Growth is the ultimate goal for most entrepreneurs and business owners. But, with today’s fierce competition, achieving these goals is no easy feat. There’s nothing that guarantees overnight success, however, there are proven methods that have helped major brands like McDonald’s, KFC, Anytime Fitness, to expand and skyrocket to success - franchising and licensing.
Although both are contractual agreements that involve sharing certain rights and aspects of a brand for a fee, franchising and licensing are vastly different. If you’re a business owner or an entrepreneur pondering over which method to choose for expanding into new markets, we’ve got you covered. In this blog, we’ll walk you through the key differences, pros, and cons of franchising and licensing, so you’re able to choose the one that fits perfectly to your business like a glove.
By exploring the intricacies of each model, we aim to equip you with the knowledge and insights necessary to make an educated decision. Whether you are a seasoned business owner or a budding entrepreneur, understanding the nuances of franchising and licensing is vital for charting a successful path towards growth and market expansion.
What is Franchising?
Franchising broadly refers to an arrangement in which the franchisor permits the franchisee to sell its products or services for a fee to conduct business, as an independent branch of the parent company. Considering that this model allows for rapid growth with minimal capital investment and risk, it’s one of the popular methods amongst most well-known brands for expansion. For example, McDonald’s, an American multinational fast food chain is a well known franchisor and has over 40,000 franchise locations worldwide. While the locations are run by individual franchisees under the same brand name, the company has developed highly standardized systems and procedures for operating its restaurants. This has helped the brand to deliver consistent experience across all locations and build trust and loyalty with its customers. In addition, McDonald’s has created a franchising model that has enabled it to rapidly expand its business across the globe and achieve significant cost efficiencies, which in turn has allowed it to offer affordable prices and maintain high profit margins.
Pros of Franchising
If you’re a business owner, looking to expand your business through franchising, this model has an array of advantages to offer. These include:
- Rapid expansion: As a franchisor, you get to scale your business rapidly while minimizing some of the efforts and work, which is instead done by franchisees.
- Brand consistency: By franchising your business, you can maintain consistency in branding, operations, service, and quality across all of your locations, which in turn leads to increased brand awareness and recognition.
- Wider customer base: Franchising your business allows you to reach a wider customer base while maintaining your brand’s value.
- No upgrade costs: This model allows you to avoid upgrade costs typically borne by franchisees to meet business standards, resulting in significant savings for your business premises upgrades.
Cons of Franchising
While franchising has numerous advantages to offer, it has some disadvantages you must consider:
- Loss of control: When you expand your business through franchising, you lose some degree of control over a few of the day-to-day operations. In this model, the franchisees may make decisions that conflict with your brand’s image or operational standard, leading to damaging your business’ reputation.
- Revenue sharing: While franchising can provide a constant source of income, it also means that you may not receive as much revenue as you would if you operate your business yourself.
- Legal liabilities: As the franchisor, you’ll be held liable for the actions of your franchisees, which may lead to legal and financial liabilities. For example, if a franchisee is found to violate labor laws or engage in fraudulent activities, you may be held responsible for it.
- Limited growth: Franchising your business may limit your growth potential as you’re dependent on finding qualified franchisees who’re willing to invest in your business. In case you fail to find suitable franchisees in a given market, you won’t be able to expand your business in the new market.
What is Licensing?
Licensing refers to a business agreement in which the licensor (business owner) permits the third-party to use its trademark, technology, or other intellectual property asset such as copyrights, patents, etc. In this agreement, the ownership of the intellectual property remains in the hands of the licensor, however, a licensee has certain rights to use it to sell or manufacture new products under the name of the licensor’s brand.
For example, Apple, an American multinational technology company grants individual computer users a license, allowing them to use its Mac operating system. Another example of licensing is Spotify, a digital music service company that grants its subscribers a license to listen to music available on the Spotify network.
Another brand that uses licensing agreements is Disney. Whenever someone buys products that have Disney characters printed on them, it’s most likely that Disney has signed licensing agreements with third-parties (licensees) giving them the rights to use the characters and images on their products. One of the licensees of Disney is H&M that uses Disney’s IP as prints on their apparel. Apart from these, there are many other brands like Subway, Dunkin’, 7-Eleven, Baskin Robbins, The UPS Store, etc., that operate in a franchise model.
