With growth in business and increase in demand, many companies go for expansion in terms of their operations and customer reach by increasing the number of their stores, outlets or offices. In this endeavor, a company can opt for a chain business or a franchising depending on its objectives, available resources and the nature of products and services it sells.
It is common to see the terms franchise and chain being used interchangeably when talking about top brands like McDonald’s, Pizza Hut, Walmart or Body Shop etc. Only slight difference set them apart. In a chain business, a parent company is the sole owner of all of its business sites. Whereas, in the case of a franchise, ownership of a few shops or branches is handed over to distinct external individuals, firms or companies that are placed in charge of running their operations. Let’s analyze their meanings and differences in greater depth.
Definitions and meanings
Franchising is a business expansion approach under which a company transfers certain rights to an investor. The parent company that transfers the rights is known as franchisor and the investor to whom such rights are transferred is known as franchisee. The franchisor grants such rights against an upfront fee and a periodic ongoing fee as royalty which normally comprises of a certain percentage of franchisee’s monthly sales revenue. Depending on the available investment and the nature of trade, the franchisee may adopt any appropriate format of business to operate his franchise, including sole tradership, firm, partnership, limited liability company or corporation.
The usual rights that a franchisor transfers to his franchisee include the use of brand name, business protocols and procedures, intellectual properties like trademark, sale of products or services, operational support and access to the use of necessary tools like software and marketing materials etc. The franchisee is in charge of setting up his franchise in the form of a new store, outlet or office etc. and hiring staff to carry out operational activities. Examples of common franchises are KFC, Marriott International and Hertz car rentals and dealers. Franchising is so popular and practical worldwide that many countries have special laws dedicated to regulate and deal with various matters related to this business model.
Both franchisor and franchisee sign a franchise agreement which makes franchisee the affiliated dealer of the products of franchisor for a definite period of time. The franchise agreement details rights and obligations of both the parties and other important business matters. Its content usually includes the territory or region where the new franchise is authorized to operate, upfront franchise fee and ongoing or recurring royalty, details regarding various business aspects including standards to follow, use of franchisor’s intellectual property, preferred or suggested marketing approaches, renewal procedure of agreement, duration of business relationship and cancellation or exit strategy etc. Once the franchisor and franchisee sign the franchise agreement, the two parties become legally bound to the agreement.
If successfully operated, a franchise can be fruitful expansion approach for franchisor. For example, it offers franchisor the opportunities of brand marketing and business expansion with the lowest of investment. The franchisee is often responsible for incurring cost to set up a new franchise for him, buy necessary assets and hire staff to start operations. Due to the minimum involvement of liability risk and capital investment, the franchising is also considered a convenient model to enter into a foreign market.
A couple of notable disadvantages are, however, also associated with franchising model. Firstly, the revenue generated is divided between franchisor and franchisee where the franchisee holds the greater part and only a small percentage is received by the head company in the form of royalties. Secondly, many entities reluctant to opt for franchising because of the risk of undermining their hard earned brand name in case the franchisee doesn’t take care of their strict operational standards.
In a chain business, a single parent company with a centralized management owns and runs several branches, retail stores, outlets or offices under its brand name. Some extremely popular and large business chains like Walmart, Safeway and Body Shop have several hundreds of stores spread across the globe. The types of shops that they run include supermarkets, restaurant chains, specialized shops and marketing and merchandizing stores and outlets.
A chain has a centralized management and supply chain, similar operational infrastructure, strict quality control, consistency in pricing, common buying incentives like sales and warranties and the same variety of products or services.
Having a chain business can be advantageous because the enterprise can handpick ideal locations for its sites to obtain maximum customers. Because of a centralized ownership, they can set up volume discounts or better whole sale prices for customers and win the competition against local shops who have to set their prices high due to their daily functioning costs. They can have custom made products with private labels and launch them in the market easily without restrictions and external interference. The profit generated or loss incurred by each individual store or outlet belongs to the single parent company.
