Chapter 15. Franchising

I.                    What Is Franchising and How Does It Work?

1.       What Is Franchising?

Franchising is a form of business organization in which a firm that already has a successful product or service (franchisor) licenses its trademark and method of doing business to other businesses (franchisees) in exchange for an initial franchise fee and ongoing royalty.

2.       How Does Franchising Work?

There are two distinctly different types of franchise systems:

·         Product and Trademark Franchise

An arrangement under which the franchisor grants to the franchisee the right to buy its products and use its trade name. For example are automobile dealerships and soft-drink distributorships.

·         Business Format Franchise

The franchisor provides a formula for doing business to the franchisee along with training, advertising, and other forms of assistance. For example is fast-food restaurants.

Three forms of a franchise agreement:

·         Individual Franchise Agreement: involves the sale of a single franchise for a specific location.

·         Are Franchise Agreement: allows a franchisee to own and operate a specific number of outlets in a particular geographic area.

·         Master Franchise Agreement: similar to an area franchise agreement but also has the right to offer and sell the franchise to other people in its area.

II.                  Establishing a Franchise System

Nine steps in setting up a franchise system:

(1)    Develop a franchise business plan

(2)    Get professional advice

(3)    Conduct an intellectual property audit

(4)    Develop a franchise documents

(5)    Prepare operating manuals

(6)    Plan an advertising strategy and a franchise-training program

(7)    Put together a team for opening new franchise units

(8)    Plan a strategy for soliciting prospective franchisees

(9)    Help franchisees with site selection and the grand opening of their franchise outlets

III.                Advantages and Disadvantages of Establishing a Franchise System

Two primary advantages are franchising helps a venture grow quickly because franchisees provide the majority of the capital and it is more effective for a units to be run by franchisees than by managers because they are more committed to the success.

The primary disadvantage is that an organization allows others to profit from its trademark and business model.

IV.                Buying a Franchise

Is franchising right for you? Answering the following questions will help determine whether franchising is a good fit for people thinking about starting their own entrepreneurial venture:

(1)    Are you willing to take orders?

(2)    Are you willing to be part of a franchise “system” rather than an independent businessperson?

(3)    How will you react if you make a suggestion to your franchisor and your suggestion is rejected?

(4)    What are you looking for in a business?

(5)    How willing are you to put your money at risk?

V.                  Steps in Purchasing a Franchise

(1)    Visit several of the franchisor’s outlets

(2)    Meet with a franchise attorney

(3)    Meet with the franchisor and check the franchisor’s references

(4)    Review all franchise documents with the attorney

(5)    Sign the franchise agreement

(6)    Attend training

(7)    Open the franchise business

VI.                Legal Aspects of the Franchise Relationship

                The legal and regulatory environment surrounding franchising is based on the premise that the public interest is served if prospective franchisees are as informed as possible regarding the characteristics of a franchisor.

1.       Federal Rules and Regulations

        However, the offer and sale of a franchise is regulated at the federal level. Under the Franchise Rule, which is enforced by the Federal Trade Commission (FTC), franchisors must furnish potential franchisees with written disclosures that provide information about the franchisor, the franchised business, and the franchise relationship.

        In most cases, the disclosures are made through a lengthy document referred to as the Franchise Disclosure Document (FDD). The FDD contains 23 categories of information that give a prospective franchisee a broad base of information about the background and financial health of the franchisor.

VII.              More About Franchising

1.       Franchise Ethics

        Most franchisors and franchisees are highly ethical individuals who are interested only in making a fair return on their investment. There are certain features of franchising, however, that make it subject to ethical abuse. These features are the following:

-          The get-rich-quick mentality

-          The false assumptions that buying a franchise is a guarantee of business success

-          Conflicts of interest between franchisors and their franchisees

2.       International Franchising

        International opportunities for franchising are becoming more prevalent as the markets for certain franchised products in the United States have become saturated. Although potentially attractive, entrepreneurs from any country thinking of buying a franchise in a different country should carefully examine all local rules and regulations, as well as the franchisor itself, prior to deciding to purchase a franchise.