Understanding the Risks of Franchising



Franchising can be a rewarding business arrangement, both for the franchisor and the prospective franchisee. However, this does not negate the fact that like most business ventures, this business model comes with its own risks for either party.

As a prospective franchisee, you should carefully consider the risks and rewards of franchising before deciding whether it is the right choice for you. You should research industry trends and market demand and consider the size and growth rate of the franchise system.

Evaluating the franchisee satisfaction and turnover rates of the franchise business you would like to be a part of can help ensure that the franchisor is providing adequate support and resources. Nevertheless, your research can only do so much.

Franchisees are usually restricted geographically, and a business model that seems to be working in one city could still prove difficult to navigate as a new franchisee in New York, for instance. The franchise attorneys of New York will be more acquainted with news to help with your research and understanding of the risks of franchising in your local terrain.

Associated risks of franchising for the franchisee

1. High initial investment

While it is expected that a franchisee will, to a great extent, be financially prepared for the financial commitment expected before going into a franchise relationship, the reality of it can often be overwhelming. The franchisee typically needs to pay significant upfront fees, which could be a financial burden.

This investment may include a franchise fee, leasehold improvements, equipment, inventory, and other start-up costs. Like most businesses, the first few years of operation are usually difficult as the customer base for the franchise is still growing regardless of how popular the franchise brand is. Hence, a lot of businesses run on a deficit in the first year of operation.

While the franchisor is expected to give support, there is usually a limitation to this support, as will be detailed in the franchise agreement. The major work of ensuring business success mostly lies with the franchisee.

Therefore, the franchisee must have access to adequate financing or capital to launch their business successfully. This is a risk any franchisee must consider before pursuing a franchise relationship.

2. Restricted business practices

A lot of regulations are involved in maintaining a franchise. These regulations could range from state laws to the localized stipulations of the franchisor as contained in the franchise agreement. The franchisee may have to operate their business in a particular way, as defined by the franchisor, which can limit the franchisee’s ability to make their decisions.

A franchisee is expected to replicate the business systems of the franchise. But more often than not, a prospective franchisee may be after utilizing just the brand name and not necessarily replicating their business model.

This can pose some challenges for the franchisee as they may have to follow specific product pricing, marketing campaigns, and advertising strategies. This is in addition to implementing the sales techniques of the franchisor. This is a risk for franchisees who may not agree with these methods or practices or even believe them to be effective.

3. Limited control

Typical of the franchise business model, the franchisor exerts a lot of control over the operations of their franchise units. The franchisee may have limited control over their business operations and decisions, which could cause frustration and discontent.

This control can stretch over many aspects of the business, including product selection, branding, and customer service. This lack of control can lead to feelings of powerlessness or a sense that you are not running the business but merely functioning as a manager.

Not only does the consequence of such feelings culminate in dissatisfaction, but it is also deleterious to business efforts and ultimately, the profitability and longevity of the franchise unit. This failure will place a financial burden on the franchisee, who will have no business to run at the end of the day.

4. Litigious proceedings

A franchise unit is but one among many that a franchisor supports. A piece of scandalous news from one of these units can spread to other regions and affect their relationship with customers. Worse, they could lose patronage depending on the kind of damage the brand name had sustained.

This is a risk to running a franchise business. You have little influence over how the brand is perceived, and a legal battle in one of the units, even though it is run independently, can affect your sales and the public perception of your business.

Associated risks of franchising for the franchisor

Like the franchisee, there are risks that a franchisor incurs when running a franchise. These risks are similar to those suffered by a franchisee but usually in a bigger capacity and with more to lose.

These risks include:

1. Loss of control

As much as a franchisor controls many aspects of a franchise as laid down in the agreement, the franchisor must give up some level of control over how the franchisee operates their business.

This loss of control could result in damage to the brand’s reputation, particularly if the franchisee does not adhere to the franchisor’s brand standards or fails to provide quality customer service. Despite the training franchisees undergo, they may not be able to run the franchise exactly how the franchisor would.

Most times, they make their own decisions based on local demands. These alterations may not be reflective of or consistent with the overall brand values. As a result, the franchisor must be willing to trust that the franchisee will represent their brand well but also stand the risk of losing brand control.

2. Legal liability

If the franchisee fails to comply with legal regulations or causes harm to customers, the franchisor could be held liable for the franchisee’s actions. In such situations, the franchisor may have to pay fines, penalties, or compensation to affected customers, leading to reputational damage and financial loss.

3. Financial loss

Despite the initial investment made by the franchisee, the franchisor still has to flesh out huge capital to train, market, and offer ongoing support to the new franchise unit. This can prove to be expensive, and many franchisors mostly recuperate the expenses through ongoing royalty payments.

But, should a franchisee fail to generate sufficient revenue, it could impact the franchisor’s revenue and reputation. This risk is higher for new franchisors, who may not have a solid business model or brand recognition.

Final words

Franchising can be an excellent opportunity for both the franchisor and the franchisee. However, it also comes with some risks that must be weighed against the potential benefits. Understanding and mitigating these risks are crucial to creating a successful franchise partnership.