Franchising Components
Types
of Franchises
Franchised businesses
fall into two different types of franchisor/franchisee relationships,
business format and product distribution.
Business
Format
In business format
franchising the franchisee is usually provided with a complete range
of goods and/or services, including product, trade names and
operating procedures. The franchisor often assists with almost
everything needed to start the business, including the location of
the business, the size and build-out, furnishings, initial and
on-going training, inventory and marketing. This complete package is
often referred to as a Turnkey operation. Click here for more
information on Turnkey franchises:
What is a Turnkey
Franchise?
Both retail product
(fast food, print and copy) and service franchises (house cleaning,
lawn maintenance) can be business format franchises.
Business format
franchising is the most common form of franchising in the U.S. When
people think of a franchise, whether it is a food, retail, service or
home based franchise, just about any brand name that is recognized is
a business format franchise.
Product
Distribution
Product or trade name
franchising involves more of a distribution arrangement (car
dealership) than a business format franchise. The franchisee obtains
the right to distribute a product manufactured by the franchisor. In
this type of relationship the distributor may sometimes offer other
products besides those of the franchisor.
Franchise
Arrangements
A franchisor may sell single units
and/or multiple locations. If a franchisee wishes to become a
multiple unit operator, they follow the franchisors process in
investigating whether this is a viable option for them. Franchisors
typically want franchisees to meet minimum standards and then
actively encourage expansion with those who own successful
operations. The primary determination of the number of units a
franchisee is allowed to operate is financial – a combination
of liquid capital and net worth. Following is a listing of the
types of franchise arrangements available:
- Single Unit Franchise
– Franchisee owns and operates one unit.
- Multi Unit Franchisee –
Franchisee owns and operates more than one unit of a franchise, most
often in the same geographic area.
- Area
Developer Franchisee – Franchisee owns a large
territory with the objective of subdividing and developing
individual franchise locations. The franchisor will sometimes
require the franchisee to open a certain number of units within a
specified time frame.
- Master Region or
Master Franchisee – The
Master Franchisee owns the right to a large area with the intention
of developing a number of units, also usually within a certain time
frame. The difference between an Area Developer and a Master
Franchisee is that the Master Franchisee also has the right, and in
some instances the obligation, to sell franchises within the
territory to other people.
How
do Franchisors Determine Territories?
Territories are usually mapped out by
the franchisor, most often using population density, median income
statistics, and/or statistics relevant to that particular industry.
These territories could be delineated by streets, cities, counties,
zip codes, area codes, state or region and will often be determined
by a combination of factors. The goal is for each territory to
contain an optimal number of potential customers as determined by the
experience of the franchisor.
Franchise
Fees (and other payments beyond initial
investment)
Franchising, based on it’s
framework and structure, has the franchisor providing certain
elements that are paid for by fees assessed on the franchisee.
Understanding the franchise fees and other related financial
considerations is important, as franchise ownership may require the
payment of a number of different fees. Following is a sampling of
the most common types of fees assessed by the franchisor:
Advertising Fees /
Marketing Fund
Some franchised businesses require
franchisees to make payments into an advertising or marketing fund.
Payment amounts can be a percentage of sales or a flat fee, paid
weekly, biweekly or monthly. This fund could be for national or local
advertising and some companies may require contributions to both.
Advertising money may be spent on TV, radio, print media or printed
materials, depending on the franchise, the age of the system, the
penetration of the franchise in a market or other considerations. The
franchisee may have input to where or how funds are spent, or the
decisions may be driven completely by the franchisor.
Audit Fee
If the franchisor requires financial
audits of the franchise location, the franchisee may have to pay for
the cost, especially if any irregularities are found. Audit fees are
common to most franchise agreements.
Franchise Fees
The franchise fee is the initial fee
paid to the franchisor to obtain the rights to the operating system
of the franchise. This fee typically covers such items as site
selection assistance, training, marketing materials and operations
manuals. This is usually a one-time fee payable upon signing of the
contract and is typically based on the number of units or territories
purchased or the size of the territory.
Product Fees
Some franchisors require that
franchisees purchase proprietary or general products from them. The
primary reason franchisors require specific product/equipment
purchases is to insure quality control and uniformity across the
system. All the details of required product/equipment purchases are
explained in the FDD and/or the franchise agreement.
Renewal Fee
Franchise agreements most often have
limited terms (5 or 10 years), and typically do not automatically
renew. When it is time to renew the franchise agreement, the
franchisor may require a fee be paid in order to renew the agreement.
Sometimes the renewal fee can be paid in the form of remodeling or
upgrades to the physical location of the franchise, but at a minimum
most franchisors require the franchisee to be in full compliance with
the operating system to qualify for renewal.
Royalty Fee
This
is a fee paid by franchisee to franchisor on a routine basis for the
duration of the contract agreement. Often calculated as a percentage
of gross sales, royalty fees can also be fixed amounts or may be
based on other factors. These royalties are paid in exchange for the
ongoing right to use the franchisor’s brand/trademark and
system. These fees enables the franchisor to offer such benefits as
ongoing support and training, research and development, and building
of the brand.
Territory
Fees
When
a franchisor allows a franchisee to purchase an additional or
non-standard territory, they may require a one-time fee for these
rights. This fee is similar to the initial franchise fee paid for
the initial territory.
Training Fees
Most
franchisors include initial training in the franchise fee. Additional
training, for franchisee or staff, may also be available and fees may
apply.
Transfer Fee
When
a franchisee sells his franchise, the franchisor may require the
payment of a transfer fee as a condition for transferring the
franchise agreement to the new owner (franchisee).
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