Franchising · 20 July 2015

Insight into the franchising business model

KFC is an example of one of the larger franchise businesses in the UK

Franchising provides a well trodden path for companies to develop and grow their business. In essence, it is a relationship between two contracting parties (1) the franchisor (who has developed a proven business format and systems which are operated under an established brand) and (2) the franchisee who is trained and licensed by the franchisor to use the brand and systems to run their own independent business under the terms of a franchise agreement.

Sometimes, there is an additional party (a master franchisee or developer) that has a licence from the franchisor to operate the business model, brand and systems over a certain specified geography. The master franchisee or developer may have the additional right to sub-franchise the business to individual or unit franchisees.

Franchising is an innovative business model since it allows a franchisor to grow their business quickly using the financial resources of a third party (the franchisee). Typically, a franchisee will (1) have to finance the set up and operation of their franchised business, (2) pay the franchisor an initial fee for the grant of the franchise and (3) pay ongoing fees (usually a fixed fee or a small percentage of the franchisee’s turnover) for the use of the brand and systems business model. In return, the franchisor will (1) provide initial and ongoing training to the franchisee on how to set up and run the business and (2) licence the franchisee to use the brand name and systems that have been developed by the franchisor.

There are many businesses that are franchised. These include major international brands such as McDonalds, Subway and KFC. In those types of retail based restaurant businesses, the franchisor will help the franchisee to identify suitable premises and fit them out in line with the requirements of the franchise and its brand standards. The franchisees will be responsible for the cost of acquiring the lease of suitable premises and fitting them out in line with the requirements of the franchisor. The franchisee will purchase the products they will be selling in their business (either directly from the franchisor or from a nominated supplier) and will be entitled to keep the profits that are made from operating the franchised business.

Franchising can extend to almost any type of business and a large proportion of franchises are not retail based since the service provided can be delivered remotely from the franchisee’s home or at the customer’s location. This means that the franchising business model is extremely flexible and there is almost no type of business or service that cannot be operated via a franchise model. However, as a general rule the more complex the underlying service that is provided, the more difficult it will generally be to find franchisees that have the requisite skills to operated the underlying business and/or provide the relevant service.

A franchisor will make a lessor return from each franchised unit than if it operated the business directly. However, it also does not have to (1) incur the cost of setting up the business (which can be considerable in the case of a retail outlet) or (2) run the financial risk that is associated with running an independent business. The beauty of franchising is that it will allow the franchisor to (1) grow quickly and at a limited cost and (2) focus on developing their systems and growing the business without the time and cost it would usually have to expend in running its own outlets. The negative of the business model is that the franchisor is effectively delegating the operation of its outlets to third parties so there will undoubtedly be some loss of control in the ultimate delivery although to a large degree this can be mitigated through (1) a well drafted franchise agreement and (2) recruiting franchisees that are well suited to delivering the end product and/or service.

 

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ABOUT THE EXPERT

Andrew Pena is a commercial litigator who has worked at well-known City practices. Having acted for major international companies and many recognisable high street brands, he now heads up Cubism Law’s franchise law practice.

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