A specific business model : the franchise

Franchising is based on a marketing concept, in which one company, the franchisor, licences its know-how, procedures, intellectual property, and the use of its whole business model, including its brand and rights to sell its branded products and services to another company, the franchisee. The franchisee pays certain fees and agrees to comply with certain obligations, defined in a franchise agreement.

For the franchisor, the use of a franchise system is an alternative business growth strategy, compared to expansion through newly established outlets (chain stores) owned by the company. Adopting a franchise system strategy for the sale and distribution of goods and services minimizes the franchisor's capital investment and liability risk, by involving the franchisee company’s capital, and legal obligations.

Franchising is not an equal business partnership, the franchisor usually has some legal advantages over the franchisee. But under the circumstances of transparency, financial means and proper market research, franchising can be a vehicle of success for both franchisor and franchisee.

Franchising is often used as a mode of entering a foreign market.

The history of franchising

The boom in franchising started after World War II, although early history goes back to 1886, when an enterprising druggist named John S. Pemberton in the USA concocted a beverage comprising sugar, molasses, spices, and cocaine. Pemberton licensed selected people to bottle and sell the drink, which was an early version of what is now

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known as Coca-Cola. Pemberton developed a bottling procedure with lower unit costs for the bottlers, and gave this know-how to his partners. His was one of the earliest—

and most successful—franchising operations in the United States.

In the early 20^th century, as the United States shifted from an agricultural to an industrial economy, manufacturers licensed individuals to sell automobiles, trucks, gasoline, beverages, and a variety of other products, although the franchisees did little more than selling the products. The sharing of responsibility typical for contemporary franchising did not exist, and franchising was not a growth industry in the United States.

Perhaps the father of modern franchising is Louis K. Liggett, who, in 1902, invited a group of druggists to join a ’drug cooperative’. About 40 druggists pooled $4,000 of their own money and set up their own manufacturing company, adopting the name

’Rexall’, as a private label for marketing their products. The key to success was the lower unit production costs, which allowed lower prices. Sales soared, and Rexall became a franchisor. The chain's success set a pattern for other franchisors to follow.

In the 1960s and 1970s people with more entrepreneurial spirit began to discover the attractiveness of franchising, but there were serious pitfalls for investors, which almost ended the practice before it became truly popular.

Fees, contract agreement, and obligations of the partners

There are three main components of the payment made to a franchisor:

- a royalty for the trademark,

- reimbursement for the training and advisory services given to the franchisee, - a percentage of the individual business unit's sales.

A franchise usually lasts for a fixed time period and serves a specific geographical area.

One franchisee may manage several such locations. Agreements typically last from five to thirty years, with premature cancellation of the contract often bearing serious consequences for franchisees. No laws require an estimate of franchisee profitability, therefore, franchisor fees are typically based on "gross revenue from sales" and not on profits realized. Various tangibles and intangibles such as national or international advertising, training, and other support services are commonly made available by the franchisor.

Obligations of the parties

Franchisor and franchisee have their specific interests to protect. It is the major interest of the franchisor to protect the trademark, the know-how and this determines the obligations of the franchisee.

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The franchisee is obligated to carry out the services for which the trademark has been made prominent or famous, with a great deal of standardization required. The place of service has to bear the franchisor's signs, logos and trademark in a prominent place.

The uniforms worn by the staff of the franchisee have to be of a specified design and colour. The service has to be in accordance with the pattern applied by the franchisor in the successful franchise operations. Thus, franchisees are not in full control of the business, as they would be in retailing. However, as the specific service requires the purchase of specific equipment, the franchisee gets assistance in this by the franchisor.

When starting the franchise, the franchisee usually receives an initial training from the franchisor, the fee of which is covered by the initial franchise fee.

The franchisee must carefully negotiate the license and must develop a marketing or business plan with the franchisor. The start-up costs and working capital must be known, and assurance must be provided that additional licensees will not crowd the

"territory" if the franchise is worked according to the plan. Franchise agreements carry no guarantees and the franchisee has little or no recourse to legal intervention in the event of a dispute.Franchise contracts tend to be unilateral and favourable for the franchisor, and franchisees are required to acknowledge, in effect, that they are buying the franchise knowing that there is risk, and that they have not been promised success or profits by the franchisor.

Advantages and disadvantages

Franchising offers a possibility to the franchisor to access venture capital without the need to give up control over the operations of the chain. After the brand and formula are properly designed, franchisors, by selling franchises, are able to expand rapidly across countries using the resources of their franchisees while reducing their own risk.

Although this way franchisors pass most of the risk to their franchisees, failure rates are much lower for franchise businesses than for independent business startups.

The primary advantage for a firm looking to expand into new areas and foreign markets is, that the firm does not have to bear the development cost and risks of opening a foreign market on its own. It is the franchisee’s responsibility to handle these costs and risks, and build a profitable operation as quickly as possible.

A primary disadvantage to franchising is quality control, as distance can make it difficult to detect whether the franchises are of poor or good quality. The franchisor wants its own brand name to convey a message to consumers about the quality and consistency of the firm's product, requiring the same consumer experience and quality regardless

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of location or franchise status. A customer who had a bad experience at one franchise may assume that same experience can be expected at other locations.

Advantages for the franchisee are: the access to an already successful trademark and marketing strategy, together with brand name, logo, the looks of the franchise, therefore the franchisee will have to introduce an internationally well-known name to a local market. This may require much less capital than to start up a completely new business.

A disadvantage for the franchisee is, that there is little control over the marketing and product development, as there are typically set out in the franchise contract. The franchisee looses the freedom of an independent entrepreneur, and the success of the franchise depends on the bad business decisions of the franchisor, just as on bad performance of other franchisees.

Some of the most popular international franchise brands are:

- McDonald’s

- KFC

- Burger King - Pizza Hut - 7 Eleven

- Marriott International - RE/MAX

- Dunkin’Donuts

- InterContinental Hotels and Resorts

- SUBWAY