The Economics of Franchises: Balancing Rewards and Risks

Franchising has always been a unique business opportunity for entrepreneurs who want to combine the freedom of owning their own business with the established support of a regional or national brand. While franchises have the potential to yield significant profits, some pitfalls may also exist that entrepreneurs need to overcome for long-term success.

Like any business opportunity, opening a franchise involves balancing risk and reward. While some may see franchises as a ready-made shortcut to success, franchising can present many challenges that can trip up even the savviest entrepreneur if they are not adequately prepared.

Here, we delve into the details of becoming a franchisee and discuss how to balance the many perks of a franchise operation with some of the hurdles that business owners may encounter.

Economic considerations 

Franchises allow entrepreneurs and franchisors to collaborate to maximize the efficiency of building a brand. This collaborative effort has numerous benefits, creating a strong economic engine that can benefit both the franchisor and the franchisee.

There’s much to consider when entering a franchise operation. The franchisor provides the established brand and operating structure, but the franchisee is responsible for the initial investment, startup costs, and fees — which can be considerable depending on the size and type of the business.

While startup costs may seem less than purchasing a franchise, the entrepreneur must overcome the costs of trial-and-error, mistakes, and lessons learned, which can often cost more than the initial franchise fee. Developing a duplicatable system and training alone can reduce paying employees, supplies, and other overhead items that may even offset the cost of paying royalty to the franchisor for this ongoing support.

The age-old question of which costs more, a startup or a franchise, comes with the answer: it depends.

In my experience, new entrepreneurs should consider franchises, while experienced business operators might spend less with a startup. Even so, the leverage of the franchise as a buying group and efficiencies of operations and brand recognition may still outweigh the urge to try a startup first.

Profits to be made 

The reason franchise opportunities are so popular with entrepreneurs is that there are proven profits to be earned within many franchises. Years of operating history and economic data can outline what profits can be expected after someone enters into a franchise agreement.

With built-in market credibility and brand recognition, franchisees do not have to struggle to build their own brand and trust within the market. Most franchisors will provide strong training and support programs, access to proven marketing materials, and a ready-made targeted customer base.

Profitability can vary depending on many factors, such as how much work a franchisee puts into their business or market conditions. Do your due diligence, for example, on how long it will take to recover your initial investment. Traditional brick-and-mortar may take five to seven years, while services can be less than two years. Watch the cost of goods and overhead expenses. Mobile and home-based businesses can yield higher gross margins, but you have to reach out to your customers versus them walking in your door.

Hurdles in franchising 

No business, or job for that matter, is without risk. One of the most significant pitfalls to franchising for fiercely independent entrepreneurs is the lack of autonomy. Because you represent an established brand, there isn’t as much creativity in building one’s own business. Franchisees have to stick to the standards set by the franchisors in terms of marketing and the operation of the business, which may not always be what the entrepreneur would do if the business were their own independent venture.

Another consideration for franchisees is market saturation. As anyone who lives near a city center can tell you, some franchises have seemingly popped up on every corner. Franchisees should be careful when entering into an opportunity, researching their chosen market, and making sure their business won’t be buried under the 10 to 20 other identical locations in their market area. However, there is great brand awareness available in areas with busier foot traffic, too.

After years in this industry, I have seen both good and bad franchisors and franchisees. If you need help with your search, get the help of an advisor. I chose franchising because it has served me well.

Dr. Robert Needham is the director of franchise development for Repicci’s Real Italian Ice and Gelato.