Franchising (from the French franchir: vt to clear an obstacle or difficulty) refers to the method of practicing and using another persons philosophy of business. The "franchisor" authorizes the proven methods and trademarks of his business to the "franchisee" for a fee and a percentage of gross monthly sales. Various tangibles and intangibles such as national or international advertising, training, and other support services are commonly made available by the franchisor. Agreements typically last five to twenty years, with premature cancellations or terminations of most contracts bearing serious consequences for franchisees.
The term "franchising" is used to describe business systems which may or may not fall into the legal definition provided above. For example, a vending machine operator may receive a franchise for a particular kind of vending machine, including a trademark and a royalty, but no method of doing business. This is called "product franchising" or "trade name franchising".
A franchise agreement will usually specify the given territory the franchisee retains exclusive control over, as well as the extent to which the franchisee will be supported by the franchisor (e.g. training and marketing campaigns).
The franchisor typically earns royalties on the gross sales of the franchisee.In such cases, franchisees must pay royalties whether or not they are realizing profits from their franchised business.
Cancellations or terminations of franchise agreements before the completion of the contract have serious consequences for franchisees. Franchise agreement terms typically result in a loss of the sunk costs of the first-owner franchisees who build out the branded physical units and who lease the branded name, marks, and business plan from the franchisors if the franchise is canceled or terminated for any reason before the expiration of the entire term of the contract. (Item 15 of the Rule of the Federal Trade Commission requires disclosure of terms that cover termination of the franchise agreement and the terms substantiate this statement)
History of Franchising
Franchising dates back to at least the 1850s; Isaac Singer, who made improvements to an existing model of a sewing machine, wanted to increase the distribution of his sewing machines. His effort, though unsuccessful in the long run, was among the first franchising efforts in the United States. A later example of franchising was John S. Pemberton's successful franchising of Coca-Cola.Early American examples include the telegraph system, which was operated by various railroad companies but controlled by Western Union, and exclusive agreements between automobile manufacturers and operators of local dealerships.Earlier models of product franchising collected royalties or fees on a product basis and not on the gross sales of the business operations of the franchisees.
Modern franchising came to prominence with the rise of franchise-based food service establishments. This trend started before 1933 with quick service restaurants such as A&W Root Beer.In 1935, Howard Deering Johnson teamed up with Reginald Sprague to establish the first modern restaurant franchise. The idea was to let independent operators use the same name, food, supplies, logo and even building design in exchange for a fee.
The growth in franchises picked up steam in the 1930s when such chains as Howard Johnson's started franchising motels. The 1950s saw a boom of franchise chains in conjunction with the development of the U.S. interstate highway system. Fast food restaurants, diners and motel chains exploded. In regard to contemporary franchise chains, McDonalds is unarguably the most successful worldwide with more restaurant units than any other franchise network.
According to Franchising in the Economy, 1991-1993, a study done by the University of Louisville, franchising helped to lead America out of its economic downturn at the time.Franchising is a unique business model that has encouraged the growth of franchised chain formula units because the franchisors collect royalties on the gross sales of these units and not on the profits. Conversely, when good jobs are lost in the economy, franchising picks up because potential franchisees are looking to buy jobs and to earn profits from the purchase of franchise rights. The manager of the United States Small Business Administration's Franchise Registry concludes that franchising there is continuing to grow and that franchising is growing in the national economy.
Franchising is a business model used in more than 70 industries and that generates more than $1 trillion in U.S. sales annually.
Businesses for which franchising works best
Businesses for which franchises is said to works best have the following characteristics
- Businesses with a good track record of profitability.
- Businesses built around a unique or unusual concept.
- Businesses with broad geographic appeal.
- Businesses which are relatively easy to operate.
- Businesses which are relatively inexpensive to operate.
- Businesses which are easily duplicated.
Advantages of Franchising
As practiced in retailing, franchising offers franchisees the advantage of starting up a new business quickly based on a proven trademark and formula of doing business, as opposed to having to build a new business and brand from scratch (often in the face of aggressive competition from franchise operators). A well run franchise would offer a turnkey business: from site selection to lease negotiation, training, mentoring and ongoing support as well as statutory requirements and troubleshooting
After their brand and formula are carefully designed and properly executed, franchisors are able to expand rapidly across countries and continents, and can earn profits commensurate with their contribution to those societies. Additionally, the franchisor may choose to leverage the franchisee to build a distribution network.
Also with the help of the expertise provided by the franchisers the franchisees are able to take their franchise business to that level which they wouldn't have had been able to without the expert guidance of their franchisors.
Franchisors often offer franchisees significant training, which is not available for free to individuals starting their own business. Although training is not free for franchisees, it is supported through the traditional franchise fee that the franchisor collects.
Disadvantages of Franchising
For franchisees, the main disadvantage of franchising is a loss of control. While they gain the use of a system, trademarks, assistance, training, marketing, the franchisee is required to follow the system and get approval for changes from the franchisor. For these reasons, franchisees and entrepreneurs are very different. The United States Office of Advocacy of the SBA indicates that a franchisee "is merely a temporary business investment where he may be one of several investors during the lifetime of the franchise. In other words, he is "renting or leasing" the opportunity, not "buying a business for the purpose of true ownership." Additionally, "A franchise purchase consists of both intrinsic value and time value. A franchise is a wasting asset due to the finite term, unless the franchisor chooses to contractually obligate itself it is under no obligation to renew the franchise." ]
Starting and operating a franchise business carries expenses. In choosing to adopt the standards set by the franchisor, the franchisee often has no further choice as to signage, shop fitting, uniforms etc. The franchisee may not be allowed to source less expensive alternatives. Added to that is the franchise fee and ongoing royalties and advertising contributions. The contract may also bind the franchisee to such alterations as demanded by the franchisor from time to time. (As required to be disclosed in the state disclosure document and the franchise agreement under the FTC Franchise Rule)
The franchisor/franchisee relationship can easily cause conflict if either side is incompetent (or acting in bad faith). For example, an incompetent franchisee can easily damage the public's goodwill towards the franchisor's brand by providing inferior goods and services, and an incompetent franchisor can destroy its franchisees by failing to promote the brand properly or by squeezing them too aggressively for profits. Franchise agreements are unilateral contracts or contracts of adhesion wherein the contract terms generally are advantageous to the franchisor when there is conflict in the relationship. Additionally, the legal publishing website Nolo.com listed the "Lack of Legal Recourse" as one of Ten
Good Reasons Not to Buy a Franchise:
As a franchisee, you have little legal recourse if you're wronged by the franchisor. 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. Shamefully, the Federal Trade Commission (FTC) investigates only a small minority of the franchise-related complaints it receives