Franchising

Types of Franchises

There are three major types of franchises – business format, product, and manufacturing – and each operates in a different way.

Learning Objectives

List the different types of franchises

Key Takeaways

Key Points

  • A business format franchise is a franchising arrangement where the franchisor provides the franchisee with an established business, including name and trademark, for the franchisee to run independently.
  • A product franchise is a franchising agreement where manufacturers allow retailers to distribute products and use names and trademarks.
  • A manufacturing franchise is a franchising agreement where the franchisor allows a manufacturer to produce and sell products using its name and trademark.

Key Terms

  • franchise: The authorization granted by a company to sell or distribute its goods or services in a certain area.

Types of Franchises

While there are many ways to differentiate between different types of franchises (size, geographic location, etc), we will be looking at how different franchisors allow franchisees to use their name. On this basis, there are three different types of franchise:

  • Business format franchises
  • Product franchises
  • Manufacturing franchises

Business Format Franchises

In business format franchises (which are the most common type), a company expands by supplying independent business owners with an established business, including its name and trademark. The franchiser company generally assists the independent owners considerably in launching and running their businesses. In return, the business owners pay fees and royalties. In most cases, the franchisee also buys supplies from the franchiser. Fast food restaurants are good examples of this type of franchise. Prominent examples include McDonalds, Burger King, and Pizza Hut.

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McDonalds: McDonalds is perhaps the most famous franchise in the world.

Product Franchises

With product franchises, manufactures control how retail stores distribute their products. Through this kind of agreement, manufacturers allow retailers to distribute their products and to use their names and trademarks. To obtain these rights, store owners must pay fees or buy a minimum amount of products. Tire stores, for example, operate under this kind of franchise agreement.

Manufacturing Franchises

Through manufacturing franchises, a franchiser grants a manufacturer the right to produce and sell goods using its name and trademark. This type of franchise is common among food and beverage companies. For example, soft drink bottlers often obtain franchise rights from soft drink companies to produce, bottle, and distribute soft drinks. The major soft drink companies also sell the supplies to the regional manufacturing franchises. In the case of Coca Cola, for example, Coca Cola sells the syrup concentrate to a bottling company, who mixes these ingredients with water and bottles the product, and sells it on.

Advantages of Franchises

A franchise agreement can have many benefits for both the franchisor and the franchisee.

Learning Objectives

Discuss the advantages of participating in a franchise

Key Takeaways

Key Points

  • Benefits to the franchisor include regular royalty payments, expansion with reduced financial risk, and a greater geographical presence.
  • Franchisee benefits include lower risk, lower startup costs, existing brand recognition, and parent company marketing support.
  • Potential franchisees can select a franchise based on their location, interests, resources, and needs, which means that entering into a franchising arrangement can be a flexible process.
  • – Royalty payments
  • Franchisee benefits include:
  • – Higher chance of success due to tried and tested business model
  • – Franchisor support, training and expertise
  • – Brand recognition and national marketing

Key Terms

  • franchisor: a company or person that authorizes another to sell or distribute its goods or services in a certain area
  • royalty: Regular payment made from the franchisee to the franchisor for the right to be a franchisee.

Benefits for the Franchisor

Franchisors benefit from franchise agreements because they allow companies to expand much more quickly than they could otherwise. A lack of funds and workers can cause a company to grow slowly. Through franchising, a company invests very little capital or labor because the franchisee supplies both. The parent company experiences rapid growth with little financial risk.

A company can also ensure it has competent and highly motivated owners and managers at each outlet through franchising. Since the owners are largely responsible for the success of their outlets, they will put in a strong and constant effort to make sure their businesses run smoothly and prosper. In addition, companies are able to provide franchising rights to only qualified people.

Other benefits include:

  • Franchising allows a business to have an international presence.
  • Franchisors can experience economies of scale.
  • Franchisors can benefit from growth without worrying about running costs.
  • Franchisors receive royalty payments that are set as a percentage of profits.

Benefits for the Franchisee

The franchisee also has numerous advantages that come from entering a franchising agreement, including:

– There is a low risk due to the tried and tested formula. Buying a franchise business provides a higher chance for success. They get the benefit of owning a proven business formula that has been tested and shown to work well in other locations. In addition, they receive the support from the main company toward establishing the business, and the training to operate it successfully.

