Chapter 15. Franchising

What is Franchising and How does it Work?

Franchising is a form of business organization in which a firm that already has a successful product or service (franchisor) licenses its trademark and method of doing business to other businesses (franchisees) in exchange for a initial franchise fee and an ongoing royalty.
A franchise is an agreement between a franchisor (the parent company) and a franchisee (an individual or firm that is willing to pay the franchisor a fee for the right to sell its product, service, and/or business method.
There is nothing magical about franchising. It is a form of growth that allows a business to get its products or services to market through the efforts of business partners or "franchisees".

There are two distinctly different types of frachise systems:

• A product and trademark franchise: An arrangement under which the franchisor grants to the franchisee the right to buy its products and use its trade name.
• The business format franchise: The franchisor provides a formula for doing business to the franchisee along with training, advertising, and other forms of assistance. 

A person who owns and operates more than one outlet of the same franchisor, whether through an area or a master franchise agreement, is called a multiple-unit franchisee. By owning more than one unit, a multiple-unit franchisee can capture economies of scale and reduce its administrative overhead per unit of sale.

Establishing a Franchise System

Establishing a franchise system should be approached carefully and deliberately. Franchising is a complicated business endeavor, which means that an entrepreneur must look closely at all of its aspects nefore deciding to franchise. Indeed, franchising often involves the managerially demanding tasks of training, supporting, supervising, and nurtuting franchisees.

When to Franchise

Franchising is a second growth alternative available to firms. Franchising is perhaps especially attractive to young firms in that the majority of the money needed for expansion comes from the franchisee. Franchising is appropriate when a firm has a strong or potentially strong trademark, a well-designed business model, and a desire to grow, A franchise system will ultimately fail if the franchisee's brand doesn't create value for customers and its business model is flawed or poorly developed. 

Steps to Franchising a Business

• Develop a franchise business plan
• Get professional advice
• Conduct an intellectual property audit
• Develop a franchise documents
• Prepare operating manuals
• Plan an advertising strategy and a franchisee-training program
• Put together a team for opening new franchise units
• Plan a strategy for solicitating prospective franchisees
• Help franchisees with site selection and the grand opening of their franchise outlets

Along with the steps above, it is important for a franchisor to remember that the quality of the relationships it maintains with its franchisees often defines the ultimate success of the franchise system. It is to the franchisor's advantage to follow through on all promises and to establish an examplary reputation.

Selecting and Developing Effective Franchisees

The franchisor's ability to select and develop effective franchisees strongly influences the degree to which a franchise system is successful. For most systems, the ideal franchisee is someone who has solid ideas and suggestions but is willing to work within the franchise system's rules. Franchisees must me team players to properly fit within the context of a successful franchise system.

Advantages and Disadvantages of Establishing a Franchise System

There are two primary advantages to franchising. First, early in the life of an organization, capital is typically scarce, and rapid growth is needed to achieve brand recognition and economies of scale. Franchising helps a venture grow quickly because franchisees provide the majority of the capital. Many franchisors even admit that they would rather grown through company-owned stores but that the capital requirements needed to grow their firms dictated franchising.

Second, a concept called agency theory argues that for organizations with multiple units, it is more effective for the units to be run by franchisees than by managers who run company-owned stores. 

The primary disadvantage of franchising is that an organizational allows others to profit from its trademark and business model. When a company decides to investigate franchising as a means of growth, it should ensure that it and its product or service meet several criteria. Businesses that fail to
satisfy these criteria are less likely to make effective franchise systems.

• The uniqueness of its product or service
• The consistent profitability of the firm
• The firm's year-round profitability
• The degree of refinement of the firm's business systems
• The clarity of the business proposition

Buying a Franchise

Purchasing a franchise is an important business decision involving a substantioal financial commitment. Potential franchise owners should strive to be as well informed as possible before purchasing a franchise and should be well aware that it is often legally and financially difficult to exit a franchise relationship. Some franchise organizatioms are designed to provide their franchises a part-time rather than a full-time income, which is attractive to some people.
Franchising may be a particularly good choice for someone who wants to start a business but has mo propr business experience. Along with offering a recimed business system, well-run franchise organizations provide their franchisees training, technical expertise, and other forms of ongoing supports.

Is Franchising Right for You?

Entrepreneurs should weigh the possibility of purchasimg a framchise against the alternatives of buying an existing business or launching their own venture from scratch. Are you willing to take orders? How will you react if you make a suggestion to your franchisor and your suggestion is rejected? What are you looking for in a business? How hard do you want to work?

None of these questions is meant to suggest that franchising is not an attractive method of business ownership for entrepreneurs. It it important, however, that a potential franchisee be fully aware of the subtles involved with franchising before purchasing a franchise outlet.

