Understanding the Franchise Model
When consumers and individuals consider owning their own business they inevitably consider a franchise. Franchising has become synonymous with being “in business for yourself but not by yourself” thanks to the International Franchise Association (www.franchise.org). Yet, there is little known at the consumer level about the franchise model, just the anticipated results… strong earnings potential under a common brand. Yet, to capture this prize individuals would do well to develop a solid foundation in the theory of franchising. How is this powerful model supposed to work?
As it turns out, understanding how any model works is paramount to maximizing a predictable outcome. Let’s say you want to learn to be a pilot, then it is essential you understand the theory of flight, otherwise you are apt to make bad decisions. In order to achieve flight and master aviation you must be fully engaged in the theories that underpin a predictable outcome and lead to a safe landing. Franchising is essentially the same, unless you understand how the model is designed to work it is hard to predict whether you will achieve a “safe landing” or not, let alone take advantage of the model for your benefit.
Three Keys to the Franchise Model
According to the research on the franchise model there are three basic outcomes that it seeks to achieve.
First, resource allocation for the franchisor. This is especially true when the business owner wants to rapidly expand their concept but lacks the capital to do it in a “company-owned” manner. The franchise model provides a systematic way to expand using other people’s capital to acquire the concept, build-out the business framework and cover the ongoing operating expenses of the venture. So, a critical element of the franchise model is accessing the franchisees money to build the business. As prospective franchisees this is important to understand. The franchisor cannot grow without you.
They must provide a compelling value proposition to attract you to their business venture, and while many franchisors will indicate they are unwilling to negotiate with individuals on the terms of their franchise offer, I have found that many will, especially those concepts that need to gain traction in the market and/or sustain their momentum. The key areas of negotiation tend to be territory and development fees for growth. The more mature the brand becomes, the less likely the franchisor is to negotiate any terms with prospective franchisees.
The second element of the franchise model is operating efficiencies. With each new franchisee the franchisor realizes a stronger profit margin given they don’t need to re-invest in core assets such as technology platforms and staff. Thus, as each franchisee pays “full value” for their franchise, the franchisor is realizing significant economies of scale. This is important to understand, especially when the franchisor is benefitting financially from the supply chain, which should be disclosed in the franchise documents.
Many unsuspecting franchisees have entered into a franchise relationship understanding the royalty they must pay, but often not understanding the “effective royalty” being charged by the franchisor through supply chain benefits. These benefits could be in the form of rebates to the franchisor based on volume or other metrics, and unless you understand the impact, or the potential for impact, it is likely to only benefit the franchisor. The best way to avoid this situation to contract with a franchisor who only benefits from your royalty income and not directly from the supply chain economics.
The third element of the model is related to Agency Theory, the relationship between a principal (the franchisor) and the agent (the franchisee). Under this scenario the principal grants limited, delegated authority to the agent with respect to the trademark(s) and the business operations, yet the principal always maintains the legal upper-hand. The rationale for that is to ensure they can protect the value of the brand for all the agents, or said another way, to make sure that no one agent can devalue the brand at the expense of the other agents.
Likely, you’ve been to a branded business and had a bad experience and it probably affected your likelihood of visiting other businesses that operate under that brand. If the franchisor cannot enforce their standards it would be virtually impossible to stop the brand from being degraded over time. Consequently, as a franchisee you will always be at a distinct disadvantage to the franchisor according to the model… but you do have distinct competitive advantages in two specific areas.
Advantage #1: The People Paradox
The relationship between a franchisee and the franchisor is designed to be one of “independent contractor” whereby both parties are free to pursue their goals without interference from the other. The one common denominator in the relationship is the brand. The franchisor and franchisee both benefit if the value of the brand increases, so it is in both parties best interest to see that happen, however, it is the franchisor’s responsibility to ensure that it does. So what role does the franchisee play? Firstly, it is in hiring, training and managing people at the local level. This is not an easy thing for the franchisor to do from their corporate headquarters, nor is it prudent.
The franchisee has a distinct competitive advantage over the franchisor in this regard, primarily due to the franchisees local sphere of influence. I have known franchisees that have been extremely successful identifying employees from their relationships at the church they attend, the neighborhood they live in, the social relationships they maintain and the communities in which they live. I have also known many franchisees that try to rely on the franchisor to help them identify, train and in some cases manage employees in their franchise. Yet, it is the franchisees local presence and influence that should give them a distinct advantage in this regard.
Certainly, the franchisor will provide guidance on the training protocol’s related to the operations of the business standards, but make no mistake, they will not be there to determine how well it is being implemented on a daily basis. That is the responsibility of the franchisee and it should be a deliberate and continuous focus to take advantage of this clear competitive advantage.
Advantage #2: Grassroots Marketing
The other advantage the franchisee should have in the franchise relationship is in marketing the brand promise locally, yet time and time again franchisees sit in wait for the franchisor to “grow their business”. The franchisor is responsible for building brand value to the benefit of all agents operating under the trademarks, and this doesn’t always flow down at the same rate or impact to each franchisee. This should cause franchisees to focus on what they can control and become effective and relentless grassroots marketers. I often here franchisees say they need more social media support, however I would say “what are you doing that is worthy of being discussed on social media?”
Franchisees have a clear competitive advantage over the franchisor with respect to their local marketing efforts, yet all too often they do not take advantage of it by having a deliberate public relations strategy, aligning their business with a local community cause and supporting local teams, activities and events. These are inexpensive methods of connecting the brand locally that can pay strong dividends with loyalty, improved pricing strategies and expansion opportunities.
At the end of the day, the story locally is not the brand but you and your connection to your community. I have no doubt that most franchisees are doing “newsworthy” things but most don’t capitalize on it, rather they lay in wait for franchisor support that is not a key driver of the franchise model. Start with developing a local marketing plan and build it from the inside out with you and your team as the center. Then the local journalist and blogger will have something to share and you’ll be the beneficiary.
Rising Above the Ordinary
The franchise model is designed to help the franchisor leverage your capital, increase their profitability and reduce their monitoring costs associated with agency theory. The franchisee plays an important role in the relationship but it is decidedly “local” and requires an intentional focus on people and marketing. Understanding and capitalizing on these two clear competitive advantages will help you as a franchisee rise above the ordinary.