Types of Franchise Models Explained

Editor’s Note: This post was originally published and has been updated for accuracy and comprehensiveness.

Franchising is a business model in which a company (the franchisor) grants an individual or group of individuals (the franchisee) the right to operate a business using the franchisor’s established brand, trademark, and business model. 

This arrangement allows entrepreneurs to start a business with a proven business model, established customer base, and brand recognition. 

For franchisors, it’s a scalable way to expand their business and increase market share without the need for substantial capital investment.

How Does Franchising Work? 

In franchising, one business (the franchisor) gives another company (the franchisee) a license to sell products and services under the franchisor’s brand name. 

In some models, the franchisee owns the business unit, which allows them to exercise control over its operations and financial investments. 

But in most cases, the franchisor provides the franchisee with a range of resources, like access to their operational processes, proprietary knowledge, franchise marketing support, and trademarks. 

In the US, the franchise business is overseen and regulated by the Federal Trade Commission (FTC). By the FTC rules, every franchisor must prepare a Franchise Disclosure Document (FDD) that provides detailed information about the: 

• Business model, 
• Fees, 
• Renewal & termination terms and 
• Dispute resolution procedures. 

More importantly, the FDD contains information on other affiliate franchisees and how much they’ve made or are projected to make within a specific period. This is called “Item 19.” 

It provides key details such as the average revenue, gross margins, and net profits from existing franchise locations (if the franchisor chooses to disclose it). Also, you get to know if the franchisor has had any litigations with the associate franchisees. 

With this information, you can learn a great deal about the brand before committing, and: 

• Predict the average volume of sales in a financial year. 
• Identify the top-performing franchisees and what contributes to their success.  
• Compare earning potential across different locations.  
• Understand the startup costs and how long it takes to become a profitable enterprise.  

In return for these benefits, the franchisee pays ongoing royalty fees to the franchisor.

Different types of franchise models

Although all franchise arrangements have the same foundational franchisor-franchisee relationship, several franchise models cater to different business needs and preferences. 

Here are some of the most popular franchise model variations out there:

1. Business-format franchise model

The business-format model replicates the franchisor’s business concept across all franchise units (locations). This includes its operational processes, support, marketing plans, and training programs. 

And not only do franchisors give franchisees the right to sell products and services under the franchise brand name, but they also provide comprehensive guidance and ongoing support for setting up and operating their business.  

In simpler words, the franchisor develops a standardized system that all franchisees must follow. This system covers everything required to kick-start operations in the new company, including equipment procurement, staff training and recruitment, standard operating procedures, customer service protocols, and sales and marketing strategies.

Under the business-format model, franchisees pay an initial fee to join the franchise network in addition to recurring royalty fees based on a percentage of revenue. Sometimes, franchisees will also pay marketing and advertising fees. McDonald’s, Subway, and 7-Eleven are classic examples of this franchise model. 

Pros:

• Access to a proven business system and operational manual. 
• Less risk and higher success rate.  
• Franchises can piggyback on a well-known and trusted brand to streamline marketing efforts.  
• Easy access to capital for franchisors. 

Cons:

• High starting costs for the franchisee. It costs between $522,500 to $2.64 million to get a McDonald’s restaurant up and running.
• Profits are disbursed through a royalty fee. 
• Franchisees are limited to the franchisor’s mode of operation.

Best for: The business-format franchise model is popular in the fast food, fitness, retail, restaurant, and business services industries.  

2. Product distribution franchise model

Under the product distribution franchise model, franchisors grant franchisees the right to sell their products, often within designated territories. And yes, it’s not as all-encompassing as the business-format franchise model. 

In this model, franchisees can sell products under their own brand identity and have greater autonomy over their business operations. It’s similar to a conventional supplier-retailer relationship. 

However, unlike the regular retail arrangements, the franchisee sells the franchisor’s products on an exclusive basis. The franchisee may also pay a licensing fee to use the franchisor’s trademarked goods or agree to minimum purchase requirements. Coca-Cola and GoodYear Tires are well-known examples of using this model.

In essence, franchisors focus on manufacturing the products, while franchisees handle the distribution and sales within their local markets. This can include responsibilities like warehousing, inventory management, product transportation, and customer relationship management.

There are three main types of product distribution franchise: 

• Wholesaler-Supplied:

Here, the wholesaler is the franchisor that sources and supplies the products to the franchisees. 

• Manufacturer-supplied: 

In this model, the manufacturer is the main supplier of the products and delivers directly to the franchisees. 

• Retailer supplied: 

In this case, the franchisor is the retailer and sources, manages, and distributes the products to the franchisees. 

