Let’s take for example McDonalds.   McDonalds runs its stores via two different models it operates its own corporate chain stores and then it leases some of it stores to individuals and sells some of it stores to individuals.  These individuals that buy the lease to the store or buy a new store are called frachisees.  They also pay management fees to McDonalds Corporation which are usually royalty fees and the training and advisory services fees.  There is also a fee for the “Disclosure” which is separate and is always a “front-end fee”.  The franchisee also pay a percentage of their gross revenues to the franchisor (McDonalds corporation) which is usually negotiated by their contract.   That percentage is usually a 3-5% range or maybe more.  The franchisor owns all the trademarks, business methods, and supplies that it allows others to use under its contract.

So in a frachisee-frachisor agreement another individual has to buy the right to run the store under the name of the corporation for a limited time and pay certain fees and gets to keep the profits after paying a percentage to the profits to the corporation.  The big corporation gets to sell somebody the right to run their store or own their brand name for a certain time, gets a certain percentage of the profits and charges management fees and other fees to the franchisor.

The advantage to the big corporation that it gets start up capital from the franchisor, motivated management, and reduced risk by shifting some of the liabilities over to the franchisor and gets a chance to grow at the expense of the franchisor.  The advantage to the franchisor (or a nascent entrepreneur) is that it gets a proven business model, low chances of failure (return on investment), established customer base, free marketing and advertising, and free training of staff.

In my opinion the key in a franchisee-franchisor agreement is the time limit of the contract and ownership of land/building.  If the big corporation is shrewd they can really tighten the noose on the franchisor if they are very profitable.  The renewed contract signed for another limited period of time will almost always have increased charges which will take a bigger chunk out of the profits of the owner.  If the owner has the lease they can increase the rent.  Thus the big corporation can force out an owner if they really want by increasing their fees and rent.  The owner who owns the land and the building has the real bargaining power because they can always they can always threaten to sell the building and the land.  Also if your contract has a longer time period then you basically delay the renegotiation to higher fees.

The failure rate for franchisees is lower than for independent businesses is because it is operating a already successful business model.  It has the benefit of getting the help and the experience of a successful corporation.  The owner is motivated to make a profit so they drive their employees to work hard.  The location that has the best chances to be profitable is picked because the big corporation has the expertise and market research capabilities to do that.

I do not know why anyone would prefer to be a manager of a company owned store? Most likely because they do not have the capital and are risk averse individuals.  They may also like the steady paycheck, chance to move up the company ladder and the ability to walk away with ease via transfer.  As a company manager you don’t get to realize the profits from all your hardwork because you just get a steady paycheck.