Disadvantages of Franchises

Key Points
  • Disadvantages to franchisors include a lack of control over franchisees, reputational risks, and slow growth through franchising compared to mergers and acquisitions.
  • Disadvantages to franchisees include high costs and royalty payments, strict product rules, lack of support from uninterested franchisors, lack of flexibility in where to locate and how to trade, and other start-up challenges.
  • Entering into an agreement with an interested franchisor is important. Uninterested franchisors will not provide adequate support and are only interested in collecting fees and payments from franchisees.

 

Term

Uninterested Franchisors: Franchisors that have little interest in the actual success of the franchise, and more interest in collecting fees from franchisees. Example: In the early 2000s, the popularity of Krispy Kreme donuts increased rapidly, leading to a huge increase in the number of franchises. However, poor policies on the part of the main company led to struggling franchisees: huge growth led to market saturation and a weakening of the brand as franchisees were found everywhere from malls to gas stations (whereas the original appeal was as a delicacy); Krispy Kreme forced franchisees to buy equipment at very high mark-ups, weakening the franchisee profits. Thus, the company's focus was on profits through fees and sales to franchisees rather than royalty payments.

 

Disadvantages to the Franchisor

Of course, no business arrangement is without potential risks and disadvantages. While there are many advantages for the franchisor in entering a franchising agreement, some of the potential risks are:

  • Difficult to control activities of franchisees: In any franchise agreement (particularly when there is geographical separation between the franchisor and the franchisee), it can be difficult to control the activities of the franchisee and ensure that their activities are up to standard.
  • Huge risk in reputation by allowing other businesses to use their names: if a franchisee does not live up to the quality standards of the franchisor (cleanliness, customer service, pricing, quality of the product, etc.), this can have a negative reputational effect not just on the franchisee, but on the broader reputation of the franchisor as well. Thus, there is a risk in allowing others not directly connected to the business to use the business name and trademark.
  • Not as quick a method of growth as mergers or acquisitions: M&A allows companies to expand very rapidly, whereas entering into franchising agreements means that the franchisor enters agreements with numerous individuals over time, and has to wait for them to start up and begin operations (instead of taking over existing operations). This method of expansion can be slow.

 

Disadvantages to the Franchisee
  • High entry and ongoing cost: It can be more expensive to start a franchise than an independent business. You can open your own burger bar for the fraction of the cost of buying the rights to a McDonald's franchise. Thus, franchising is often an option open only to already wealthy businessmen.
  • Franchisees have to pay a significant percentage of their revenues to the franchisor: On top of the upfront money needed to start a franchise, the franchisee must pay fees and royalties to the franchisor. The franchise fee may range anywhere from $5,000 to over $1 million and hence can be a major expenditure for the franchisee. Royalties are paid periodically during the life of the franchise agreement. They are either a percentage of an outlet's gross income – usually under 10 percent of an outlet's gross income – or a fixed fee.
  • Other franchise costs: In addition to royalties and payments, the franchisee may be required to buy certain items from the franchisor like computer systems and software.
  • Uninterested franchisors: Some franchisors may have little interest in their franchisee's success and may be more interested in just collecting the fees associated with the franchise. Thus, support and marketing may not be adequately provided.
  • Strict product rules: Franchisees experience less flexibility to use their own initiative due to restraints from the franchisor. Franchisees can only sell the products of the franchise, and they may be tied into a national brand with a strict set of instructions about how they should trade.
  • Start-up challenges: The franchisee may have to find or build the right location, hire and train staff, and install equipment. This may be difficult for someone with limited business skills just starting out.

 

Franchise costs vary to some extent because of costs associated with different kinds of businesses and with different locations. For example, a person who wishes to open a franchised employment service operation, such as Talent Force, based in Atlanta, Georgia, can get away with as little as a $7,500 fee, plus one year's starting capital investment of $50,000 to $110,000. On the other hand, start-up costs for a company like J.O.B.S., based in Clearwater, Florida, can be as little as $45,000, including a $30,000 franchise fee.

Source: Boundless
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