– There are lower start-up costs since the business idea was already developed.

– They are buying a name and brand that is recognized by the public. So they have a big advantage over starting a business from scratch, as they already have an established customer base.

– A franchise gives more security from the beginning. New independent businesses are known to have as high as a 90% failure rate, often causing the business owner heavy losses and at times bankruptcy.

– When you start a business from scratch, you spend huge amounts of time trying to operate the business without being successful because you may not have the necessary skills for that particular area. When you purchase a franchise, all the necessary groundwork has been done already. In addition, the franchisee gets training and head office support from the franchisor; this may be essential if the franchisee is new to running a business and has no experience or business knowledge.

– The franchisee gets the support of national marketing which a small business would not normally be able to afford. In some cases of larger brands, they may have customers waiting for their doors to open (for example in a new McDonalds).

– Since all the product selection and the marketing have been already developed, you simply have to take care of the daily operations of the business. Your goal will be to grow from an established foundation and expand from there.

– The new franchise owner gains many benefits from the association with the main franchise company. The franchisor offers a great deal of business experience that would take years for the average business person to acquire.

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Pizza Hut Franchise: Franchisees gain many benefits from being a franchisee rather than starting their own business from scratch.

– There are a lot of part-time franchising opportunities, which are perfect if someone has a small amount to invest and wants to support themselves and maintain their investment. They may be able to sell the franchise to someone else once they no longer wish to run it.

Disadvantages of Franchises

A franchise agreement can also have disadvantages for both the franchisor and the franchisee.

Learning Objectives

Discuss the disadvantages of participating in a franchise

Key Takeaways

Key Points

  • Disadvantages to franchisors include a lack of control over franchisees, reputational risks, and slow growth through franchising compared to mergers and acquisitions.
  • Disadvantages to franchisees include high costs and royalty payments, strict product rules, and other start up challenges.
  • Entering into an agreement with an interested franchisor is important. Uninterested franchisors will not provide adequate support, and are only interested in collecting fees and payments from franchisees.
  • Franchisee disadvantages may include:
  • – High entry costs, which include fees and start-up capital, and ongoing royalty fees
  • – Lack of support from uninterested franchisors
  • – Lack of flexibility in how to trade, as well as where to locate

Key Terms

  • uninterested franchisors: Franchisors that have little interest in the actual success of the franchise, and more interest in collecting fees from franchisees.

Disadvantages to the Franchisor:

Of course, no business arrangement is without potential risks and disadvantages. While there are many advantages for the franchisor in entering a franchising agreement, some of the potential risks are:

– Difficult to control activities of franchisees: In any franchise agreement (particularly when there is geographical separation between the franchisor and the franchisee), it can be difficult to control the activities of the franchisee and ensure that their activities are up to standard.

– Huge risk in reputation by allowing other businesses to use their names: if a franchisee does not live up to the quality standards of the franchisor (cleanliness, customer service, pricing, quality of product, etc.), this can have a negative reputational effect not just on the franchisee, but on the broader reputation of the franchisor as well. Thus, there is a risk in allowing others not directly connected to the business to use the business name and trademark.

– Not as quick a method of growth as mergers or acquisitions: M&A allows companies to expand very rapidly, whereas entering into franchising agreements means that the franchisor enters agreements with numerous individuals over time, and has to wait for them to start up and begin operations (instead of taking over existing operations). This method of expansion can be slow.

Disadvantages to the Franchisee

– High entry and ongoing cost: It can be more expensive to start a franchise than an independent business. You can open your own burger bar for the fraction of the cost of buying the rights to a McDonald’s franchise. Thus, franchising is often an option open only to already wealthy businessmen.

– Franchisees have to pay a significant percentage of their revenues to the franchisor: On top of the upfront money needed to start a franchise, the franchisee must pay fees and royalties to the franchisor. The franchise fee may range anywhere from $5,000 to over $1 million and hence can be a major expenditure for the franchisee. Royalties are paid periodically during the life of the franchise agreement. They are either a percentage of an outlet’s gross income—usually under 10 percent of an outlet’s gross income—or a fixed fee.

– Other franchise costs: In addition to royalties and payments, the franchisee may be required to buy certain items from the franchisor like computer systems and software.

