In a chain, all store locations are owned by a parent company, while in a franchise, units are owned and operated by separate individuals who contract with a franchisor to use the parent company’s business model and trademarks. In this article, we will break down the differences between chains and franchises.
What is a Franchise?
A franchise is a type of business in which the owner of a company, called a franchisor, allows individuals to operate a location under its brand and using its business model. The individual owners, called franchisees, will set up the location, run it, and pay an initial fee and ongoing royalties in exchange for the franchisor’s support and training.
Key characteristics of franchises
- The franchisor will grant the right to operate under its trademark and sell its products. The franchisee must follow the franchisor’s standards to benefit from its brand awareness and support.
- Franchisees must pay an initial fee and ongoing royalties to benefit from using a proven business model and the brand’s built-in awareness.
- Franchisees will be in charge of setting up the location and managing it.
- The franchisor will provide training and ongoing support to the franchisee.
Types of franchise agreements
Depending on the type of franchise agreement you enter, you can have different benefits that will allow you to manage multiple locations. The following are the arrangements you can have as a franchisee:
- Single-unit franchise: This is the classic franchise model, in which a company grants an individual the right to use its business model to open one location in exchange for an initial fee and ongoing royalties.
- Multi-unit franchise: Under the same terms as a traditional franchise, a franchisee can open multiple locations in a determined area.
- Area development agreement: Similar to a multi-unit franchise, an area developer has the right but also the obligation to open a defined number of locations in a territory by following a specific schedule.
- Master franchise agreement: Also called subfranchising, this agreement consists of a franchisor granting the right to an individual or company to develop and operate multiple franchises in a specified territory. This entity called the master franchisee, will sell multiple locations to individual franchisees who will be trained and required to pay fees and royalties. The master franchisee will collect the fees from franchisees and send a percentage to the franchisor.
Examples of franchises
The following are some of the most popular examples of franchises:
- KFC
- Kumon
- Chick-Fil-A
- Subway
- 7 Eleven
- Better clean services
- McDonald’s
- Holiday Inn
- Gold’s gym
- Lube Pros
What is a chain?
A chain is a network of multiple outlets with the same brand name and appearance that are operated by a single parent company. Every location of a chain offers the same products and abides by specific operating procedures. These individual outlets are owned by the company and operated by a manager who was assigned by the chain. The independent chain manager does not need to make any investments to work for the chain but does not receive any profit from it either.
Key characteristics of chains
- All the outlets of a chain are entirely owned by a parent company, which means all the profit goes directly to it.
- The parent company controls every aspect of the separate locations and employs managers to supervise operations
- The parent company keeps all the earnings of each of its outlets
Examples of chains
The following are some of the most popular examples of franchises:
- Walmart
- Best buy
- Chipotle
- Starbucks
- The Body Shop
- Home Depot
- Bed Bath & Beyond
- Hilton Hotels & Resorts
- Trader Joe’s
- Apple Store
Similarities between chains and franchises
Some of the similarities between chains and franchises include:
- Both are a group of businesses that share the same name, products, and services.
- They abide by the same quality standards and appearance
- They are endorsed by the parent company and benefit from an existing customer base, brand awareness, and overall marketing efforts.
Differences between franchises and chains
Although both terms are often confused and used interchangeably, there are structural differences between the two. Here is how chains and franchises differ across multiple aspects:
Ownership and management
In a chain business, the parent company owns the totality of each location and directly operates them by employing managers. A chain business offers no flexibility for its supervisors, for the parent company is in charge of assigning prices, operating procedures, and making key decisions. Franchises, on the other side, are owned by independent business owners who have to pay for the right to use the company’s brand. Depending on the terms of the franchise agreement, they can have a margin of flexibility in decision-making.
Profits and losses
As the owner of a franchise business, your profit will be shared with the franchisees. You will periodically receive a portion of each location’s sales percentage, but not the totality of it. As a chain store owner, all the profits and losses stay within the corporation.
Setting up
In a chain business, the costs of setting up the location, such as those necessary to acquire equipment, furniture, and software are covered by the parent company. On the contrary, the independent owners of a franchise have to include the setting up of their location in their initial investment.
Costs
While franchising your business is expensive, starting a chain business requires even higher investment. Franchisees carry the burden of their startup and operating costs and payrolls, while chains have to pay for all those expenses.
Manager Recruitment
To join a franchise, the potential franchisee must go through a rigorous vetting process to prove he or she is financially capable of sustaining the business and has the required managerial abilities. Furthermore, the franchisor must by law provide a document in which the franchise opportunity and its implications are explained in depth so the franchisee can make an informed decision before entering the franchise agreement. With a chain business, the parent company typically recruits a trusted employee of its organization or an external one after a common employee recruitment process.
Staffing
When opening a new location, the franchisee will take care of staffing and everything it involves. While the franchisor may provide some guidelines on how to recruit personnel, the franchisee is responsible for conducting that process. Nonetheless, the chain’s parent company will provide guidance for staffing.
