It’s a hot Tuesday afternoon and the college lectures have left you exhausted and hungry. As you walk towards the station, the “Golden Arches” grab your attention. You walk into McDonald’s, as there is something comforting about its uniformity across all locations – the familiar settings, tried and tested products and fast service.

McDonald’s is the product of the ultimate revolution in business models – franchisees. Indeed, its founder Raymond Kroc, is regarded as the pioneer of franchising and the massive industry of fast food. Now, it is one of the most famous and profitable franchises in the world and has a presence in over 120 countries, serving 68 million customers every day.

But are all franchises just as profitable and successful?

Not quite.


The Rogue Economist’s Guide to Franchisees:

Legally, the franchisor grants the franchisee (a third party), the license to conduct the business under the trademark and brand name of the franchisor. They specify the products and services to be sold, providing them with successfully established operating systems and business models. The franchisee is liable to pay an initial fee to the franchisor when investing in the business and then continues to pay royalties to the franchisor monthly or annually. The royalties are a percentage of the profits generated by the franchisee

The franchisee is bound to adhere to the stipulated prices as uniform advertising is practiced. Moreover, the franchisor can also lend marketing and advertising strategies to the franchise to boost sales. However, this business model also grants the franchisees ample independence to tap into labour laws, hence deciding the working hours and wages. They are also free to incorporate new methods of advertising and innovation to boost sales. They are responsible for managing the day-to-day business in their outlet. The Brand value also plays an important role in the initial expansion of business and vastly relies on building a loyal and strong clientele.

Despite this independence, franchisees are legally bound to adhere to certain guidelines put down by the Franchise Disclosure Document (FDD) to maintain uniformity across all the outlets. While the food industry takes a major chunk of the franchisee business module, it can be operated in a large variety of sectors such as automobiles, cosmetics, consulting, education, and tourism.



Is this business model capable of generating Profits? 

It is a common misconception that franchisees earn huge profits and require lesser involvement on the part of the investor.

It may appear to potential investors that a franchisee makes immense profits, as they tend to look only at the gross sales (bottom line revenue) instead of the actual profits generated. While the sales could be up to a million, the actual profit that the entrepreneur takes home could be only a few thousand. This is because the revenue is used to cover business costs such as that of labour and new equipment.

Even the profits can be misleading, as one is required to pay corporate taxes from that share. According to a report by the Franchisee Business Review, where 28,500 franchisees were surveyed, 51.5% earn profits less than 50,000$ a year. On the other hand, a smaller, lesser-known franchisee could have lower sales such as 100,000$ but a greater profit percentage.

Many potential investors also opine that investing in a Franchisee ensures lesser effort as a successful business model is already established. But success and huge financial profits largely depend upon local advertising and the market that one sets up the shop at.

Lessons in “How Not To Run a Franchisee” :

Dunkin’ Donuts is a group of restaurants set up in over sixty countries, headquartered in Massachusetts, USA. Franchisees of the same opened in India in 2012 and over the years have failed to meet their sales targets owing to stiff competition by McDonald’s and other established fast food joints in the country.

Initially, it was an “AM” joint, offering coffee and doughnuts, the classic American breakfast. It quickly realized that the menu didn’t cater to Indians and soon changed into a “PM” joint offering burgers and wraps, which is popular among Indian consumers. Despite this effort, it was unable to gain market share owing to the popularity of the ‘McVeggie’ and ‘McAloo Tikki’ among Indian consumers.

The franchisee has tried to penetrate the market by reducing costs and offering coffee at 75₹ per cup much cheaper, in comparison to the global giant Starbucks that offers coffee at 200₹ per cup. The jury remains out on whether this strategy will pay off or if it is already too late to gain market share.Another American doughnut chain “Krispy Kreme” attracted widespread criticism as its franchisees accused the company of “channel stuffing,” wherein the stores received twice the inventory at the end of the quarter so the corporation could bolster its reported profits.

Moreover, the company prodded its franchisees to purchase equipment and supplies from headquarters. While this is a common practice for franchises, the tremendous markup Krispy Kreme placed on these purchases could not bode well for the long-term success of its franchisee stores.

To aim for long standing success, a company needs to focus on royalty payments as this aligns the headquarters goals with its franchisees. Forcing franchisees to buy equipment at tremendous mark-ups only bodes well for headquarters, and it is a very greedy, short-term profit generating solution.

From analyzing the above case studies it is clear that franchisees need just as much effort on the part of the entrepreneur as starting a new business, if not more. The entrepreneur should understand market trends and invest in a venture that dabbles in an industry showing an upward trend. Moreover, it is crucial to study the market for the franchisee concerned.

Starbucks recently opened its biggest outlet in China – spreading over three floors and several thousand square feet – as it sees huge potential in the Chinese market. It made use of smart market entry strategies such as setting up shop in high traffic areas and introducing beverages using popular local ingredients such as green tea.

More often than not, franchisees are also a gamble, which might pay off by injecting a newfound love for a commodity in the market. Starbucks has been expanding in South Korea, which largely remains a tea drinking country. Nevertheless, the opening of the outlets has sparked a major turn to coffee.

Investors in franchisees should be aware that they have to invest a large amount of time, money and effort to establish the business and gain loyal customers in order to turn the franchisee into a cash cow. Profits don’t come easy and the franchisee could garner huge revenue but at the same time lose money and generate a chain of debt.

-Gauri Agarwal

Further reading







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