– Uninterested franchisors: Some franchisors may have little interest in their franchisee’s success and may be more interested in just collecting the fees associated with the franchise. Thus, support and marketing may not be adequately provided.

– Strict product rules: Franchisees experience less flexibility to use their own initiative due to restraints from the franchisor. Franchisees can only sell the products of the franchise, and they may be tied into a national brand with a strict set of instructions about how they should trade.

– Start up challenges: The franchisee may have to find or build the right location, hire and train staff and install equipment. This may be difficult for someone with limited business skills just starting out.

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Closed shop: Franchisees face risks and disadvantages that may jeopardize their ability to stay open.

Franchise costs vary to some extent because of costs associated with different kinds of businesses and with different locations. For example, a person who wishes to open a franchised employment service operation, such as Talent Force, based in Atlanta, Georgia, can get away with as little as a $7,500 fee, plus one year’s starting capital investment of $50,000 to $110,000. On the other hand, start-up costs for a company like J.O.B.S., based in Clearwater, Florida, can be as little as $45,000, including a $30,000 franchise fee.

Working from Home or Online

Home franchise operations have made franchising more accessible and affordable than ever, but still require knowledge and expertise.

Learning Objectives

Assess the factors driving the increase of home-based franchises

Key Takeaways

Key Points

  • Home based franchising allows those who do not have the resources to become traditional franchisees to get involved, due to the fact that there is no need to invest in a dedicated business space (lower cost), as well as increased flexibility.
  • This reduced cost is an advantage to both the franchisor and the franchisee.
  • There are still risks involved with home based franchising: franchisees must choose opportunities that they are suited for, based on their skills and expertise, as well as based on the local market.

Key Terms

  • home based franchise: Home based franchises are ways of affiliating with organizations and working from home, often involving less investment than traditional franchises, sometimes even needing little more than a computer with an Internet connection.

One important factor leading to the record number of franchises in recent years is the proliferation of home based franchise opportunities. This has made franchising accessible to a wider group of people. Previously, franchising a business meant that a franchisee would need to come up with a huge cash investment. This was mainly to cover the franchise payment and to establish a real store or business office, as directed by the business agreement. In some cases, this franchise fee is actually dwarfed in size by the cost of the volume needed for the business area.

Because of enormous charges in traditional franchise companies, very few people meet the expense needed to become franchise owners. With home based opportunities, you clear away the need to invest in a real business space by using your present home as a base of operations instead. With a computer and an Internet connection, people are often ready to begin.

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Working From Home: Often, your office could be your own home, and your laptop your main asset.

Despite the advantages introduced by home based operation opportunities, a new business owner should not take the responsibilities and decisions lightly. You might have almost all the elements of operating and marketing your franchise–however that does not mean that you can just going to sit back and let the system do all of the work for you. Franchising a successful home business does not necessarily promise that you will always be profitable. In fact, even experienced businesspeople can fail with a successful franchise when they do not choose the right home based opportunity.

In considering franchises, you should see if you are well-suited to particular franchise options by determining your areas of expertise. Decide if your skill set is going to be an asset to the business. Thorough and honest assessment should guide which opportunities you consider, and you should explore your weaknesses as well. If you feel there are certain aspects of the franchise which may be hindrances to your success, then skip those, even if the opportunity is otherwise tempting. For example, if you have been an avid angler all your life, you should consider home based fishing franchise prospects. This can include things like selling fishing gear and other fishing related items on the internet or offering your services as a local fishing tour guide. But if you hate the idea of fishing, that one will probably not be right for you.

Technology in Franchises

Advances in technology benefits franchisors, franchisees, and the end customers.

Learning Objectives

Give examples of how franchises are using technology to improve business performance

Key Takeaways

Key Points

  • New technologies, such as greater connectivity, mobile apps, and cloud technology, means that franchisors can spend less time on training and support and focus on value-creating initiatives.
  • New technologies, such as the Pulsar Call Management Software adopted by Pop-A-Lock, allow franchisees to better serve customers and meet their needs.
  • Being ahead of the technological curve also allows franchisees to outdo their competitors in their local market. Support from the franchisor in this respect means the franchisee does not have to adopt and learn how to use new technologies by themselves.

Key Terms

  • cloud: Regarded as an amorphous omnipresent space for processing and storage on the Internet; the focus of cloud computing.

