Franchising

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Franchising

When an individual has the desire and drive to be an entrepreneur but lacks a strong idea for a company, franchising a proven business can be extremely rewarding. Franchising is an agreement or alliance between two organizations—the franchisor and the franchisee. The franchisor has the business model, training materials, and other materials for the business. The franchisee is the entrepreneur who agrees to operate a branch of the business while paying the franchisor various fees and royalties for the use of the business idea or model.

TYPES OF FRANCHISING

Business-format franchising exists when a franchisor allows someone to market products or services, using the business name or trademark, in return for fess and royalties. When franchising is mentioned, most people think of business-format franchising, like McDonald's, AAMCO Transmission, or Molly Maid. There is also product or trademark franchising. This is a limited franchise where a manufacturer may grant another party a license to sell goods produced by the manufacturer. This might include sale of cars through dealerships (e.g., Ford dealerships), sale of gasoline through service stations (e.g., Shell stations), and sale of soft drinks through local franchising (e.g., Coca Cola bottlers). A final type of franchising is conversion franchising. This franchising model is designed to bring formerly-independently-operating businesses together under the collective power of a national name and advertising. An example of conversion franchising is Century 21 Realtors, an affiliation of previously-established real estate agents.

FRANCHISE START-UP

Franchise fees typically include a lump-sum entrance fee and other charges for regular services, including royalties on sales, advertising fees, and marketing. In exchange for these licensing fees, the franchisor retains control over the delivery of the products and services, as well as marketing and the operational and quality standards of the franchise. The franchising company's revenue is generated through the franchisee that pays these on-going sales royalties, typically averaging 5 percent of sales. The contract, or franchise agreement, is signed by both parties and establishes the relationship between the franchisee and the franchisor. The contract also details the responsibilities and privileges of both parties.

Franchises include such popular names as H&RBlock, McDonald's, 7-Eleven, Body Shop, Pizza Hut, and Jiffy Lube. These franchise operations have well-established names, brands, and reputations. The best franchises provide a strong brand or trademark of the concept, a proven business system, extensive training and product development, along with a number of initial and on-going managerial support services. Some help the franchisee secure funding and offer benefits, including discounted supplies. Typically, the franchised business is less risky than other forms of new venture creation because the business idea has been tested and there are mutual advantages to both parties. The Service Corps of Retired Executives (SCORE), a volunteer group involved in counseling would-be entrepreneurs, reports that franchises are safer than other business formats. Franchises experience less than a 5 percent failure rate compared to an 80 percent five-year failure rate for independent businesses and a 90 percent failure rate for independent restaurants. Banks are also supportive of the franchising business model and many will offer up to 70 percent of the initial capital costs.

WHY FRANCHISE?

Franchising allows a business to rapidly expand beyond its original owners. Franchisees pursue a new business, experience the advantages of running their own business and being their own boss, and gain wealth through a proven business idea. They provide the management skills to run the business, and contribute the capital to fund the opening and on-going operations. The franchisor also benefits from the partnership and gains economy of scope advantages as more franchises are established. National or international advertising becomes possible and the franchisor can more easily expand business locations with help and capital from the franchisee. The franchisee helps to build brand awareness through market proliferation. The franchisee has a unique opportunity to run a business with a greater chance of success. There is experience from the franchisor for starting the business and many of the initial

mistakes have already been made, learned from, and corrected.

Franchisees create their own jobs and often create a number of new jobs in operation areas as they hire employees. As the franchise becomes successful, the franchisee may choose to open other stores to create even more wealth. Franchising is popular in the United States and abroad. Franchising is at a mature level in the United States, Europe, and Australia, while Asia, South America, Mexico, and Central America report rapid growth. China, too, is experiencing franchise business growth.

RESEARCHING FRANCHISES

It is important to carefully perform initial due diligence and to thoroughly examine any franchise offering. A Federal Trade Commission (FTC) rule was created and adopted in the mid-1970s that requires franchisors to disclose to franchisees very specific information, including information about themselves, the business, and the terms of the relationship. This document is the Uniform Franchise Offering Circular (UFOC) and provides important legal information about the franchisor and its franchising program.

When deciding on a franchise, it is important to first ascertain personal goals for business ownership and to examine the franchise offering to find a compatible opportunity. While there are no guarantees in franchising, a well-developed operating plan is often an advantage. An entrepreneur should consider a number of issues regarding a possible franchise. For example, is the franchise in only one local market, or does it have a regional, national, or international presence? Lower-risk franchises have a national or global presence and benefit from the size advantage. The franchisee will also want to consider if most of the existing outlets are profitable, and whether the franchise is the market leader with the largest market share among competitors. The entrepreneur should evaluate the presence of a national marketing and purchasing program. The lower-risk franchises also have documented training, manuals, field support, marketing and promotion, standardized operating procedures, and on-going feedback channels between the franchisor and the franchisees. The terms of the license agreement vary from less than ten years to more than twenty years and some have automatic renewal. Capital requirements for obtaining the franchise also vary. Other factors to consider include territory limitations, failure rates, and any relevant litigation history against the franchise. Investment requirements should also be clearly disclosed.

