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1. Trends in franchising, major forms, and identify best practices.
Franchising is a form of licensing in which a parent company (the franchiser) grants another independent entity (the franchisee) the right to do business in a prescribed manner. This right can take the form of selling the franchisor’s products, using its name, production and marketing techniques or general business approach. One of the common forms of franchising involves the franchisor supplying an important ingredient for the finished product. International franchising/licensing agreements have grown very substantially. As an entry strategy, franchising and licensing requires neither capital investment nor knowledge and marketing strength in foreign markets.
"Franchising" is used to describe a number of business models, the most commonly identified of which is “business format franchising”. The other major form is called an authorized franchise system. There are however, four other categories which are also dependent on franchise relationships. The first is Manufacturer-Retailer, where the retailer as franchisee sells the franchisor's product directly to the public (eg. New motor vehicle dealerships). The second is Manufacturer-Wholesaler, where the franchisee under license manufactures and distributes the franchisor's product (eg. Soft drink bottling arrangements). The third is Wholesaler-Retailer, where the retailer as franchisee purchases products for retail sale from a franchisor wholesaler (frequently a cooperative of the franchisee retailers who have formed a wholesaling company through which they are contractually obliged to purchase) (eg. Hardware and automotive product stores). And the fourth is Retailer-Retailer, where the franchisor markets a service, or a product, under a common name and standardized system, through a network of franchisees. The fourth category, Retailer-Retailer, is the classic business format franchise. The first two categories above are often referred to as product and trade name franchises. These include arrangements in which franchisees are granted the right to distribute a manufacturer's product within a specified territory or at a specific location, generally with the use of the manufacturer's identifying name or trademark, in exchange for fees or royalties.
The business format franchise, however, differs from product and trade name franchises through the use of a format, or a comprehensive system for the conduct of the business, including such elements as business planning, management system, location, appearance and image, and quality of goods. Standardization, consistency and uniformity across all aspects are hallmarks of the business format franchise. Business format franchising is today the fastest-growing segment of franchising. It has significantly more franchise systems, more outlets, more employees and more opportunities than product and trade name franchises. Business format franchising requires a unique relationship between the franchisor (the owner of the system) and the franchisee (the owner of the individual outlet), which is commonly referred to as a "commercial marriage". This ongoing business relationship includes the product, service and trademark, as well as the entire business concept itself from marketing strategy and plan, operational standards, systems and formats, to training, quality control and ongoing assistance, guidance and supervision. In short, it provides small business (the franchisee) with the tools of big business (provided by the franchisor). It is also a Win-Win relationship where the franchisor is able to expand its market presence without eroding its own capital and the franchisee gains through access to established business systems, at lower risk, for their own commercial advantage.
The "commercial marriage" between franchisor and franchisee is ultimately a legal relationship, with the full obligations and responsibilities of both parties outlined in a highly detailed franchise agreement. This commercial contract varies in length and conditions from one system to the next, such that it would be almost impossible for any two franchise systems to have identical agreements. By nature of the relationship, the franchise agreement will be imbalanced in favor of the franchisor, as the franchisor must at all times remain in control over certain standards critical to the ongoing success of the business format. One advantage for franchising internationally is that it may be employed as a pre-emptive strategy against competitors by combing the foreign markets before the competitors is able to enter. In addition, franchising has been used by many companies to harvest their obsolete products. Franchising and licensing involve a minimal commitment of resources and effort on the part of the international marketer, and are easy ways of entering the foreign markets. Under international licensing, a firm in one country (the licensor) permits a firm in another country (the licensee) to use its intellectual property (such as patents, trademarks, copyrights, technical know-how and marketing skill). The monetary benefit to the licensor is the royalty or fees that such a licensee pays. In many countries, the government regulates such fees or loyalties. These feeds do not exceed five per cent of the sales in many developing countries. A licensing agreement may also be one of cross licensing, wherein there is a mutual exchange of knowledge and/or patents. In cross licensing, a cash payment may or may not be involved.
The Top 10 Franchises in 2006, provided by the Franchise Prospector website, are listed in the table below.