Dave Materson, Chief Technology Officer of a franchise company in West Palm Beach, Florida believes that new technology benefits those who train franchisees, the franchisees themselves, as well as their customers. Here’s what he has to say about technology and franchises:

“Put our franchisees in the mix and tech “ease of use” shines through in a pronounced way. Our people are subjected to so many pulls at their time, the new technology available can really make a difference. Being able to price and schedule your work from any location is a dream come true. Could this be any easier than with a tablet computer? No way! Storing files in the cloud for accessibility anywhere on any device is wonderful. Posting to social media in real time with pictures, links and information solidifies the belief that each franchisee should “be the expert” in their local market. And we at the Corporate Office are delighted for two reasons. We don’t have to train people on how to use the tools; technology has given us a big lead-in for this task. Most importantly, we DO get to teach how use of the tools is beneficial to their business. We distribute information as to what our collective group finds successful. We focus more on the business of business instead of the buttons and gadgets that for years were the root of so much frustration for new franchisees. ”

Franchisees are using technology in various ways. Here are just a few.

Saladworks

In the first quarter of 2010, Saladworks released three new technological advances for the franchise and its customers.

  • MySaladworks 2.0 – upgraded company intranet
  • FreshCart – new online ordering system
  • iPhone App – mobile ordering app available for the iPhone, iPod Touch, and iPad.

Pop-a-Lock

In 2005 Pop-A-Lock adopted the use of the Pulsar Call Management Software platform to assist in performing its dispatch functions. Pulsar is utilized to receive initial information from customers concerning their issues, regulates pricing of service based on standard pricing practices and local franchisee SOP and perform back office functions for payroll and billing.

Pop-A-Lock utilizes T-Mobile as a corporate sustaining partner to provide phone, Blackberry and Internet services in many franchise markets. The franchise does use other phone providers based on specific coverage needs and the desires of the local franchisee.

The T.I.M.E.S (Technical Information Management and Exchange System) was adopted for Pop-A-Lock in 2007 from many other Locksmith companies in order to provide a computer based reference system for Locksmith information including Key Generation procedures, Installation Instructions and other technical information. The TIMES program utilizes an interactive system which allows users to submit data for consideration immediately in order to maintain the most current collection of data possible.

Question from Top New Franchises: What role does technology play in your organization?

Answer from Robyn Elman: A big one! To compete in any business, being technologically savvy has its advantages. From mobile email and texting, to social media, to using the right software & phone systems. By staying on top of all the latest technology, we have not only been able to make the lives of our clients easier (making them even more satisfied with our company and services,) but have been able to out-compete other companies in the industry who aren’t as familiar or comfortable with the newest trends. If any franchisee is lacking in skills in any of these areas, we provide additional (free) training until they are comfortable and excited about what new technology has to offer them.

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Technology in franchises: The use of new technologies, such as social media, apps, and smartphone connectivity, can help franchisees and franchisors to get the most out of their business.

Trends in Franchises: Growth

Franchising grew greatly in 2001 to 2005, before stagnating and following the growth trend of the rest of the economy in the years that followed.

Learning Objectives

Identify the latest market trends happening in the franchising sector

Key Takeaways

Key Points

  • The franchising sector outgrew most other sections of the US economy between 2001 to 2005, growing 41% compared to other businesses’ growth of 26% over that period.
  • Following 2005, growth stagnated. Although the International Franchise Association (IFA) predicts a revival in 2012, recent history shows that these predictions are questionable.
  • Franchisers must not repeat the mistakes of the past, when franchise growth was driven by an excess of debt accumulation. It may be necessary to be more selective about choosing potential franchisees.
  • Ultimately, an honest appraisal of the state of the franchising industry and the “good ‘ole days” is required.

Key Terms

  • franchise: The authorization granted by a company to sell or distribute its goods or services in a certain area.

Trends in Franchising

From 2001 to 2005, the franchising sector grew at a faster pace than many other sectors of the U.S. economy. Direct economic output expanded by over 41% from $625 billion to $881 billion, while economic output of other businesses grew by 26%, from $16 trillion to $20.1 trillion. Employment generated by franchised businesses grew by 12.6%, from 9.79 million to 11 million, compared to 3.5% for all businesses, from 132 million to 136.7 million. Payroll generated by franchised businesses grew 21.6% compared to 15.4% for all businesses.