Pros:

• Access to an established supply chain. 
• Ability to purchase bulk products at a lower cost. 
• Access to a proven inventory system. 
• Low or no royalty payments (especially if the franchisor profits from product sales). 
• Franchisees have more control over product quality. 

Cons: 

• High starting costs. 
• Reliance on the franchisor’s supply chain. 
• Limited product diversity. 

Best for: The product distribution model is popular in consumer goods, automotive, and electronics industries.  

3. Manufacturing franchise model

Under this model, franchisors grant franchisees exclusive rights to manufacture and distribute their products using the franchisor’s established processes and intellectual property.

To ensure quality and consistency, franchisees must adhere to the franchisor’s guidelines when manufacturing products (like following recipes and using specific equipment). 

The franchisors also provide ongoing support and training to ensure these operations run smoothly. This ensures that all products manufactured under the franchisor’s brand meet the same quality standards.

Consider Coca-Cola, for example. The company manufactures the syrup concentrate (coke extract) and distributes it to other bottling partners (franchisees). These bottling partners have the exclusive right to mix the concentrate with water and sweeteners, bottle it, and distribute it to retailers and consumers in their local market. 

Franchisees are also responsible for supply chain management, including sourcing raw materials, coordinating production schedules, and ensuring products reach end-users in time.  

Pros: 

• Consistent product quality in all locations.  
• Centralized manufacturing allows for efficient supply chain management.  
• Effective quality control for the franchisors. 
• Easy to scale across multiple regions. 

Cons: 

• Franchisees depend on franchisors for inventory. Any delay in the supply can affect the entire local process. 
• Franchisors must ensure franchisees follow their quality control measures to ensure consistency.

Best For: This model is used across a range of industries, such as food and beverage, consumer goods, and pharmaceuticals. 

4. Conversion franchise model

The conversion franchise model allows existing independent businesses operating within the same industry to join the franchise’s network.

When such businesses become franchisees, they adopt the franchisor’s brand identity, operational standards, and processes. However, conversion franchisees often retain some degree of autonomy over day-to-day operations and marketing activities within their respective markets.

For the franchisor, it’s a fast route to expand their business network to other countries. It’s low cost, too. The incoming businesses would already have all the essentials – staff, a building, customer base, and, more importantly, industry experience. All that’s left is to align them with the franchise system, technology, and branding. 

An excellent example of this is Marriott. Marriott International offers a wide range of hotel brands across various categories, including luxury and select-service options. The converted business (franchisee) will adopt Marriott’s global standards, operational procedures, and management expertise to grow its business. 

Pros: 

• Less risky since the franchisors have a working business model.  
• Ability to capitalize on the franchisor’s brand name for brand recognition and support.  
• Access to a broad, international customer base. 
• A quick way to expand your business as a franchisor across different markets.  

Cons: 

• Royalty fees payment after sales may affect the franchisee’s financials.  
• It can be challenging to balance the franchisor’s mode of operation with the local market. 

Best for: Established medical clinics, retail stores, and home service providers.

5. Master franchise model

The model enables franchisees to become “master franchisees” or sub-franchisors. 

Here, the franchisee owns the rights to develop and manage sub-franchisees within a specific territory. This means the franchisee gets to create, manage, and sub-franchise multiple franchise units within a specific geographic territory.

Think of master franchisees as middlemen between the franchisor and individual unit franchisees. They’re responsible for overseeing and supporting the sub-franchisees within their designated area. This may include training and onboarding, recruitment, and supply chain management in their territory.

For instance, a franchisor can grant a master franchisee exclusive rights to the territory of New York. The master franchisee is then responsible for recruiting and supporting new franchisees within this area, and ensuring they’re on par with the brand guidelines.   

In return, the master franchisees pay a fee to the parent franchisor for the rights to develop and manage sub-franchisees and receive royalties from those sub-franchisees.

Pros: 

• The master franchisee can earn money (royalties) from the sub-franchisee, increasing the income streams. 
• It’s a quick way for franchisors to spread out and serve new markets without putting in much work. The master franchisees will carry a majority of the burden. 

Cons

• The multi-tiered system of the master franchise model can become complicated if not properly managed. 
• There can be communication challenges between the franchisors and master franchisees. 

Best for: Master franchisees are common in fitness, full-service restaurants, automotive, and health industries. 

6. Investment franchise model

Under the investment franchise model, capital investors provide the necessary financial resources to set up or buy a franchise unit to make a return. 

The franchisee owns the unit but does not engage in day-to-day operations like in other models. Instead, they hire a management team to manage the business. 

In most cases, investment franchisees are corporate investors or high-net-worth individuals with a strong track record in business (it can be related or different). They view franchising as diversifying their portfolio, so they don’t get involved with its day-to-day operations. 