1 Subway
Fast Food Franchise
2 Curves for Women
Recreation Franchise
3 Dunkin Donuts
Fast Food Franchise
4 Jani-King International
Commercial Cleaning Franchise
5 UPS Store
Services Franchise
6 Taco Bell
Fast Food Franchise
7 Jackson Hewitt Tax Service
Services Franchise
8 RE/MAX International
Real Estate Franchise
9 McDonald's
Fast Food Franchise
10 Merle Norman Cosmetics
Cosmetics Studio Franchise
The food industry is the largest in franchising (the US fast food sector employs almost 12 million people). Between work, school, family or other commitments, Americans often struggle to find free time and when there are a few spare moments to be had, few want to spend them cooking or washing dishes. Consumers prefer convenience and rather to reach into their wallets than walk into their kitchen. Convenience is one of the hottest trends in any market, but especially so when it comes to a restaurant. Because not everyone has the time or desire to dine in, takeout is a must. By that same token, home delivery is the ultimate in convenience for the work-at-home individual who is buried in paperwork, the busy mom who doesn't have time to cook or the guys at the office who are working.
Three key trends have influenced and driven the fast-food sector to change. The first is the threat of lawsuits. The second is a consumer led trend toward healthier lifestyles. Despite the recent legal attention most leading fast food chains had already begun responding to a general change in customer tastes, based on a desire to lead healthier lifestyles. Sandwich chains, such as Subway, are clearly capitalizing on the trend toward more healthy living. The chain has surpassed McDonalds’s for the number of restaurants in the United States. Interestingly, Subway is reported to have said the health benefits of eating Subway sandwiches are one reason for its growth. And the third trend is that Dr. Atkin’s and related low carbohydrate, high protein diets have influenced the fast food sector. The demand for low-carb products is strong, and that demand, has had a twofold affect on the franchise community. The big challenge for most chains is wrestling with what to offer as a low-carb substitute to the existing product range. For example, Krispy Kreme has lost a considerable amount of revenue because of the difficulty its having switching its menu over to healthier and less fattening foods.
As far as best practices are concerned in a successful franchise operation, the following are points to consider about the franchisor, your personal needs, and market viability before you make a final decision. It is imperative that you analyze and evaluate such things as franchise advertising, years of operation, and franchise profits. Information contained in the disclosure statement provides a basis for thoroughly analyzing the potential for a franchise. You should consider things like the experience of management and directors of the franchisor as well as the number of franchises in operation. This will provide some measure of stability and experience of the franchisor. You should look at franchise profits from the certified financial statement provided by the franchisor. You should also find out the number of franchises no longer in operation, year’s franchisor has been in operation, type and amount of training, assistance franchisor provides in financing, site location assistance, planning and constructing a building, reputation among franchisees, projected operating losses, and potential profits. The following are points to consider about personal needs; equity requirements, interest and enthusiasm, and business skills. The following are points to consider about market viability; community fit, location availability, longevity of product/service, population stability, competition, price, advertising, advertising campaign effectiveness, and cooperative advertising. The previous points are merely guidelines and do not ensure a successful franchise operation.
2. Franchise Programs for franchisees (Best Practices).
For franchising operations, there are several models a franchisor may choose to follow when fist starting up or entering a new market. Based upon the economic situations, cultural barriers, legal restrictions, and costs associated with entering a new market, the most effective model can but utilized. Franchise models include direct franchising, master franchising, area development, joint venture, and having area representative. The section below outlines the basic best practices for each model as well as the benefits and downfalls of each.
Direct Franchising
This franchising model is most frequently used in domestic markets where the franchisor forms contracts with individual franchisees. These franchisees are generally single unit business found in locations that match the franchisors target market. By employing this system the franchisor is able to retain the most control over their franchisees when compared to the alternative models. Additionally, these single-unit franchisees are characterized by their smaller size and lack of sophistication.
Benefits
• Eliminates the need for a middle man which can result in higher royalties and revenue streams
• Domestically this method can be very effective without having to deal with many of the barriers associated with targeting international audiences
• Can test a foreign or new market before pursuing growth through another franchise model
• Good use for businesses that are not technical and require little training
Disadvantages
• Can slow the growth rate of the company resulting from the need to negotiate individuals contracts
• Requires greater level of support from the franchisor due to the low levels of sophistication
• When entering international markets the franchisor must build contacts, purchase advices concerning the local market, as well as establish costly distribution networks
• Franchisor provides all training, advertising, and promotional materials
• In some situations the franchisor may be forced to open a local office
Master Franchising
This most common form of franchising eliminates many of the costly characteristics associated with the direct franchising model. A franchisor utilizing this model will form an agreement with a master franchisee. These franchisees then gain the ability to offer sub-franchisee units within a designated territory. It some instances exclusivity rights may be given to a master franchisee while alternatively master franchisees may also compete within the same territories. In addition to gaining the right to offer sub-franchisees, the master franchisor must take responsibility for developing new distribution network and training programs within their territories.