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McDonald’s Franchise: Franchising is the practice of using another firm’s successful business model.

The International Franchise Association reported that 2012 would be the year that franchising rebounds. In its Franchise Business Economic Outlook for 2012, the IFA stated, “after three years of restrained growth, due to the recession and its lingering effects, franchise businesses show signs of recovery in the year ahead. ” The IFA went on to state that “franchise business growth has been restrained over the past three years due to underlying factors, such as the weak rebound in consumer spending, that have been a drag on the economy as a whole. In addition, tighter credit standards have limited the formation of new franchise small businesses and the expansion of existing businesses. ”

Every six months the IFA puts out a statement about how the tight lending standards are retarding the growth of franchising. While that is undoubtedly true, it would be helpful to learn exactly what the IFA deems as the optimal level of liquidity in the system. If the IFA is silently longing for the loose credit standards that reigned supreme in the middle of the last decade then that perhaps is the wrong path down which to proceed. If it is not, then it is incumbent upon the leadership to set forth with more particularity the goals because liquidity in the system is inextricably linked to the franchise growth projections. And if that is the case, then the growth rate that was experienced in the years leading up to the Great Recession cannot be the benchmark for growth in the next decade.

The economic outlook published for 2012 projects an increase of 1.9% in franchise establishments. But as stated above, the one constant with the economic outlooks produced by the IFA over the last four years is that each year the reports change many of the figures stated in the report of the previous year. The reports do have a convenient escape mechanism in that all of the reports state that the numbers are “estimates. ” In other words, neither the IFA nor the high powered accounting and consulting firms commissioned to compile the reports know conclusively how many franchise establishments exist today. If you read the reports carefully you will see that the PWC reports state that 2007 was the first time that there was enough data to even put forth a sound estimate. So while 1.9% may well be the appropriate and realistic growth rate for 2012, given the track record of the reports put forth by the IFA, franchisers must be more than a little skeptical about the numbers that they provide.

Trends in Franchises: International Adoptions

Franchises can be a powerful strategic tool in expanding globally, which has resulted in various trends in international adoption

Learning Objectives

Recognize the value in international franchising, and why there are increasing trends in global adoptions

Key Takeaways

Key Points

  • Expanding a business to a new country or locale is complex culturally, linguistically, and legally.
  • Franchising offers strategic solutions to these challenges by providing ownership to local business owners who are in touch with the cultural climate.
  • International franchising has various pros and cons for the franchisee, the franchiser, and the local governments. The advantages for all parties has created a positive trend in international franchising.
  • As companies expand globally using this strategy, the local understanding has evolved product and service offerings to better meet the needs of the local consumers.
  • These trends of international adoption are best seen at business like McDonald’s, KFC, and 7-Eleven, where menus and product offerings can vary greatly from region to region.

Key Terms

  • BRIC: An acronym for Brazil, Russia, India, and China, which have some of the fastest growing economies in the world.
  • franchisee: The individual who is granted a franchise and opens the new branch of a company in a local area.
  • franchiser: The parent company that provides the brand assets to the franchisee.

International expansion is complex for both legal and cultural reasons, and franchising is a uniquely strong solution for both. The concept of franchising enables organizations to expand their business through empowering locals in a given area to open a business location representing the parent company’s brand, operational strategy, and products.

The Pros and Cons

When considering the current trends in franchising from an international perspective, it’s important to understand why organizations do this, why individuals are interested in opening a franchise, and why governments are open to allowing this approach. Let’s take a quick look at the benefits of global franchising, and where the potential pitfalls are:

Pros

  • For the franchiser (i.e. the parent company), franchising allows rapid expansion with less risk and required capital (as some of this risk is assumed by franchisee, along with funding).
  • For the franchiser, success is closely tied to understanding the culture and language of a given area. A franchising model can provide both.
  • For the local government, jobs are created and ownership remains local.
  • For the franchisee, they are given an opportunity to own a business with an incredible pool of resources, knowledge, and support.
  • For the franchisee, much of the initial business plan, sourcing, quality control, marketing, and other core functions are already prepared, tried, and tested.

Cons

  • The franchiser is outsourcing some amount of control and returns on investment to the franchisee.
  • The franchisee, as a result, is incurring a substantial cost. As of 2010, opening a McDonald’s franchise could cost anywhere from around $1 million to around $2 million (USD).
  • For local governments, there are a great deal of legislative and contractual considerations when allowing franchising into the economy. Ensuring each party acts legally and ethically requires resources.

