Franchise (West's Encyclopedia of American Law)
A special privilege to do certain things that is conferred by government on an individual or a corporation and which does not belong to citizens generally of common right, e.g., a right granted to offer CABLE TELEVISION service.
A privilege granted or sold, such as to use a name or to sell products or services. In its simplest terms, a franchise is a license from the owner of a TRADEMARK or TRADE NAME permitting another to sell a product or service under that name or mark. More broadly stated, a franchise has evolved into an elaborate agreement under which the franchisee undertakes to conduct a business or sell a product or service in accordance with methods and procedures prescribed by the franchisor, and the franchisor undertakes to assist the franchisee through advertising, promotion, and other advisory services.
The right of suffrage; the right or privilege of voting in public elections. Such right is guaranteed by the Fifteenth, Nineteenth, and Twenty-fourth Amendments to the U.S. Constitution.
As granted by a professional sports association, franchise is a privilege to field a team in a given geographic area under the auspices of the league that issues it. It is merely an incorporeal right.
(The entire section is 2127 words.)
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Franchising (Encyclopedia of Business and Finance)
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 drinksoca-Cola, Dr. Pepper, PepsiCorant 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 existingnd successfulystem 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.
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 tastesor 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.
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Pride, William, and Ferrell, O.C. (2000). Marketing Concepts and Strategies. Boston: Houghton Mifflin.
U.S. Bureau of the Census. (1997). Statistical Abstract of the United States. Washington, DC.
Franchising (Encyclopedia of Management)
When an individual has the desire and drive to run their own business but lacks a strong idea for a company, this person may look to franchising in order to be their own boss and run a proven business. Franchising is an agreement or alliance between two organizationshe franchisor and the franchisee. The franchisor has the business model, training materials, and other materials for the business. The franchisee is the entrepreneur who agrees to operate a branch of the business in their location while paying the franchisor various fees and royalties for the use of the business idea or model.
TYPES OF FRANCHISING
Business-format franchising exists when a franchisor allows someone to market products or service, using the business name or trademark, in return for fess and royalties. When franchising is mentioned, most people think of this business-format franchising, like McDonald's, AAMCO Transmission, or Molly Maid. There is also product or trademark franchising. This is a limited franchise where a manufacturer may grant another party license to sell goods produced by the manufacturer. This might includes sales of cars through dealerships (e.g., Ford dealerships), sales of gasoline through service stations (e.g., Shell stations), and sales of soft drinks through local franchising (e.g., Coca Cola bottlers). A final type of franchising is conversion franchising. This franchising model is designed to bring formerly-independently-operating businesses together under the collective power of a national name and advertising. An example of the conversion franchising is Century 21 Realtors, an affiliation of previously-established real estate agents.
Franchise fees typically include a lump-sum entrance fee and other charges for regular services including royalties on sales, advertising fees, and marketing. In exchange for these licensing fees, the franchisor retains control over the delivery of the products and services, as well as marketing and the operational and quality standards of the franchise. The franchising company's revenue is generated through the franchisee that pays these on-going sales royalties, typically averaging 5 percent of sales. The contract, or franchise agreement, is signed by both parties and establishes the relationship between the franchisee and the franchisor. It also details the responsibilities of both sides.
Franchises include such popular names as Kentucky Fried Chicken (KFC), McDonald's, 7-Eleven, Body Shop, Tie Rack, Pizza Hut, and Jiffy Lube. These franchise operations have well-established names, brands, and reputations. The best franchises provide a strong brand or trademark of the concept, a proven business system, extensive training and product development, along with a number of initial and on-going managerial support services. Some help the franchisee secure funding and offer benefits, including discounted supplies. Typically, the franchised business is less risky than other forms of new venture creation because the business idea has been tested. There are mutual advantages to both parties to the agreement. The Service Corps of Retired Executives (SCORE), a volunteer group involved in counseling would-be entrepreneurs, report franchises are safer that other business forms and report less than a 5 percent failure rate compared to an 80 percent five-year failure rate for independent businesses and a 90 percent failure rate from independent restaurants. Banks are also supportive of the franchising business model and many will offer up to 70 percent of the initial capital costs.
Franchising allows a business to rapidly expand beyond its original owners. The franchisee pursues a new business, experiences the advantages of running their own business and being their own boss, and can gain wealth through a proven business idea. They provide the management skills to run the business, as well as contribute the capital to fund the opening and ongoing operations. The franchisor also benefits by the partnership and gains economy of scope advantages as more franchises are established. National or international advertising is then possible and the franchisor can more easily expand business locations with the help and capital from the franchisee. The franchisee helps to build brand awareness through market proliferation. The franchisee has a unique opportunity to run a business with a greater chance of success. There is experience from the franchisor for starting the business and many of the initial mistakes have been made and corrected.
The franchisee creates their own job and often creates a number of new jobs in the area as they hire employees. As the franchise becomes successful, the franchisee may chose to open other stores to create even more wealth. Franchising is popular in the United States as well as internationally. Franchising is at a mature level in the U.S., Europe and Australia, while Asia, South America, Mexico, and Central America report rapid growth. China, too, is experiencing franchise business growth.
It is important to carefully perform initial due diligence to thoroughly examine the franchise offering. A Federal Trade Commission (FTC) rule was created and adopted in the mid-1970s that requires franchisors to disclose to franchisees very specific information including information about themselves, the business, and the terms of the relationship. This document is the Uniform Franchise Offering Circular (UFOC) and provides important legal information about the franchisor and its franchising program.
When deciding on a franchise, it is important to first gather information about an individual's personal goals for business ownership and to examine the franchise offering to find a compatible opportunity. While there are no guarantees in franchising, a well-developed operating plan is often an advantage. An entrepreneur should consider a number of issues regarding a possible franchise. For example, is the franchise in only a state or local market, or does it have a regional or national presence? Lower-risk franchises have a national presence and benefit from the size advantage. The franchisee will also want to consider if most of the existing outlets are profitable, and whether the franchise is the market leader with the largest market share among competitors. The entrepreneur should evaluate the presence of a national marketing and purchasing program. The lower-risk franchises also have documented training, manuals, field support, marketing and promotion, standardized operating procedures, and on-going feedback channels between the franchisor and the franchisees. The terms of the license agreement vary from less than ten years to more than twenty years and some have automatic renewal. Capital requirements for obtaining the franchise also vary. Other factors to consider include territory limitations, failure rates, and any relevant litigation history against the franchise. Investment requirements should also be clearly disclosed.
