Disadvantages Of Franchising For Franchisor And Franchisee

Some of the most successful companies in America operate under a franchise business model. But for every success story, there is an instance where franchising caused a less than optimal outcome. The franchisor may have to open four or five franchises to get the equivalent financial gain of operating one store themselves. Franchising also carries an inherent litigation risk and relatively high set-up costs. For the franchisee, the main disadvantages are reduced profit margins, restrictive regulations, and the potential for conflict resulting from power imbalances.

Aspect	Explanation
Disadvantages of Franchising	While the Franchising Business Model offers several advantages, it also comes with several disadvantages that potential franchisees should consider before entering into a franchise agreement. Here are some key drawbacks:
1. High Initial Costs	– High Franchise Fees: Franchisees often need to pay significant upfront fees to acquire the rights to a franchise, which can be a substantial financial burden. – Startup Costs: Establishing and setting up a franchise unit can be costly, including expenses for leasehold improvements, equipment, and inventory.
2. Ongoing Royalties	Franchisees are required to pay ongoing royalties to the franchisor, typically calculated as a percentage of their revenue. These royalties reduce the franchisee’s profitability and can be a long-term financial commitment.
3. Limited Autonomy	Franchisees have limited autonomy in decision-making. They must adhere to the franchisor’s rules, standards, and operating procedures, which can restrict their ability to adapt to local market conditions or innovate independently.
4. Standardization	Franchisors enforce strict standardization across their franchise network to maintain consistency in brand image and customer experience. While this consistency is an advantage, it can also limit the franchisee’s ability to differentiate their unit.
5. Dependence on Franchisor	The success of a franchise unit is closely tied to the performance and reputation of the franchisor. If the franchisor faces financial difficulties, legal issues, or reputational damage, it can negatively impact the franchisee’s business.
6. Franchise Agreement Terms	Franchise agreements often have long-term commitments, and breaking these agreements can result in financial penalties and legal consequences. Franchisees may find it challenging to exit a franchise without significant consequences.
7. Limited Territory Control	In some cases, franchisors may restrict the geographic area in which a franchisee can operate. This limitation can affect the growth potential of the franchise unit. Franchisees may also face competition from other franchisees within the same brand.
8. Royalty Increases	Franchisors may have the right to increase royalty percentages in the future. This can result in increased costs for franchisees and impact their profitability over time.
9. Marketing and Advertising	While franchisors often provide marketing and advertising support, franchisees are usually required to contribute to national or regional advertising funds. The effectiveness of these funds and the allocation of resources may not always align with a franchisee’s specific needs.
10. Limited Exit Options	Exiting a franchise can be challenging, as franchise agreements often limit the sale or transfer of the franchise unit. Franchisees may find it difficult to sell their business or recoup their investment when they decide to exit the franchise.
Conclusion	Despite these disadvantages, the Franchising Business Model can still be a successful and profitable venture for individuals who value the benefits it offers, such as brand recognition and operational support. Prospective franchisees should carefully evaluate the specific terms and conditions of a franchise agreement to make an informed decision.

Table of Contents

Franchising origin story

Some of the most well-known companies in the United States owe much of their success to franchising, including McDonald’s, Anytime Fitness, The UPS Store, Burger King, Ace Hardware, and 7-Eleven.

For every franchising success story, however, there is a franchising failure. Blockbuster franchises failed because the company CEO believed the business model was sustainable. Krispy Kreme’s foray into franchising also failed because the opening of new stores did not mirror the popularity of its products. What’s more, the company allowed too many franchisors to open in the same area, creating unnecessary competition and forcing some stores to close.

In this article, we’ll discuss some of the key disadvantages of franchising for both the franchisee and the franchisor.

Read Our Full Analysis Here: Franchising Business Models.

Disadvantages of franchising for the franchisor

Per-unit contribution

In a franchising agreement, it should first be noted that the franchisor does not profit from every dollar the franchisee makes. In other words, the revenue the franchisor collects from the franchisee is a fraction of what it could make owning and operating the franchise unit itself.

