Franchising is an arrangement whereby a supplier, or franchiser, grants a dealer, or franchisee, the right to sell products in exchange for some type of consideration. It is a business arrange ment involving a contract between a manufacturer or another supplier and a dealer that specifies the methods to be used in marketing a good or service. The franchiser may receive some percentage of total sales in exchange for furnishing equipment, buildings, management know-how, and market research. The franchisee supplies lab or and capital, operates the franchised business and agrees to abide by the provisions of the franchise agreement.

Historically, franchising was a grant by a king to allow a citizen an exclusive right to sell a product or render a service. For this right, the sovereign protected the exclusivity and the subject paid the government an appropriate tribute in service, food, goods, or money. Franchising in the United States started shortly after the Civil War, when the Singer Company began to set up sewing-machine franchises. The concept became increasingly popular after 1900 in the automobile industry. Because of this, other automotive franchises developed for gasoline, oil, and tires. In the 1950s, food operations made a dramatic entrance into franchising with the development of McDonald's, currently one of the world's largest franchise organizations.

In 1999, franchising accounted for $916 billion in annual sales, with 533 outlets employing more than 7 million people. A new franchise opens somewhere in the United States every six minutes. Franchising accounts for approximately 40 percent of all United States retail sales. Because of changes in the international marketplace, shifting employment options in the United States, the expanding U.S. economy, and corporate interest in more joint-venture activity, franchising will continue to increase rapidly.

Franchising represents the small entrepreneur's best chance to compete with the giant companies that dominate the marketplace. Without franchising, thousands of businesspeople would never have had the opportunity to own their own businesses.

The largest percentages of franchise operations are in the recreation, entertainment, and travel fields, followed closely by business services, nonfood retailing, and automotive products and services. In 1999, the top ten franchises in descending order were Yogen Fruz Worldwide (first place), McDonald's, Subway, Wendy's International Inc., Jackson Hewitt Tax Service, KFC, Mail Boxes Etc., TCBY Treats, Taco Bell, and Jani-King.

Retail franchise agreements fall into three general categories. In one type of arrangement, a manufacturer authorizes a number of retail stores to sell a certain-brand name item. This franchise arrangement, one of the oldest, is common in the sales of cars and trucks, farm equipment, shoes, paint, earth-moving equipment, and gasoline. About 90 percent of all gasoline is sold through franchised independent service stations, and franchised dealers handle virtually all sales of new cars and trucks.

In the second type of retail franchise, a producer licenses distributors to sell a given product to retailers. This arrangement is common in the soft drink industry. Most national manufacturers of soft drinks—Coca-Cola, Dr. Pepper, PepsiCo—grant franchises to bottlers, which then service retailers.

In the third type of retail franchise, a franchiser supplies brand names, techniques, or other services, instead of complete products. The franchiser may provide certain production and distribution services, but its primary role in the arrangement is careful development and control of marketing strategies. This approach to franchising, very common today, is used by such organizations as Holiday Inn, AAMCO, McDonald's, Dairy Queen, KFC, and H&R Block.

A good franchise system can offer the prospective franchisee a diversified array of business savvy. In most instances, the franchisee enjoys the benefit of a nationally recognized trade name, national recognition, and the instant collective goodwill of the franchise. Standard quality and uniformity of a product or service coupled with an existing—and successful—system of marketing and accounting are other benefits. In addition, expert advice on location, design, capitalization, and operational issues is provided by the franchiser. Specialization on a national level is done in order to maintain the necessary research and market analysis that will enable the franchisee to remain competitive in an ever-changing marketplace. In other words, a business framework is supplied that reduces the number of risks that may arise when starting a new business. Most often these risks are associated with the financial investment involved. However, the franchise agreement often offers a cost savings by sharing a centralized purchasing system, and in some instances, direct financial assistance.

