disadvantages-of-franchising

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.

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.

Read Our Full Analysis Here: Franchising Business Models.

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