Chapter 8 Franchising – a growth strategy Chapter 8 Franchising – a growth strategy What is Franchising and how does it work? When to Franchise? Selecting and developing Effective Franchising? Advantages and disadvantages of Franchising as a growth strategy Buying a Franchise

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 an initial franchise fee and an ongoing royalty. Franchising is a business growth that allows a business to get its products or services to market through the effort of business partners called franchisees. Franchising as a business growth strategy increased its popularity in the whole world. Example: In the USA 1/3 from the retail is conducted by companies created through franchising. However many companies created through franchising have reached insolvency because they worked in industries with strong competition.

Many service companies and retail companies consider franchising as being an attractive method which facilitates business growth. Some industries such as restaurants, hotels, car service are dominated by companies founded by franchising. In other branches, although it began to manifest, franchising is less common: internet providers, furniture restoration, service for mobile phones. In some cases, franchising is not suitable. Example: new technologies are not introduced through franchising, especially when the technology is being kept secret or is complex. This is because the franchising requires the spreading of knowledge from the franchisor to the franchisee, issue that involves many people. The invention of new technologies usually involve a small number of people in order to keep the information secret.

There are different types of franchise systems:  Product and trademark franchise is 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. Example: General Motors has established a network of dealers that sell GM cars and use the GM trademark in their advertising; British Petroleum (BP) has established a network of franchisee – owned gasoline stations to distribute BP gasoline; other examples include agricultural machinery dealers, soft – drink bottlers, and beer distributorships. This type of franchising offers the franchisee the possibility to operate autonomously because the franchisor is mainly concerned with preserving the identity of its products and only secondly with monitoring the activity of the franchisee. In this type of franchising, franchisors get most of its revenue from selling its products to dealers or distributors.

 Business format franchise is by far the more popular approach to franchising and is more commonly used by entrepreneurial firms. 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. Example: fast-food restaurants, convenience stores, Internet Service providers, and consulting services. This type of franchising can become very rigid and demanding. For example fast-food restaurants such as McDonald’s teach their franchisees every detail of how to run their restaurant, from how many seconds to cook French fries to the exact words their employees should use when they greet customers. In this type of franchising franchisors obtain the majority of their revenues from their franchisees in the form of royalties and franchise fees.

Individual franchise agreement is the most common form of The franchisor-franchisee relationship can take one of the following forms of a franchise agreement: Individual franchise agreement is the most common form of franchise agreement and 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 is similar to area franchise agreement, with one major difference. A master franchisee 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.

When to Franchise? The alternatives of a business that aims to grow are: To built company-owned outlets. This choice presents a company with the challenge of raising the money to fund its expansion, which is not easy for a start-up venture. Franchising is especially attractive to young firms in that the majority of the money needed for expansion comes from the franchisees. Franchising is appropriate when a firm has a strong or potentially strong trademark, a well-designed business method, and a desire to grow.

Example: Franchising works very good for fast-food restaurants but would not work for Wal-Mart. Fast-food restaurants (McDonald’s, Burger King) have a limited menu, and policies and procedures can be written to cover almost any contingency. Wal-Mart stores are much larger, more expensive to build, and more complex to run. It would be nearly impossible for Wal-Mart to find an adequate number of qualified people who would have the financial capital and expertise to open a Wal-Mart store of their own.

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. The ideal franchisee is someone who has good ideas and suggestions but is willing to work within the franchise system’s rules. Franchisees must be team players. When the franchisor selects its franchisees he must check for the following qualities:  the ability to follow instructions  the ability to operate with minimal supervision  team oriented  experience in the industry in which the franchise competes  adequate financial resources  ability to make suggestions even if they are not adopted

After selecting the franchisees, the franchisor has to develop their potential through the following ways:  provide mentoring/training  keep operating manuals up to date  keep product, services, and business up to date  solicit input from franchisees to reinforce their importance in the larger system  maintain the franchise system’s integrity

Advantages and disadvantages of Franchising as a growth strategy The advantages of franchising as a means of business expansion are: Rapid, low-cost market expansion. Because franchisees provide most of the cost of expansion , the franchisor can expand the size of its business fairly rapidly. Income from franchise fees and royalties. Franchisee motivation. Because franchisees put their personal capital at risk, they are highly motivated to make their franchise outlets successful. Access to ideas and suggestions. Franchisees represent a source of intellectual capital and often make suggestions to their franchisors.

Cost savings. Franchisees share many of the franchisor’s expenses, such as cost of regional and national advertising. Increased buying power. Franchisees provide franchisors increased buying power by enlarging the size of their business systems, allowing them to purchase larger quantities of products and services when buying those items. Using the franchising as a form of business growth has also its disadvantages:  Profit sharing. By selling franchises instead of operating company-owned stores, franchisors share the profits derived from their proprietary products or services with their franchisees.  Loss of control. It is typically more difficult for a franchisor to control its franchisees than it is for a company to control its employees.

