The Franchise Misnomer

In the wake of the largest franchise IPO ever last week (Archos), I was reminded of a topic that I’ve pondered for quite some time. With franchise chains being the easiest way to get a business jump started, it’s no wonder that there are almost 1M locations representing $1T of sales in the US alone. No MBA required, no resume massaging; just a roll-up the sleeves attitude and a propensity to work hard is all you need to sign up. But are franchisees actually entrepreneurs? Do they run their own business or are they merely buying themselves a living?

Let’s look at the dynamics of the largest franchiser on the planet, Subway, as an example. Subway makes it easy for new locations: a very small upfront fee ($10k or so), soup to nuts setup and management services, and a straightforward royalty model (take ~12% off the top). This looks great, right? If atmabus wanted to leave the corporate world for business-ownership, this seems to be a low risk option right? Let’s look a bit closer of who would actually “own” this business.

Subway controls more aspects of this endeavour than atmabus would. In addition to the branding, Subway mandates your procurement for everything from napkins to lettuce (at a profit for corporate). They dictate how the store should look, how much you need to spend on improvements, and mandate computer and accounting systems. Margins and pricing is controlled at some levels — most franchises actually lose money on the $5 footlong (but have limited say in what they can do). Sure Atmabus would manage some parts of the operations; but he would not control supply chain, advertising, pricing, and product offerings under this franchise agreement. So what’s left?

When you think of entrepreneurship, you think of control and unlimited upside potential. Here you get neither. Given your sales are limited to your foot traffic in a specific geography, the only way to scale is to buy more franchises. Couldn’t Subway technically “own” the stores and pay a management fee to operators and accomplish the same thing? This model feels more like a distributor relationship versus a B2B one as advertised by the franchisers. Remember the Coca-Cola bottlers? Look who owns them now.

Certainly new franchisers will command less control and costs than established players like Subway. But ultimately franchise models tilt in favour of the corporations. Incentives are misaligned; the $5 footlong promotion benefits franchisors (Subway sells the ingredients) at the expense of franchisees. Most hotel chains are moving away from ownership to franchise models because their is frankly more profit and less headache for them through the arrangement. As long as their are people willing to live on site and work 7 days a week, they can continue along this path.

Don’t get me wrong – there is money to be had for franchisees. Many make a decent living doing them. You just have to do it in a big way since so much of the margin is taken by franchisors. If you get in on the ground floor of a bustling one, you might be able to negotiate a sweet deal. Plus just the mere fact that its considered a “business” gives owners a path to tax benefits associated with ownership. Given the limited control, upside, and autonomy for franchise owners, its hard to consider them entrepreneurial ventures.

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