THE FRANCHISE BUSINESS MODEL

A franchise enables you, the investor or franchisee, to operate a business. You pay a franchise fee and you get a format or system developed by the company (franchisor), the right to use the franchisor’s name for a specific number of years and assistance. For example, the franchisor may provide you with help in finding a location for your outlet; initial training and an operating manual; and advice on management, marketing or personnel. The franchisor may provide support through periodic newsletters, a toll-free telephone number, a website or scheduled workshops or seminars.

Owning a franchise comes with defined costs, franchisor controls and contractual obligations.

Costs

In exchange for the right to use the franchisor’s name and benefit from the franchisor’s assistance, you will pay some or all of the following:

Initial Franchise Fee and Other Expenses

Your initial franchise fee will typically range from tens of thousands of dollars to several hundred thousand dollars and may be non-refundable. You may face significant costs to rent, build and equip an outlet and to buy initial inventory. You also may have to pay for operating licenses and insurance and a “grand opening” fee to the franchisor to promote your new outlet.

Continuing Royalty Payments

You may have to pay the franchisor royalties based on a percentage of your weekly or monthly gross income. Typically, you must pay royalties for the right to use the franchisor’s name, even if you are losing money. You may have to pay royalties for the duration of your franchise agreement even if the franchisor doesn’t provide the services it promised and even if you decide to terminate your franchisee agreement early.

Advertising Fees

You also may have to contribute to an advertising fund. Some portion of the advertising fees may be allocated to national advertising or to attract new franchise owners, rather than to promote your outlet.

Franchisor Controls

To ensure uniformity, franchisors usually control how franchisees conduct business. These controls may significantly restrict your ability to exercise your own business judgment. A franchisor may control:

Site Approval

Many franchisors retain the right to approve sites for their outlets, and may not approve a site you select. Some franchisors conduct extensive site studies as part of the approval process and a site they approve may be more likely to attract customers.

Design or Appearance Standards

Franchisors may impose design or appearance standards to ensure a uniform look among their outlets. Some franchisors require periodic renovations or design changes; complying with these requirements may increase your costs.

Restrictions on Goods and Services You Sell

Franchisors may restrict the goods and services you sell. For example, if you own a restaurant franchise, you may not be able to make any changes to your menu. If you own an automobile transmission repair franchise, you may not be able to perform other types of automotive work, like brake or electrical system repairs.

Restrictions on Method of Operation

Franchisors may require that you operate in a particular way. They may dictate hours; pre-approve signs, employee uniforms and advertisements; or demand that you use certain accounting or bookkeeping procedures. In some cases, a franchise advertising cooperative may require you to sell some goods or services at specific discounted prices, which may affect your profits. Or, the franchisor may require that you buy supplies only from an approved supplier, even if you can buy similar goods elsewhere for less.

Restrictions on Sales Area

A franchisor may limit your business to a specific location or sales territory. If you have an “exclusive” or “protected” territory, it may prevent the franchisor and other franchisees from opening competing outlets or serving customers in your territory, but it may not protect you from all competition by the franchisor. For example, the franchisor may have the right to offer the same goods or services in your sales area through its own website, catalogs, other retailers or competing outlets of a different company-owned franchise.

Contractual Obligations

Franchise contracts last only for the number of years stated in the contract. You can lose the right to your franchise if you don’t comply with the contract. You won’t have a right to renew unless the franchisor gives you that right.

Terminations

A franchisor can end your franchise agreement for a variety of reasons, including your failure to pay royalties or abide by performance standards and sales restrictions. Many franchise contracts will give you a chance to “cure” an occasional failure to comply (like making one late payment) but keep the right to terminate your franchise for other failures. If your franchise is terminated, you’re likely to lose your entire investment.

Renewals

Franchise agreements may run for as long as 20 years. Renewals are not automatic. At the end of the contract term, the franchisor may decline to renew or may offer a renewal that doesn’t have the same terms and conditions as your original contract. For example, the franchisor may raise the royalty payments, impose new design standards and sales restrictions, or reduce your territory. Any of these changes may result in higher costs, reduced profits or more competition from company-owned outlets or other franchisees.

Source: Federal Trade Commission