The Franchise Business Model | Valid or Worrying Prospect?

The earliest or most old school type of business is setting up shop and selling something. If you didn’t have the funds to set up a shop, you could start a stall in a market and be in business. As time went on, this idea was scaled and standardised. The franchise was born.

A franchisor licenses some or all of its know-how, procedures, intellectual property, use of its business model, brand and rights in order to sell its products and services to a franchisee. In return, the franchisee pays certain fees and agrees to comply with certain obligations, typically set out in a franchise agreement. The premise of franchising is based on a marketing concept which an organisation can adapt as a strategy for business expansion.

The boom in franchising started after WWII. What we now know as Coca-Cola was one of the earliest and most successful franchising operations in the US. It was started by a druggist named John S. Pemberton. In 1886, he concocted a beverage comprising sugar, molasses, spices and cocaine. He then licensed selected people to bottle and sell the drink. Although many business owners did affiliate with cooperative ventures of one type or another, there was little growth in franchising until the early 20th century.

The United States is a leader in franchising, a position it has held since the 1930s when it used the approach for fast-food restaurants, food establishments and motels. Mid-sized franchises like petrol stations involve substantial investment. There are also large franchises like hotels, spas and hospitals. Failure rates are believed to be much lower for franchise businesses than independent startups.

A 2007 study found that franchise restaurants fail at about the same rate as independent restaurants within the first three years of operation. Empirical studies show that people at various ages, and in various aspects of life, systematically suffer from an inherent bias: over-optimism. Entrepreneurs, in particular, believe that their own odds for success as far higher than would seem justified by the historical statistics of new entrepreneurs.

While the statistics revealed that less than 50% of businesses survive for more than five years, entrepreneurs believed that their chances of success were 81%. They also perceived that their prospects for success as substantially better than those for similar business.

Optimism bias has potential negative implications for the willingness of individuals to seek information about their potential risks. People tend to avoid information that contradict or run counter to the optimism that led them to make a particular decision.

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