It is often a good idea to interview existing franchise owners to determine if start-up costs and processes are realistic. The expertise of a lawyer may be required to negotiate and interpret the franchise agreement contract. SCORE also recommends that potential franchising clients plan and analyze their options. This planning and analysis should include researching Chamber of Commerce and Better Business Bureau records for a given franchise. SCORE agrees the most important step for choosing a franchise is also considering the entrepreneur's interests, personal skills, and experience. It is easier to evaluate an established franchise than a new franchise. There may be few, if any, owners with whom to speak about the franchise. It is important that the new franchise have strong franchisee support and a proven business system. The business strategy should also be examined carefully.
FRANCHISING AND THE ECONOMY
A study by the International Franchise Association (IFA) revealed that more than 9.7 million people are employed by franchised businesses. This group of 767,483 franchises, ranging from automobile dealers to food operations, have a $506.6 billion U.S. payroll. These businesses are clearly important to the economy. The IFA also reports that the start-up costs for franchising can range from less than $5,000, to more than $500,000. IFA offers information on franchisingncluding news and events as well as discussion forums and education. It also includes information on government regulations for franchising.
In a 2004 study conducted by Pricewaterhouse-Coopers (for the International Franchise Association Educational Foundation) on the economic impact of franchised businesses, more than 760,000 franchised businesses exist in the United States and they generate some $1.53 trillion each year. This represents 9.5 percent of the private-sector economic output in the United States. These franchises generate one out of every seven jobs in America.
The IFA established a Franchise Index to track the market performance of the top fifty U.S. public franchisors. The index has increased steadily since January 2000, compared to a drop of 20.1 percent in the Standard and Poors (S&P) 500 Index over the same period. Interestingly, the franchise index has grown during tough economic times. Thus, franchising is a major economic force and franchising has a significant impact on the nation's economy.
The franchising business model attracts a number of qualified individuals, particularly in times of recession or slow business growth. Individuals are attracted to franchising through the opportunity to create their own jobs. While franchising is not a get-rich-quick proposition, many do have attractive returns on investment. Most analysts agree a three- to five-year period of hard work and dedication is needed before the franchised business is profitable. Over the years, more individuals are touting the advantages and value of franchising. These franchises are quick to pick up on key business trends, social and demographic changes, and changing lifestylesealthy fast food, home health care for the elderly, pet care, education, personal services, home services, business services, automotive services, and travel services. Many also offer exclusive territories in a given market.
Additional advice on finding and comparing franchising opportunities is available on the franchise-broker websites (e.g., www.FranNet.com, www.FranChoice.com, and www.francorpconnect.com). is a franchise-broker website representing franchise consultants. Some potential franchisees prefer using a broker to find a franchise.
While there are many advantages to franchising, there are some disadvantages. Once a business grows beyond a certain size, it could make more money if it were wholly owned, since a percentage of the profit margin goes to the franchisor. Even if a franchise is capable of making strong profit figures, the individual running the franchise needs to enjoy the process of dealing with the franchisor as well as operating the business. The franchisee needs to be committed to the idea and the business model. The individual also needs to be supportive of the franchisor's system since the key to a successful product or service is the consistency of the offering. Customers expect a similar product or service from a franchise. Individuals who do not want to follow the predetermined structure and operating procedures of the franchise may not be successful.
The franchising arrangement is a balance of entrepreneurial spirit, standard business procedures, and following instructions. The venture, like other start-ups, will require a time and energy commitment as well. A disadvantage for the franchisor is the difficulty encountered in finding a franchisee with drive, energy, and business experience to run the business according to the franchise guidelines. The franchise also needs an appropriate location that must be researched to discern its current and future growth potential. Finally, the franchisee must provide some of their own funds for the start-up.
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Zaragoza, S. "Due Aims to Take Pain Out of Franchising." Dallas Business Journal 28, no. 17 (2004): 12.
Franchising (Encyclopedia of Small Business)
Franchising is a kind of licensing arrangement wherein a business owner, known as the "franchisor," distributes or markets a trademarked product or service through affiliated dealers, who are known as "franchisees." While these franchisees own their establishments, terms of franchising agreements typically require them to share operational responsibilities with the franchisor.
Over the past few decades, franchising has emerged as an integral part of America's commercial landscape. Indeed, companies as diverse as McDonald's, The Gap, and Jiffy Lube owe their ubiquitous presence in the marketplace to the practice. Department of Commerce figures indicate that franchises exceeded $300 billion in annual sales in the mid-1990s, and the International Franchising Association (IFA) estimates that within a few short years, 50 percent of all U.S. retail sales will take place in franchise outlets.
Franchising has been embraced by many entrepreneurs eager to run their own company. But the characteristics of a franchising business are dissimilar in some crucial respects from those of other start-up businesses. Some businesspeople have even gone so far as to characterize franchisees as glorified employees of the franchisor, the company that owns the trademark and business concept that the franchisees use. Other observers find this description of the relationship to be misleading and simplistic, but they also acknowledge that there are many aspects of franchising that a prospective small business owner should learn about before entering into such an agreement.
Three different kinds of franchising arrangements are commonly found in the United States today. Business format franchises are the most popular of the franchise types. Under this arrangement, the franchisee pays an initial fee and an ongoing royalty to the franchisor in exchange for a proven business operation and identity. Benefits of this package include the franchisor's name and its product line, marketing techniques, production and administration systems, and operating procedures. A second option is to pursue a product or trade name franchise in which the franchisee becomes part of a franchisor's distribution network. Still other small business owners, meanwhile, choose to combine their resources under the banner of a single operating network. These affiliate franchises are thus able to pool their assets together for purchasing, advertising, and marketing visibility purposes.
