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.
