The Franchise Business Model

101 – Introduction and How Does

It Work
Articles & Insights November 30, 2018 9 min to read

The franchise business model is not new. In fact, franchising is an

ancient distribution model that dates back to the middle ages and
ancient China. “In the middle ages, the local titled landowner
would grant rights to the peasants or serfs, probably for a
consideration, to hunt, hold markets or fairs or otherwise conduct
business on his domain. With the rights came rules and these
rules became part of European Common Law, explained
FranChoice.

Modern-day franchising is believed to have started with Benjamin

Franklin, who in 1731 entered into the first franchise agreement
with Thomas Whitmarsh to provide printing services in
Charlestown, South Carolina. In the early 1850s, Isaac M. Singer
again looked to the franchising model to distribute the Singer
sewing machines. But, it would be another century after Singer
before franchising would become truly popular, thanks to Ray
Kroc and his discovery of the McDonalds hamburger stand.
Today, there are thousands of franchises across hundreds of
industries and sectors. As of 2018, the franchise industry
employed 21 million people and generated $2.3 trillion of
economic activity, according to a U.S. government report.

Franchising has contributed greatly to the overall US economy

and has proven to be a lucrative avenue for those who seek both
freedom and financial stability. But what exactly is a franchise?
Are there different types of franchise models? How does it all
work? And is owning a franchise right for you?

What is a Franchise? Understanding the

Franchise Business Model and How Does It
Work
A franchise is a type of business that is operated by an
individual(s) known as a franchisee using the trademark,
branding and business model of a franchisor. In this business
model, there is a legal and commercial relationship between the
owner of the company (the franchisor) and the individual (the
franchisee). In other words, the franchisee is licensed to use the
franchisor’s trade name and operating systems.

In exchange for the rights to use the franchisor’s business model

— to sell the product or service and be provided with training,
support and operational instructions — the franchisee pays a
franchisee fee (known as a royalty) to the franchisor. The
franchisee must also sign a contract (franchise agreement)
agreeing to operate in accordance with the terms specified in the
contract.

A franchise essentially acts as an individual branch of the

franchise company.
Should You Buy a Franchise or Start a Business From
Scratch?

The Franchisor and Franchisee Relationship

The Franchisor is the parent company that sells the rights to
franchise their brand to prospective franchisees. The franchisor is
the one who has developed the company, brand and operating
systems. Upon the decision to franchise their business, the
franchisor offers franchisees the rights to their proven business
model, recognizable trademark, established business systems,
and their training and support.

The Franchisee is the individual who buys the rights to sell the
products or services and utilize the proven and established
business systems mentioned above. Although the franchisee is, in
essence, buying a pre-established business, franchisees must
work hard in order to gain loyalty in their market, attract talent
and grow their franchise business. After all, it is the franchisee
that runs the day to day business.

The franchisor/franchisee relationship should be one built upon

mutual respect, understanding, and support. Of course, as with
all relationships, no two are the same. Although relationships
between franchisee and franchisor will differ from brand to brand,
one thing always remains the same: the franchisee/franchisor
relationship matters.

What Franchisees Can Expect from Their

Franchisor
The FDD

When a franchisee is serious about a franchise opportunity, the

franchisor will share their Franchise Disclosure Document (FDD),
which holds imperative information about bankruptcies, various
fees, franchisee obligations, and more.

Financing Options

For interested and serious buyers, some franchisors offer

financing programs that can assist franchisees in finding a loan
servicer or alternative methods of payment.

Location Assistance

If the franchise requires a physical location, usually, the

franchisor will assist in site selection as well as finding a local
contractor to construct the approved architecture.

Training and Operational Guidance

Franchisors also provide franchisees with an operating manual

and in-person or online training to understand how the business
runs. The operating manual includes all of the roles of employees,
performance standards, management operations, and other
specifications. The training tends to take place either at the
franchisor’s corporate headquarters or a combination of online
training and in-person training.

Marketing and Advertising

Franchisors also supply their franchisees with marketing and

advertising. This could be through television and radio ads or
through social media and email campaigns. Franchisees are
usually charged a marketing fee to cover this cost. Some
franchisors also lend administrative services for their franchisees,
like human resources and accounting services.