Assuming the franchise itself is profitable, the business may need to sell four or five franchises to realize the same financial again.

Litigation risk

Franchisors are also exposed to litigation. For better or worse, litigation is a part of American culture and so the risk of being sued must be treated with respect. McDonald’s being hit with a multimillion-dollar lawsuit over the temperature of its coffee is perhaps the most obvious example.

Litigation risk can be minimized to some extent by developing a rock-solid contractual agreement. These agreements help protect the franchisor against workplace injuries, customer “slip and fall” accidents, and employment liability around harassment, wrongful termination, and so forth.

Cost

Franchising is a relatively low-cost means of expansion, but this does not mean it is no-cost. Some of the major costs a franchisor can expect to meet include:

Business plan creation and financial analysis.
Developing a franchise operations manual with quality control documents, systems, and processes for the franchisee.
Marketing plans and other associated material.
Training employees on the franchising process.
Negotiating third-party vendor agreements on behalf of the franchisee.

Read Our Full Analysis Here: Franchising Business Models.

Disadvantages of franchising for the franchisee

Reduced margins

Many franchisees are required to pay ongoing royalties to the franchisor based on total gross sales. Furthermore, the franchisee may be required to pay regular advertising costs and a charge for training services.

This means profit margins will be negatively impacted.

Restrictive regulations

While the franchisee operates with some degree of autonomy, the scope of their decision-making is nonetheless limited by the franchise agreement.

Depending on the nature of the agreement, the franchisor has ultimate control over the business location, opening hours, pricing, signage, store layout, advertising, marketing, décor, and resale conditions.

Conflict

In any business arrangement, there is potential for conflict – particularly when one party is more powerful than the other.

In theory, the franchise agreement is used to clarify contentious issues. But in many cases, the franchisee does not have the financial clout to take the franchisor to court. Whether the disagreement is due to a lack of support or a simple clash of personalities, it is imperative that the franchisee understand the franchisor’s personality or management style before signing an agreement.

Case Studies

Drawbacks for Franchisors:

Litigation Costs for McDonald’s: McDonald’s has faced several high-profile lawsuits, including the famous “hot coffee” case, where a customer sued the company for injuries caused by hot coffee. These legal battles can be costly for the franchisor.
Quality Control Challenges for Subway: Subway, a global sandwich franchise, has struggled with maintaining consistent quality across its thousands of franchise locations. Instances of food safety violations and quality concerns have arisen, impacting the brand’s reputation.
Brand Damage for KFC: KFC faced a significant brand challenge in China when a supplier was found to be using excessive antibiotics in its chicken production. This incident not only harmed the brand but also resulted in a drop in sales for franchisees.
Market Saturation for Subway: Subway’s rapid expansion in the past led to oversaturation in some markets, causing franchisees to face increased competition and reduced profitability due to cannibalization of sales.

Drawbacks for Franchisees:

High Initial Costs for Subway: Subway franchisees often face substantial upfront costs, including franchise fees, equipment purchases, and leasehold improvements. These expenses can be financially burdensome.
Royalty Payments for McDonald’s: McDonald’s franchisees are required to pay royalties based on a percentage of their sales. These ongoing payments reduce the franchisees’ profit margins.
Dependency on the Franchisor for Tim Hortons: In 2014, Tim Hortons franchisees in Canada faced challenges when the franchisor, Restaurant Brands International, decided to cut certain benefits and increase supply chain costs. This move was met with resistance from franchisees who felt their profitability was at risk.
Limited Creativity for UPS Store: Franchisees of The UPS Store have limited flexibility when it comes to pricing and service offerings, as these are often dictated by the franchisor. This can hinder franchisees’ ability to adapt to local market conditions.
Termination Risk for Quiznos: Quiznos faced criticism when it initiated a large-scale termination of franchise agreements due to financial difficulties. Many franchisees lost their investments and livelihoods as a result.

