Introduction to Franchising

Introduction to Franchising

• Franchising involves a start-up entrepreneur buying a license to operate a business locally, like Jollibee or Pizza Hut.
• Franchising has seen a phenomenal global increase in recent years.
• In the U.S., franchising sales increased from $334 billion in 1980 to $758 billion in 1991.
• Projected sales in the Philippines were 82 billion pesos in 2000 and 100 billion pesos in 2001, showcasing the growing popularity of franchising among Filipinos.
• Colonel Harlan Sanders founded Kentucky Fried Chicken through franchising.
• Franchising is considered a quick and successful way to become an entrepreneur.
• The term "franchise" originates from the Old French word "franchir," signifying freedom, privilege, or freedom from burden.

What is a Franchise?

• A franchise is an agreement or license between two legally independent parties.
• The franchisee gains the right to market a product or service using the franchisor’s trademark or trade name.
• The franchisee gains the right to market a product or service using the franchisor's operational methods.
• The franchisee has an obligation to pay fees to the franchisor.
• The franchisor is obligated to provide rights and support to the franchisee.

Types of Franchises

• There are two main types of franchises, product distribution and business format.

Product Distribution Franchises

• Product distribution franchises involve the franchisor licensing their trademark and logo to the franchisee.
• The franchisor typically does not provide a complete system for running the business
• Common industries include soft drink distributors, automobile dealers, and gas stations.
• Examples of product distribution franchises include Pepsi, Exxon, and Ford Motor Company.
• Product distribution franchises represent the largest percentage of total retail sales.
• Most franchises available today are business format opportunities

Business Format Franchises

• Business format franchises use the franchisor's product, service, trademark, complete method to conduct the business itself (marketing plan and operations manuals).
• Business format franchises are the most common type of franchise.

Industries with popular franchising opportunities

• According to USA Today, these are fast food, service, restaurants, building/construction, business services, retail, automotive, maintenance, retail-food, and lodging.

Business Format Franchise Examples

• Restaurants include KFC, McDonald's, Pizza Hut, and Taco Bell.
• Retail includes Blockbuster Video, Radio Shack, The Athlete’s Foot, and GNC Franchising.
• Lodging includes Choice Hotels, Bass Hotels/Holiday Inn, and Marriott Hotels.
• Health & Beauty includes Merle Norman Cosmetic Studios, Supercuts, Jenny Craig International, and Cost Cutters Family Hair Care.
• Business Services include Mail Boxes Etc., H & R Block, ACE America Cash Express, and Kwik Kopy.
• Maintenance/Cleaning includes Jani-King International, The ServiceMaster Company, and Merry Maids.
• Automotive Service includes Meineke Discount Mufflers, AAMCO Transmissions, Midas International, and Precision Auto Care.
• Education/Training includes Dale Carnegie Training, Barbizon School of Modeling, Berlitz International, and Sylvan Learning Systems.
• Real Estate includes Century 21, RE/MAX International, Coldwell Banker, and Residential Affiliates.
• Convenience includes 7-Eleven and FamilyMart.

Types of Franchise Arrangements

• There are two main types of franchise arrangements which are single-unit (direct-unit) and multi-unit.
• Multi-unit franchises can further be broken down into area development and master franchise arrangements.

Single-Unit (Direct-Unit) Franchise

• A single-unit franchise is where the franchisor grants a franchisee the rights to open and operate one franchise unit, which is the most common type of franchise.
• A franchisee may purchase additional single-unit franchises after their original franchise unit becomes successful.

Multi-Unit Franchise

• A multi-unit franchise is an agreement where the franchisor grants a franchisee the right to open and operate more than one unit.
• A multi-unit franchise can be achieved through an area development franchise or a master franchise.

Area Development Franchise

• An area development franchise grants the franchisee the right to open more than one unit within a specific area during a specific time.
• A franchisee may agree to open 5 units over five years in a specified territory.

Master Franchise Agreement

• A master franchise agreement gives the franchisee more rights than an area development agreement.
• A master franchisee has the right and obligation to open and operate a certain number of units in a defined area.
• Moreover, a master franchisee has the right to sell franchises to other people within the territory, known as sub-franchisees.
• The master franchisee takes over tasks, duties, and benefits of the franchisor, provides support and training, and receives fees and royalties.

Common Franchise Terms

• Business format franchise includes a product, service, trademark, and the complete method to conduct the business, including the marketing plan and operations manuals.
• Disclosure statement known as the UFOC (Uniform Franchise Offering Circular), provides information about the franchisor and franchise system.
• Franchise a license describing the relationship between the franchisor and franchisee, including use of trademarks, fees, support, and control.
• Franchise agreement is the legal, written contract between the franchisor and franchisee that specifies each party's responsibilities.
• Franchisee is the person or company that obtains the right from the franchisor to conduct business under the franchisor's trademark or trade name.
• Franchising is a method of business expansion involving a trademark license, payment of fees, and significant assistance or control.
• Franchisor is the entity that grants the franchisee the right to conduct business under their trademark or trade name.
• Product distribution franchise describes where the franchisee simply sells the franchisor's products without using the franchisor's method of conducting business.
• Royalty is the regular payment made by the franchisee to the franchisor, often a percentage of the franchisee's gross sales.
• Trademark includes the franchisor's identifying marks, brand name, and logo licensed to the franchisee.
• UFOC The Uniform Franchise Offering Circular is one format for the disclosure document containing information about the franchisor and franchise system.

