Chapter 15 - Franchising

What Is Franchising and How Does It Work?

A. What Is Franchising?
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 an initial franchise fee and an ongoing royalty.

B. How Does Franchising Work?
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.”
A franchise is an agreement between a franchisor 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 are two distinctly different types of franchise systems

• 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. This approach typically connects a single manufacturer with a network of dealers or distributors.
• Business format franchise: far the more popular approach to franchising and is more commonly used by entrepreneurs and entrepreneurial ventures. In a business format franchise, the franchisor provides a formula for doing business to the franchisee along with training, advertising, and other forms of assistance.

The franchisor–franchisee relationship has three forms of a franchise agreement

• Individual franchise agreement: involves the sale of a single franchise for a specific location.
• Area franchise agreement: allows a franchisee to own and operate a specific number of outlets in a particular geographic area.
• Master franchise agreement: similar to an area franchise agreement, with one major difference. A master franchisee, in addition to having the right to open and operate a specific number of locations in a particular area, also has the right to offer and sell the franchise to other people in its area. The people who buy franchises from master franchisees are typically called subfranchisees.

Establishing a Franchise System

 A. When to Franchise
Retail firms grow when two things happen:

• First, when the attractiveness of a firm’s products or services become well known
• Second, when a firm has the financial capability to build the outlets needed to satisfy the demand for its products or services

B. Steps to Franchising a Business
Step 1: Develop a franchise business plan
Step 2: Get professional advice
Step 3: Conduct an intellectual property audit
Step 4: Develop franchise documents
Step 5: Prepare operating manuals
Step 6: Plan an advertising strategy and a franchisee training program
Step 7: Put together a team for opening new franchise units
Step 8: Plan a strategy for soliciting prospective franchisees
Step 9: Help franchisees with site selection and the grand opening of their franchise outlets

C. Selecting and Developing Effective Franchisees
Qualities to Look for in Prospective Franchisees

• Good work ethic
• Ability to follow instructions
• Ability to operate with minimal supervision
• Team oriented
• Experience in the industry in which the franchise competes
• Adequate financial resources and a good credit history
• Ability to make suggestions without becoming confrontational or upset if the suggestions are not adopted
• Represents the franchisor in a positive manner

Ways Franchisors Can Develop the Potential of Their Franchisees

• Provide mentoring that supersedes routine training
• Keep operating manuals up-to-date
• Keep product, services, and business systems up-to-date
• Solicit input from franchisees to reinforce their importance in the larger system
• Encourage franchisees to develop a franchise association
• Maintain the franchise system’s integrity

Advantages and Disadvantages of Establishing a Franchise System

Before deciding to franchise, a firm should consider the following:

• 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

Advantages:

• Rapid, low-cost market expansion
• Income from franchise fees and royalties
• Franchisee motivation
• Access to ideas and suggestions
• Cost savings
• Increased buying power

Disadvantages:

• Profit-sharing
• Loss of control
• Friction with franchisees
• Managing growth
• Differences in required business skills
• Legal expenses

Buying a Franchise
Franchising may be a particularly good choice for someone who wants to start a business but has no prior business experience. Along with offering a refined business system, well-run franchise organizations provide their franchisees training, technical expertise, and other forms of ongoing support.

A. Is Franchising Right for You?
Questions that will help to determine whether franchising is a good fit (for people thinking about starting their own entrepreneurial venture):

• Are you willing to take orders?
• Are you willing to be part of a franchise “system” rather than an independent businessperson?
• 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 willing are you to put your money at risk?

B. 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.

The following costs are typically associated with buying a business format franchise:

• Initial franchise fee
• Capital requirements
• Continuing royalty payment: Royalty fees are usually around 5 percent of gross income
• Advertising fees: Advertising fees are typically less than 3 percent of gross income.
• Other fees

C. Finding a Franchise
There are thousands of franchise opportunities available to prospective franchisees. 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.

