Franchising vs. Licensing: Which One Is Right for You?
If you want to start a business and get a head start without having to reinvent the wheel, franchising or brand licensing may be right for you.
While both methods are popular among small business owners and entrepreneurs, they aren’t the same. Let’s look at the differences between franchising vs. licensing, their pros and cons, the costs involved in each business model and how to decide which one is right for you.
Franchising vs. Licensing: What’s the Difference?
Franchising is a method used by existing brands to distribute their products or services more widely. In a typical franchise structure, the franchiser establishes a brand’s trademark and business system while the franchisee pays a royalty for the right to do business under the franchisor’s name and processes.
Some franchising examples include fast-food chains (McDonald’s,) retailers (GNC,) logistics (The UPS Store,) urgent-care clinics (American Family Care,) commercial cleaning services (Jan-Pro), fitness centers (Orangetheory) and more.
Brand licensing refers to the establishment of a license agreement in which the original owner of a brand (the licensor) gives permission to a company (the licensee) to produce or market a product or service. The licensee can produce, promote, and distribute the product or service and, in exchange, the licensor will get royalties from the sale.
Some licensing examples include Starbucks, which licenses out its cafes in airports and bookstores, and Disney, which grants licenses to other companies to create products based on its trademarked characters.
Unlike brand licensing, which is a legal agreement limited in scope and only pertains to the use of a trademark or technology, franchising is a more involved business relationship. For instance, the franchisee is required to operate per designated systems and procedures as required by the franchiser.
One of the key differences between licensing and franchising is the amount of control involved. A franchiser retains a lot of power over its franchisees by supplying the business model, determining the territory of operation and enforcing the use of standardized marketing materials.
A licensor, on the other hand, sells the rights to use its products and trademarks in exchange for royalties, which are usually an agreed-on percentage of the licensee’s sales. However, the licensor doesn’t have control over the licensee’s business model or operations.
Franchising vs. Licensing: The Pros and Cons
A license is a limited legal agreement while franchising is a more extensive relationship that includes a franchise license. Here are the pros and cons of these 2 options:
The Advantages of Franchising
You get the freedom and flexibility of self-employment while mitigating the risk of completely on your own by being part of a proven business.
You can leverage a trusted brand name, a tried-and-true business model, proprietary information and an established operating system so you don’t have to reinvent the wheel.
Thanks to a ready-made business plan, you can often get funding more easily. Also, some franchisers have their own financing arms to provide loans to franchisees.
Most franchisers offer support to help you find a location, procure licenses, create a business plan, purchase equipment, etc., so you can get started quickly.
Many franchises have a built-in customer base so you can start generating revenue right away. Some also have a dedicated sales team to help franchisees find clients without doing any selling on their own.
Franchisors perform ongoing research and development at the brand level, taking the time and resources required for new product development off your plate.
The initial investment for some franchise opportunities may be lower compared with starting a new business.
Some franchisers limit the number of franchisees in each geographic region to reduce competition and ensure that each franchisee is getting enough business.
You can choose from a diverse mix of products and services thanks to the many types of franchise businesses available in the market.
The Disadvantages of Franchising
You don’t have much control over certain decisions as the franchisor controls many aspects of the business, such as pricing, marketing and operations.
Some franchises require a high startup cost because you have to set up the business according to many specific requirements.
Most franchising agreements are standardized, so there’s little room for negotiation.
The profits can be slightly lower than if you own your business because you have to pay franchise fees.
You have to go through a selection process with the franchisor. For example, you need to meet certain financial requirements, such as a minimum amount of liquid capital.
The Advantages of Licensing
You can enter the market with lower risk and less capital because you’re leveraging the reputation of a known brand and a built-in customer base.
A licensee has more liberty to create, improve and market a product to further increase profitability and market shares.
You have more freedom to structure and promote your business than you would in a franchising model.
There’s less risk in product development, market testing, manufacturing and distribution because you’re working with an established brand and production processes.
Unlike franchising, you’re free to negotiate the terms of your contract.
The Disadvantages of Licensing
Licensors typically don’t provide much support to licensees so you should have a well-established business system and resources to support the licensing deal.
Many licensing agreements require a long-term commitment, some for as long as 15 to 20 years.
Your ability to sustain the business and make a profit is dependent on the licensor’s brand reputation and intellectual property (IP), which aren’t under your control.
A licensor can increase a renewal fee dramatically or decide not to renew a licensing agreement when the contract is up.
There’s no guarantee of exclusivity in most licensing agreements so other licensees can enter the market, become your competitors and impact your profitability.
Other licensees may inadvertently tarnish the reputation of the brand, which could then impact your sales.
Licensors offer little, if any, product or brand research support to licensees.