Alternatives to Franchising

• Businesses can expand their markets and distribution channels through distributorships and licensing.

Distributorships

• In a distributorship, the distributor typically has a contractual relationship with the supplier.
• Distributors purchase in bulk from the supplier and sell in smaller quantities.
• Distributors are familiar with local markets and customers.
• Distributors may do business with multiple companies, unlike being tied to a single supplier/producer.
• Distributors may not receive contractual support and training from the supplier/producer, unlike franchisees.
• Distributors may be subject to controls by the supplier/producer and begin to resemble a franchise.
• Some popular distributorships include Amway, Color Me Beautiful Cosmetics, Mountain Life Spring Water, Knorr Soup Vendor, and Campbell's Soup Vending Machines.

Licensing

• Licensing allows a licensee to pay for the rights to use a particular trademark.
• Licensors are mainly interested in collecting royalties and supervising the use of the license rather than influencing the operations of the business, unlike franchises.
• Some licensors include Netscape Communications, Apple Computer, Canon Inc., Woolmark, and Compaq Computer.

Advantages of Owning a Franchise

• Owning a franchise allows one to go into business for themselves, but not by themselves.
• Franchises provide independence in operating a business.
• Franchises offer an established product or service with widespread brand recognition.
• Association with proven products and methods increases the chances of business success.
• Franchises offer consumers a consistent level of quality because it is mandated by the franchise agreement.
• Franchises provide pre-opening support, including site selection, design/construction, financing, training, and grand-opening programs.
• Franchises provide ongoing support, including training, advertising, operating procedures, supervision, management support, and bulk purchasing access.
• Franchising lessens the possibility of failure.
• Franchising facilitates market location through urbanization.
• Franchises benefit from customer patronage and brand loyalty.
• Building a good reputation/recognition, advertising costs are lower.

Disadvantages of Owning a Franchise

• Franchisees are not completely independent.
• Franchisees must operate according to the franchisor's procedures and restrictions.
• Restrictions include products/services offered, pricing, and geographic territory.
• High cost of franchise
• Operation is controlled by the franchisor
• Franchisees pay initial fees, ongoing royalties, and advertising fees.
• Franchisees must balance restrictions and support with their ability to manage their business.
• Continuous market acceptability is important
• A damaged system-wide image can result from poor performance or problems.
• Franchise agreement duration is limited with little franchisee input on termination.

Legal Issues of Franchising

• A good franchisor-franchisee relationship is critical for success.
• Understanding the franchise program is crucial due to the long-term business relationship.
• Seeking advice from an experienced franchise attorney can help avoid costly mistakes.
• Franchising is governed by federal and state laws.
• Franchisors must provide prospective franchisees with information about the franchisor-franchisee relationship.
• Key legal documents include the Disclosure Document (UFOC) and the franchise agreement.

The UFOC (Uniform Franchise Offering Circular)

• The UFOC informs prospective franchisees about the franchisor, franchise system, and agreements.
• Includes the actual franchise agreement, other agreements, and the franchisor’s financial statements.
• It provides information needed to make an informed decision about investing in a franchise.
• Franchisors must present a Disclosure Document before offering a franchise; some states require UFOC registration.

The UFOC includes Information about

• The Franchisor.
• Key staff.
• Management experience in franchise management.
• Franchisor bankruptcy and litigation history.
• Initial and ongoing fees.
• Required investment and purchases.
• Territory rights.
• Responsibilities of franchisor and franchisee.
• Other franchisees in the system with contact information.
• The "ten-day rule" grants prospective franchisees 10 business days to consider their decision before signing.

The Franchise Agreement

• The franchise agreement specifies the terms of the franchisor-franchisee relationship.

A typical franchise agreement may include specifics about

• The franchise system's use of trademarks and products.
• Territory
• Rights and obligations of parties (standards, procedures, training, etc.)
• Term (duration) of the franchise
• Payments made by the franchisee to the franchisor
• Termination/transfer rights

Legal Agreements to keep in mind for Franchises

• The franchise agreement governs the relationship and specifies terms of the franchise purchase
• Prospective franchisees are entitled to have the final agreement for at least 5 business days before signing.
• The professional advice of lawyers, bankers, accountants will help in troubleshooting problems and identifying friction points in the contract.
• Agreements need to include provisions on termination, transfer, and renewal.
• Agreements need to show provisions that show excessively strict cancellation policies.
• Agreements need to clearly specify transfer and renewal of the contract.