The Disadvantages of Owning a Franchise

By Consumer Dummies

So, you want to start your own business. Is franchising for you? This particular type of business ownership is not right for every person, and you need to understand some of the disadvantages in a franchise relationship:

  • Loss of independence: For some people, one of the most serious disadvantages of becoming a franchisee is loss of independence. If you want to make all your own decisions, franchising may be the wrong choice. Franchise systems are structured in such a way that the franchisor sets many of the rules; the franchisee is required to operate the business according to the franchisor’s manuals and procedures.

  • Over‐dependence on the system: Loss of independence, if taken to extremes, leads to a further disadvantage: over‐dependence on the franchise system. Franchising succeeds when financial and emotional risks motivate franchisees. When franchisees rely totally on the system for their success, their over‐dependence can cause problems. Franchisees have to balance system restrictions with their personal ability to manage their own businesses.

    For example, when a franchisee depends on national advertising exclusively and doesn’t invest in local marketing, she’s shortchanging her business by relying too greatly on what the franchisor is bringing to the party.

  • Other franchisees that are “bad apples”: The principal reason for the success of franchising is the public’s perception of quality and consistency throughout the system. When the public receives great service at one location, the assumption is that the system has great service. This consumer expectation is also one of the potential major frailties of any chain, including franchising. Franchisees are not only judged by their performance, but they are also judged by the performance of other franchisees.

    Poorly performing fellow franchisees or company‐owned locations damage a franchisee’s business even where they do not share the same market. If the hotel room is dirty in one location or, even worse, if the press were to report that the hotel had rodents, the public assumes the problem exists throughout the system.

  • Income expectations: Although good franchisors try to prevent it, some franchisees have unrealistic expectations about the income they are going to earn. If their expectations are unrealistic, they will regret their investment in dollars, time, and effort and may become a negative influence on the system. Having realistic expectations is important to any investment decision.

  • Franchising inelasticity: Franchise systems are bound together through legal agreements between franchisors and franchisees. Often, these agreements contain restrictions that potentially impact the franchisor’s ability to make strategic decisions. For example, if a nonfranchisor finds a perfect location for a new store, it is free to do so.

    In a franchise system, the franchisor must first look to the legal agreements between itself and the franchisees in the market. If the franchisor has granted the franchisees protected territories, and the potential location is in one of those territories, the franchise system loses that market opportunity — often to a competitor who does not have the same restrictions. A similar situation can arise with e‐commerce sales over the World Wide Web if the franchisor has provided the franchisee with those rights in the agreement.

Because of the potential loss of market opportunities, many franchisors are reducing the size of the territory they are granting franchising today, and others are granting exclusivity for a short period of time or eliminating protected territories altogether. In the long run, having a market fully developed is a benefit to the franchisee and the franchisor, although it may have an impact on a particular unit’s sales.

The restrictions of franchising can be a double‐edged sword — they can make franchising successful but can also be disadvantages to some franchisees. The restrictions may be on the product and services they are allowed to offer; limitations on size and exclusivity of their territory; the possibility of termination for failure to follow the system; the added investment often required for reimaging, remodeling, or new equipment as a condition of renewal; the cost of transfer and renewal; and restrictions on independent marketing.

Also, the added costs for royalties, advertising, additional training, and other services potentially reduce a franchisee’s earnings.

There are special rules relating to how certain franchise costs are written off for tax purposes. There are also special rules relating to leasehold improvement. Tax treatment depends on the agreements and circumstances, but a franchisee should not automatically assume that the total upfront franchise costs will be totally deductible in the first year. More than likely some costs will be written off over several years. Be sure to consult an accountant or a tax attorney with a lot of experience in what is tax deductible for your franchise.