People Innovation Excellence

Franchises 101

by Deva P. Setiawan S.T., M.M.

There are three basic forms of business ownership: a sole proprietorship, partnership, and corporation. A franchise is an alternative as a special form of business ownership. A franchise can be formed as a sole proprietorship, a partnership, or a corporation.

A franchise agreement is an arrangement whereby someone with a good idea for a business (the franchisor) sells the right to use the business name and sell a product or service (the franchise) to others (the franchisee) in a given territory.

Some people, uncomfortable with the idea of starting their own business from scratch,  would rather join a business with a proven track record through a franchise agreement. Some of the best-known franchises are McDonald’s, Holiday Inn, 7-Eleven, Alfamart, Indomaret, etc.

The popular businesses for franchising are restaurants (fast food and full service), gas stations with convenience stores, retail stores, financial services, health clubs, hotels and motels, automotive parts, and service centers.

Advantages of franchises are:

  • management and marketing assistance: better change to success compare with a scratch business start-up, franchisors provide an establish product to sell, help choosing a location, give assistance in all phases of promotion and operation, intensive training.
  • personal ownership: you are still your own boss, although you must follow more rules, regulations, and procedures than with your own privately owned business.
  • nationally recognized name
  • financial advice and assistance: franchisors help for major problems for small-business owners, i.e. arranging financing and learning to keep good records.
  • lower failure rate: the failure rate for franchises has been lower than that of other business ventures. However, franchising has growth rapidly that many weak franchises have entered the field, so you need to be careful and invest wisely.

Disadvantages of franchises are:

  • large start-up costs: demand a fee for the rights to the franchise.
  • shared profit: the franchisor often demands either a large share of the profits in addition to the start-up fees or a percentage commision based on sales, not profit, before taxes and other expences (it is called a royalty).
  • management regulation: management ‘assistance’ has a way of becoming managerial orders, directives, and limitations.
  • coattail effects: what happens to your franchise if fellow franchisees fail? The actions of other franchises have an impact on your future growth and profitability. Due to this coattail effects, you could be forced out of the business even if your particular franchise has been profitable.
  • restrictions on selling: many franchisees face a restrictions on the resale of their franchises. To control quality, franchisors often insist on approving the new owner, who must meet their standards.
  • fraudulent franchisors: many small company as franchisors delivered little or nothing of what they promised. You should get what you pay for.

Reference: William G. Nickels, et al (2016). Understanding Business. Eleventh edition. McGraw-Hill.

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