital cost than it would if it had to finance its own outlets. For the franchisee, the main uses include reducing the risk of running a business, as they are implementing an already successful business model. The franchisee also receives assistance with crucial aspects like strategic planning, marketing, and operational efficiency from the franchisor. This alliances expand competitive power as well for both parties.
Examples
1. McDonald’s: It is perhaps the world’s most recognized fast food restaurant and one of the best examples of a franchise. Anyone interested in owning a McDonald’s pays an initial franchise fee, invests in the construction and equipment costs, and then pays ongoing royalties and rent to the corporation. In return, the franchisee gets the right to operate under the McDonald’s brand, with its operating system and ongoing support.2. 7-Eleven: This convenient store chain operates as a franchise across dozens of countries worldwide. Franchisees get the licenses to use the 7-Eleven system, trademark, and equipment, contributing to the replication of the successful central business model. 3. Marriott Hotels: These are also operated under franchise agreements. An individual or a company can own the hotel property and then pay Marriott to use their brand, their reservation system, and get operational support from them. This spreads the Marriott brand and service style across the world while allowing property owners to benefit from the company’s respected reputation and customer base.
Frequently Asked Questions(FAQ)
What is a Franchise?
A franchise is a type of license that a party (franchisee) purchases to allow them to have access to a business’s (franchisor) proprietary knowledge, processes and trademarks, enabling the party to sell a product or service under the business’s name.
How is a Franchise Established?
A franchise is established through a contractual relationship between the franchisor and franchisee. The franchisor provides their brand, operational model and required support and, in turn, the franchisee pays certain fees and agrees to comply with specific rules to maintain the standard of the brand.
What Benefits Does a Franchise Offer?
Franchises offer numerous benefits such as brand recognition, established operational processes, ongoing support and decreased risk of failure, which makes it a popular choice among entrepreneurs.
What are the Potential Risks of Buying a Franchise?
The potential risks of buying a franchise include the high initial cost, ongoing franchise fees, limited control, dependency on the franchisor, long-term commitment, and difficulties in selling it later on.
What is a Franchise Agreement?
A franchise agreement is a legal document between a franchisor and franchisee outlining the terms and conditions of the franchise relationship, the obligations of each party and the procedures for conflict resolution.
What are Some Common Types of Franchises?
Common types of franchises include fast food restaurants, convenience stores, hair salons, cleaning services, health and fitness centers, and real estate agencies.
What are Franchisee Fees?
Franchise fees are the costs that a potential franchisee pays up front to operate the franchise. It also includes royalties on sales the franchisee has to pay to the franchisor.
How do Franchisors Make Money?
Franchisors primarily make money by charging the franchisee an initial start-up fee as well as ongoing royalties. They can also earn by selling supplies directly to their franchisees.
Related Finance Terms
- Franchise Fee
- Royalty Payments
- Franchise Agreement
- Franchisee
- Franchisor
Sources for More Information
- Entrepreneur Magazine – Franchises Section
- Federal Trade Commission – Franchise Advice
- International Franchise Association
- Investopedia – Franchise Definition
