Franchising is big business in the United States, with some of the country’s most recognizable names leading the way: McDonalds, Meineke, Subway, and Supercuts. At the end of 2023, there were over 790,000 franchise establishments in the United States accounting for nearly 3% of the total Gross Domestic Product (GDP) and spanning over 300 different business format categories.

That’s impressive but what exactly is a franchise?

A franchise is the right, or license, to market a product or service in a defined territory for a specified length of time. The franchisor grants the right to the franchisee. The franchisee is authorized to use the franchisor’s trademarks, marketing system, intellectual property, technology, training, support, and so on, as spelled out in the franchise agreement, in exchange for a franchise fee and ongoing royalties.

Leading franchisors deliver turnkey business models, provide strong and repeatable operating systems, and generate robust revenue streams. They provide the product or service, marketing and sales system, operational infrastructure, technology platform, and world-class initial and ongoing training and support. Importantly, all aspects of the system will be predictable and consistent.

It is precisely the efficient and reliable nature of franchises that makes them desirable and drives their success. In addition, basic business model mistakes and kinks have been worked out of the system. Finally, franchises gain economies of scale because the franchisees band together, pool their resources, experiences, influence, and buying power. That is the power of a great franchise system!

Franchisors provide products and services but, to a large extent, the business model itself is the most important aspect of the business. Following the business model creates expected and recurring results. That is why people flock to franchising as a method to build a business.

The best franchises are ones that you can launch, run, and scale effectively at a lower cost, even with the expenses associated with a franchise, than if you did it on your own.

Franchises come in all shapes and sizes. Investment ranges from $75,000 to millions of dollars. Some are home-based; others require brick-and-mortar locations. Some franchises acquire customers through sales and networking, and others rely on marketing and physical locations to drive business.

There are franchises in every sector of the economy and in basically every investment range. Once again, to reiterate, the most important aspect of franchising is finding the right fit. Therefore, the key to franchise exploration is finding a brand that matches your personal and professional interests, and financial goals.

The best franchise businesses are systems-based and not people dependent. Yes, you need people, but if the system is good, so are the results. The idea is that people, though a crucial part of a franchise, perform at a higher level because of the systems that define and simplify the tasks. Some brands are so successful at this that they can succeed at a high level even if their product or service is merely good.

At its core, a franchise is a system of systems.

For example, you can probably make a better hamburger than McDonalds, but do you want to compete with them? Nope, because they have killer systems. Think about it. One of the most iconic and successful brands in the world is run by a bunch of seventeen-year-old kids flipping burgers and making fries!

That is the power of franchising.

Franchising enables franchisors to expand their brand without large capital expenditures. In addition, the franchisor relies on franchisees who, as owners, are more vested in outcomes than employees could be.

Franchisees benefit from the ability to execute on a proven business model. Franchisees can avail themselves of the franchisors’ support to grow their businesses. Franchisees can focus on executing the business plan instead of creating it from scratch!

At its best, franchising is truly a synergistic relationship that benefits both the franchisor and franchisee. The biggest takeaway is that in franchising, the franchisor and franchisee succeed together.

Franchises are acquired in units. A unit is a defined territory or location in which a franchisee can conduct business. These areas are generally protected. That means no other franchisee of that brand can do business in that area.

Some franchises, such as food, fitness or automotive, are location-based, with a retail location with a certain radius of territory protection. For example, a location can have exclusivity for a five-mile radius. Other franchises such as home service brands do not have retail locations and are territory oriented. Territories are generally defined by the number of people, businesses, homes, and so on, that meet certain predefined requirements.

For both territories and locations, leading franchises will focus on building in areas that include an optimal number of ideal customers. Depending on your goals, you may consider single or multiple units as this allows you to grow substantially and scale a business.

There are several fees associated with a franchise and these will vary by brand.

Franchise fees. Franchise fees are the price of admission to a franchise. This is the fee the franchisee pays to the franchisor for the right to license use of the brand, its systems, products, or services.

Franchise fees vary, and when purchasing multiple units, franchisors generally reduce each incremental fee. All franchise fees are not created equal. For example, some franchise fees include training or provide a laptop/iPad loaded with company software, whereas others do not include these extras.

It is interesting to note that franchisors usually do not profit on the franchise fee. Indeed, the fee generally barely covers the cost of recruiting, training, and onboarding a franchisee.

Royalties. Royalties are the fees paid to franchisors for the ongoing rights to use the business model and support. They are generally paid as a percentage of gross sales, but sometimes can be flat rates. Royalties pay for the franchisor’s operating expenses and generate the franchisor’s profit. Franchisors use royalties to pay corporate staff and expenses, provide support to franchisees, and generate profit. Royalties vary widely between franchises. The critical aspect of a royalty is not its amount but what you receive for it.

Some brands will have higher royalty costs but provide bells and whistles such as call-center support or client billing. Obviously, these save significant costs and time for a franchisee and are typically well worth the expense. While it is easy to think that a lower royalty percentage is better, that is often incorrect. Do your validation and find out how franchisees feel!

Ad fund. Most franchises have a national advertising fee. This is used to create brand recognition, marketing materials, search-engine optimization, and lead generation at the national level.

Tech Fees. Finally, franchises charge technology fees. These fees are the passing through of actual costs of program licenses, such as Salesforce or other CRMs, Microsoft Office Suite, and proprietary systems.

A lot of the expenses associated with franchising are ones that you would incur in any business. And in many cases, they are more than offset by financial benefits such as buying products at lower costs because of the franchise volume.

This article is meant to be a starting point for the DocWealthHub community on the topic of franchising. Just as you need to build a strong foundational knowledge base in human anatomy before moving on to more advanced topics in med school, it’s important to build a foundational knowledge base on franchising before going too far down this path. Stay tuned for more articles in our franchising series with DocWealthHub.