D. Advantages and Disadvantages of Buying a Franchise
Advantages:

• A proven product or service within an established market
• An established trademark or business system
• Franchisor’s training, technical expertise, and managerial experience
• An established marketing network
• Franchisor’s ongoing support
• Availability of financing
• Potential for business growth

Disadvantages:

• Cost of the franchise
• Restrictions on creativity
• Duration and nature of the commitment
• Risk of fraud, misunderstandings, or lack of franchisor commitment
• Problems of termination or transfer
• Poor performance on the part of other franchisees
• Potential for failure

Steps in Purchasing a Franchise
Step 1: Visit several of the franchisor’s outlets
Step 2: Meet with a franchise attorney
Step 3: Meet with the franchisor and check the franchisor’s references
Step 4: Review all franchise documents with the attorney
Step 5: Sign the franchise agreement
Step 6: Attend training
Step 7: Open the franchise business

Common Misconceptions About Franchising
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
• 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"

More About Franchising
A. Franchise Ethics
An understanding of these features can help franchisors and franchisees guard against making ethical mistakes. These 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

B. International Franchising
These are some of the steps to take before buying a franchise in a foreign country (for U.S. citizens):

• 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
• Uncover whether the franchisor has experience in international markets
• Find out how much training and support you will receive from the franchisor
• Evaluate currency restrictions
• Direct franchising arrangement
• Master franchise agreement
• Other agreements

C. The Future of Franchising
The future of franchising appears bright. Franchising represents a large and growing segment of the retail and service sectors of U.S. businesses and is in some cases replacing more traditional forms of business ownership. More and more college graduates are choosing careers in industries that are heavily dominated by franchising. Franchising is also becoming more popular among seniors. At the same time, the number of franchises focusing on “senior care” is increasing. There are also innovations taking place today in franchising, such as the extensive use of social media that is occurring in many franchise organizations.

Chapter 14 - Strategies for Firm Growth

Internal Growth Strategies
Internal growth strategies involve efforts taken within the firm itself, such as new product development, other product-related strategies, and international expansion, for the purpose of increasing sales revenue and profitability.

New Product Development
New product development involves designing, producing, and selling new products (or services) as a means of increasing firm revenues and profitability. In many fast-paced industries, new product development is a competitive necessity.

Advantages of Internal Growth Strategies:

• Incremental, even-paced growth.
• Provides maximum control
• Preserves organizational culture
• Encourages internal entrepreneurship
• Allows firms to promote from within

Disadvantages of Internal Growth Strategies:

• Slow form of growth
• Need to develop new resources
• Investment in a failed internal effort can be difficult to recoup
• Adds to industry capacity

The keys to effective new product and service development:

• Find a need and fill it
• Develop products that add value
• Get quality and pricing right
• Focus on a specific target market
• Conduct ongoing feasibility analysis

The Top 5 Reasons New Products Fail

• The potential market was overestimated
• Customers saw the product as too expensive
• The product was poorly designed
• The product was no different than the competition’s
• The costs of developing the product line were too high

Additional Internal Product-Growth Strategies
Firms also grow by improving existing products or services, increasing the market penetration of an existing product or service, or pursuing a product extension strategy.

A. Improving an Existing Product or Service
Enhancing quality, making it larger or smaller, making it more convenient to use, improving its durability, or making it more up-to-date. Improving an item means increasing its value and price potential from the customer’s perspective.

B. Increasing the Market Penetration of an Existing Product or Service
A market penetration strategy involves actions taken to increase the sales of a product or service through greater marketing efforts or through increased production capacity and efficiency.

C. Extending Product Lines
A product line extension strategy involves making additional versions of a product so that it will appeal to different clientele or making related products to sell to the same clientele.

D. Geographic Expansion
Geographic expansion is another internal growth strategy. Many entrepreneurial businesses grow by simply expanding from their original location to additional geographic sites. This type of expansion is most common in retail settings.

The keys to successful geographic expansion follow:

• Perform successfully in the initial location
• Establish the legitimacy of the business concept in the expansion locations
• Don’t isolate the expansion location

International Expansion
International new ventures are businesses that, from inception, seek to derive competitive advantage by using their resources to sell products or services in multiple countries. From the time they are started, these firms, which are sometimes called “global start-ups” or “born globals,” view the world as their marketplace rather than confining themselves to a single country.