Benefits
• Cost savings associated limited capital investment and resource delegation
• Gain marketing advantage through the master franchisees local contacts and knowledge
• Avoids legal complications with local laws
• Allows the franchisor to target and expand into large territories simultaneously
Disadvantages
• Franchising success is based upon the “the abilities and resources of the master franchisee”
• May be difficult to find an appropriately experienced master franchisee
• Loss of royalties and revenue to the master franchisee
• Loss of a significant amount of control in directing individual franchisee units
Notes:
In order for this model to be successful the franchisor must incorporate the proper standards, goals, and performance measurements into the contract with the master franchisee. This will ensure the master franchisees performance in the territory, meets the expectations and goals of the franchisor. In many cases, master franchisors are required to directly own franchise units to help familiarize them selves with the business.
Area Development
This franchise model is essentially an extension of the direct franchising method with the inclusion of the franchisees ability to operate multiple units within a given territory. The success of this type of arrangement relies on the quality and ability of the franchisee, very similar in nature to that of the master franchisee arrangement. To help substantiate the quality and ability of a possible franchisee, they may be given a small initial territory which later can be expanded depending on the franchisee’s performance. The costs associated with limiting a franchisee’s initial territories are seen as acceptable to help reduce the risk of investing with an untested entity. In smaller territories the benefits and disadvantages of this type of arrangement are very similar to that of direct franchising; however, in larger territories the franchisor may realize many additional benefits.
Benefits
• Lower initial capital investment
• Lowered administrative costs in areas where franchisees operate multiple units
• Minimized need for training and monitoring of individual units
• Less direct franchise interaction is required
• Larger revenue stream when compare to alternative models
• Retains greatest amount of control of franchisee performance, process, promotions, etc.
Disadvantages
• The success of the territory relies upon the franchisee
• Higher initial investment when initially designating smaller territories
Joint Venture
The joint venture model provides an alternative method when franchisors may wish to open new units by sharing ownership with a local operating entity or partner. This model shares the same primary advantages and disadvantages of either the direct franchising or area development systems. By choosing this model franchisors may be looking to offset some of the risk associated with solely owning a franchising unit.
Benefits
• Partners may have local knowledge and expertise
• Can gain tax and business advantages where locals are protected by legalities
(tariffs)
• Provides additional sources of capital investment
• Retains greater control of operating entities
Disadvantages
• Additional responsibilities concerning the distribution network
• May be required to administer additional training programs
Notes:
In this relationship the franchisor is operating on a much more equal ground with the franchisee. The franchisor in most cases retains more control of the system while also providing the bulk of the financing. In reconciliation, the franchisee is expected to provide the local expertise to ensure the franchise units profitability and success.
Area Representative
This final model allows franchisors to extend a local entity the rights to market, train, and service franchisees in the stead of the franchisor. The local entity acts rather as an agency than an actual franchising unit and can avoid directing applying for franchising rights. However, this model is not extremely effective due to the fact that the franchisor must still directly interact with the franchisees. This model should be viewed as an opportunity to advertise and market the specific franchise or business to potential franchisees, not as an alternative to other franchising systems.
3. Nature of operational & strategic issues in working relationships between franchisor and franchisees, as well as implementation of franchisor polices.
While the various aspects of each individual relationship between the franchisee and the franchisor vary depending on the situation there are many stages and obligations that each party experiences. In general there are six stages of the franchise relationship that define the nature of the franchisee-franchisor relationship. In addition to the six emotional stages there are also many polices that the franchisor imposes on the franchisee. These two aspects of the relationship define the success or failure of a successful franchise.
Initially the franchisee is very excited about their new venture and is going to have great aspirations for his or her individual chain. During the Glee Stage the franchisee has paid the franchisor for “but merely for the privilege of obtaining the franchise and the associated rights, and for the right to obtain the franchisor's know-how to enable the franchisee to operate that business in the most profitable fashion;” During the baby stages of the business everything usually runs according to plan and each party is happy with the situation. The franchisee is following the outlined policies and the franchisor is providing everything that was promised.
As the profitability and potential of the business starts to become realized the franchisee enters what is known as the Fee Stage . This was when the franchisee may start to become frustrated by the continual fees associated with being a franchisee. Even though the franchisee fully understood that paying royalties, advertising fees and other misc. franchise fees was apart of the agreement this still may turn into a frustration for the franchisee. While at times the franchisor may give the franchisee a break when they realize they are a successful business many times this does not happen and the franchisee may enter the next stage.
