Franchises

The 4 Disadvantages of Franchising

In Franchise Your Business, author and franchise consultant Mark Siebert delivers the ultimate how-to guide to employing one of the greatest growth strategies ever -- franchising. Siebert shares decades of experience, insights, and practical advice to help grow your business exponentially through franchising while avoiding the pitfalls. In this edited excerpt, Siebert outlines four "cons" of expanding your business through franchising.

Like any other form of business expansion, franchising comes with certain disadvantages that should be considered when deciding on a growth strategy.

1. Per-Unit Contribution

As a franchisor, you will not profit from every dollar that goes to the franchisee’s bottom line. The revenue you generate from each franchisee will be a fraction of what you might otherwise achieve if you owned and operated the franchise unit yourself.

If you were to open a company-owned location, you would be entitled to 100 percent of the profits from that unit (and, of course, would be responsible for 100 percent of the losses). As a franchisor, your revenues would come from some combination of royalties, product sales, rebates, advertising assessments, and other fees.

As a franchisor, you might need to sell four to five franchises or more to realize the same financial gain as you would with just one company-owned operation -- assuming, of course, that it was profitable. And while your ROI will be immeasurably higher through franchising, if you can achieve market saturation without significantly taxing your resources, you will have the potential for higher total dollar returns if you gow through a company-owned-and-operated channel.

2. The Specter of Litigation

At least once a month, someone tells me they're worried about franchising not for business reasons, but because they're afraid of litigation.

They've all heard the horror stories: McDonald’s hit with a multimillion-dollar lawsuit because its coffee was too hot. Franchisees suing franchisors. And it can be scary. Litigation is a fact of life in America, and ignoring that is the business equivalent of building a straw house -- good shelter, but not in the long run.

That being said, litigation is much less of an issue in franchising than most people imagine. A franchisor’s contractual liability is largely limited to the commitments you make in your franchise agreement. And if you know what you're doing, your franchise agreements will be written by an attorney who is an expert at limiting that liability. The fact of the matter is that most franchise agreements are decidedly one-sided in favor of the franchisor, making successful litigation very difficult for franchisees.

For example, as a franchisor, you largely avoid the “slip and fall” liability associ­ated with accidents that happen in a franchisee’s place of business. You also avoid most of the potential “employment liability” associated with company-owned operations (sexual harass­ment, wrongful termination, etc.). And as a franchisor, you're not responsible for on-the-job injuries -- that responsibility belongs to your franchisees.

The bottom line is that as long as you are careful that your franchise relationship qualifies as an independent contractor and you have not created an “agency” role or been negligent as a franchisor, your franchisee has the responsibility for virtually everything that happens at her location. 

3. The Issue of Control

As a franchisor, it's fair to point out that you won't have the same level of control over day-to-day operations as you would in a company-owned facility. You're not responsible for hiring, training, disciplining, scheduling, compensating, monitoring, or terminating employees. In virtually every franchise, the franchisee makes the final decision on where to locate the business and which contractors to use for build-out. The franchisee typically makes most decisions in regard to choosing suppliers and pricing their services.

Moreover, with company operations, you can hire and fire at your own discretion. But when it comes to terminating a franchisee, you won't have that same level of discretion.

But that's not to say that you cannot terminate a franchisee -- you can. When it comes to terminating a franchisee, you'll need to show cause, which will amount to some type of violation of the franchise agreement. 

4. Investment in Franchising

Finally, let’s not forget that while franchising is often a lower-cost means of expanding a business, it is not a no-cost means of expansion. As a new franchisor, you may need to anticipate costs (in terms of time and capital) in a number of areas:

  • Creating your business plan and financial analysis
  • Developing appropriate legal documents
  • Developing a franchise operations manual and other quality control documents, systems, and processes
  • Creating marketing plans and collateral materials
  • Adding a franchise opportunity section to your current website
  • Training your people on the franchise process
  • Creating a new franchisor legal entity
  • Printing brochures, letterhead, and other marketing materials
  • Marketing for new franchisees
  • Refining your local store marketing materials for use by franchisees
  • Negotiating third-party vendor agreements on your franchisees’ behalf
  • Accounting for franchise sales expenses (which might initially be your time) and perhaps longer-term personnel expenses

For most companies, the costs of developing a franchise business are significantly lower than opening just one more company-owned facility -- and the returns can be substantially higher. While the amount of capital needed will be directly related to your goals and your desired rate of growth, you should never go into franchising undercapitalized.