Key Highlights:

Franchising Advantages and Disadvantages: Franchising offers a way for businesses to expand, but it comes with drawbacks. Franchisors may need multiple franchises to match the financial gains of operating one store themselves, while franchisees face reduced profit margins, restrictive regulations, and potential conflicts.
Franchising Success and Failures: Some renowned companies like McDonald’s, Anytime Fitness, and Burger King have thrived through franchising, but there are also instances of failure. Blockbuster and Krispy Kreme faced challenges due to unsustainable business models and oversaturation of stores.
Franchising Disadvantages for Franchisors:
- Per-unit Contribution: Franchisors receive only a fraction of the revenue generated by franchisees, making it necessary to sell multiple franchises to match their potential earnings.
- Litigation Risk: Franchisors are exposed to the risk of lawsuits, necessitating strong contractual agreements to mitigate workplace and liability issues.
- Costs: Franchising expansion involves expenses such as creating business plans, developing operational manuals, marketing, training, and negotiating vendor agreements.
Franchising Disadvantages for Franchisees:
- Reduced Margins: Franchisees often pay ongoing royalties and advertising costs, impacting their profit margins.
- Restrictive Regulations: Franchise agreements limit decision-making autonomy, controlling aspects like business location, pricing, and marketing.
- Conflict: Power imbalances can lead to conflicts, and franchisees may have limited recourse due to their financial constraints, making it crucial to understand the franchisor’s management style before entering an agreement.

Case Studies

Disadvantage of Franchising	Description	Implications and Considerations
Initial Franchise Fees	Franchisees often pay significant upfront fees to join.	High initial costs can be a barrier to entry for some potential franchisees.
Ongoing Royalty Fees	Franchisees are required to pay ongoing royalties.	Continuous financial obligations may affect profitability.
Lack of Full Control	Franchisees have limited control over business decisions.	Franchisees must adhere to the franchisor’s rules and guidelines.
Brand Image Dependency	The franchisee’s success is tied to the franchisor’s brand.	Negative publicity or brand issues can impact the franchisee’s reputation.
Uniformity and Compliance	Strict adherence to franchise standards is required.	Franchisees must conform to set procedures and may have limited flexibility.
Territory Restrictions	Franchisees may face territorial restrictions.	Limited geographic freedom can affect market expansion.
Marketing and Advertising	Franchisees contribute to a shared marketing fund.	Contributions may not always align with local marketing needs.
Limited Product Selection	Franchisees may have limited product or service offerings.	Inflexibility in product offerings can affect customer preferences.
Contractual Obligations	Franchise agreements involve legally binding contracts.	Breaking contracts can lead to penalties or legal consequences.
Exit Strategy Challenges	Exiting a franchise can be complex and costly.	Reselling a franchise unit may not guarantee a favorable return.
Competition with Other Franchisees	Franchisees may compete with nearby franchise units.	Over-saturation in a market can affect profitability.
Changing Industry Trends	Franchise models may struggle to adapt to evolving trends.	Staying competitive requires flexibility and innovation.

