Franchise

What It Means

A franchise is a license allowing one party, the franchisee, to use the brand name and business processes already developed by a parent company, the franchisor. Acquiring a franchise usually involves paying a start-up fee and agreeing to pay a regular percentage of sales to the parent company. Franchises are an extremely popular way of starting a business in the United States, especially for those who want to compete in the fast-food, automotive sales and rentals, lodging, real-estate, and other retail industries. Specific corporations that engage in franchising include McDonald’s, Subway, Baskin-Robbins, Coca-Cola, Ford, Chevrolet, Toyota, Hertz, Avis, Thrifty, Holiday Inn, Howard Johnson, Days Inn, Century 21, and RE/MAX.

Franchises offer advantages and disadvantages for the entrepreneur. The use of an established brand name and/or a proven business model can significantly simplify the launching and operation of a business. This and other advantages may be outweighed, in some cases, by the sometimes-steep franchise fees that must be paid each month or year. Additionally, depending on the type of franchise and the particular company, a franchisee may have very little leeway in his or her decision-making.

When Did It Begin

Sewing-machine maker I. M. Singer and Company (later called Singer Manufacturing Company), which was started by Isaac Singer in 1851, is generally considered the first company to engage in franchising in the United States. Singer enlisted independent dealers to sell his sewing machines in the early stages of his company’s development. Though the company ultimately abandoned the franchise model for a more centralized corporate structure, other companies adapted the original franchising strategy with better results. The Coca-Cola Company, which began operating on a franchise basis in the late nineteenth century, was one of the most successful early examples, and its operations today still technically follow the franchise model. (The parent company sells the condensed syrup that is the basis of the drink to franchisee bottlers, who mix it with water and sell it to retailers.) Franchising began to assume its modern form in the early 1900s, when A&W Root Beer began establishing fast-food restaurants on a franchise basis. The Howard Johnson’s hotel chain began selling franchises in the 1930s, bringing the trend to that industry. The popularity of franchises increased with the construction of the interstate highway system in the United States in the 1950s. Travelers were particularly likely to trust a brand-name hotel or restaurant over unknown local competitors. The expansion in franchising that led to the proliferation of chain stores seen all over the United States today occurred mainly after 1965.

More Detailed Information

There are two common models for franchises in the United States today. One type, called product franchising, is less restrictive for the franchisee than the other type, business-model franchising.

In product franchising relationships a parent company gives a franchisee the right to sell its products and use its brand name and trademarks, but it does not tell the franchisee how to run his or her business. Such arrangements are common in the automotive sales industry, in which car dealerships are franchises with the rights to sell certain brands but do not have to do so according to specific directions from the manufacturers of those brands. The arrangement between Coca-Cola and its regional bottlers is also an example of product franchising. Bottlers have the right to bottle and sell Coke, but they run their business affairs largely on their own. Product franchising generates about two-thirds of all the money brought in by franchises in the United States.

Business-model franchising comes with more specific guidance from the parent company. In this type of franchising the franchisee purchases more than the rights to a brand name. The franchisor often provides assistance with the launch and the operation of the business; the parent company may decide where the franchise should be located, what the physical layout will look like, what equipment should be used, and how employees should be trained, among other features of the business. In the fast-food industry business-model franchising is the norm, and it explains why each branch of most national chains (such as McDonald’s, Wendy’s, Burger King, Subway, and KFC) looks virtually identical to all others and conducts business in such a way that you can expect the same experience from franchises whether you are in Walla Walla, Washington, Tampa, Florida, or anywhere in between. Though business-model franchises are more widespread than product franchises, accounting for three-quarters of all franchised businesses, they bring in only one-third of the revenue generated by all U.S. franchises.

Entrepreneurs gain significant advantages when they choose to buy a franchise rather than start a business from scratch. Foremost among these advantages is the head start provided by an established brand name. Whereas a new business may spend years and huge amounts of money building its brand through advertising and customer interactions, a franchisee has the privilege of selling a brand consumers already recognize and seek out. Franchisees also commonly benefit from national advertising campaigns and other promotional efforts conducted by the franchisor. Highly visible marketing of this type is not otherwise available to small business owners, who generally operate on a limited budget. Most franchise agreements also include a provision giving the franchisee rights to be the only seller of the franchisor’s brand within a certain territory. This represents an important competitive advantage in many cases.

