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The difference between franchising and licensing

Written by Roz Goldstein on Thursday, 17 November 2016. Posted in Legal

There’s a range of factors that can help you decide whether franchising or licensing will suit your business best

The difference between franchising and licensing

Franchising and licensing are excellent options for business owners looking to expand because they provide an alternative to organic growth, which often entails less risk. But there’s often a lack of clarity as to how the two models differ and business owners sometimes head in the direction of one, without fully understanding the merits of the other. However, there really is no great mystery involved and to prove it we will run through the pros and cons of each to help you understand which might suit your business best.

Terminology

First up, let’s look at terminology. In the majority of cases, ‘franchising’ refers to the business format franchising. The franchisor, being a business with a strong brand and a well-established and profitable business model, looks to replicate that model by franchising it to other people – the franchisees. In a licence agreement, on the other hand, the licensor grants a licensee the right to use the licensor’s brand name and / or other intellectual property rights – such as copyrights.

As with a franchise, the licensee’s business benefits from the brand and intellectual property of the licensor and the licensee pays fees to the licensor accordingly. The difference is that a licence arrangement tends not to involve the replication of an existing business format. Often, the intention is the opposite, with the licensor licensing their brand to a third party who may exploit it in a consumer sector where the licensor has no presence or expertise.

Is there a rule as to which model works best with certain business types?

Sadly, it is not quite as simple as that. Of course, franchising has brought the likes of McDonald’s, Starbucks, Mail Boxes Etc. and hundreds of other brands their international reach and success. Indeed, the advantages of franchising are well-known. For one, new startup franchises have a much lower failure rate than other startups. Moreover, franchise arrangements extend the use and reputation of the brand to a wider geographic area and a bigger audience, to the benefit of all.

Does this mean franchising produces a win-win for everyone? Sometimes, yes. But not always. Franchising is not the perfect solution for every business and it isn’t easy. As a potential franchisor, you soon realise that there are more franchise opportunities on offer than there are franchisees wanting to take them on. Your franchise offer must be as – or even more – attractive than those of your competitors.

Furthermore, a franchise concept is unlikely to thrive unless you have a business model with a proven track record of profitability. In getting your franchise offering off the ground, you’re likely to have invested time, effort and money in everything from a company operations manual to a franchise prospectus and detailed marketing strategy. It’s no surprise successful franchisors will often have spent upwards of £30,000 to launch a franchise business model and sometimes more.

As for licensing, the perfume industry is a good illustration of where this particular model has thrived. The majority of all the big-name fragrances are made and sold by just two or three perfume houses. Calvin Klein, Cerruti, and Chloe, for example, are all manufactured and distributed by Coty under licence from the brand owners.

Licensing also works well when the licensor has developed some specific technology, know-how, brand images or design that’s attractive to licensees who wish to incorporate it into their existing businesses. Software and database technology, for example, are invariably exploited through licensing.

Coaching and training concepts, however, have been shown to work well either as franchised businesses or licences. ActionCOACH and Pitman Training are examples of successful franchised operations. But there are also many businesses that have developed coaching and personal development tools licensed to training establishments that incorporate those tools into their own business structures, such as neuro-linguistic programming.

Pros & cons

To clarify, let’s highlight the pros and cons that apply to each business model.

Franchising: pros

On the franchisor’s side, the fact that they receive an immediate income from their franchisees is a big positive. Similarly, the franchisee benefits from the opportunity to buy into an already proven business concept. Both franchisor and franchisee profit from franchise arrangements that extend the use and reputation of the brand to a wider geographic area and audience.

Franchising: cons

Bear in mind that a franchise is unlikely to thrive unless you already have a proven track record of profitability. A franchisor will often have spent upwards of £30,000 prior to launching their business model on expenses such as a business analysis, a pilot franchise operation; compelling franchise prospectus, a marketing strategy and a robust tailor-made franchise agreement.

Licensing: pros

Turning to licensing, one advantage of a licence is that it can be easier to manage than a franchise. The licensee also has more freedom to run their business their own way and, as a general rule, a licence arrangement is cheaper and easier to set up than a franchise concept and demands less in terms of time

Licensing: cons

A licence agreement, however, has to focus carefully on quality assurance and compliance with the licensor’s standards. Products or services sold under licence should enhance and complement the reputation of the licensor and the licence agreement must allow the licensor to pull the plug whenever quality or compliance are compromised. Before granting any licence, the business owner must demonstrate how they will monitor quality in practical terms.

Both franchising and licensing can set your business on the road to success but it is essential to choose the right direction. Once you have made that important decision the sky is your limit. 

About the Author

Roz Goldstein

Roz Goldstein

Roz Goldstein brings her experience with brands like Burger King, O2 and Laura Ashley to Goldstein Legal, the legal practice she founded where she offers franchise clients straight-talking advice.

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