Franchising

Franchising is a business model in which many different owners share a single brand name. A parent company allows entrepreneurs to use the company's strategies and trademarks; in exchange, the franchisee pays an initial fee and royalties based on revenues. The parent company also provides the franchisee with support, including advertising and training, as part of the franchising agreement.

Franchising is a faster, cheaper form of expansion than adding company-owned stores, because it costs the parent company much less when new stores are owned and operated by a third party. On the flip side, potential for revenue growth is more limited because the parent company will only earn a percentage of the earnings from each new store. 70 different industries use the franchising business model, and according to the International Franchising Association the sector earns more than $1.5 trillion in revenues each year.

The franchising business model is used across many industries, but it is most popular in the fast food restaurants, hotel, and casual & upscale restaurants industries. According to an International Franchise Association study, franchisee-owned locations accounted for 56.3 %, 18.2 %, and 13.1 % of each respective industry's total locations in 2001.

McDonald's (MCD) operates the world's largest fast food chain, and earns 37 % of its revenue from franchising across its approximate 31,400 restaurant locations. Franchisees operate 65 % of McDonald's restaurants worldwide.

The franchising business model consists of two operating partners: the franchisor, or parent company, and the franchisee, the proprietor that operates one or multiple store locations. Franchising agreements usually require the franchisee to pay an initial fee plus royalties equal to a certain percentage of the store's monthly or yearly sales. Initial fees vary significantly across each industry, ranging from $35,000 for an Applebee's restaurant to over $85,000 to open a Hilton hotel. Royalty fees are also variable - for example, Intercontinental Hotels Group (IHG) franchisees are required to pay the company 5 % of their yearly sales, while Applebee's franchisees pay 4 % of monthly sales and IHOP franchisees pay a 4.5 % royalty fee of weekly sales. The franchisee also covers the costs of actually starting and operating the store, including legal fees, occupancy or construction costs, inventory costs, and labor. Franchise agreements usually have a term of between 10 and 20 years, depending on the company.

The parent company authorizes the franchisee's use of the company's trademarks (for example, selling Big Mac's at McDonald's) as part of the franchising agreement. Additionally, the franchisor provides training and support as well as regional and/or national advertising.

Franchisees require less initial capital than independently starting a company and can use proven successful strategies and trademarks. Franchisees are provided with significant amounts of training, not common to most entrepreneurs. The franchisor benefits because it can expand rapidly without having to increase its labor force and operating costs, using much less capital.