ADVANTAGES AND DISADVANTAGES OF FRANCHISING

Franchising offers several advantages to both the franchisee and the franchiser. It enables a franchisee to start a business with limited capital and to benefit from the business experience of others. Moreover, nationally advertised franchises, such as ServiceMaster and Burger King, are often assured of customers as soon as they open. If business problems arise, the franchisee can obtain guidance and advice from the franchiser at little or not cost. Franchised outlets are generally more successful than independently owned businesses. Less than 10 percent of franchised retail businesses fail during the first two years of operation, whereas approximately half of independent retail businesses fail during that period. The franchisee also receives material to use in local advertising and can benefit from national promotional campaigns sponsored by the franchiser. At the turn of the twenty-first century, Taco Bell franchisees profited from a national advertising campaign featuring a Chihuahua demanding "Yo quiero Taco Bell" ("I want some Taco Bell"). The ads helped boost same-store sales at Taco Bell by 3 percent in an otherwise flat industry. The talking dog was especially popular among teenagers, who spend more than $12 billion per year at fast-food restaurants.

The franchiser gains fast and selective product distribution through franchise arrangements without incurring the high cost of constructing and operating its own outlets, thus giving it more capital for expanding production and advertising. It can also ensure, through the franchise agreement, that outlets are maintained and operated according to its own standards. The franchiser benefits from the fact that the franchisee, being a sole proprietor in most cases, is likely to be very highly motivated to succeed. Success of the franchise means more sales, which translate into higher income for the franchiser.

Despite these numerous advantages, franchise arrangements also have drawbacks for both parties. The franchiser can dictate many aspects of the business: decor, design of employees' uniforms, types of signs, and numerous other details of business operations. In addition, franchisees must pay to use the franchiser's name, products, and assistance. Usually franchisees must pay a one-time franchise fee as well as continuing royalty and advertising fees, often collected as a percentage of sales. For example, Subway requires franchisees to come up with $40,000 to $80,000 in start-up costs. Franchisees often must work very hard, putting in twelve-hour days, six or seven days a week. In some cases, franchise agreements are not uniform; one franchisee may pay more than another for the same services. The franchiser also gives up a certain amount of control when entering into a franchise agreement. Consequently, individual establishments may not be operated exactly the way the franchiser would like.

When entering into a franchise agreement, franchisees must be prepared to make major commitments of both money and time. They must be prepared to invest a substantial amount of money, both in the initial franchising fee and in start-up costs and carrying funds to provide a cash flow sufficient to operate the business during the beginning months or, if necessary, years. Most franchisees average a net profit of less than $30,000 a year.

The second commitment is that of time; in the beginning, the proprietor will be obliged to devote long hours to the details of the business operation. Experience has shown that this commitment is the common denominator to many successful franchise operations. Franchisees must rely to a large extent upon their own aptitude and drive in order to learn the business. They must also rely upon the product, services, and business skills of the franchiser.

In deciding whether or not to enter into a franchise agreement, there are several key points that need to be considered. The first consideration is price and costs. What is the total cost? What are the initial fees? What are the ongoing costs? Are there any hidden extras? Are you restricted in your right to purchase other goods?

The second consideration is the location. Where will the franchise be located? What is the territory that it will serve? What are the protections and limitations? Who can compete with you?

The third issue involves control and support. What controls will be in place? What policies and regulations govern the franchise agreement? What training and ongoing support will be supplied?

Advertising is the fourth consideration. The franchisee needs to determine what national and regional advertising will be supplied, as well as what the franchisee pays for and what the franchiser finances.

The last area of concern involves profits and losses, transfer and death, and duration and termination. Potential franchisees need to determine not only what protection they will receive for their earnings if they are successful but also what obligations they will be responsible for if the franchise fails. In addition, they need to find out whether, in the event of their death, the franchise agreement can be transferred to their heirs or automoatically reverts to the franchiser. Finally, they need to determine what stipulations, penalties, and other responsibilities are involved in terminating the contract with the franchiser should they no longer wish to continue in the business.

THE FRANCHISING SECTOR

A franchise is like any other business property in that it is the buyer's responsibility to know what he or she is buying. Poorly financed or poorly managed franchise systems are no better than poorly financed or poorly managed nonfranchise businesses. It is important to remember that there are trends in franchises, just as in other types of businesses. Growth areas for franchising in the 1990s included providing home care (finding nannies for children and nurses for homebound patients), catering to children (operating educational and child-care centers), tending people's homes (maid service), servicing cars, and, as always, operating fast food establishments.

