What’s The Difference Between A Chain And A Franchise?
Several years ago I took an Uber from Santa Monica to Orange County. For those of you that don’t know Los Angeles, that can take anywhere from 45 minutes to 2 hours depending on traffic. Needless to say, conversation, unwanted or otherwise, tends to pop up on a long trip like that.
This particular conversation was frustrating. My Uber driver argued with me for more than half the drive, contending that a chain store and a franchise are exactly the same thing. The topic arose after passing a Starbucks and my driver mentioning that he much prefers supporting local businesses over franchises.
After 13 years in franchising, I had a few thoughts on his comment:
Starbucks is not a franchise
We wrote an entire post focused just on this point, so I won’t belabor it here. The short version is that only Starbucks shops that you find in hotels, airports, grocery stores, etc are franchises, and all of the stand-alone or inline retail locations are owned by Starbucks, the corporation. Starbucks blurs the line between a franchise and a chain, but the large majority of its locations are not franchises, so it’s an improper classification.
Franchises are (mostly) owned by local individuals
When you go to your local coffee shop, you are supporting a small business owner. Similarly, when you go to a coffee shop franchise (again, not Starbucks) like Dunkin’ Donuts or Coffee Bean, you are also supporting a small business owner. What’s the difference?
The local coffee shop owner started everything from scratch. The franchise owner bought the rights to use a brand name and proprietary systems and has to pay a royalty to the franchise brand.
However, both invested a significant amount of capital in building their locations and both have operating costs like rent, labor, and supplies. Both owners are trying to make enough income to put a roof over their head, feed their families, and build a valuable business.
Again, the difference is that one of them pays fees to a bigger entity, and the other does not. But their investment, goals, struggles, and contributions to the community (i.e. hiring local workers) remain the same.
There are exceptions as private equity has become more involved in franchising, acquiring franchisee development rights for large areas and then hiring people to manage the operation, but their footprint is still quite small, and the majority of franchise owners are still local individuals.
Franchises are not the same as chains
As already mentioned, franchises are typically owned by local individuals. Chains are not.
Chains are owned by corporations and do not sell the rights to use their brand name and proprietary systems. Examples of chains include In-N-Out Burger, Chipotle, and Best Buy. When a chain store closes, the corporation loses out, but there’s not a local owner that has its individual personal finances affected.
Franchises and chains have different strategies
When a brand chooses to offer franchises, it’s usually due to two factors: capital available and speed to market.
If it costs $300,000 to open a location and you have $600,000 in the bank, you can open 2 more locations. To open additional locations beyond that, you would need to wait until you’ve recouped an additional $300,000 from those 2 locations, raise money from investors, or borrow money from a lender. Chain stores often take on early investment or borrow. However, if you don’t want to give up equity to investors or carry debt, you risk losing out on market share by not moving quickly enough in expanding your business.
Enter the franchise strategy. Franchising enables brands to grow much faster using other people’s money, but without giving up equity. In the scenario above, you invest your $600k into 2 locations. But what if you invested $200,000 into setting up your brand as a franchise, and then sold 5 franchises to individuals looking to open their own business? Now you get 5 locations open instead of 2, and you retain $400,000 in the bank.
Now, obviously the scenarios above exist in a vacuum and not in reality in terms of dollars and cents, but I think it paints the picture for why some household brand names are franchises and others are chains.
If you want to support local business owners rather than chains, I fully support it. Just remember that franchises are not chains, and are operated by your neighbors. Supporting your local franchise locations IS supporting local business owners.