What are the basics of economic feasibility and viability of Franchise businesses in the UK?

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economics

Franchise Business in the UK – A Study in Economic Fine-Tuning

Like any other business model, franchising has to use simple as well as complex economics and principles to make the most of available opportunities. Unlike sole proprietorship or multiple partnership businesses, franchising always deals with two distinct business entities whose business fortunes are intricately interlinked.

This is what separates studies into the economics of franchising as well. For those who are interested in learning more about the same, there are quite a few academic resources available. We will, for the sake of clarity, limit this discussion to analysing the rudimentary economics that govern the most common franchise businesses in the UK.

Are All Franchises Economically Viable?

Certainly not. Despite workable economics, many franchise businesses fail to take off. This is where potential franchisors and franchisees can make the best use of their understanding of what makes franchising tick. As we discussed on our Types of Franchises page, the most common form of franchising in the UK is the ‘Business Format Franchising’. It involves the licensing of the brand, logo, services, products and business strategies to the franchisees. We will, on this page, discuss how a typical Business Format Franchise can achieve economic feasibility.

Franchise Agreement (Franchise Contract)

The Franchise Agreement is the legally binding contract document that dictates each and every aspect of accounts, economics and finances of a franchise business. Therefore, it’s worth knowing how such agreements are drafted and how you – as the franchisor or the franchisee – can safeguard your interests in the process.

A well-drafted Franchise Agreement adheres closely to the outlines drawn by the British Franchise Association’s code of ethics. Such agreements are supposed to have in place adequate measures to look after the interests of all the parties involved. The minimum terms of agreement stipulated by the BFA include (but are not limited to) the following:

  • The rights held by the franchisor and the franchisee
  • The obligations carried by the franchisor and the franchisee
  • Terms of deposit fees and other concurrent initial expenses
  • The overall duration over which the agreement remains valid
  • Terms of termination
  • Terms of renewal
  • The qualitative and quantitative mention of products and/or services being handled
  • Terms of payment
  • Terms of licensing (trademark, logo, business strategies etc.)
  • Terms of sub-franchising
  • Terms of good faith and goodwill

As one can notice, these terms adequately cover the skeletal structure upon which franchise businesses can be built.

Note: It is always advisable to seek legal counsel before getting into any legally binding agreement.

Typical Costs Involved in Franchise Businesses

To study the economics of financing is, at its heart, to study the costs involved in franchising. If you are a potential franchisee, you must be aware of the costs you will need to pay for before you even begin to start operations.
Some of these costs are detailed below:

1. Franchise Fee

This is the first ever cost every franchisee has to pay while opening a franchise. To put it simply, this is the one-time, upfront fee franchisors charge for the ‘licensing’ of their products, services and other franchising components.

The franchise fee you will be, as a franchisee, required to pay will largely depend upon the business sector you will operate in, the standing in the industry of the franchisor and the market for the business itself. In many cases, this fee covers the initial expertise and know-how franchisees will require to get the franchise up and running. This may involve inventory, architecture, training expenses, themed décor, staffing expenses, licensing fees etc.

Franchise fees in the UK range from as low as £500 to as high as £500,000.

2. Legal Fees

Drafting a reasonable Franchise Agreement will cost you, as well as the franchisor, a certain sum of money in the form of legal fees. These fees can either be shared or borne individually by the parties involved.

3. Initial Working Capital

Arranging for the franchise fees isn’t, in itself, enough to get your franchise business started. You will need to invest initial working capital to procure the inventory, handle the daily expenses, pay the personnel salaries, maintain the location and so forth.

It’s a good idea to discuss with the franchisor and other successful franchisees working with them the initial working capital that you will require to invest.

franchise4u offers easy-to-secure, affordable franchise finance solutions in association with our partners. Please visit our Franchise Finance page to learn more about how you can fund your franchise business.

4. Recurring Fees

This component of the overall costs involved has the most significant impact on the economics of all franchises. Franchisees are required to pay a monthly/quarterly fee in the form of sales royalties and franchise servicing fees to the franchisor. Some franchisors charge a fixed monthly fee, but most franchisors prefer to base their monthly fees as a fixed percentage of the overall sales.

5. Marketing and Advertising Costs

These costs are usually fixed and are either rolled into the monthly payment component or charged on an annual basis. The marketing and advertising fees collected from all the franchisees are used by the franchisor, at their sole discretion, to market the products and/or services.

6. Franchise Maintenance Fees

Miscellaneous fees such as contract termination fees, contract renewal fees, contract amendment fees etc. will also need to be paid by the franchisee over the course of time.

7. Utilities and Other Operational Costs

Running a franchise is no different from running your own business. Therefore, operational expenses such as utilities, insurance premiums, banking fees and other incidental costs will need to be taken into account while assessing the feasibility of any franchise business.

Estimating the Returns Involved

There’s no fixed formula or proven method that can help you gauge the returns you can make by running a franchise. The most effective way is to use your own judgment, consult with the experts in the given industry and seek feedback from franchisees who are already working with the franchisor in question.

This approach can help you estimate, to a fair degree of confidence, the returns you can get on your initial investment. Once you have that estimate ready, you can weigh it against the sum of major costs involved (as discussed above) to understand the level of economic feasibility of the franchise.

Conclusion

It certainly pays in the long run to analyse the market, the business model and the costs involved before you zero in on any franchise opportunity. Getting into business with a reputable franchisor with a proven business plan often helps minimise the risks and maximise the returns.