In May 2018, two well-established and well-known coffee brands Nestle and Starbucks signed a licensing agreement. In this deal, the licensee (Nestle) paid the licensor (Startbucks) $7.15 billion to gain exclusive rights to sell Starbucks products including teas, bagged beans, single-serve coffee, etcetera, across the world using Nestle’s Global Distribution Network. By signing this agreement, Starbucks was able to create strong brand recognition outside of North America. On the other hand, Nestle gained access to the products and strong brand image of Starbucks.
Pros of Licensing
Many companies including major corporations as well as small businesses recognize the benefits of licensing their brand. Some of these major benefits include:
- Low cost entry: Unlike traditional expansion models like franchising, licensing your business allows you to expand your brand or its product offerings without spending high costs.
- Increased profitability: By licensing your brand, you can earn royalties from your licensees without spending money on goods production, marketing, or distribution.
- Increased brand recognition: If you aren’t already a big name in the business game, you'll be able to expand your business through licensing for better brand visibility.
- Global expansion: WIth licensing model, you can easily expand your business into foreign territories without added tariffs or the hassles of building relationships with retail outlets or distributors overseas.
Cons of Licensing
As with any business venture, licensing a brand has some potential pitfalls that you must consider before signing the dotted line. The cons associated with licensing model includes:
- Loss of control: When you license your business or intellectual property to a licensee, you lose a significant amount of control over how your product is used. The licensee may modify your product, market it differently than you intended, or even discontinue its production altogether.
- Risk of intellectual property (IP) theft: Licensing agreements should clearly outline the permitted usage of IP, however, monitoring and controlling all of the uses can be difficult. This may ultimately lead to unauthorized usage of your business’ IP for purposes beyond what was originally agreed upon, resulting in potential loss of your royalties.
- High legal costs: Licensing agreements can be legally complex, and as a licensor, you may require the assistance of legal experts to review and ensure the validity of the document. Additionally, any disputes that arise between the licensor and licensee can lead to a significant increase in legal costs.
- Revenue uncertainty: Licensing your business introduces revenue uncertainty for you, as the percentage of revenue you receive from the licensee can be unpredictable. In the event that your licensee underperforms or sales don’t meet your expectations, your revenue stream is directly affected.
Why is licensing not an alternative to franchising ?
It’s undeniably true that licensing and franchising share similarities. However, it’s important to note that licensing cannot be considered a substitute for franchising. While every franchise agreement involves licensing, the same cannot be said for licensing agreements. There are some potential differences between the two explained in the chart below:
Key differences between franchising and licensing
Business Model
The franchisor provides a complete business model to the franchisee, including products, services, branding, operating systems, and ongoing support.
The licensor grants the licensee the right to use a specific product, service, or technology under certain conditions, but doesn’t provide the same level of ongoing support over the licensee’s operations.
Degree of Control
The franchisor has a high degree of control over the franchisee’s operations, including standards for quality, customer service, etc.
The licensor has limited control over the operations of the licensee, focusing mainly on the use of the licensed intellectual property.
Assistance/Level of Support
The franchisor offers continual support, comprehensive training, and round the clock assistance to the franchisee to ensure consistency in operations and product or service quality across all locations.
The licensor typically provides the licensee with limited support and training.
Proprietorship
The business is owned and operated by the franchisee, however, adhering to the franchisor’s guidelines and standards is a must.
The business is owned and operated by the licensee, however, it’s critical for the licensee to comply with the licensor’s conditions for using the intellectual property.
Legal Status
It’s regulated by the Federal Trade Commission (FTC) and requires a Franchise Disclosure Document (FDD) to be provided to potential franchisees.
The agreements aren’t regulated by the FTC, but it may be subject to other legal requirements.
Branding and Marketing Plan
It includes a standardized branding and marketing plan that all franchisees must follow.
While it allows the licensee to use the licensor’s branding and marketing plan, the licensee has the freedom to create its own plan.
Payment (Fee and Royalties)
It includes initial franchise fee and royalties that a franchisee needs to pay to the franchisor.
The licensee typically pays a fee or royalty to the licensor for the use of the intellectual property.
Summing it up
From the above explanations, it’s clear that franchising and licensing are two well-known methods for expanding a business. While both the models are relatively similar, each has its own distinct upsides and downsides. No matter whether you choose to franchise your business or enter a licensing agreement, it’s crucial that you conduct comprehensive research to determine which option is right for you as this could significantly impact your business’ bottom line and its future.