BENEFITS OF FRANCHISE OWNERSHIP
There are many significant advantages to franchise ownership. In most instances, an entrepreneur who decides to buy a franchise is purchasing a business concept with a proven track record of success. In addition, a franchise agreement provides instant name recognition for the business, which can be a huge advantage if the name enjoys a solid reputation in the marketplace. But franchising provides benefits in many other areas of business operation as well. These include:
ADVERTISING AND PROMOTION Franchisees benefit from any national advertising campaigns launched by the corporation with which they have gone into business. In addition, many franchisors provide their franchises with a wide range of point-of-sale advertising materials, ranging from posters to mobiles to brochures. Since such materials are often expensive to produce, they would otherwise be beyond the reach of some individual franchisees.
OPERATIONS Franchisors provide franchisees with a wide range of help in the areas of administration and general operations. The entrepreneur who becomes a franchise owner is instantly armed with proven products and production systems; inventory systems; financial and accounting systems; and human resources guidelines. Many franchisors also provide management training to new franchisees, and ongoing seminar workshops for established owners.
BUYING POWER Franchisees are often able to fill inventory needs at discount prices because of their alliance with the franchisor, which typically has made arrangements to buy supplies at large-volume prices. "This is an increasingly great advantage because today you have to compete with national chains, conglomerates, buying consortiums, and other large franchises," observed the editors of The Entrepreneur Magazine Small Business Advisor. "The small-business person who purchases in small quantities can't compete with their buying power. When you become a franchisee, you have the collective buying power of the entire franchise system."
RESEARCH AND DEVELOPMENT Most small business owners are able to devote little time or money to research and development efforts. Franchising, then, can provide a huge lift in this regard, for many franchisors maintain ongoing research and development systems to develop new products and forecast market trends.
CONSULTING SERVICES It is in the franchisor's best interests to do all it can to ensure the success of all of its franchises. As a result, the entrepreneur who decides to become a franchisee can generally count on a wide range of training and consulting services from the larger company. Such services can be particularly helpful during the start-up phase of operations.
DRAWBACKS OF FRANCHISE OWNERSHIP
But while the benefits of franchising are many and varied, there are well-documented drawbacks that should be considered as well. These include:
COST The initial franchise fee, which in some cases is not refundable, can be quite expensive. Some fees are only a few thousand dollars, but others can require an up-front investment of several hundred thousand dollars. In addition, some franchisors require their franchisees to pay them regular royalty fees percentage of their weekly or monthly gross incomen exchange for permission to use their name. Some franchisors also require their franchise owners to help pay for their national advertising expenditures. Other costs include insurance, initial inventory purchases, and other expenses associated with equipping a new business.
LIMITED CONTROL Franchisees are subject to many franchisor regulations concerning various aspects of business operation and conduct. As the Federal Trade Commission (FTC) acknowledged to prospective franchisees in its Consumer Guide to Buying a Franchise, "these controls may significantly restrict your ability to exercise your own business judgment." Areas in which franchisors generally wield significant control include the following: Site Approvalany franchise agreements include stipulations that give the franchisor final say in site selection. Some franchisors also limit franchise territories, and while such restrictions generally prevent other company franchisees from impinging on your territory, they can also act to restrict your ability to relocate once you have become established.
Operating Restrictionsranchise agreements include many instructions on the ways in which a franchisee must conduct business. These encompass all aspects of a business's operation, from operating hours to accounting procedures to the goods or services that are offered. "These restrictions may impede you from operating your outlet as you deem best," admitted the FTC. "The franchisor also may require you to purchase supplies only from an approved supplier, even if you can buy similar goods elsewhere at a lower cost."
APPEARANCE Many franchisors cultivate a certain readily recognizable look to their outlets, for they know that such standards, when applied consistently, contribute to national recognition of the company name and its products and services. Franchisees generally accept these regulations willingly, for these standards of appearance in the areas of decor, design, and uniforms have proven to be part of a winning formula elsewhere. This is just as well, for the franchise owner who does wish to make changes in his business's appearance often has little freedom to do so.
ASSOCIATION WITH THE FRANCHISOR For the small business owner whose franchise is attached to a highly regarded, financially robust franchisor, the association can be a powerful positive in his or her business. Business experts note, however, that a franchise outlet can suffer severe damage if its franchisor is beset with financial difficulties or public relations problems. "If the franchisor hits hart times, you'll most likely feel them as well," noted the editors of the Small Business Advisor. "You are inevitably tied to the franchisor, not only by contract, but by concept, name, product, and services sold."
Prospective franchisees, then, need to weigh many factors in their decision making about entering the burgeoning world of franchising. But most small business consultants acknowledge that these factors usually boil down to a couple of fundamental concerns. As Steve Spinelli wrote in The Portable MBA in Entrepreneurship, "the choice of becoming a franchisee or starting a stand-alone business hinges on your answers to two important questions: Is risk sufficiently mitigated by the trademark value, operating system, economies of scale, and support process of the franchise to justify a sharing of equity with the franchisor (vis-à-vis the franchise fee and royalty payments)? Is my personality and management style amenable to sharing decision-making responsibilities in my business with the franchisor and other franchisees?"
SELECTING A FRANCHISE
It is imperative for prospective franchise owners to make an intelligent, informed decision regarding franchise selection, for once a contract has been signed, the franchisee has committed himself to the enterprise. But the selection process can be a bewildering one for the unprepared entrepreneur. Franchise opportunities are available in a wide array of industries, each of which offer their own potential benefits and drawbacks. Moreover, every franchisor has its own strengths and weaknesses. Several business areas, then, need to be investigated as part of any effective franchise selection process.