When the franchisee feels as they have been a total success due to their own doing they may feel cheated by the franchisor. Questioning why they are following the strict guidelines and paying the high fees that the franchisor requires can become mentally taxing on a business owner. “As the franchisee moves into the Me Stage he or she will typically be thinking that their success is due purely to their own hard work and effort.” As part of the program the franchisee must typically pay a continuing royalty, conduct the business along the strict compliance guidelines that the franchisor has set forward, use the franchisors trademark, ad here to the standard booking keeping practices set forth, go through a training program, not divulge any franchisor related information, and comply with employee hiring programs .
Having the numerous restrictions typically leads a business owner to want to break out the mold and try something new that may potentially prove to be more profitable in any given market. While initially the franchisee is typically dependent on the franchisor after the franchisee starts to fall into a mold they may form ideas that may turn out to be more beneficial to their business if they had the chance to implement them. Unfortunately since franchisees simply do not have this freedom they fall into what is known as the Free Stage . This can lead to many different avenues that the franchisee may take but it can sometimes have a negative influence on the business. Since there are so many restrictions placed on the franchisee at times it does not form a healthy business model. If the business owner does not have the opportunity to acclimate to their specific situation it can lead to their demise. If a franchisor’s business model does not work in any given market for example “an incompetent franchisee can easily damage the public's goodwill towards the franchisor's brand by providing inferior goods and services” .
If the franchisee simply disagrees with the franchisors policies and regulations this may lead to a bunk business. Since the relationships is also usually based on a 10-15 year contact is can become a very uncomfortable situation for the franchisee. If they take a step towards understanding why the franchisor sets their standards that they must adhere to then they move on to the next phase. Understanding that the franchisor is providing a proven business model that has made a lot of money is an important aspect for the franchisee to understand. The See Stage is when the franchisee and franchisor understand that each other points of view and typically concede to help each other become more successful.
If the franchisee has made it this far they enter the We Stage. Working has a franchisee-franchisor team is a successful model to ensure a profitable endeavor. At this point in the relationship each party fully understands the ramifications of their relationship. The franchisee follows the guidelines to the point and the franchisor has provided what was expected each step of the way.
While the expectations from each party are difficult to overcome in many situations having a strong franchisee franchisor relationship will lead to a successful business as almost all franchises are based off of successful business models. Below is a table that outlines many of the policies that are required from both parties.
The franchisor provides the following: The franchisee agrees to do the following:
• grants a license to use and display proprietary marks;
• provides a marketing plan;
• grants the right to utilize all of its know-how related to operation of the franchise;
• provides a manual that details operational systems and procedures;
• grants the right to operate the franchise system for a fixed period of time; and
• furnishes specifications, standards, or duties for:
o accounting and reporting procedures;
o advertising;
o personnel requirements;
o construction and design;
o site selection;
o furniture;
o fixtures and equipment;
o product or service; and
o maintenance. • pay the franchisor an initial franchisee fee, not for any product, service or specific assistance, but merely for the privilege of obtaining the franchise and the associated rights, and for the right to obtain the franchisor's know-how to enable the franchisee to operate that business in the most profitable fashion;
• pay the franchisor a continuing royalty in return for the franchisor's continuing assistance and for the on-going privilege of using the franchisor's know-how, systems and methods;
• at all times conduct the franchised business in strict compliance with the franchisor's standards, procedures, policies and specifications, and to adhere to all such requirements throughout the life of the franchise relationship;
• use the franchisor's name, trademark and service mark;
• adhere to the franchisor's standard bookkeeping specifications and to submit to the franchisor required reports;
• undergo and successfully complete the franchisor's training program;
• not divulge to a third party any confidential information, knowledge or know-how conveyed to the franchisee by the franchisor;
• purchase all required products, supplies, and materials only from suppliers designated or approved in writing by the franchisor, or from the franchisor itself;
• not relocate the franchise without first informing the franchisor and, perhaps, procuring the franchisor's approval.;
• comply with all employee hiring and training requirements;
• consent to inspections by franchisor to determine compliance with franchisor's policies and procedures; and
• discontinue, upon termination or expiration of the franchise, use of the franchisor's name, trademark and service mark; cease operating or doing business under any name or in any manner which might cause the public to believe that a franchise relationship with the franchisor still exists; and immediately and forever cease using, in any manner, franchisor's trade secrets, procedures, techniques, systems, standards, specifications, and services.