In return for their financial investment, they receive a share of the profit generated by their franchise unit.

Pros 

• Capital investors can have a long-term return on investment on their franchise units, especially if they purchase one in high-demand sectors such as hospitality or fitness. 
• The ability to open multiple units allows for greater market presence.  
• Investors benefit from the brand recognition, proven business system, and franchisor support. 
• For franchisors, investment franchisees bring capital, business experience, and management infrastructure to grow the business. 

Cons

• Requires high capital for franchisee, construction, and staffing fees. 
• Since the investors are not involved in the day-to-day operations, the franchisee is at the mercy of the management team. Poor hires can lead to underperformance or reputational damage. 

Best for: Some common examples of investment franchises include fitness centers, hotel chains, and real estate brokerages.

7. Hybrid Franchise Models

Hybrid franchise models combine elements from different models to create a unique and flexible business structure. These can be business format franchise models, with the product distribution franchise model, or franchising with other business strategies like licensing or partnerships. 

Hybrid franchise models offer the best of both worlds and provide comprehensive support and operational efficiency. However, they also require careful planning and management to navigate the complexities.

Pros

• Easy customizability, as you can combine aspects of different franchise types to suit your business or region. 
• It gives flexibility and autonomy to franchisees who have creative control.
• Business responsibilities can be split between the franchisor and franchisee based on their strong suits. 

Cons

• Too much flexibility can lead to inconsistencies in brand perception. 
• Hybrid models require detailed planning, and this can be complex to implement.  

Examples of hybrid franchise models

Examples of hybrid franchise models include:

• Business Format Franchise Model + Product Distribution Franchise Model: 

This model combines the comprehensive support and guidance of a business format franchise model with the efficiency of a product distribution franchise model. Franchisees benefit from a standardized system while managing product distribution and sales.

• Franchise Owned Company Operated + Company Owned Franchise Operated: 

This model merges the autonomy of a franchise-owned company-operated model with the support and guidance of a company-owned franchise-operated model. Franchisees own the units, but the franchisor handles day-to-day operations to ensure brand consistency and business efficiency.

• Hybrid Franchise Model + Licensing: 

This model combines the flexibility of a hybrid franchise model with the simplicity of a licensing agreement. Franchisees operate under the franchisor’s brand and business model while leveraging licensing agreements to expand their product or service offerings.

• Investment franchise model + Ghost Kitchen 

The investment franchise model and ghost kitchen are most popular in the Quick Service Restaurant (QSR) space. In this model, the capital investors fund the delivery-only virtual restaurants (or ghost kitchens). 

At the same time, a third-party (or even the franchisor in some cases) manages the operations using the brand menu and technology stack. This hybrid model is cost-effective as it eliminates the need to build or purchase a building from scratch. 

Also, your management team can focus on profit-maximizing activities rather than operational ones, such as in-store customer service or staff management. 

Wendy’s Kitchen’s partnership with Reef Technology is a good example of this model. Reef funds and operates ghost kitchen pods that serve Wendy’s menu through delivery apps. 

Best for: Automotive services, furniture retailers, and health & wellness brands. 

Now that we’ve covered the most prevalent franchise business models, let’s quickly address the four kinds of franchise ownership structures.

Franchise unit ownership models

1. Company-owned, company-operated (COCO)

Under this model, the franchisor directly owns and operates its outlets. Technically, this doesn’t count as a franchise model since no independent franchisees are involved.

Typically, franchisors use the COCO model as a testing ground for their business concept and to iron out best practices. If the business proves viable, they can begin searching for franchising opportunities.

2. Company-owned, franchise-operated (COFO)

The COFO model is a more collaborative approach to franchising where the franchisor maintains ownership of franchise units but delegates day-to-day operations to a franchisee. 

In this case, franchisors are still responsible for providing franchisees with guidelines, training, and support, while franchisees handle routine functions like staffing, inventory management, and customer service.

3. Franchise-owned, franchise-operated (FOFO)

This is the most common form of franchising, where the franchisee owns and operates individual franchise units under the franchisor’s brand name. While franchisees retain control over business operations (like staffing, inventory management, and local marketing efforts), they also must follow the franchisor’s guidelines and brand standards to ensure consistency.

4. Franchise-owned, company-operated (FOCO)

Finally, under the FOCO model, franchisees own the units, but day-to-day operations fall into the franchisor’s hands. This approach is often adopted by franchisors who want to maintain complete control over their brand image, operational consistency, and customer experience. 

Now that we’ve explored the major types of franchise models, how do you make the right choice for your business? 

