Franchise 1. A right conferred or established by a government, such as the right to vote (exercise one's franchise) in a local or national election.

2. Commerce: (1) A privilege granted to make or market a good or service under a patented process or trademarked name. (2) A business operating under such privilege. 3. Law: A government-conferred right to exist as a legal business entity within a particular jurisdiction and to exercise corporate powers. Franchisor The company that allows an individual (known as the franchisee) to run a location of their business. The franchisor owns the overarching company, trademarks, and products, but gives the right to the franchisee to run the franchise location, in return for an agreed-upon fee. Fast-food companies are often franchised. Franchisee One who purchases a franchise. The franchisee then runs that location of the purchased business. He or she is responsible for certain decisions, but many other decisions (such as the look, name, and products) are already determined by the franchisor and must be kept the same by the franchisee. The franchisee will pay the franchisor under the terms of the agreement, usually either a flat fee or a percentage of the revenues or profits, from the sales transacted at that location.

How Franchising Works The franchising business model consists of two operating partners: the franchisor, or parent company, and the franchisee, the proprietor that operates one or multiple store locations. Franchising agreements usually require the franchisee to pay an initial fee plus royalties equal to a certain percentage of the store's monthly or yearly sales. Initial fees vary significantly across each industry, ranging from $35,000 for an Applebee's restaurant to over $85,000 to open a Hilton hotel. Royalty fees are also variable - for example, Intercontinental Hotels Group (IHG) franchisees are required to pay the company 5% of their yearly sales, while Applebee's franchisees pay 4% of monthly sales and IHOP franchisees pay a 4.5% royalty fee of weekly sales. The franchisee also covers the costs of actually starting and operating the store, including legal fees, occupancy or construction costs, inventory costs, and labor. Franchise agreements usually have a term of between 10 and 20 years, depending on the company. The parent company authorizes the franchisee's use of the company's trademarks (for example, selling Big Mac's at McDonald's) as part of the franchising agreement. Additionally, the franchisor provides training and support as well as regional and/or national advertising.

Advantages of the Franchising Model

Franchisees require less initial capital than independently starting a company and can use proven successful strategies and trademarks. Franchisees are provided with significant amounts of training, not common to most entrepreneurs. The franchisor benefits because it can expand rapidly without having to increase its labor force and operating costs, using much less capital. Franchised stores have a higher margin for the parent company than company-owned stores because of minimal operating expenses in maintaining franchised stores. For example, DineEquity, Inc.(DIN) earned a 52.7% profit margin from franchisee-owned restaurants in 2007 while company-owned restaurants operated at a mere 6.7% profit margin.

Drawbacks of the Franchising Model

Franchising stores reduces the amount of control that the parent company has over its products and service, which may lead store quality to vary greatly from store to store. Franchisees must pay a percentage of their revenues to the parent company, reducing their overall earnings.