A. Assessing a Firm’s Suitability for Growth Through International Markets
Evaluating a Firm’s Overall Suitability for Growth Through International Markets:
1. Management/Organizational Issues

• Depth of management commitment
• Depth of international experience
• Interference with other firm initiatives

2. Product and Distribution Issues

• Product issues
• Distribution issues

3. Financial and Risk Management Issues

• Financing export operations
• Foreign currency risk

B. Foreign Market Entry Strategies
The majority of entrepreneurial firms first enter foreign markets as exporters, but firms also use licensing, joint ventures, franchising, turnkey projects, and wholly-owned subsidiaries to start international expansion.

C. Selling Overseas
It is important to handle the inquiry appropriately and to observe protocols when trying to serve the needs of customers in foreign markets.

External Growth Strategies
External growth strategies rely on establishing relationships with third parties. Mergers, acquisitions, strategic alliances, joint ventures, licensing, and franchising are examples of external growth strategies.

A. Mergers and Acquisitions
A merger is the pooling of interests to combine two or more firms into one.
An acquisition is the outright purchase of one firm by another. In an acquisition, the surviving firm is called the acquirer, and the firm that is acquired is called the target.

Emphasizing External Growth Strategies
Advantages:

• Reducing competition
• Getting access to proprietary products or services
• Gaining access to new products and markets
• Obtaining access to technical expertise
• Gaining access to an established brand name
• Economies of scale
• Diversification of business risk

Disadvantages:

• Incompatibility of top management
• Clash of corporate cultures
• Operational problems
• Increased business complexity
• Loss of organizational flexibility
• Antitrust implications

1. Finding an Appropriate Acquisition Candidate
There are typically two steps involved in finding an appropriate target firm. The first step is to survey the marketplace and make a “shortlist” of promising candidates. The second is to carefully screen each candidate to determine its suitability for acquisition.

2. Steps Involved in an Acquisition
Step 1: Schedule a meeting with the target firm’s executives:
Step 2: Evaluate the feelings of the target firm’s executives about the acquisition:
Step 3: Determine how to most appropriately finance the acquisition:
Step 4: Actively negotiate with the target firm:
Step 5: Make an offer if negotiations indicate that doing so is appropriate:
Step 6: Develop a non-compete agreement with key target firm employees who will be retained:
Step 7: Hire an attorney to prepare the closing documents:
Step 8: As soon as practical, meet with all employees to explain the acquisition:
Step 9: Move forward with the plan for adding the acquired firm to the organization:

B. Licensing
Licensing is the granting of permission by one company to another company to use a specific form of its intellectual property under clearly defined conditions. Virtually any intellectual property a company owns that is protected by a patent, trademark, or copyright can be licensed to a third party. Licensing also works well for firms that create novel products but do not have the resources to build manufacturing capabilities or distribution networks, which other firms may already have in place.

1. Technology Licensing
Technology licensing is the licensing of proprietary technology that the licensor typically controls by virtue of a utility patent.

2. Merchandise and Character Licensing
Merchandise and character licensing are the licensing of a recognized trademark or brand that the licensor typically controls through a registered trademark or copyright.

C. Strategic Alliances and Joint Ventures
Participating in Strategic Alliances and Joint Ventures
Advantages:

• Gain access to a particular resource
• Economies of scale
• Risk and cost-sharing
• Gain access to a foreign market
• Learning
• Speed to market
• Neutralizing or blocking competitors

Disadvantages:

• Loss of proprietary information
• Management complexities
• Financial and organizational risks
• Risk becoming dependent on a partner
• Partial loss of decision autonomy
• Partners’ cultures may clash
• Loss of organizational flexibility

1. Strategic Alliances
A strategic alliance is a partnership between two or more firms that are developed to achieve a specific goal. Various studies show that participation in alliances can boost a firm’s rate of patenting, product innovation, and foreign sales.

Technological alliances and marketing alliances are two of the most common forms of alliances.

• Technological alliances feature cooperation in research and development, engineering, and manufacturing. Research-and-development alliances often bring together entrepreneurial firms with specific technical skills and larger, more mature firms with experience in development and marketing.
• Marketing alliances typically match a company that has a distribution system with a company that has a product to sell in order to increase sales of a product or service.

2. Joint Ventures
A joint venture is an entity created when two or more firms pool a portion of their resources to create a separate, jointly owned organization.