Related Frameworks, Models, or Concepts	Description	When to Apply
Franchising	Franchising is a business model in which a franchisor grants a franchisee the right to operate a business using its brand, products, and business model in exchange for ongoing fees and royalties. Franchising allows companies to expand their presence and reach new markets quickly by leveraging the resources, capital, and local expertise of franchisees. Franchisees benefit from access to a proven business concept, brand recognition, and support from the franchisor, while assuming the risks and responsibilities of operating their own business. Franchising offers a scalable and efficient way to grow a business and capitalize on market opportunities while minimizing capital investment and operational risks.	Apply Franchising as a growth strategy to expand market presence and reach new customers. Use it to leverage the resources and local expertise of franchisees to accelerate business growth, penetrate new markets, and increase brand awareness and market share. Implement Franchising models to capitalize on entrepreneurial talent and local market knowledge, mitigate expansion risks, and achieve economies of scale through standardized operations and centralized support services.
Franchise Agreement	A Franchise Agreement is a legally binding contract between a franchisor and a franchisee that outlines the rights, obligations, and responsibilities of both parties. The franchise agreement defines key terms and conditions related to the use of the franchisor’s brand, trademarks, and proprietary business systems, as well as the franchisee’s rights to operate the business and comply with operating standards and guidelines set by the franchisor. Franchise agreements typically cover areas such as franchise fees, royalties, territory rights, training and support, marketing requirements, and renewal and termination provisions.	Apply Franchise Agreement to establish clear expectations and terms between franchisors and franchisees. Use it to define the rights and obligations of both parties, protect intellectual property and brand integrity, establish operating standards and quality controls, and ensure compliance with legal and regulatory requirements. Implement franchise agreements to formalize the relationship between franchisors and franchisees, minimize disputes and conflicts, and facilitate effective communication and collaboration in franchise partnerships.
Franchise Disclosure Document (FDD)	The Franchise Disclosure Document (FDD) is a legal document that franchisors are required to provide to prospective franchisees in the United States. The FDD contains detailed information about the franchisor’s business, financial performance, legal history, and franchise offering, as well as key terms and conditions of the franchise agreement. The FDD helps prospective franchisees make informed investment decisions by providing transparency and disclosure of material information about the franchise opportunity, including risks and obligations associated with the investment.	Apply Franchise Disclosure Document (FDD) to provide prospective franchisees with comprehensive information about the franchise opportunity. Use it to disclose key aspects of the franchisor’s business, including financial performance, legal and regulatory compliance, territory rights, training and support, and fees and royalties, to enable prospective franchisees to assess the viability and suitability of the franchise investment. Implement FDD disclosure requirements to comply with franchising laws and regulations, build trust and transparency with prospective franchisees, and mitigate legal and reputational risks associated with franchise sales.
Franchisee Training and Support	Franchisee Training and Support encompass the programs, resources, and assistance provided by franchisors to franchisees to help them start, operate, and grow their franchised businesses successfully. Franchisee training programs typically cover areas such as business operations, sales and marketing, customer service, and financial management, and may include classroom instruction, on-the-job training, and online learning modules. Franchisee support services may include ongoing guidance, coaching, and mentoring from franchisor representatives, access to operational tools and resources, and assistance with site selection, lease negotiations, and business planning.	Apply Franchisee Training and Support to empower franchisees with the knowledge, skills, and resources needed to succeed in operating their franchised businesses. Use it to provide comprehensive training programs and support services that align with the franchisor’s brand standards and operating procedures, ensure consistent quality and customer experience across franchise locations, and foster a culture of collaboration and continuous improvement. Implement franchisee training and support initiatives to onboard new franchisees effectively, enhance operational efficiency and performance, and drive franchisee satisfaction and success.
Franchisee Selection and Recruitment	Franchisee Selection and Recruitment is the process of identifying, evaluating, and selecting qualified candidates to become franchisees in a franchised system. Franchisee recruitment involves marketing and advertising franchise opportunities, screening and qualifying prospective candidates, and conducting interviews and due diligence to assess their suitability and alignment with the franchisor’s brand values and business culture. Franchisee selection criteria may include factors such as industry experience, financial stability, entrepreneurial skills, and commitment to the franchise system’s standards and requirements.	Apply Franchisee Selection and Recruitment to attract and onboard qualified candidates who are a good fit for the franchised business. Use it to develop targeted marketing and advertising campaigns to reach prospective franchisees, establish criteria and benchmarks for evaluating candidate qualifications and suitability, and conduct thorough screening and due diligence processes to assess their background, skills, and alignment with the franchisor’s brand and values. Implement franchisee selection and recruitment strategies to build a network of high-performing franchisees, drive system growth and expansion, and enhance the overall quality and reputation of the franchise brand.