There are potential downsides to consider before deciding to purchase a franchise, however. One of the most serious of these negative aspects is the financial arrangement between the franchisor and the franchisee. In addition to paying the start-up expenses related to opening any business (such as rent, construction, labor, and product costs), a McDonald’s franchisee as of 2007 was required to pay a fee of $45,000 for the right to operate under the brand name for a period of 20 years. Beyond this initial investment a franchisee is further obligated to pay fees amounting to 12.5 percent of all sales to the franchisor. Burger King charges a higher start-up fee ($50,000) but requires a lower percentage of sales (4.5 percent). Other franchisors may offer lower fees, but this is typically because the brand is less established. McDonald’s can charge high fees because of its enormous consumer base. In any case, a franchisee should plan on handing over a substantial portion of whatever money he or she makes to the parent company.

Additionally, the success of franchises is based on conforming to a single business model. For the entrepreneur who wants to make his or her own decisions, this might not be a fulfilling environment. While the advantages of a proven business model are significant, they may undercut the personal satisfaction some entrepreneurs seek when they go into business for themselves. Further, the obligation to conform can become a liability if the parent company does not hold up its end of the bargain. If the advertising on behalf of the brand is ineffective or if the parent company otherwise fails to maintain high standards for the brand, the individual franchisee may be locked into a struggling business model at a time when individual creativity could help avert losses.

For established companies franchising offers a way to expand a brand without undertaking all of the costs of doing so in a more centralized fashion. A company intent on owning all of its own outlets must use its own money to buy equipment and hire workers with each new branch opening. This may mean putting off profitability for several years. By contrast, a franchisor’s expenses are minimal; willing franchisees undertake much of the financial burden of expanding the brand’s reach. The result is the possibility for extremely rapid expansion. For example, it took the real-estate franchisor Century 21 only eight years (1972–80) to establish 7,400 branches. The fast-food giant McDonald’s grew to 6,200 franchises and one of the world’s most recognized brands within 25 years (1955–77), and at its fiftieth anniversary in 2004, it had more than 31,000 outlets in 119 countries.

One of the risks of being a franchisor is that a handful of inept franchisees can cause serious damage to the overall brand. For example, the standardization of fast-food restaurants leads many consumers to consider the various branches interchangeable. Health-code violations or other scandals at a few franchises can affect consumer perceptions nationwide, cutting into profits at the corporate level.

Recent Trends

Franchises spread rapidly across the United States at the end of the twentieth century. During the 1960s and 1970s franchises reached most areas of the country, and a further boom in franchises occurred in the 1980s and 1990s as a result of increased wealth, the massive marketing campaigns of franchisors, and the widespread American belief in the value of entrepreneurship. By the early twenty-first century there were more than 2,000 franchisors in the United States and more than 500,000 franchisees. The 600,000 franchises owned by these franchisees generated roughly one-third of all retail sales in the country.

There were numerous critics of franchises and their place in American culture at this time. Some critics pointed to the fact that franchises generally paid low wages, employed most workers on a part-time basis, and almost never offered benefits such as health insurance. Since franchises were such a dominant force in the economy, many believed that their labor practices harmed the employment conditions for workers in general. At the same time, the poor pay and lack of benefits meant that franchisees often found it difficult to keep good employees.

An additional criticism of franchises was that they drained money away from local economies, since such a large portion of any franchisees’ profits went to the parent company. The ability of franchises to use their established brands to fight off local competitors meant, further, that it was harder and harder for strictly local businesses to compete, increasing the amount of money leaving individual communities over time.

Finally, many ordinary citizens disliked the fact that the growing presence of franchises nationwide made American towns and cities increasingly indistinguishable from one another. During the early twenty-first century an increasing number of towns began passing regulations meant to keep out franchises and other chain stores, in an attempt to preserve community values and provide opportunities for local businesses.