Access to Capital for Growth and Expansion. After the brand and formula are carefully designed and properly executed, franchisors are able to sell franchises and expand rapidly across countries and continents using the capital and resources of their franchisees.
Cash Flow for Operations. In addition to initial franchise fees that can range from $50,000 to $5 million, franchisors receive payments in the form of royalties from each franchisee. These royalties typically range from 4 percent to 8 percent of gross revenues. In addition, franchisors also receive payments from franchisees to spend on marketing and advertising.
Economies of Scale. Once a franchise is established with multiple locations, the company may be able to leverage its buying power to realize economies of scale with suppliers, advertisers, and vendors. If purchasing and distribution for the franchise locations can be centralized, then the cost savings will increase the franchisor’s profits, particularly if the franchise agreement provides for a percent-of-sales payment to the franchisor.
Disadvantages for the Franchisor
Lack of Control. Despite the language of the franchise agreement, once the franchisee has established their location, the franchisor may have difficulty ensuring that quality standards are met and the franchise is operating in a manner that benefits the brand. A Dunkin’ Donuts franchise in Russia had to be closed after it was discovered that instead of serving donuts and coffee, the franchisee was serving vodka and meat pies.
Trade Secrets. If the success of a business is based on a trade secret, special process, or innovative technology, establishing a franchise may make the business vulnerable to knock-offs or imitation. Although the franchise agreement specifically prohibits the disclosure of trade secrets, the fact that the franchisee may improve upon the process and become a competitor is not expressly prohibited and would be difficult to stop.
Overexposure, Brand Dilution. One or two locations of a business is unique and may generate enough demand that the business can charge top dollar for goods or services. When franchises appear on almost every street corner, the allure of the business may fade, and the brand or business may suffer.