Risks
When a franchise business opens a new outlet, the investment risks are distributed between the franchisor and the franchisee. While the franchisee has to pay the initial fee, royalties, and startup costs, the franchisor also invests in training and exposes its trademarks, reputation, and trade secrets to third parties. Conversely, with a chain, the parent company undertakes the whole risk since it must cover the costs of setting up the location while a manager does not make any investment.
Financing
To fund the opening of a chain location, it is typically the owners of the business or lending organizations who finance the investment. On the contrary, when this occurs in a franchise, it is the franchisees who have to pay for the startup costs. This can be done by using their funds, or lending alternatives, such as SBA or bank loans.
Why you can’t FRANCHISE WITH chain
Chains do not sell the rights to use their brand names and access their business model. However, there are companies, such as McDonald’s, that use a hybrid business model in which they combine the franchise and chain systems. While they directly open and manage specific outlets, they also recruit franchises and allow independent business owners to manage their outlets.
While asking yourself whether you should buy into a franchise or a chain is typically out of the question, unless you are up for a multimillion-dollar deal, an entrepreneur can decide if they want to expand by franchising their business or taking the chain route.
Franchises vs Chains: The Pros and Cons
If you are planning to expand the operations of your business and you do not know whether to opt for opening a chain or a franchise, here are some considerations you can analyze:
Advantages of forming a franchise
Among the advantages and disadvantages of franchises you can find:
- Investment: Although starting a franchise requires a hefty investment to ensure you create a replicable business model and operating procedures, you transfer the investment burden of expanding into someone else’s hands.
- Funding facilities: For their lower failure rating, starting a franchise allows you to have access to a variety of financing opportunities.
- Finding interested franchisees: Since franchising is becoming increasingly popular, it is not so difficult to find candidates to run one of your businesses. The fact that franchisees have made a considerable investment to enter your business and that they are going to receive earnings from it motivates them to strive for success.
Disadvantages of forming a franchise
- Lack of absolute control: Even if as a franchisor you can limit the franchisees’ decisions, you cannot be too stringent with them because this may lead to potential disputes.
- Vulnerable intellectual property: Exposing your trademarks to third parties will always come with a risk. Properly protecting your intellectual property is key when franchising your business.
- Regulatory compliance: As a franchisor, you need to ensure you are compliant with the state and federal franchise laws. Providing an FDD, ensuring you have a franchise agreement with fair terms, and that your franchise is properly structured are key. It’s of the utmost importance to be assisted by a franchise attorney who will help you be compliant.
Pros of starting a chain
- Higher profit potential: As a chain owner, the totality of the profits will go directly to you.
- Full control: Chain owners have complete control over all aspects of their business, including branding, operations, and decision-making.
- Quality consistency: Controlling every aspect of a business allows chain owners to closely track finances and ensure all their locations meet the same quality standards.
Cons of starting a chain
- High investments: Starting a chain store requires significant effort to invest in setting up each separate location and training employees.
- Higher risks: By being a chain owner, you bear full responsibility for the success or failure of the business, including the initial investment, operational costs, and potential losses.
- Operational Challenges: Managing multiple locations can be complex and demanding. You will need to ensure consistent quality control, efficient supply chain management, and effective communication across all locations. This requires careful planning, organization, and coordination.
Hiring a lawyer when expanding your business
Whether you want to grow your business through franchising or by opening a chain store, it is paramount to count on legal assistance to ensure your investment is protected. A corporate attorney will help you:
- Ensure legal compliance: A lawyer can assist with drafting and reviewing contracts, lease agreements, franchise disclosure documents, and other legal documents to protect your interests and ensure compliance with applicable laws.
- Negotiation: To help you understand the terms and conditions of the contracts you will enter and their profitability, the attorney will carefully review the required documents to ensure you are making an informed decision.
- Intellectual property protection: An attorney will help you protect your intellectual property rights, such as trademarks and copyrights to ensure there is an authorized usage of them.
- Risk mitigation: By working with an attorney, you can minimize the risks associated with starting a chain store or franchise. They can identify potential legal pitfalls, offer advice on risk management strategies, and help you make informed decisions to protect your investment.
Motiva Business Law Attorneys assisting Franchisors, Franchisees, and Business owners
Are you a business owner looking to open a chain store, purchase a franchise, or expand your business? Look no further than Motiva Business Law attorneys. Our team of experienced and dedicated attorneys specializes in franchise and business law, and we are here to guide you every step of the way.
From reviewing franchise agreements to negotiating favorable terms, our attorneys will protect your interests and ensure legal compliance. We understand the complexities involved in expanding your business and can provide expert advice on regulatory compliance, contracts, and franchises. With our comprehensive legal support, you can confidently navigate the intricacies of the franchising or expansion process, allowing you to focus on growing your business. Trust Motiva Business Law to be your trusted legal partner. We will help you achieve your business goals.