Franchising is the practice of using another firm's successful business model. The word 'franchise' is of Anglo-French derivation - from franc- meaning free, the franchise is an alternative to building 'chain stores' to distribute goods and avoid investment and liability over a chain. The franchisor's success is the success of the franchisees. The franchisee is said to have a greater incentive than a direct employee because he or she has a direct stake in the business.
However, except in the US, and now in China (2007) where there are explicit Federal (and in the US, State) laws covering franchise, most of the world recognizes 'franchise' but rarely makes legal provisions for it. Only Australia, various provinces within Canada, France and Brazil have significant Disclosure laws but Brazil regulates franchises more closely.
Where there is no specific law, franchise is considered a distribution system, whose laws apply, with the trademark (of the franchise system) covered by specific covenants.
- Businesses for which Franchising works:-
- Businesses with good track record of profitability
- Businesses which are easily duplicated.
As practiced in retailing, franchising offers franchisees the advantage of starting up quickly based on a proven trademark, and the tooling and infrastructure as opposed to developing them.
Although there are franchises around products – Chanel and other cosmetics, to name the prominent – by and large, the franchises revolve around service firms. At the sub-$80,000 level, they are, by far, the largest number of franchises. These allow a business, combined with family time and a location not far from home. Some franchises are available for a few thousand dollars.
The following US-listing tabulates the early 2010 ranking of major franchises along with the number of sub-franchisees (or partners) from data available for 2004. It will also be seen from the names of the franchise that the US is a leader in franchising innovations, a position it has held since the 1930s when it took the major form of fast-food restaurants, food inns and, slightly later, the motels during the first depression. Franchising is a business model used in more than 70 industries that generates more than $1 trillion in U.S. sales annually (2001 study).
The midi-franchises like restaurants, gasoline stations, trucking stations which involve substantial investment and require all the attention of a business. There are also the large franchises - hotels, spas, hospitals, etc. - which are discussed further in Technological Alliances. Two important payments are made to a franchisor:
- a royalty for the trade-mark and
- reimbursement for the training and advisory services given to the franchisee.
These two fees may be combined in a single 'management' fee. A fee for "Disclosure" is separate and is always a "front-end fee". A franchise usually lasts for a fixed time period (broken down into shorter periods, which each require renewal), and serves a specific "territory" or area surrounding its location. One franchisee may manage several such locations. Agreements typically last from five to thirty years, with premature cancellations or terminations of most contracts bearing serious consequences for franchisees. A franchise is merely a temporary business investment, involving renting or leasing an opportunity, not buying a business for the purpose of ownership. It is classified as a wasting asset due to the finite term of the license. A franchise can be exclusive, non-exclusive or 'sole and exclusive'.
Although franchisor revenues and profit may be listed in a franchise disclosure document (FDD), no laws require the estimate of franchisee profitability, which depends on how intensively the franchisee 'works' the franchise. Therefore, franchisor fees are always 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.
Franchise brokers help franchisors find appropriate franchisees. There are also main 'master franchisors' who obtain the rights to sub-franchise in a territory.
According to the International Franchise Association approximately 4% of all businesses in the United States are franchisee-worked.
It should be recognized that franchising is one of the only means available to access venture investment capital without the need to give up control of the operation of the chain and build a distribution system for their services. After the brand and formula are carefully designed, and properly executed, franchisors are able to sell franchises and expand rapidly across countries and continents using the capital and resources of their 'franchisees' while reducing risk.
Franchisor rules imposed by the franchising authority are usually very strict and important in the US and most countries need to study them to help the small or start-up franchisee in their countries to protect them. Besides the trademark, there are proprietary service marks which may be copyright - and corresponding regulations.
Obligations of the parties
Each party to a franchise has several interests to protect. The franchisor is most involved in securing protection for his trademark, controlling the business concept and securing his know-how. This requires the franchisee to carry out the services for which the trademark has been made prominent or famous. There is a great deal of standardization proposed. The place of service has to carry 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 particular shade and colour. The service has to be in accordance to the pattern followed by the franchisor in his successful operations. Thus, for the franchisee he is not in full control of the business as he would be in retailing.
A service can be successful by buying equipment and supplies from the franchisor or those recommended by the franchisor if they are not over-priced. A coffee brew, for example, can be readily identified by the trademark when its raw materials come from a particular supplier. If the franchisor requires purchase from his stores, it may come under anti-trust legislation or equivalent laws of other countries. So too the purchase of uniforms of personnel, signs, etc. But it also applies to sites of franchise if they are owned or controlled by the franchisor.
The franchisee must carefully negotiate the license. They, along with the franchisor must develop a marketing plan or business plan. The fees must be fully disclosed and there should not be any hidden fees. The start-up and costs and working capital must be known before taking the license. There must be assurance that additional licensees not crowd the "territory" if the franchise is worked to plan. The franchisee must be seen as an independent merchant. He must be protected by the franchisor from any trademark infringement by third-parties. A franchise attorney is required to assist the franchisee during negotiations.
Most often the training period - the costs of which are in great part covered by the initial fee - is too short to operate complicated equipment and the franchisee has to learn on his own from Manuals. The training period must be adequate but in low-cost franchises it would be considered expensive. Many franchisors have set up corporate universities to train staff online. This is in addition to literature and sales documents and reach by email.
Also, franchise agreements carry no guarantees or warranties and the franchisee has little or no recourse to legal intervention in the event of a dispute. Franchise contracts tend to be unilateral contracts in favor of the franchisor; they are generally protected from lawsuits from their franchisee because of the non-negotiable contracts that require franchisees 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. Contracts are renewable at their sole option. Most franchisors make franchisees sign agreements waiving their rights under federal and state law, and in some cases allowing the franchisor to choose where and under what law any dispute would be litigated.