ANALYSIS OF SELF Experts counsel prospective franchise owners to evaluate their own personal strengths and weaknesses before signing any franchise contract. Prospective franchisees should also have an understanding of their ultimate business and personal objectives before beginning the search for an appropriate franchise. The entrepreneur who is most interested in achieving financial security may want to look in an entirely different industry than the entrepreneur who hopes to land a franchise that will enable him or her to devote more time to family life.
ANALYSIS OF INDUSTRY AND MARKET Prospective franchise owners need to evaluate which industries interest them. They also need to determine whether the franchisor's principal goods or services are in demand in the community in which he or she hopes to operate. Other industry wide factors, such as the cost of raw materials used and the amount of industry competition, need to be weighed as well. The latter issue is a particularly important one, for it can be a fundamental factor in a franchisee's success or failure. The presence of some competition, for instance, often indicates a healthy demand for goods or services in that industry area. A dearth of competitors, though, might indicate that demand is low (or nonexistent). Similarly, the presence of several competitors might necessitate an examination of whether the market can support another provider in that area, or whether you might have to take meaningful market share from already existing businesses in order to survive.
ANALYSIS OF FRANCHISOR Entrepreneurs interested in franchising should be knowledgeable about the strengths and weaknesses of companies that offer such arrangements. Factors that should be considered include the franchisor's profitability, organizational structure, growth patterns, public reputation, litigation history, financial management capabilities, fee requirements, and relationship with other franchisees.
Perhaps the best source of information on these and many other issues is the franchisor's disclosure document. This important document, which must be given to prospective franchise owners at least ten business days before any contract is signed or any deposits are owed, usually takes the form of the Uniform Franchise Offering Circular (UFOC). The UFOC contains important information on key aspects of the franchisor's business and the nature of their dealings with franchisees. Information contained in the UFOC includes a franchise history; audited financial statements and other financial history documents; franchise fee and royalty structures; background on the franchise's leading executives; terms of franchise agreements; estimated start-up costs for franchisees (including equipment, inventory, operating capital, and insurance); circumstances under which the franchisor can terminate its relationship with a franchisee; franchisor training and assistance programs; franchisee advertising costs (if any); data on the success (or lack thereof) of current and former franchisee operations; and litigation history.
Some prospective franchise owners pay less attention to a company's litigation history than other information included in the UFOC, but a company's past litigation experiences can, in some cases, provide important insights into the franchisor's business ethics and/or operating style. "The disclosure document tells you if the franchisor, or any of its executive officers, has been convicted of felonies involving, for example, fraud, any violation of franchise law or unfair or deceptive practices law, or are subject to any state or federal injunctions involving similar misconduct," noted the Federal Trade Commission. "It also will tell you if the franchisor, or any of its executives, has been held liable or settled a civil action involving the franchise relationship. A number of claims against the franchisor may indicate that it has not performed according to its agreements, or, at the very least, that franchisees have been dissatisfied with the franchisor's performance. Be aware that some franchisors may try to conceal an executive's litigation history by removing the individual's name from their disclosure documents."
The inclusion of other information on a franchisor's business dealings with franchisees is up to the discretion of the franchisor. For example, while franchisors are required by law to provide prospective franchisees with documentation of expected start-up costs, they are not required to provide long-term earnings projections. Those who do provide such information are obligated by the FTC's Franchise Rule to have a reasonable basis for the claims they make and provide prospective franchisees with written information substantiating their projections.
It is important, then, to utilize other sources of information in addition to the disclosure document when pondering a move into the world of franchising. For example, small business consultants often urge prospective franchisees to conduct interviews with franchisor representatives about various business issues. Other sources of information often cited include financial institutions (for financial evaluations of the franchisor), state agencies (for information on franchisee rights in the state in which the franchisee is operating), the Better Business Bureau (for news of possible complaints against the franchisor), industry surveys, and associations (such as the Franchise Consultants International Association and the International Franchise Association).
Many experts also encourage prospective small business owners to interview current and former franchisees associated with the franchisor. Would-be franchisees can thus gain first-hand information on a great many business subjects, including: likely size of total investment, hidden or unexpected costs, satisfaction with franchisor performance (in training, advertising, operating, etc.), franchisee backgrounds, and business trends in the industry. Franchisee lists can be a valuable resource, but consultants caution their clients to make certain that they receive a complete list, rather than a list of selected franchisees who are compensated by the franchisor for giving positive appraisals of the company.
The United States has developed an extensive regulatory system designed to govern franchising practices throughout the business world. Chief among the federal guidelines are the FTC's Franchising and Business Opportunity Ventures Trade Regulation Rules and Subsequent Guidelines. In addition, many state governments have fashioned pieces of legislation that directly impact franchising operations. A good many of the laws governing franchisingoth at the state and federal levelre expressly designed to protect prospective small business owners from unscrupulous franchisors who misrepresent themselves.
Franchising experts commonly urge prospective franchisees to enlist the help of an attorney during the franchise selection process. Indeed, since franchising is such a complicated business, many entrepreneurs secure an attorney's services throughout the process. Legal assistance is especially helpful when the time comes to sign the franchise or license agreement, the document that lays out the terms of the partnership between a franchisee and a franchisor. "The franchise agreement is the foundation on which your franchise is built," stated the Entrepreneur Magazine Small Business Advisor. "The agreement gives both parties a clear understanding of the basis on which they are going to continue to operate."
The franchise contract covers all aspects of the franchisee-franchisor agreement, from record keeping to site selection to quality control provisions. The contract is designed to cover both relatively minor issuesuch as sign display requirementso matters of major importanceuch as the franchisee's schedule of royalty payments and required insurance provisions. Franchise agreements also include a section devoted to detailing the length of the contract, and any possibilities for extending the terms of the contract beyond the termination date. Long term agreements (15 years or more) give franchisees more security, though this can be problematic if their relations with the franchisor take a bad turn. Since shorter terms do make it easier for franchisors to rid themselves of under performing or troublesome franchisees, some prefer to go this route. Others, however, place a higher value on securing the franchisee royalties that often pour in under the longer agreements.