The growth of the franchised fast-food industry has been truly spectacular. These franchise operations are second only to automobile dealerships and gasoline stations in gross volume of sales. Most often located at key intersections or on busy highways, fast-food enterprises enjoy a high visibility.

In this segment of the franchise industry, the majority of franchise operators have already owned other businesses before entering into a fast-food franchise. Many successful operators are college graduates, but the significant number of successful franchisees with only a high school education suggests that education alone is not a determining factor. A fast-food franchise is the type of venture in which both husband and wife can contribute to the success of the business.

Most fast-food franchisers consider geographic location to be an important factor in the success of the operation. And, like franchisers in other fields, they cite the importance of adequate capitalization, the efficient operation of the franchise system, good customer relations, quality employees, and the contributions of the franchisees, such as their management skills and especially their hard work.

According to Cassano's Pizza and Subs, a franchiser with twelve outlets in four states, the successful franchise operator must have several traits: (1) an excellent attitude toward customer service and customer relations; (2) an entrepreneurial ability and spirit combined with good business techniques; (3) a willingness to take a hands-on attitude toward the business. Newcomers to the Cassano's franchised fast-food business must have prior retail management experience and previous food service experience. All new franchisees are trained at the home office in Dayton, Ohio, for one month. After that, the franchise provides ongoing training and managerial assistance.

GLOBAL FRANCHISING

Franchising is growing rapidly abroad, with more than 370 franchise companies operating in about 40,000 outlets overseas. Canada is the largest of these markets, followed by Japan, Europe, Australia, and the United Kingdom. In 1995, Subway signed a deal with Japanese financiers to open 1000 franchise outlets in Japan. Subway tailored its products to fit the local tastes—for example, offering the Japanese market fried pork sandwiches.

Franchising can be a workable way for small firms to enter foreign markets, especially markets where there are few competitors. For example, Automation Paper Company, a small New Jersey-based supplier of high-technology paper products, used franchising to gain exclusive representation in target markets. The franchisees receive rights to the company's trademark, as well as training for local staffs and the benefit of the firm's experience, credit lines, and advertising budget.

The problems facing franchise companies in international transactions are relatively less formidable than those facing other service sectors. Franchisers must comply with the same local requirements as other businesses, and the franchise agreements must comply with local contract law, antitrust law, and trademark and licensing laws. Aside from language and cultural differences, many of the problems of conducting business in foreign countries are the same as those involved in the United States. The success or failure of foreign franchising will depend in large measure on the soundness of the franchiser's domestic market position and on the franchiser's ability to provide the necessary expertise to others in another part of the world.

Some franchises popular in the United States actually started in another country. For example, Molly Maid started in Canada in 1980 and came to the United States four years later.

All trends indicate that franchising will continue to expand both domestically and internationally, creating great opportunities for existing and new businesses; developing new entrepreneurs, new jobs, new products, new services; and providing export opportunities. Rising personal income, stable prices, high levels of consumer optimism, and increased competition for market share are turning many companies, both small and large, to franchising. Education will play an important role in the future of franchising, as both high schools and colleges increase the number of courses that are taught in marketing, business management, and entrepreneurship. In addition, changing patterns in American demographics, coupled with the increased number of women in the work force, are influencing the number of new franchises each year. In 1998, approximately 14 percent of franchisee-owned outlets are run by women, whereas 21 percent are run by female-male partners.

Furthermore, shifting demographic patterns and the use of new technology have intensified competition among franchise companies. These factors have increased the number of mergers and acquisitions in the franchising system, and it is expected that this merger/acquisition trend will persist for several years. Creativity and imagination in the treatment of goods and services are the focus of most business ventures today. Education, computers, and the ability to work with and manage people will be profitably utilized by new emerging businesses. All these developments suggest that franchising will be one of the leading methods of doing business in the first decade of the tweny-first century, even in an environment of mixed signals in the economy.