It is often a good idea to interview existing franchise owners to determine if start-up costs and processes are realistic. Legal counsel may be required to negotiate and interpret the franchise agreement contract. SCORE also recommends that potential franchising clients plan and analyze their options. This planning and analysis should include researching Chamber of Commerce and Better Business Bureau records for a given franchise. SCORE agrees that the most important step for choosing a franchise is also considering the entrepreneur's interests, skill set, and experience. It is easier to evaluate an established franchise than a new franchise. There may be few, if any, owners with whom to speak about the franchise. It is important that the new franchise have strong franchisee support and a proven business system. The business strategy should also be examined carefully.

FRANCHISING AND THE ECONOMY

In 2005 more than 11 million people were employed by franchised businesses. This group of approximately 3,000 franchised names—ranging from automobile dealers to food operations—generates nearly 5 percent of gross income in the United States. Giving nearly 8 percent of able-bodied workers a job, curbing unemployment during tough economic times, and creating wealth where there previously was none, these businesses are clearly important to the economy. The IFA reports that for franchising the start-up costs can range from less than $5,000 to more than $1,000,000. Growth in the franchise sector is on an upward trend even during otherwise questionable economic times. For this reason, PricewaterhouseCoopers suggests the outward growth of franchises may not necessarily have an end in sight. IFA offers information on franchising, including newsletters about events and discussion forums and educational materials. It also includes information on government regulations for franchising.

In a 2004 study conducted by PricewaterhouseCoopers (for the International Franchise Association Educational Foundation) on the economic impact of franchised businesses, more than 760,000 franchised businesses exist in the United States and generate some $1.53 trillion yearly. This represented 9.5 percent of the private sector economic output in the United States. These franchises generate one out of every seven jobs in America.

The IFA established a Franchise Index to track the market performance of the top fifty U.S. public franchisors. The index has increased steadily since January 2000, compared to a drop of 20.1 percent in the Standard and Poors (S&P) 500 Index over the same period. Interestingly, the franchise index has grown during tough economic times. Thus, franchising is a major economic force with a significant impact on the nation's economy.

The franchising business model attracts a number of qualified individuals, particularly in times of recession or slow business growth. Individuals are attracted to franchising and the opportunity to create their own jobs. While franchising is not a get-rich-quick proposition, many do have attractive returns on investment. Most analysts agree a three- to five-year period of hard work and dedication is

needed before the franchised business is profitable. Over the years, more individuals are touting the advantages and value of franchising. These franchises pick up on key business trends that affect—and are affected by—social and demographic changes and changing lifestyles. Healthy fast food, at-home care for the elderly, pet care, Internet education, personal services, automotive services, green living, and travel services are all industries that have grown because of changing attitudes. Many of these industries offer exclusive territories in a given market.

Additional advice on finding and comparing franchising opportunities is available on the franchise-broker Web sites (e.g., www.FranNet.com, www.FranChoice.com, and www.francorpconnect.com). FranNet.com is a franchise-broker Web site representing franchise consultants. Some potential franchisees prefer using a broker to find a franchise.

While there are many advantages to franchising, there are some disadvantages. Once a business grows beyond a certain size, it could make more money if it were wholly owned, since a percentage of the profit goes to the franchisor. Even if a franchise is capable of making large profits, the franchise manager must deal with the franchisor as well as business operations. The franchisee must be committed to the idea and business model. The franchisee must also be supportive of the franchisor's system, as the key to a successful franchise operation is consistency. Customers expect a similar product or service from all branches of a franchise. Entrepreneurs who do not want to follow the predetermined structure and operating procedures of a franchise may not be successful.

The franchising arrangement is a balance of entrepreneurial spirit, standard business procedures, and following instructions. The venture, like other start-ups, will require a serious time and energy commitment. It can be difficult for a franchisor to find a franchisee with drive, energy, and the experience necessary to run a business according to franchise guidelines. A franchise also needs an appropriate location. Aside from who runs the franchise, where it is located is of the highest importance. A franchise location must be researched thoroughly to determine its growth potential.

The combination of franchisor guidance, franchisee know-how and determination, reasonable capital investment, and well-researched location will almost always result in successful franchise operation regardless of economic climate, season, or trends. A strong business model coupled with a determined business owner are the keys to success in franchising.

SEE ALSO Business Plan; Due Diligence; Entrepreneurship; Strategy Formulation