Information included in the franchise contract includes the following:
- Accounting and recordkeeping provisions
- Existence (and terms) of any performance quotas
- Fairness of the franchise fee
- Fairness of the royalty arrangement
- Franchisor's continuing services to franchisee
- Insurance protection (if any) under franchisor's patent or liability insurance coverage
- Operating provisions (including quality control, human resource management, and other areas)
- Restrictions (if any) on business activities outside the franchise
- Restrictions (if any) on selling franchise
- Start-up investment required
- Termination or default terms (as well as arbitration clauses)
- Terms of contributions, if any, to parent company's national advertising campaigns
- Terms of inventory and ordering practices
- Terms of renewing the franchise agreement
- Territorial protections
Given the scope of its coveragend its importance as the binding legal document between franchisee and franchisorhe franchise contract is, in its final form, an imposing and complicated document. Again, the importance of the agreement makes it imperative perative that prospective franchise owners consult with an attorney before signing the contract.
A Consumer Guide to Buying a Franchise. U.S. Federal Trade Commission.
Caffey, Andrew A. "Now You're Cooking." Entrepreneur. January 1999.
Dicke, Thomas S. Franchising In America. University of North Carolina Press, 1992.
The Entrepreneur Magazine Small Business Advisor. Wiley, 1995.
Evaluating Franchise Opportunities. Small Business Administration.
Harris, Pat Lopes. "Fickle Franchising: Buying a Franchise May Seem Like a Low-Risk Way to Becoming a Successful Entrepreneur, But It's Not Necessarily a Sure Thing." Washington Business Journal. November 6, 1998.
Hoy, Frank, and Scott Shane. "Franchising as an Entrepreneurial Venture Form." Journal of Business Venturing. March 1998.
Love, Thomas. "The Perfect Franchisee." Nation's Business. April 1998.
Luhn, Rebecca. Buying Your First Franchise. Crisp Publications, 1993.
Spinelli, Steve. "Franchising," in The Portable MBA in Entrepreneurship. Wiley, 1994.
SEE ALSO: Buying an Existing Business
Franchising (Encyclopedia of Business)
- HISTORY OF FRANCHISING
- THE ADVANTAGES OF FRANCHISING
- GOVERNMENTAL REGULATION IN FRANCHISING
- FRANCHISING GOES INTERNATIONAL
- FURTHER READING:
The primary trade association for franchising issues, the International Franchise Association, defines franchising as a "continuing relationship in which the franchisor provides a licensed privilege to do business, plus assistance in organizing, training, merchandising, and management" in exchange for fees and royalties from the franchisee. In other words, franchising is the process of expanding a business whereby a company (franchisor) grants a license to an independent business owner (franchisee) to sell its products or render its services. A franchise, therefore, is a legal agreement permitting a business to furnish a product, name, trademark, or idea to an independent business owner. Each party of a franchise agreement gives up some legal rights to gain others. The franchisor increases its number of outlets and gains additional income. The franchisee opens an established business with strong potential for success. Franchising offers people a chance to own, manage, and direct their own business without having to take all the associated risks. This aspect has allowed many people to open businesses of their own who might never have done so otherwise.
Franchising plays a significant role in the U.S. economy. Franchise sales accounted for about over 50 percent of all retail sales in the United States in the late 1990s and U.S. franchises generated roughly $1 trillion in sales of goods and services annually in the United States during this period, according to the International Franchise Association (IFA). Approximately 1 out of 12, or 600,000, businesses are franchises, which supply jobs for over 8 million people, and there are about 3,000 franchisors in the United States.
According to the U.S. Small Business Administration, franchising is the fastest-growing kind of small business. Furthermore, each new franchise generates 8-14 new jobs and a new franchise opens an average of every eight minutes per business day. Overall, franchises create over 300,000 new jobs per year.
Franchising has opened the door of opportunity for women, families, and minorities. Women have discovered that operating franchises often allows them to spend more time with their families. Women wholly own about 10 percent and jointly own about 30 percent of U.S. franchise outlets, according to the Small Business Administration. In many cases, families pool their resources and time to operate outletsnd often use the profits to create their own mini-chain of stores. Minorities have benefited, too. They have been able to locate establishments in urban areas which at one time lacked minority ownership. Significantly, some franchisors such as Burger King and the Southland Corporation, owner of the 7-11 convenience stores, provide special financial programs for minority owners. They also work closely with organizations like the National Association for the Advancement of Colored People (NAACP) to recruit more minority owners. In this respect, franchises have been a boon for society.
No matter who owns a franchise outlet, the franchisee and the franchisor share the risks and the responsibilities, although not always equally. Since both parties have a financial investment at stake, the risk can be substantial.
TYPES OF FRANCHISES
There are four major types of franchises: business format franchises, product franchises, manufacturing franchises, and business opportunity ventures, according to the Franchise Opportunities Handbook. Via business format franchises, the most common type, a company expands by supplying independent business owners with an established business, including its name and trademark. The franchisor company generally assists the independent owners considerably in launching and running their businesses. In return, the business owners pay fees and royalties. The franchisee also often buys supplies from the franchisor. Fast food restaurants are good examples of this type of franchise.
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.
Through manufacturing franchises, a franchisor 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.
Finally, business opportunity ventures involve an independent business owner buying and distributing the products from one company. The company supplies the business owner with clients or accounts and therefore the business owner pays the company a fee in return. Business owners obtain vending machine routes and distributorships, for example, through this type of franchise arrangement.
HISTORY OF FRANCHISING
Franchise operations, as we know them, are not very old. The boom in franchising did not take place until after World War II. Nevertheless, the rudiments of modem franchising date back to the Middle Ages when the Catholic Church made franchise-like agreements with tax collectors, who retained a percentage of the money they collected and turned the rest over to the church. The practice ended around 1562 but spread to other endeavors. For example, in 17th century England franchisees were granted the right to sponsor markets and fairs or operate ferries. There was little growth in franchising, though, until the mid19th century, when it appeared in the United States for the first time.
