When trying to expand or leverage your successful business to further growth two models that are commonly used are franchising and licensing. While they may mistakenly be used interchangeably they are two distinct concepts and this article will discuss their differences to assist you in deciding between franchising vs. licensing.
In a franchising model you are selling another individual or company the right to use your business model and business name to essentially operate as an independent location of your company. With franchising you still retain a great deal of control over the actual operations of the other location and in many cases they have to share some costs with you. These costs may relate to branding and marketing of the business as a whole, which you still manage yourself but for which all franchises would benefit.
Franchise owners typically provide territorial rights to franchisees, allowing them to control a certain area, which also ensures that new franchises can’t cut in on an already existing franchises business. Examples of franchises in the U.S. would include Burger King, Subway, and Chipotle.
It is important to note that franchises are governed by securities laws and any arrangement that is technically a franchise arrangement (even if it’s legally worded differently) will fall under these laws. There have been instances in the past where companies have issues agreements labelled as licensing agreements but they have been later deemed to be franchises.
In a licensing model you are selling the right to use your intellectual property (IP), brand, or business processes to another party. Licenses do not typical come with restriction in terms of providing a territory or a market for the exclusive use of the licensee. Additionally you do not retain control over the licensee once you have sold the right to use your IP or brand, though limits can be in place over how they use it specifically. Examples of licensed products include Microsoft Office and sports teams giving merchandise sellers a license to use their brand.
Licensing arrangements are governed by standard contract law so there are less administrative burdens than in a franchising arrangement.
Franchising vs. Licensing
When considering which model will work best for your business you need to consider the nature of your business and what degree of control you need over your IP or brand when it is used by others. In assessing this you need to consider if someone else using your IP or product in a manner you would not approve would impact your business. For a company like Burger King ensuring rigid control and consistency among locations is important, but if you’re selling software it’s less important that you control the use of the users.
|Terminology||The term royalties is normally used.||Management fees is considered as the appropriate term.|
|Element||Products, or even a single product, are the common element.||Covers the total business format, including know-how, intellectual rights, goodwill, trade marks and business contacts. Franchising is all-encompassing, whereas licensing concerns just one part of the business.|
|Business situation||Licenses are usually taken by well-established businesses.||Tends to be a startup situation, certainly as regards the franchisee.|
|Duration||Terms of 16-20 years are common (particularly where they relate to technical know-how, copyright and trade marks). The terms are similar for patents.||The franchise agreement is normally for 5 years. Sometimes it is extended to 11 years. Franchises are frequently renewable.|
|Selection of partner||Licenses are usually self-selecting. They are often established businesses and can demonstrate that they are in a strong position to operate the license in question. A licensee can often pass its licence on to an associate or sometimes unconnected company with little or no reference back to the original licensor.||The franchisee is very definitely selected by the franchisor. Its eventual replacement is controlled by the franchisor.|
|Research||Usually concerns specific existing products. Thus, very little benefit from ongoing research is being passed on by the licensor to its licensee.||The franchisor is expected to pass on to its franchisees the total business format, including benefits of ongoing research programmes as part of the agreement.|
|Goodwill||There is no goodwill attached to the licence as it is totally retained by the licensor.||Although the franchisor does retain the main goodwill, the franchisee picks up an element of localized goodwill: he invests more for the business format than the assets received are actually worth, as intangible assets not shown on the balance sheet are likewise part of the agreement.|
|Negotiation||Licensees enjoy a substantial measure of free negotiation. They can use their trade muscle and their established position in the marketplace as bargaining tools.||There is a standard fee structure. Any variation within an individual franchise system would cause confusion and is therefore usually not applicable.|
Both arrangements can generate significant revenues through the royalties and cost sharing that can occur. That is why so many businesses approach use these models as otherwise it would be difficult to expand and grow the business out of internal cash and resources alone.