While these lists could both be expanded a great deal, this should provide some context for the why behind the high volume of global franchising.

Trends in International Adoptions

The number of global franchises has seen a great deal of expansion in recent years, particularly with emerging economies (such as the BRIC grouping) seeing substantial growth and increased purchasing power. Considering the cultural advantages discussed earlier, franchising has also seen some unique trends in adopting cultural perspectives and adapting product offerings.

A nice example of adopting cultural tastes can be see in the fast food industry. McDonald’s, KFC, and a variety of other small food chains have distinctly different menu items depending on where in the world you are when you visit one of these chains. Convenience stores that franchise, such as 7-Eleven, operate quite similarly. Understanding local demand and local availability of certain products changes what the consumer in those areas are offered. These cultural adaptations allow globally expanded companies to compete effectively throughout the world.

The map is overwhelmingly green with the exception of large areas of Africa and the Middle East.

KFC World Operations: As of 2014, KFC carried out operations in all of the countries highlighted in green. Localizing, adapting to culture, and expanding their scope to this level of global operating is evidence of just how advantageous franchising can be as an expansionary tool.

Franchise Agreements

A Franchise Agreement is a legal, binding contract between a franchisor and franchisee, enforced in the United States at the State level.

Learning Objectives

List the items included in a franchise agreement

Key Takeaways

Key Points

  • The Franchise Agreement can vary in content depending on the franchise system, as well as the state in which the franchisor, franchisee and arbitrator are based.
  • The typical franchise agreement contains a number of documents including the UFOC or the FDD. It also defines the parties involved, the franchise system, trademarks, license in formation, length of agreement, and other key information pertaining to the franchise.
  • The UFOC or FDD is a legal document which is presented to prospective buyers of franchises in the pre-sale disclosure process in the United States.

Key Terms

  • franchise rule: defines the acts/practices that are considered unfair or deceptive in the US franchise industry. It is published by the FTC.
  • Franchise Disclosure Document: a legal document which is presented to prospective buyers of franchises in the pre-sale disclosure process in the United States.

A Franchise Agreement is a legal, binding contract between a franchisor and franchisee, enforced in the United States at the State level.

Prior to a franchisee signing a contract, the US Federal Trade Commission regulates information disclosures under the authority of The Franchise Rule.The Franchise Rule requires that a franchisee be supplied a Uniform Franchise Offering Circular (UFOC ) or Franchise Disclosure Document (FDD ) prior to signing a franchise agreement, a minimum of ten days before signing a franchise agreement.

Once the Federal ten-day waiting period has passed, the Franchise Agreement becomes a State level jurisdiction document. Each state has unique laws regarding franchise agreements.

The content of a franchise agreement can vary depending on the franchise system, the state jurisdiction of the franchisor, franchisee, and arbitrator.

A typical franchise agreement contains:

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Legal documents: Franchising agreements contain many legal documents that must be understood and filled out.

  • Uniform Franchise Offering Circular (UFOC) or FDD Franchise Disclosure Document (FDD)
  • Disclosures required by state laws
  • Parties defined in the agreement
  • Recitals, such as Ownership of System, and Objectives of Parties
  • Definitions, such as: Agreement, Territory Area, Area Licensee, Authorized deductions, Gross Receipts, License Network, The System Manual, Trademarks, Start Date, Trade name, Termination, Transfer of license.
  • Licensed Rights, such as: Territory, Rights Reserved, Term and Renewal, Minimum Performance Standard
  • Franchisors Services, such as: Administration, Collections and Billing, Consultation, Marketing, Manual, Training
  • Franchisee Payments, such as: Initial License Fee, Training Fees, Marketing Fund, Royalties, Renewal fee, and Transfer fee
  • Franchisee Obligations, such as: Use of Trademarks, Financial Information, Insurance, Financial and Legal responsibility
  • Relationship of Parties, such as: Confidentiality, Indemnification, Non-Compete
  • Transfer of License, such as: Consent of franchisor, Termination of license, Termination by licensee, Termination by licensee
  • Other provisions
  • Governing law
  • Amendments
  • Waivers
  • Arbitration
  • Severability