One of the first successful American franchising operations was started by an enterprising druggist named John S. Pemberton. In 1886, he concocted a beverage comprising sugar, molasses, spices, and cocaine (which is no longer an ingredient). Pemberton licensed selected people to bottle and sell the drink, which is now known as Coca-Cola. His was one of the earliestnd most successfulranchising operations in the United States.
The Singer Company implemented a franchising plan in the 1850s to distribute its sewing machines. The operation failed, though, because the company did not earn much money even though the machines sold well. The dealers, who had exclusive rights to their territories, absorbed most of the profits because of deep discounts. Some failed to push Singer products, so competitors were able to outsell the company. Under the existing contract, Singer could neither withdraw rights granted to franchisees nor send in its own salaried representatives. So, the company started repurchasing the rights it had sold. The experiment proved to be a failure. That may have been one of the first times a franchisor failed, but it was by no means the last. (Even Colonel Sanders did not initially succeed in his Kentucky Fried Chicken franchising efforts.) Fortunately, the Singer venture did not put an end to franchising.
Other companies tried franchising in one form or another after the Singer experience. For example, several decades later, General Motors Corporation established a somewhat successful franchising operation in order to raise capital. Perhaps the father of modern franchising, though, is David Liggett. In 1902, Liggett invited a group of druggists to join a "drug cooperative." As he explained to them, they could increase profits by paying less for their purchases, especially if they set up their own manufacturing company. His idea was to market private label products. About 40 druggists pooled $4,000 of their own money and adopted the name "Rexall." Sales soared, and "Rexall" became a franchisor. The chain's success set a pattern for other franchisors to follow.
Although many business owners did affiliate with cooperative ventures of one type or another, there was little growth in franchising until the early 20th century, and what franchising there was did not take the same form as it does today. As the United States shifted from an agricultural to an industrial economy, manufacturers licensed individuals to sell automobiles, trucks, gasoline, beverages, and a variety of other products. The franchisees did little more than sell the products, though. The sharing of responsibility associated with contemporary franchising arrangement did not exist to any great extent. Consequently, franchising was not a growth industry in the United States.
It was not until the 1960s and 1970s that people began to take a close look at the attractiveness of franchising. The concept intrigued people with entrepreneurial spirit. However, there were serious pitfalls for investors, which almost ended the practice before it became truly popular.
Since there was no regulation of franchises to speak of, a number of hucksters involved themselves in the field. Many of them initiated get-rich-quick schemes which cost investors countless dollars. As a result, franchising became a bad word to some people. In 1970 alone, over 100 franchisors went out of business. Concomitantly, thousands of franchisees lost their businesses and their money. However, public and private sector watchdogs helped to restore franchising's name and launch its way to a prominent place in the American economy.
Some franchisors formed the IFA in 1960 to police the franchising industry and eliminate the con artists. Individual states began passing laws to regulate franchise activities. By 1979, the Federal Trade Commission (FTC) initiated a franchise trade rule requiring disclosure of pertinent information to prospective franchise owners. Franchising became a respectable word again, and the practice flourished, aided by the efforts of early franchisors like Ray Kroc and Dave Thomas.
Ray Kroc, the founder of the highly successful McDonald's hamburger chain and one of the paradigmatic franchisors, called franchising the "updated version of the American Dream." He established his franchising operation in 1955, after obtaining exclusive franchise rights from Dick and Mac McDonald, who started the chain. Kroc went on to launched a massive franchising campaign and 15 years later the chain included 1,500 outlets.
Wendy's founder Dave Thomas believed that McDonald's hamburgers were skimpy and decided he could improve the basic hamburger. In 1968, Thomas received $1.7 million as his share of the sale of four chicken stores by Hobby House Restaurants, for whom he was a manager. He invested most of it into a new chain of hamburger stands. By the end of 1972, he had nine outlets with annual sales of $1.8 million. By June 1975, he opened the 100th Wendy's restaurant. Less than two years later, the number jumped to 1,000. In 1978 alone he opened 500 outlets. By 1999 there were well over 5,000 outlets worldwide. Thomas proved that there was plenty of room in the franchising world.
THE SPREAD OF FRANCHISING
Franchising grew slowly during the 1940s and 1950s. The majority of the outlets were placed in the suburbs or along highways as people moved out of the cities and into rural areas. The now familiar "strips" lined with franchises started changing Americans' eating and shopping habits. Spurred by the success of the early franchisors, others entered the competition for the shoppers' dollars.
Franchise chains in virtually every business category started operations. Their stores were not always well received, especially in urban areas. Individuals and community groups protested the arrival of franchises, but their efforts were generally unsuccessful. Even today, many community groups and individuals protest the arrival of well-known franchise outletsometimes successfully.
Nonetheless, franchises are active and successful in a wide range of categories. They exist in lawn, garden, and agricultural supplies and services, maid and personal services, security services, tools and hardware, weight control, and many types of food products, including baked goods, donuts and pastry, popcorn, ice cream, yogurt, and fast foods. As the economy and consumers' preferences change, technology advances, and new products are introduced, existing franchises will likely continue to grow, change, and innovate in response.
More than 95 percent of the franchise chains in existence today started operations in the last four decades. Most of them formed between 1965 and 1985. Their growth was phenomenal. For example, Century 21, the real estate operation, began in 1972 and grew to include 7,400 outlets by 1980. It took McDonald's only 25 years to establish its 6,200th store and the chain boasted of 25,000 outlets by 1999. There is hardly a community anywhere that does not have at least one franchise operation.
THE ADVANTAGES OF FRANCHISING
Franchising offers a number of advantages not only to franchisors but also to franchiseeshich helps explain why franchising has been so successful. Franchisors benefit from these 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. However, through franchising a company invests very little capital or labor, because the franchisee supplies both.
A company also can ensure it has competent and highly motivated owner/managers at each outlet through franchising. Since the owners are largely responsible for the success of their outlets, they will put a strong, constant effort to make sure their businesses run smoothly and prosper. In addition, companies are able to provide franchising rights to only qualified people. Moreover, franchisors can raise money without selling shares of their companies through franchising.
