For a business looking to grow, the options of franchising or licensing can be very appealing. Indeed, both can offer a route to successful expansion. But business owners are seldom given advice on the differences between the two.
Quite often they find themselves steered in one direction, without a strong understanding of whether the other might have worked better. Below is a quick guide to the differences between the two, along with the pros and cons of each.
Most of the time, when people talk about ‘franchising’, they mean business format franchising. This is when a franchisor – with a well-established and profitable business model – looks to replicate that model by ‘franchising’ it to other people. These people become ‘franchisees’.
It is, of course, franchising that has brought McDonalds to be the global powerhouse that it is today. They have around 40,000 outlets in over 100 countries, but even that total is bettered by 7Eleven who have 80,000. But franchising is not just for corporate juggernauts. The UK franchising industry is dominated largely by brands that began life as small start-ups.
In a typical franchise arrangement, the franchisor charges an upfront fee. This could be anything from £10k to £20k for small start-up brands, or even £200k or more for the most well-established concepts. There is then a monthly fee, which is normally a percentage of monthly gross sales. Something in the region of 8% to 10% would be typical.
Some franchisors also impose an advertising contribution of 1% or 2%, which is used to support national or local marketing campaigns. The advantages of franchising are well-known: The franchisor gets an income from his or her franchisees. And franchisees buy in to an already proven and successful business concept.
When you start a new enterprise as a franchisee, your business has statistically a much lower failure rate than independent start-ups. Moreover, the franchise arrangements extend the use and reputation of the brand to a wider geographical area and bigger audience. This benefits both the franchisor and its network of franchisees.
But franchising is not the perfect solution for every business. For the franchisor, it not only involves hard work, but serious financial investment as well. A franchise concept is unlikely to thrive unless you have a business model with a proven track-record of profitability. In getting your franchise model off the ground, you are likely to have invested time, effort and money in the following:
• A detailed business analysis;
• A franchise prospectus;
• An operations manual;
• A training programme;
• An ongoing support structure for franchisees;
• A tailor-made franchise agreement.
The amount of return that you will make out of your franchise, in the medium to long term, is directly proportionate to the amount of time and investment you put into it in the first place. Successful franchisors may have to spend upwards of £40k to launch a franchise, and sometimes considerably more. Franchising has never been a get-rich-quick scheme.
On face value, franchising and licensing appear to be similar. Both, in essence, amount to an agreement to use a brand. The most obvious and significant difference, however, is that in a licensed agreement there will be no operations manual. The licence tends not to involve the replication of an existing business format.
In fact, in many cases, it is the exact opposite: The licensor signs an agreement with a third party who is able to exploit it in a consumer sector in which the licensor has no presence or expertise. This is particularly prevalent in the luxury goods industry. LVMH, by way of illustration, manages 75 prestigious brands, including Tiffany & Co, Christian Dior and Bulgari.
Furthermore, the majority of all the big name fragrances are – in fact – made and sold by just two or three big perfume houses. Alexander McQueen, Calvin Klein and David Beckham, for example, are all manufactured and distributed by Coty under licence.
Coaching and training concepts have been shown to work well, regardless of whether they are franchised or licensed. Pitman Training and The Alternative Board are just two examples of successful franchised operations.
There are a number of businesses which have developed coaching and personal development tools that are exploited beneficially through licences. Many training establishments have incorporated these tools into their own business structures.
Licensing tends to produce a lower income for the brand owner, as they do not usually receive a large upfront fee. They normally charge the licensee a royalty fee, which could be a similar percentage to that charged by franchisors, but is often quite less. Licence agreements tend to have a shorter duration than their franchise equivalent. Thus, as a licensor, your long-term revenue is less secure.
So which route is preferable?
Although a franchise structure usually generates more short-term revenue for the brand owner, this has to be off-set against the considerable costs involved. The franchisor needs to invest heavily in time and money when establishing the operational systems and providing ongoing support.
As a general rule, a licence arrangement is cheaper and easier to initiate than a franchise concept. It is also less demanding in terms of ongoing management time. However, the flip-side is that it generates less revenue for the brand owner.
As no two businesses are the same, there is no one-size-fits-all answer. The decision on whether to build a franchise model, or a licence model, requires careful consideration.
The owner needs to understand the specific profile of the business, along with the industry sector, as well as the nature and strength of the brand. They also need to consider intellectual property. And what is the business owner’s long term expectation of growth?
This article comes courtesy of PartnerWise Franchise, which is a franchise support business that collaborates with a range of clients, from start-ups to globally recognised brands.
To watch an expert discussion about ‘franchising versus licensing’, click on: https://partnerwisefranchise.com/news/franchise-over-licensing/.