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Licensing or Franchising: Which is Better for Your Expansion Plans?

For hospitality owners looking to open new locations, licensing and franchising are two great alternatives to investing in an entirely new store.

By Dave Eagle

Because profit margins are notoriously slim in the hospitality business, restaurants, bars and cafés are always looking for ways to increase revenue or reduce costs to maximise the bottom line.

But there’s only so much you can do to increase what you make without increasing what you charge.

It’s a kind of paradox: your success could actually hamper your growth because once you’ve found that secret formula that works – competitive pricing, consistent food and service quality and regular patronage from customers who are also your fans – you risk upsetting the balance if you change anything.

READ NOW: Three Methods to Help Restaurants Increase Revenue Without Raising Prices

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If you’ve gotten to a great place with your venue, the logical way to get bigger is to expand into new locations, and do what you’ve done well already in other places.

Of course, this is not without its own set of issues, most notably the enormous sum of money it takes to open a new site. For the business owner who’s been through the kind of spending spree required to set up shop, the idea of a second location can seem daunting. And that’s where licensing and franchising can be good routes to take.

With both of these options, it’s someone else who takes on the financial risk of opening the new location while paying royalties or fees to you, the owner of the concept.

A new location set up in this way won’t make you as much money as opening your own second storefront, but it also doesn’t cost you nearly as much to get going, in money or time.

To help you decide what’s a better option for your brand, we look at how these two business models work, what the important differences are, and offer some insight from one of our customers that’s tried both out.

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Licensing vs. franchising: what’s the difference?

In both cases, you’ll be expanding your brand without owning any of the new locations. The chief difference between the two is how much involvement and control you’ll have over them, and there are pros and cons to each choice.

What licensing is: an easier way to get additional revenue with your brand

With a licensing model, you’re basically entering into a contract that grants the right to use your intellectual property (IP) to another person or business. For a hospitality business, that includes things like your brand name, logo, recipes, and some processes.

There’s no template for how much or how little rights you can grant them, nor are there any hard and fast rules as to how much you should receive in royalties. All of that gets worked out during contract negotiations.

An example of a licensing model is seen in Uber, which licenses the rights to use Google’s Maps software in its ride-hailing app, and on its food delivery service Uber Eats. This way, Uber doesn’t have to create a maps software from scratch before going to market, and can focus on its core offering –  connecting their drivers with their customers.  

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What licensing isn’t: a model you have much control over

In a license agreement, you typically lack control over performance, operations, or standards. There are reasons potential licensees go down this path – it saves them the time and money that’s required to create a brand or product that works, and what they’re licensing could only form a small part of the overall business they want to set up.

The downside of this is the potential lack of enforceable uniformity in your product and brand messaging. And without any oversight, it only takes one licensee doing things poorly to ruin the brand name for everyone else.

On the plus side, entering into a licence agreement is much less costly for you, in terms of both time and money. Once the deal is signed, the licensee goes off and mostly does their own thing, and the royalties you collect can become a steady source of passive income on top of the revenue you’re earning with your own venue.

Undoubtedly one of the world’s most famous franchises – McDonald’s. Image Credit: Fridy / Flickr (CC BY-SA 2.0)

What franchising is: a replica (almost) of your original business that other people pay to set up

If you decide to franchise your business, you’ll have a lot more control over the people you’re trusting with your brand. You’re essentially teaching people how to recreate a proven business model – one that you’ve designed and put together.

In a franchise model, you get to dictate things like operational processes, how and where ingredients are sourced, and what performance quotas you want. Compliance becomes the condition for access to your IP.

You also get to decide how all marketing is conducted, with franchisees paying into a fund that acts as a unified budget for all locations. For hospitality business owners who’ve worked hard to build a successful business and brand, there’s great appeal to a model that protects their reputation and IP in ways that licensing just can’t.

What franchising isn’t: easy or cheap

There’s much, much more work that goes into creating a successful franchise, from creating the model, to managing distribution, to the never ending oversight ensuring all franchisees are playing by the rules.

The costs, as you might imagine, are much higher, too. You’ll need to invest plenty of money (at least at the start) to do things like:

  • research the market to understand how much competition you’ll face, and how likely it will be for your franchise system to succeed.
  • create the training manuals and materials needed to teach new franchisees how to open and operate a successful branch of your business.
  • put together marketing and training plans for your franchise.
  • advertise your intent to franchise your business to potential franchisees.
  • conduct the necessary due diligence before bringing new franchisees on board.

Legal costs will also stack up as you need engage a lawyer to prepare franchise agreements and a disclosure document. You might also need to hire other specialist third parties such as operational and marketing consultants, bookkeepers and financial advisers to prepare your franchise for sale.

At a minimum, you can expect to spend anywhere from $100,000–$150,000 before selling your first franchise.

These are some other things to consider on your path to becoming a franchisor:

  • Although you get plenty of control, the royalties and fees you collect as the franchisor is much less than what you’ll make by owning and operating a second or third venue (also known as a company-owned store) yourself.
  • Franchise owners aren’t your employees, so while they are replicating your business model, you don’t have direct control over their management styles.
  • You might need to invest a lot of time and effort into looking for franchise buyers, and then evaluating if they are the right fit to carry your brand into market.

So which is the better option for you?

While both have the potential to grow your business and put more money in your pocket, there are so many variables from business to business that the decision between the two comes down to one of mechanics and personal preference. Also, it doesn’t necessarily have to be an either/or proposition.

It’s cheaper for Uber to license Google’s Maps content instead of creating a map from scratch for example, but licensing the Maps content costs money – and this cost will only increase as Uber proliferates globally. So at some point, it might make more financial sense for a company like Uber to just build their own mapping software instead of giving a certain portion of their revenue to Google on an ongoing basis.

Image Source: Acai Brothers

Case study: Acai Brothers Superfood Bar

After best mates Sam Carson and Ben Day successfully started the first Acai Brothers Superfood Bar in the Redwoods area in Melbourne, it didn’t long for them to think about expansion. But they found the franchising model too complex and expensive a leap for a concept they weren’t sure would even work elsewhere. Their solution? Test the wider market first by licensing their brand.

“It [licensing] allowed us to comfortably share our IP and have a go at recreating our model elsewhere without the large initial outlay of time and money it would have taken to fully franchise…It worked really well doing it this way, as we had an opportunity to test the concept of expansion with minimal risk,” Carson said.

By the time the third licensee opened up shop, Carson and Day’s original location had become a well-oiled and profitable machine. They knew their business better than ever, and had the confidence to give franchising a shot.

It was several months of hard work and preparation to develop their model, but once they had their franchise fully defined, Carson and Day migrated their existing licensees over to the new model.

It took only three years for Acai Brothers to reach 20 locations. Today, there are 25 different shops that bear their name all over Australia – with international expansion as the next step in their plans.

Read the full story about how Acai Brothers franchised their way Australia-wide in just three short years, and sign up for our newsletter for more tips on growing your hospitality business.