Likewise, franchisees reap a variety of benefits from franchising. As noted previously, the franchisee faces much less risk through franchising a company, than through starting a business from scratch, according to many studies. The lower risk is related to other advantages of franchising that stem from being affiliated with a proven company. The franchisor generally has had some experience in the field of business and has national or regional name recognition. Franchisors also provide franchisees with a proven and efficient method of operation through their years in the business, with management assistance and training, and with marketing assistance and advantages. Franchisors usually conduct national or regional marketing campaigns developed by professional advertising agencies and they can help franchisees run local ad campaigns, though franchisees generally must contribute 1-5 percent of their gross profit to advertising funds. All of these aspects of franchise agreements can significantly increase the chances of an outlet's success.
Furthermore, franchisors sometimes help franchisees obtain financing for their outlets as well as prepare business plans and strategies. What's more, if a prospective franchisee needs to borrow money to help with business-related costs, financial institutions may be more willing to lend if a well-known franchisor is backing the applicantspecially if the franchisor is well established, rather than based on a new concept.
THE DISADVANTAGES OF FRANCHISING
COSTS OF FRANCHISING.
In return for the benefits franchisees receive, they must pay fees and royalties to the franchisors. The franchise fee may range anywhere from $5,000 to over $1 million and hence can be a major expenditure. Besides the franchise fee, franchisees often must pay royalties periodically during the life of the franchise agreement. Royalty payments are either a percentage of an outlet's gross incomesually under 10 percent of an outlet's gross incomer a fixed fee.
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.
The costs of these businesses pale in comparison to food franchises. For example, a Popeye's Famous Fried Chicken and Biscuits, Inc. outlet will cost the franchisee a minimum of $200,000ith no financing assistance available. A franchise at Perkins Restaurants, Operating Co., L.P. costs between $959,000 and $1,500,000. An individual's initial cash investment would be about $150,000. Initial costs such as these can present serious obstacles to some people trying to purchase a franchise.
FUNDING THE FRANCHISE.
There are several sources of financial backing for potential franchisees. Since franchisors do not always offer financial assistance, people rely primarily on their own funds, family support, and the traditional sources such as financial institutions, banks, and private investors. The more money a franchise costs, the harder it is for potential operators to raise the necessary funds. However, the search does highlight another positive aspect of franchising: it involves a cadre of specialists (e.g., bankers, lawyers, and accountants), who earn all or part of their salaries from their involvement with franchise operations.
For people with limited cash or access to it, franchising may not be the easiest career path for prospective business operators, then. However, for many people who have made the investment, franchising has paid off substantially from both the company and outlet owner standpoint, as history shows.
In addition to the payment of fees and royalties, franchisees give up some control over their own businesses, as well as lose their own identity. Most patrons do not know who owns their local McDonald's, Burger King, or MAACO auto body shop. So, many franchise outlet owners are relegated to anonymityhich can be a drawback.
Franchisees are often subjected to tight supervision by the franchisor. They cannot pick out their own business name, buy products and services from whom they choose, or select the location at which they will do business. In addition, franchisees usually must follow franchisor guidelines closely and not deviate from their approach to doing business. Some franchisors control their outlets so tightly they even tell business operators when to empty their trash cans, how to dress their employees, where to dispose of food, what color to paint their fences, etc. As a result, some franchisees are largely dependent on their franchisors. Moreover, franchisees usually cannot implement changes without franchisor approval. Hence, if a coffee house franchise that sells only beverages and pastries notices customer demand for sandwiches, it cannot offer them without the consent of the franchisor.
Another problem with franchising is that franchisees may fall victim to the company's problems. While a particular business owner may be doing well, the chain itself may encounter financial problems due to mismanagement, a failing economy, or any other reason which impacts operations. This can result in increased fees or royalties or a switch in suppliers which can lead to reduced quality of goods and services. In extreme cases, the franchisor can go out of business completely. Franchisees also enter into 10-15 year agreements with franchisors and in most cases can get out of the agreement only by selling the business.
A final problem for potential franchisees is how to select the right company with which to affiliate. As the number of franchisors increases, the method of choosing which franchise is right for a particular individual becomes more complex. Obviously, if the would-be franchisee has certain skills or interests, these are likely to guide this choice. Even if a potential franchisee knows which type of business to enter, the selection of a franchisor may pose a challenge.
The person who wants to open a fast-food franchise has to decide what type of food it will serve: pizza, hamburgers, yogurt, full meals, etc. Other matters to consider include fees required, royalties, governmental regulations, and whether the particular business is part of a growing industry. Such choices are closely tied in to public policy and governmental regulation today.
GOVERNMENTAL REGULATION IN FRANCHISING
Franchising can be broken down roughly into two broad categories: retail and service. Many of the businesses in both categories are subject to extensive government regulations today, which can increase both the franchisors' and franchisees' responsibilities and financial investments. For example, franchisors in personal services, such as water conditioning and pest control experts, have to be aware of Environmental Protection Agency (EPA) regulations governing the use of pesticides and toxic products and the added costs associated with them. The same holds true for automotive retail franchises. Questions must be answered regarding where and when used batteries, replaced oil, rusted mufflers, etc., can be disposed.
These are generally matters to be resolved by the franchisor, but franchisees must be aware of current and impending local and state laws before opening their operations.
Governmental involvement in franchising is not new. For instance, California enacted the first pre-sale franchise disclosure law in 1970. The law addressed two broad areas: full and accurate pre-sale disclosure to prospective franchisees of information about the franchisor and the contract, and the fairness of the contract itself. Several other states passed similar laws shortly afterward. The first federal law was passed in 1979 under the aegis of the Federal Trade Commission (FTC).
Since many companies operated in several states, it was inevitable that the federal government would involve itself in franchise regulation. That became the FTC's role. The agency requires every franchisor to provide each potential franchisee with a detailed disclosure document which protects everyone involved in a possible agreement and this requirement is known as the Franchise Trade Rule. The required document contains 20 different categories of information about the franchise and must be given to prospective franchisees at least ten days prior to signing a franchise contract. Included is information about required fees, basic investment, bankruptcy, and the franchisor's litigation history. There are also inclusions concerning how long the franchise will be in effect, the franchisor's financial statement, and earnings claims (if they are available). The financial disclosure laws had a major impact on franchising.