The Cost of a Franchise

The initial cost of a business format franchise varies, depending on the franchise fee, the capital needed to start the business, and the strength of the franchisor. Some franchisors own the land and buildings that their franchisees use, and lease the property to the franchisees. In contrast, other organizations require their franchisees to purchase the land, buildings and equipment needed to run their franchise outlet.
While evaluating the cost of a franchise, prospective franchisees should consider all the costs involved. Franchisors are required by law to disclose all their costs in a document called the Franchise Disclosure Document and send it to the franchisee. The following costs are typically associated with buying a business format franchise:

• Initial franchise fee
• Capital requirements
• Continuing royalty payment
• Advertising fee
• Other fees

Finding a Franchise

The most critical step in the early stages of investigating franchise opportunities is for the entrepreneur to determine the type of franchise that is the best fit. Before buying a franchise, a potential franchisee should imagine operating the prospective franchise or, better yet, should spend a period of time working in one of the franchisor's outlets. There are many periodicals, websites, and associations that provide information about franchise opportunities.

Advantages and Disadvantages of Buying a Franchise

There are two primary advantages to buying a franchise over other forms of business ownership. First, franchising provides an entrepreneur the opportunitiy to own a business using a tested and refined business model. Second, when an individual purchases a franchise, the franchisor typically provides training, technical expertisem and other forms of support.

The cost involved is the main disadvantage of buying and operating a franchise. The franchisee must pay an initial franchise fee. The franchisee must also pay the franchisor an ongoing royalty as well as pay into a variety of funds, depending on the franchise organization.

Steps in Purchasing a Franchise

Owning a franchise is typically costly and labor-intensive, and the purchase of a franchise should be a careful, deliberate decision. Once the decision to purchase a franchise has been nearly made, however, the following steps should be taken:

1. Visit several of the franchisor's outlets
2. Meet with a franchise attorney
3. Meet with the franchisor and check the franchisor's references
4. Review all franchise documents with the attorney
5. Sign the franchise agreement
6. Attend training
7. Open the franchise business

Common Misconceptions About Franchising

It is easy to become enthralled with the promise of franchising and not spend an adequate amount of time examining the potential pitfalls. The following is a list of misconceptions franchisees often have about franchising:

• Franchising is a safe investment
• A strong industry ensures franchise success
• A franchise is a "proven" business system
• There is no need to hire a franchise attorney or an accountant
• The best systems grow rapidly, and it is best to be a part of a rapid-growth system
• I can operate my franchise outlet for less than the franchisor predicts
• The franchisor is a nice person ⎯ he'll help me out if I need it

Legal Aspects of the Franchise Relationship

The legal and regulatory environment surrounding franchising is based on the premise that the public interest is served if prospective franchisees are as informed as possible regarding the characteristics of a particular franchisor. The legal aspects of the franchise relationship are unique enough that some attorney specialized in franchise law. 

More About Franchising

There are a number of additional issues pertaining to the franchisor-franchisee relationship.

Franchise Ethics

There are certain features if franchising, however, that make it subject to ethical abuse. An understanding of these features can help franchisors and franchisees guard against making ethical mistakes. The features are the following:

• The get-rich-quick mentality
• The false assumption that buying a franchise is a guarantee of business success
• Conflicts of interest between franchisors and their franchisees

Similar to marriage, the franchisor-franhisee relationship is typically close, long-term, and painful to terminate. Each side of the franchise partnership should scrutinize the past ethical behavior of the other before a franchise agreement is executed.

International Franchising

International opportunities for franchising are becoming more prevalent as the markets for certain franchised products in the US have been saturated.

For US citizens, these are some of the steps to take before buying a franchise in a foreign country:

• Consider the value of the franchisor's name in the foreign country
• Work with a knowledgeable lawyer
• Determine whether the product or service is salable in a foreign country 
• Unconver whether the franchisor has experience in international markets
• Find out how much training and support will you receive from the franchisor
• Evaluate currency restrictions
• Direct franchising arrangement
• Master franchise agreement
• Other agreements

The Future of Franchising

The future of franchising appears bright. More and more college graduates are choosing careeers in industries that are heavily dominated by franchising. There are also innovations taking place in today franchising, such as the exstensive use of social media that is occurring in many franchise organizations. There are additional innovations as well, such as the extensive use if instant couponing ti encourage people to drop in and make a purchase. Many restaurants franchises are revamping their menus to appeal to health-conscious consumers. The franchisees make money in a number ways, including by selling their conent to business directories and local businesses. Franchisees are carefully selected, and they must have a unique passion and love for the destination they are purchasing.