Table Source:
http://www.wdfi.org/fi/securities/fr...e/promises.htm
4. Survey of legal issues/suits and their outcomes and the related franchising laws.
In many instances there can be abuse between the franchisee and the franchisor that can lead to the dissatisfaction of either party. There are a number of ways a franchisee can be abused by the franchisor since the franchisee obviously does not have the upper hand in the relationship. In two specific instances related to Quiznos as a franchisor there are two alleged cases of abuse.
• “The suit contends that the company forced franchisees to buy food and supplies from Quiznos or its affiliates at inflated prices while concurrently setting artificially low retail prices for its products, making the stores unprofitable for the franchisees.”
• “In addition, the franchisees allege that Quiznos unlawfully participated in a scheme to sell the franchises by omitting or otherwise misrepresenting key facts about Quiznos' business operations in an effort to induce potential franchisees to buy a franchise.”
Unfortunately along with most franchise related claims these lawsuits typically fall under the legal category of the ‘Racketeer Influenced and Corrupt Organizations’ (RICO) act. So while many of these claims may be somewhat valid they franchisees do not have much protect as they are brought up before a jury. This is simply because the RICO Act was passed to combat professional criminals. The main statue in the act that prevents many of these cases being presented to the court of law is that they must show “a pattern of racketeering activity - requiring proof that the claims asserted by the franchisee are similar to those claims made by other franchisees in the franchise system.” Unfortunately this is incredibly difficult and is the Achilles heel of almost all franchisee related cases.
It is important to note that these issues experienced between Quiznos and their franchisees exist in many other franchisor-franchisee relationships. For instance the first claim states that Quiznos inflates products they are selling to their franchisees increasing their profits while the franchisees struggle to break even. This is one of the most common issues found when dealing with franchisees as the relationships restrict the franchisees as to what they can buy and who they can buy from. In the case of Dominos, restrictions may come in the form of a payment system that they are required to purchase. The point is that the franchisor chooses the products and services that the franchisees must ultimately purchase and utilize. However, due to the unique characteristics of each franchisee, the chosen products or services may not in fact serve the best interests of the single or multi franchise group. It is therefore expected, when issues and discrepancies between franchisor and franchisees concerning product purchases arise. Because this sort of situation can be expected, franchisors should take into account and plan for lawsuits concerning these sorts of issues prior to entering into contracts with any new franchisees.
The second issue concerning the misrepresentation of the benefits provided to a franchisee is another common issue. Although successful franchisors can come up with a convincing case concerning the profitability of a franchisee, they must still compete with other franchising businesses in the market place. Just as a company uses sales and promotional techniques to attract customers to their products, franchisors must convince franchisees to invest in their business. Since the growth of franchise businesses relies directly on the outside investment of franchisees, their case must be more compelling than that of their competitors or they will not be successful in pursuing their distribution strategy. It is understandable then, why issues concerning misrepresentation of information are such a major concern for possible franchisees. In the end the franchisors must walk a careful line when they present the benefits of operating one of their franchises. Limited persuasion and the franchisor may lose valuable franchisees, while on the other hand misconstrued data can end up costing the franchisor significant sums of money in laws suits and fines.
Bibliography
Bailey, Jennifer. "Franchise Business for Sale." Ezine @Rticles. 1 Dec. 2006 <
http://ezinearticles.com/?Franchise-...;id=210143>.
"Top Franchises: the Best Franchise Opportunities." Franchise Prospector - Entrepreneurs Guide to Franchising. 1 Dec. 2006 <
http://www.franchiseprospector.com/f...chises.php>.
"What is Franchising?, Advantages of the Franchising System." FCA. 1 Dec. 2006 <
http://www.franchise.org.au/content/?id=185>.
Floyd, Dr. Callum. "What's New?" Franchise Chat. 1 Dec. 2006 <
http://www.franchise-chat.com/resour...ts_new.htm>.
"Step 3 - Analyze and Evaluate the Disclosure Statement." BeTheBoss.Com. 1 Dec. 2006 <
http://www.betheboss.com/general.cfm?page=step3.htm>.
http://www.allbusiness.com/retail-trade/1185347-1.html
http://www.franchise.org/content.asp...&PageId=13
http://www.licenseenews.com/ethics8.html
http://www.biztimes.com/daily/2006/1...s-file-lawsuit
http://en.wikipedia.org/wiki/Franchising. Wikipedia, the free encyclopedia
http://www.wdfi.org/fi/securities/fr.../promises.htm. Duties, Obligations, Promises (Franchise), State of WI; Department of Financial Institutions.
http://www.franchise-chat.com/resour..._e_factor.htm. Six Stages of Franchise Relationships, Greg Nathan; The Franchise E-Factor.
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