The laws made it clear that franchisors were in business not only to make a profit, but to supply their clients with services and products that made their ownership easier. The laws corrected any imbalance in franchise agreements that were tipped in the franchisors' favor. Under the laws, franchisors had to reveal all the information potential franchisees needed to make a decision on whether or not to open an outlet. The companies had to reveal how long they had been in business, the number of unit failures, lawsuits in which they were involved, either currently or in the past, and supporting information to back up any claims they made about their operations. This protection stands potential franchisees in good stead and reduces the potential for fraud on the part of franchisors.
It is imperative to note that the financial disclosure laws do not protect potential franchisees completely. For instance, the FTC does not certify any information provided; instead, the individual must verify information provided by franchisors. Since Congress authorized the FTC to regulate franchising, franchisees can submit complaints to the agency. Although the FTC has the ultimate authority to regulate franchising, the states may impose their own requirements as long as they are stricter than the federal requirements. Consequently, some states use the Uniform Franchise Offering Circular (UFOC) for franchisor information disclosure, which has a few more requirements than the FTC's disclosure policy.
The key is that laws exist to protect people interested in franchises, which is a far cry from the early days of franchising when caveat emptoret the buyer bewareas the watch word for franchisees. Because there was a great deal of risk involved in dealing with franchisors in those days, there was considerable controversy over the benefits of franchising. Much of that controversy remains, although it has changed in focus somewhat.
CONTROVERSIES OVER FRANCHISING
As successful as franchising has been in the United States, there are critics who suggest that it has been detrimental to the country's economy. One argument is that franchise employees receive low wages. This is partly because the majority of the workers are part-time employees who don't receive any benefits. Because of the low wages and lack of benefits, franchise owners have a hard time attracting and retaining quality workers. One of the solutions to this problem would be union organization. However, labor unions in general have lost their power in recent years, so they are more reluctant than ever to organize franchise workers in deference to focusing on unionizing larger and more stable employers. Without union representation, workers may not organize and wages may remain low.
A second criticism is that chains detract from the aesthetics of a community. They may locate in residential neighborhoods and erect huge unsightly signs. Some communities have eliminated these problems through strict zoning laws and other legislation. Often, these laws are "grandfathered," which means existing businesses are unaffected. So, if urban blight is to be eliminated, it will not happen for years to come.
Opponents of franchises also cite the distribution of franchise revenues. Much of the money franchisees take in goes to the franchisor. Thus, it is removed from the local economy. A locally owned firm's revenues would stay in the community. But, since chains drive out local owners, much of a community's revenues are lost.
Certainly, there are arguments that support the existence of franchises, too. Regardless of the controversy, franchising has had a major impact on the American economy, and is impacting foreign countries as well.
FRANCHISING GOES INTERNATIONAL
The growth of franchising in the United States has been phenomenal. Not only has it encompassed virtually every aspect of American business, but it has spread abroad. Canada in particular has proven lucrative for American franchisors. In fact, it has the second highest number of franchise outlets in the world. That is due primarily to the common language and similar culture the two countries share. Canada is by no means the only target of U.S. franchisors, though.
American companies are expanding their operations into countries as diverse as the Dominican Republic, Saudi Arabia, and Japan. Ironically, Japan, even thought it is culturally dissimilar from the United States, represents a prolific market for American franchisors.
Currently, franchises account for only about 4 percent of all retail sales in Japan. However, some American franchisors such as 7-Eleven, Inc. have made large inroads. In fact, a Japanese company, Ito-Yokado Ltd., controls U.S.-based 7-Eleven, Inc. (formerly Southland Corp.), which is the franchisor and owner of the 7-Eleven trademark worldwide. McDonald's and Toys 'R' Us run a joint venture in Japan. Certainly, not every American franchisor can function well there. For example, Gymboree, which franchises developmental programs for preschoolers and their parents, had to turn down Japanese investors due to a lack of space in which to erect equipment.
Another problem American franchisors faced in Japan was the working conditions. The concept of part-time work puzzled the Japanese. They are accustomed to lifelong, full-time employment for which workers receive adequate wages. So, when Kentucky Fried Chicken entered the Japanese market, it had to change its wage policy and upgrade working conditions. Otherwise, the company would not have survived. Other companies have faced similar problems in Japan and elsewhere, but they have overcome them, survived, and grown.
Occasional setbacks aside, American franchisors are moving ahead aggressively to gain a toehold in other countries. Century 21, for example, has established franchises in Canada, France, Japan, and the United Kingdom. Jani-King International, Inc., a commercial janitorial company, has operations in Canada, Japan, Australia, and the United Kingdom. Hardee's Food Systems has outlets in Costa Rica, the Netherlands Antilles, Singapore, Korea, Japan, Thailand, and Hong Kong. There is apparently no geographical limit to where franchisors canr willo.
THE FUTURE OF FRANCHISING
Based on the success companies have enjoyed since the franchising boom began in the 1950s, the future of franchising is positive. The U.S. Department of Commerce predicts that slower population growth, population shifts to new metropolitan areas, and the introduction of new technology will create new opportunities for franchises. Mergers and acquisitions will increase as larger franchisors take over smaller ones. Schools and universities are adding franchising studies to their business curricula. These factors, combined with the low rate of franchise failure, stability in the industry, and a considerable return on everybody's investment, have made franchising a major force in the American economy to this point. Some of the emerging franchise businesses expected to drive the growth of franchising tend to offer customers added convenience such as to-the-door services offering everything from dry cleaning and pet care to window coverings and furniture repair, according to Nation's Business. In addition, Nation's Business reported that other franchise trends of the future will include education and training businesses, second-hand merchandise stores, office support services, and health service providers.
[Arthur G. Sharp]
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