 Friction with franchisees  Friction with franchisees. Friction can develop over issues such as the payment of fees, hours of operation, surprise inspections.  Managing growth. Franchisors that are in growing industries often grow quickly. Rapid growth can be sometimes difficult to manage. A franchisor provides each of its franchisees a number of services, such as a site selection and employee training. If a franchise system is growing rapidly, the franchisor will have to continually add personnel to its own stuff.  Differences in required business skills. The business skills that made a franchisor successful in his or her original business are typically not the same skills needed to manage a franchise system. (an effective owner/manager of a business is not necessarily an effective manager of a franchise system).

Buying a Franchise Franchising can be also looked at from the franchisee’s perspective. Purchasing a franchise should be weighted against the alternative of buying an existing business or launching an entrepreneurial venture from scratch. Answering the following questions will help determine whether franchising is a good fit for people thinking about starting their own business:  Are you willing to take orders? Example: Fast-food chains are very strict in terms of their restaurants’ appearance and how the units’ food is prepared. Franchising is typically not a good fit for people who like to experiment with their own ideas or are independently minded.

 Are you willing to be part of a franchise “system” rather than an independent business person? Example: As a franchisee you may be required to pay into an advertising fund that covers the costs of advertising aimed at regional or national markets rather than the market for your individual outlet.  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?  How willing are you to put your money at risk?

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 companies like McDonald’s typically provide the land and buildings for each franchisee’s unit. Other organizations require their franchisees to purchase the land, buildings, and equipment needed to run their franchise outlet. Starting a business through franchising involves following costs: Initial franchise fee, which varies depending on the franchisor’s reputation. (for example Burger King has a initial franchise fee of $ 40,000, CD Warehouse $ 20, 000, WSI Internet $ 34,700, Subway $ 34,700) Capital requirements. These costs very, depending on the franchisor and includes the cost of buying real estate, the cost of constructing a building, the purchase of initial inventory, and the cost of obtaining a business license.

Continuing royal payment. A franchisee pays a royalty based on a percentage of weekly or monthly gross income. A franchisee may have to pay a monthly royalty even if the business is loosing money. Royalty fees are usually 5% of gross income. Advertising fees. Franchisees are often required to pay into a national or regional advertising fund, even if the advertisements are directed at goal other than promoting the franchisor’s product or service. Advertising fees are typically less than 3% of gross income. Other fees, including training additional staff, providing management expertise etc.

Finding a Franchise There are thousands of franchise opportunities available to prospective franchisees, so that it is important to determine the type of franchise that is the best fit. Questions to ask a Franchisor: What is the background of the company and its performance record? What is the company’s current financial status? What other franchisees exist in my trade area? If at some point I decide to exit the franchise relationship, how does the exit process work? Describe how you train and mentor your franchisees.

Questions to ask current Franchisees: How much does your franchise gross per year? Are the financial projections of revenues, expenses, and profits that the franchisor provides me accurate in your judgment? Does the franchisor give you enough assistance in operating your business? How many hour, on average, do you work? How often do you get a vacation? If you had to do it all over again, would you purchase a franchise in this system? Why or why not?

Buying a franchise has following advantages: A proven product or service within an established market, which substantially reduces the risk of bankruptcy. An established trademark or business system. The purchase of a franchise with an established trademark provides franchisees with considerable market power (for example, McDonald’s franchise has a trademark with proven market power). Franchisor’s training, technical expertise, and managerial experience (for example the training offered by the franchisor takes place at the firms’ headquarters or at the placement of each franchisee) Potential growth. If a franchisee is successful in its original location, the franchisee is often provided the opportunity to buy additional franchises from the same franchisor. For many franchisees, this prospect offers a powerful incentive to work hard to be as successful as possible.

The disadvantages of buying a Franchise are:  Cost of the franchise. The initial cost of purchasing and setting up and setting up a franchise operation can be quite high (franchising involves costs on short and long term). Restriction on creativity. Many franchise systems are very rigid and leave little opportunity for individual franchisees to exercise their creativity. Duration and nature of commitment. For a variety of reasons, many franchise agreements are difficult to exit. Risk of fraud, misunderstanding, or lack of franchisor commitment. Problems of termination or transfer. Often, a franchisee cannot terminate his or her franchise agreement without paying the franchisor substantial monetary damages. Poor performance on the part of other franchisees. If some of the franchisees in a franchise system start performing poorly and make an ineffective impression on the public, that can affect the reputation and eventually the sales of a well-run franchise in the same system.