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.
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:
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.
An effective business model has to focus on two dimensions: the people dimension and the financial dimension. The people dimension will allow you to build a product or service that is 10X better than existing ones and a solid brand. The financial dimension will help you develop proper distribution channels by identifying the people that are willing to pay for your product or service and make it financially sustainable in the long run.
Business model innovation is about increasing the success of an organization with existing products and technologies by crafting a compelling value proposition able to propel a new business model to scale up customers and create a lasting competitive advantage. And it all starts by mastering the key customers.
Digital and tech business models can be classified according to four levels of transformation into digitally-enabled, digitally-enhanced, tech or platform business models, and business platforms/ecosystems.
A digital business model might be defined as a model that leverages digital technologies to improve several aspects of an organization. From how the company acquires customers, to what product/service it provides. A digital business model is such when digital technology helps enhance its value proposition.
A tech business model is made of four main components: value model (value propositions, mission, vision), technological model (R&D management), distribution model (sales and marketingorganizational structure), and financial model (revenue modeling, cost structure, profitability and cash generation/management). Those elements coming together can serve as the basis to build a solid tech business model.
A platform business model generates value by enabling interactions between people, groups, and users by leveraging network effects. Platform business models usually comprise two sides: supply and demand. Kicking off the interactions between those two sides is one of the crucial elements for a platform business model success.
A Blockchain Business Model is made of four main components: Value Model (Core Philosophy, Core Value and Value Propositions for the key stakeholders), Blockchain Model (Protocol Rules, Network Shape and Applications Layer/Ecosystem), Distribution Model (the key channels amplifying the protocol and its communities), and the Economic Model (the dynamics through which protocol players make money). Those elements coming together can serve as the basis to build and analyze a solid Blockchain Business Model.
In an asymmetric businessmodel, the organization doesn’t monetize the user directly, but it leverages the data users provide coupled with technology, thus have a key customer pay to sustain the core asset. For example, Google makes money by leveraging users’ data, combined with its algorithms sold to advertisers for visibility.
In an asymmetric businessmodel, the organization doesn’t monetize the user directly, but it leverages the data users provide coupled with technology, thus having a key customer pay to sustain the core asset. For example, Google makes money by leveraging users’ data, combined with its algorithms sold to advertisers for visibility. This is how attention merchants make monetize their business models.
While the term has been coined by Andrew Lampitt, open-core is an evolution of open-source. Where a core part of the software/platform is offered for free, while on top of it are built premium features or add-ons, which get monetized by the corporation who developed the software/platform. An example of the GitLab open core model, where the hosted service is free and open, while the software is closed.
Cloud business models are all built on top of cloud computing, a concept that took over around 2006 when former Google’s CEO Eric Schmit mentioned it. Most cloud-based business models can be classified as IaaS (Infrastructure as a Service), PaaS (Platform as a Service), or SaaS (Software as a Service). While those models are primarily monetized via subscriptions, they are monetized via pay-as-you-go revenue models and hybrid models (subscriptions + pay-as-you-go).
Open source is licensed and usually developed and maintained by a community of independent developers. While the freemium is developed in-house. Thus the freemium give the company that developed it, full control over its distribution. In an open-source model, the for-profit company has to distribute its premium version per its open-source licensing model.
The freemium – unless the whole organization is aligned around it – is a growth strategy rather than a business model. A free service is provided to a majority of users, while a small percentage of those users convert into paying customers through the sales funnel. Free users will help spread the brand through word of mouth.
A freeterprise is a combination of free and enterprise where free professional accounts are driven into the funnel through the free product. As the opportunity is identified the company assigns the free account to a salesperson within the organization (inside sales or fields sales) to convert that into a B2B/enterprise account.
A marketplace is a platform where buyers and sellers interact and transact. The platform acts as a marketplace that will generate revenues in fees from one or all the parties involved in the transaction. Usually, marketplaces can be classified in several ways, like those selling services vs. products or those connecting buyers and sellers at B2B, B2C, or C2C level. And those marketplaces connecting two core players, or more.
B2B, which stands for business-to-business, is a process for selling products or services to other businesses. On the other hand, a B2C sells directly to its consumers.
A B2B2C is a particular kind of business model where a company, rather than accessing the consumer market directly, it does that via another business. Yet the final consumers will recognize the brand or the service provided by the B2B2C. The company offering the service might gain direct access to consumers over time.
Direct-to-consumer (D2C) is a business model where companies sell their products directly to the consumer without the assistance of a third-party wholesaler or retailer. In this way, the company can cut through intermediaries and increase its margins. However, to be successful the direct-to-consumers company needs to build its own distribution, which in the short term can be more expensive. Yet in the long-term creates a competitive advantage.
The C2C business model describes a market environment where one customer purchases from another on a third-party platform that may also handle the transaction. Under the C2C model, both the seller and the buyer are considered consumers. Customer to customer (C2C) is, therefore, a business model where consumers buy and sell directly between themselves. Consumer-to-consumer has become a prevalent business model especially as the web helped disintermediate various industries.
A retail business model follows a direct-to-consumer approach, also called B2C, where the company sells directly to final customers a processed/finished product. This implies a business model that is mostly local-based, it carries higher margins, but also higher costs and distribution risks.
The wholesale model is a selling model where wholesalers sell their products in bulk to a retailer at a discounted price. The retailer then on-sells the products to consumers at a higher price. In the wholesale model, a wholesaler sells products in bulk to retail outlets for onward sale. Occasionally, the wholesaler sells direct to the consumer, with supermarket giant Costco the most obvious example.
The term “crowdsourcing” was first coined by Wired Magazine editor Jeff Howe in a 2006 article titled Rise of Crowdsourcing. Though the practice has existed in some form or another for centuries, it rose to prominence when eCommerce, social media, and smartphone culture began to emerge. Crowdsourcing is the act of obtaining knowledge, goods, services, or opinions from a group of people. These people submit information via social media, smartphone apps, or dedicated crowdsourcing platforms.
In a franchained business model (a short-term chain, long-term franchise) model, the company deliberately launched its operations by keeping tight ownership on the main assets, while those are established, thus choosing a chain model. Once operations are running and established, the company divests its ownership and opts instead for a franchising model.
Businesses employing the brokerage business model make money via brokerage services. This means they are involved with the facilitation, negotiation, or arbitration of a transaction between a buyer and a seller. The brokerage business model involves a business connecting buyers with sellers to collect a commission on the resultant transaction. Therefore, acting as a middleman within a transaction.
Dropshipping is a retail business model where the dropshipper externalizes the manufacturing and logistics and focuses only on distribution and customer acquisition. Therefore, the dropshipper collects final customers’ sales orders, sending them over to third-party suppliers, who ship directly to those customers. In this way, through dropshipping, it is possible to run a business without operational costs and logistics management.
Gennaro is the creator of FourWeekMBA, which reached about four million business people, comprising C-level executives, investors, analysts, product managers, and aspiring digital entrepreneurs in 2022 alone | He is also Director of Sales for a high-tech scaleup in the AI Industry | In 2012, Gennaro earned an International MBA with emphasis on Corporate Finance and Business Strategy.