How to choose the right franchise model: a simple checklist

1. Evaluate Your Skills and Strengths 

Evaluate yourself based on your skills, interests, and capacity. Do you enjoy managing people and thrive in a fast-paced environment? Do you prefer flexibility, or are you more comfortable with a structured system? A thorough self-assessment will help you choose the model that works for you and the industry you should venture into. 

Tip: Use SWOT analysis to identify your strengths, weaknesses, threats, and opportunities. Also, envision your growth plan in the next 3 – 5 years. 

Remember: the more honest and specific you are at the evaluation stage, the easier it is to filter through the noise and find a franchise opportunity that matches your goals. 

2. Define your business goals and how franchising would help you achieve them

Next, you want to define your business goals and how franchising fits your long-term vision. Goal setting will set you off on the right foot and help you know which path is best for your business success. 

For example, as a potential franchisee, your goal might be to gain market entry fast and start making a profit. So, you’ll want a franchise model like a business format franchise that has low entry barriers, strong brand recognition, and proven systems in place. 

If you’re an intending franchisor, your goal might be to expand your footprint to other locations without overbearing the operational load of each unit. 

Once this is all panned out, you’d make informed decisions on the best models that align with your growth strategy, budget, and operational system. 

3. Evaluate your business to determine the capacity 

Each business has its demands in terms of capital, operational systems, staffing, and customer service expectations. Before you settle on any model, evaluate your current capacity to determine whether you can realistically support or scale. 

Here’s the truth: Although franchising is profitable, you can’t predict how fast or slow your growth will be, especially if you partner with a busy or expensive franchisor. 

Case in point, this business owner on Reddit shared how they lost thousands of dollars and had to close their franchise only a few months in. The reason? High franchise & royalty fees, unpredictable sales, and rigid legal agreements: 

That said, ask important questions like: 

• Can I afford the initial franchise fees and operational expenses? 
• Do I have the tools and people to maintain quality standards?
• Is there a high demand for the franchisor’s products in my location? 

As a franchisor, you also want to know if you can replicate your systems across the new locations. 

4. Find the model that best aligns with your business goals 

Once you’re certain of your business goals and capacity, the next thing on the list is to choose the one that aligns accordingly. Trust me, the last thing you want is to commit to a franchise model that constrains your growth plan or drains your resources. 

There are different types of franchise models as listed above, with their strengths and tradeoffs. Go through each option again to know which one aligns with your vision. 

5. Choose the location carefully 

Your franchise location is one of the most important determinants of its success. As expected, urban areas and cities are often attractive due to their high population density, better infrastructure, and great foot traffic. However, these benefits come at high operational costs and dense competition.  

To choose your location, consider where your target customers are. For instance, a QSR will thrive near offices or universities, while a home service franchise will thrive in residential areas.

So, conduct location feasibility studies or work with a franchise expert who can recommend strategic territories based on market data, customer demographics, and competition levels. 

6. Run your decisions through a professional 

Franchising is capital-intensive, and you can’t afford to take the wrong step, especially at the foundational stages. To avoid costly mistakes, consult a franchise expert before signing any agreements. These experts can help you: 

• Review the Franchise Disclosure Document to ensure transparency in fees, obligations, and restrictions. 
• Evaluate the financial projections and determine if the model is viable based on your current resources. 
• Assess legal risks and negotiate terms that better protect your interests. 
• Conduct due diligence on the franchisor’s reputation, history, and franchisee success rate. 

Read more on how to choose the right franchise models 

Are franchises worth considering? 

Yes! Franchises benefit the franchisor and franchisee, as both parties dot their Is and cross their Ts. 

Here’s what I mean:  

As the franchisee, buying into a franchise means stepping into a proven business model with built-in brand recognition, operational systems, and marketing support. Instead of starting from scratch, you get a head start with what already works. 

For franchisors, it’s a low-cost, yet efficient way to grow their business as they can piggyback on the capital and efforts of the associate franchisees without taking on the financial risk themselves. Franchisees invest their capital, take responsibility for day-to-day operations, and expand the business to new markets while following the brand’s guidelines. 

This symbiotic relationship mitigates the risks associated with starting a new business.

Final thoughts

Franchising is a proven avenue for businesses looking to expand their customer reach while enjoying the benefits of increased brand recognition and the efficiency of standardized operational processes. As we’ve seen, there are several ways to structure a franchise, with each model catering to different business needs and preferences.But remember, whichever franchise model works best for you, you also need to develop and implement a coherent marketing strategy to ensure your business grows. Whether you’re an established or aspiring franchisor or franchisee, we can help you create winning franchise campaigns to boost your organic traffic, leads, and sales.