Multiple locations that offer quality and price regulation win customer loyalty and offer brand recognition because buyers begin to trust these products. On the downside, setting up chain stores takes up a lot of initial investment and operational costs.
Difference between franchise and chain
Key points of difference between franchise and chain are listed below:
1. Ownership and management
- In franchising, there are many franchise owners who own and management the operations of their franchises individually. The franchisor or parent company can impact the management of a particular franchise only to the extent of terms and conditions agreed upon by signing a franchise agreement.
- In a chain business model, the ownership lies with a single parent company that is solely responsible to run and manage the operations of entire chain of stores.
2. Existence of agreement
- Franchises are mostly based on an agreement known as franchise agreement which describes various business terms between franchisor and franchisee.
- As the ownership and management of each outlet, store or shop belong to only a single parent company, no such agreement is involved in a chain model.
3. Involvement of fee
- Franchising involves an upfront as well as an on going monthly fee which the franchisee is bound to pay to franchisor (i.e., parent company) to initiate and continue franchise operations. The fee structure is mostly described in the content of franchise agreement.
- Chain stores, on the other hand, are opened and operated by the parent company itself and hence no fee is involved to commence and start operations of the store, shop or outlet etc.
- In franchising, the parent company only gets royalty from the franchisee which is mostly a small percentage of franchise’s monthly, quarterly or annual turnover revenue. The franchising model, therefore, makes a little contribution towards the overall profit of the parent company.
- Under chain system, the whole profit generated by each and every selling point goes to the parent company which makes the system potentially more profitable as compared to franchising.
5. Capital investment and liability risk
- Franchising model results in minimal capital investment and liability risk for franchisor because most of the startup and operational costs are born by the franchise owner, not the parent company.
- The investment and liability risk in a chain expansion model are much higher than the franchising model. This is because the parent company has to bear all of the start up and operational costs to make a new outlet work.
6. Operational efficiency and motivation
- Franchise owners make a substantial investment and are, therefore, automatically motivated towards efficient functioning of their franchise business. After all they start a franchise to earn profit and not to lose their precious investment.
- In a business chain, the branch or store managers are salary based employees and they don’t have any investment in business unit they manage. To remain efficient in their management function, these individuals need to receive motivation on consistent basis from owners or other managers appointed at higher hierarchal levels.
Franchise vs chain – tabular comparison
A tabular comparison of franchise and chain is presented below:
|Ownership and management|
|Ownership and management lies with many individual franchisees||Ownership and management lies with the parent company|
|Existence of agreement|
|A franchise agreement is signed by the parties involved.||No such agreement is signed with any external party|
|Involvement of fee|
|Franchise owner is obliged to pay fee to the franchisor or parent company as per franchise agreement.||No question of any such fee as the company opens and runs its own outlets in its desired localities.|
|A one time upfront fee and a minute portion of sales revenue is, however, received by the franchisor.||The aggregate profit of all the unit’s make up the total profit of the entity.|
|Capital investment and liability risk|
|Lower level of capital investment and liability risk.||Higher level of capital investment and liability risk.|
|Operational efficiency and motivation|
|Franchisors are automatically motivated as they invest their money.||The unit managers need to be motivated either by the owners or by the employees working at higher levels.|
Conclusion- franchise vs chain
Companies that need their presence in new locations have to face a certain degree of risk. By opting for a franchise, the company can minimize risks and save on investment costs. Due to minimal capital requirements, franchising model allows companies to expand operations by setting up their existence in many territories. Buying or setting up a franchise can also be beneficial for investors because it is considered a proven business model which often involves the working with an established brand.
Whether you’re a company owner seeking to open a chain store or looking for some prospective franchisee to work with or you are an investor looking for investment opportunity in some profitable business you need to go through the pros and cons involved with each model. Some companies, however, benefit from successful adoption of both business arrangements for the growth and expansion of their business.