Franchisee Relationship Management	Franchisee Relationship Management involves nurturing and managing the relationship between franchisors and franchisees to foster collaboration, trust, and mutual success. Franchisee relationship management encompasses communication, support, and engagement initiatives designed to build strong and positive partnerships between franchisor and franchisee stakeholders. Key elements of franchisee relationship management include regular communication and feedback mechanisms, responsive support and assistance from franchisor representatives, and opportunities for franchisee involvement and input in decision-making processes and system improvements.	Apply Franchisee Relationship Management to cultivate positive and productive partnerships with franchisees. Use it to establish open lines of communication and dialogue between franchisors and franchisees, provide responsive support and assistance to address franchisee needs and concerns, and foster a culture of collaboration, trust, and mutual respect within the franchised system. Implement franchisee relationship management strategies to build long-term loyalty and commitment among franchisees, enhance system performance and profitability, and promote franchisee satisfaction and retention.
Master Franchising	Master Franchising is a franchising arrangement in which a master franchisee is granted the rights to develop and sub-franchise the franchisor’s brand and concept within a specified territory or region. Master franchisees act as intermediaries between the franchisor and sub-franchisees, assuming responsibility for recruiting, training, and supporting sub-franchisees, and overseeing the development and operations of franchise units within their territory. Master franchising allows franchisors to expand rapidly into new markets and territories by leveraging the local knowledge, resources, and capital of master franchisees.	Apply Master Franchising as a strategic expansion strategy to accelerate brand growth and market penetration. Use it to identify qualified master franchisees with the capacity and expertise to develop and manage multiple franchise units within a designated territory, negotiate master franchise agreements that outline rights, obligations, and performance expectations, and support master franchisees in recruiting, training, and supporting sub-franchisees to ensure consistent brand standards and quality across the master territory. Implement master franchising models to enter new markets and geographies, scale operations efficiently, and capitalize on local market opportunities and demand.
Franchise Operations Manual	A Franchise Operations Manual is a comprehensive document provided by franchisors to franchisees that outlines the standards, procedures, and guidelines for operating a franchised business. The franchise operations manual serves as a reference guide for franchisees, detailing key aspects of business operations, including product and service offerings, customer service standards, marketing and advertising requirements, financial management procedures, and compliance with legal and regulatory standards. The operations manual helps ensure consistency and uniformity in operations across franchise locations and facilitates training and ongoing support for franchisees.	Apply Franchise Operations Manual to establish standardized operating procedures and quality controls across franchise locations. Use it to document best practices, policies, and protocols for day-to-day business operations, provide guidance and reference materials for franchisee training and onboarding, and ensure compliance with brand standards, legal requirements, and industry regulations. Implement franchise operations manuals to promote operational excellence, maintain brand consistency and integrity, and support franchisee success and performance in delivering high-quality products and services to customers.
Franchise Marketing and Advertising	Franchise Marketing and Advertising involves promoting and marketing the franchisor’s brand, products, and services to drive customer awareness, engagement, and loyalty across franchise locations. Franchise marketing initiatives may include national or regional advertising campaigns, digital marketing and social media strategies, local marketing support for franchisees, and co-op marketing programs that leverage collective marketing resources and budgets from franchisor and franchisee stakeholders. Franchise marketing and advertising efforts aim to enhance brand visibility, attract new customers, and drive sales and revenue growth for franchise businesses.	Apply Franchise Marketing and Advertising to build brand awareness and drive customer acquisition and retention. Use it to develop integrated marketing strategies and campaigns that leverage the strengths and resources of franchisor and franchisee stakeholders, tailor marketing messages and promotions to local market preferences and demographics, and track and measure marketing performance and ROI to optimize marketing investments and outcomes. Implement franchise marketing and advertising programs to maximize brand exposure, increase customer traffic and sales, and strengthen the competitive position of franchise businesses in local markets.