Support

As a franchisee gets their business up and running there are

bound to be questions and concerns that arise. The franchisor will
provide varying levels of support throughout the life of the
franchise agreement. Not to mention, franchisee also have access
to an entire network of fellow franchisees, who may be able to
offer advice or offer you a solution to a common problem.

The Pros and Cons of Franchising: Is it Right for You?

Types of Franchising – Two Primary Franchise
Business Models
There are two primary franchise business models that exist
today: The Product Distribution Franchise Model and The Business
Format Franchise Model.

Product Distribution Franchise – In the product distribution

franchise model the franchisor manufacturers the product and the
franchisee sells the product. This relationship is similar to the
supplier-dealer relationship with a few differences. One major
difference is that in the franchise relationship the franchisee may
distribute the products on an exclusive or semi-exclusive basis
whereas a supplier-dealer relationship may allow the dealer to
sell several different brands at once. Examples of product
distribution franchises include Coca-Cola, John Deere, and Ford
Motor Company.

Business Format Franchise – The Business Format Franchise is

the most common franchise model. In this model, the franchise is
allowed to use the brand and trade name of the franchisor, like in
the product distribution model, but they are also granted access
to the product distribution model. Most of the franchises that
immediately comet o mind, like Wendy’s, Dunkin Donuts, or
McDonald’s are business format franchises.

Different Types of Franchise Ownership

Single Unit Franchisee – When a franchisee purchases their
first franchise they are considered a single-unit franchisee. This is
the most common form of franchise ownership.

Multi-Unit Franchisee – If a franchisee finds success with their

first franchise venture they may choose to open up a second,
third or even fourth franchise from the same franchisor. When a
franchisee owns more than one franchise unit they are considered
to be a multi-unit owner.

Multi-Unit Area Developers – Multi-unit area developers are

similar to multi-unit franchisees except that they agree, up front,
to develop a certain number of franchise locations within a
specified time period and area. This approach is best for
franchisees who are looking for market exclusivity and have the
resources to secure that exclusivity with the franchisor.
Master Franchisee – A master franchisee is very similar to a
multi-unit area developer in that they are obligated to open a
certain number of locations in a specified time period and area.
The difference is that the master franchisee is also able, and
sometimes obligated, to sell franchises to other prospective
franchisees. The master franchisee then acts as a middleman for
the franchisee and the franchise company.

Licensing vs. Franchising

One common area of confusion for prospective franchisees is
understanding the difference between franchising and licensing.

Licensing is a broad term that businesses use for contracting

purposes. Licensing gives the licensee a right to operate in
cooperation with a brand, gaining access to the brand’s
intellectual property, brand, design, and business programs. In
exchange, the licensee pays royalty fees to the licensor. The
licensor may have a say in how the intellectual property is used
but not how the licensee operates their business. A licensor will
grant a licensee the right to use their intellectual property but the
licensor will not provide support or training or exert any control
over how the licensee uses that intellectual property.

A franchise, on the other hand, is a legal and commercial

relationship between the owner of a company (the franchisor)
and an individual (the franchisee) who is starting a branch of that
business using the business’ trademark logos and business
model. Essentially, a franchise is an independent branch of the
franchise company. The franchisee sells the product or service
that the franchisor supplies.

What’s the Difference Between Licensing and Franchising?

Learn More!

Franchise Opportunity vs. Business

Opportunity
Another common area of confusion is franchise opportunity
versus business opportunity. While at first glance they may sound
very similar, there are some major differences. For instance, a
franchise opportunity includes the licensing of trademark rights,
offers robust training and operational assistance throughout the
life of the contract, and can often cost more than a business
opportunity due to the ongoing required fees.

While all business opportunities are different and can be hard to

define, the main difference is that typically when someone
pursues a business opportunity they are unlikely to receive the
same level of support, training or guidance that a franchisee
receives from their franchisor.

43 Common Franchise Terms You Need to Know!

Not All Franchises are Created Equal

There are thousands of franchise opportunities for eager
entrepreneurs who see the appeal in the franchising model.
However, not all franchises are smart investments. That’s why it’s
important for prospective franchisees to research the
opportunities they are interested in.

To help prospective buyers find the best opportunities, each year,

Franchise Business Review surveys thousands of franchisees
across hundreds of brands. Based on this research we are able to
determine the best franchise opportunities on the market today
based 100% on franchisee satisfaction. Details on this year’s top-
rated franchise brands can be found on our Top 200 list.