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Greater National Competitiveness Doesn’t Lead to More Entrepreneurship

May 7, 2013

Entrepreneurs who have developed a successful business often wonder if they should franchise as a way to expand their operations. Like any business model, franchising has its benefits and drawbacks.

Theres no way to know for sure whether franchising is right for your company until you evaluate its pros and cons in the context of your operations. That usually requires the help of a franchise attorney or consultant, but before you start talking to the experts, you should get a sense of the key advantages and disadvantages of a franchise business .

Franchising offers three major benefits to business owners seeking to expand operations:

Access to better talent. Franchising is a great way to find talented people to manage your locations and give them an incentive to work hard. The most qualified and hardest working people generally prefer to invest in running a business in return for profits rather than taking a salary as an employee. So by franchising, you are going to get better talent that will work harder to build the business than you would by hiring someone to work for you.

Easy expansion capital. Franchising is a good way to obtain expansion capital. Because your franchisees pay to buy outlets in your chain, you can grow the number of locations without tapping much of your own capital or needing to request financing from banks or investors.

Minimized growth risk. Franchising can generate high financial returns for relatively little risk. Unlike adding company-owned outlets, when you franchise, you put relatively little money into adding each location. If you have a good business model, you can earn high royalties from sales at those outlets. The percentage returns you earn can be many times what you would have earned if you opened and ran the outlets yourself.

Offsetting these positives are three major disadvantages of the franchising business model:

Less control over managers. You cant tell franchisees what to do the way you can with employees. Franchisees are independent businesses. Moreover, they have different goals from yours, which can easily conflict and even lead to legal trouble. Consider the classic example: Franchisors make money by collecting a percentage of sales as a royalty for letting the franchisee use their brand name and operating system. Franchisees make money from the outlets profits. Anything that boosts sales, but not profits will create conflict between you and the franchisee. If you want to offer customers promotional coupons, franchisees may likely object. Coupons boost sales, but not always profits, benefitting the franchisor, but not necessarily the franchisee.

A weaker core community. Its more difficult to get franchisees as opposed to hired store managers to work together. Franchisees have an incentive to profit from each others efforts to generate business. For instance, your franchisees might try to get out of paying for the advertising needed to attract customers, figuring they will get the customers anyway if other franchisees buy the advertising. Of course, if all of them do the same thing, you end up with no customers because youve got no advertising. There are ways of minimizing franchisee free riding, of course, but those cost money and require enforcing your franchisee contracts in court.

Innovation challenges. Its a lot harder to innovate with franchising than if you own your own outlets. With franchising, if you come up with a new idea, you have to negotiate with your franchisees to get them to accept the new product or whatever innovation you want to introduce, instead of just putting the new idea in place on your own.

Before you talk to the experts about franchising your business, consider these pros and cons. Franchising isnt a silver bullet for business expansion. But when the advantages outweigh the disadvantages, it can be a great way to grow your business.