Information about Franchising

Franchising (from the French for honesty or freedom^[1]) is a method of doing business wherein a "franchisor" licenses proven methods of doing business to a "franchisee" in exchange for a recurring payment, fees and a percentage of sales or profits. Various tangibles and intangibles such as national or international advertising, training, and other support services are commonly made available by the franchisor, and may indeed be required by the franchisor, which generally requires audited books, and may subject the franchisee or the outlet to periodic and surprise spot checks. Failure of such tests typically involve non-renewal or cancellation of franchise rights.

According to Financial Times, if sales by US franchise businesses were translated into national product, they would qualify as the 7th largest economy in the world.

Overview

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).

History

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.^[2] Early American examples include the telegraph system, which was operated by various railroad companies but controlled by Western Union^[3], and exclusive agreements between automobile manufacturers and operators of local dealerships^[4].

Modern franchising came to prominence with the rise of franchise-based food service establishments. This trend started as early as 1919 with quick service restaurants such as A&W Root Beer^[5]. In 1935, Howard Deering Johnson teamed up with Reginald Sprague to establish the first modern restaurant franchise ^{[6] [7]}. 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^[8]. The 1950s saw a boom of franchise chains in conjunction with the development of the U.S. interstate highway system.^[9] Fast food restaurants, diners and motel chains exploded. In regards to contemporary franchise chains, McDonalds is arguably the most successful worldwide with more restaurant units than any other franchise network.

Advantages

Quick start

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.

Expansion

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.

Training

Franchisors often offer franchisees significant training, which is not available for free to individuals starting their own business.

Disadvantages

Control

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.

Price

It can be expensive. Because of standards set by the franchisor, the franchisee often has no choice as to signage, shop fitting, uniforms etc. and may not be allowed to source less expensive alternatives. Added to that is the franchise fee and ongoing royalties and advertising contributions. The franchisee may also be contractually bound to spend money on upgrading or alterations as demanded by the franchisor from time to time.

In response to the soaring popularity of franchising, an increasing number of communities are taking steps to limit these chain businesses and reduce displacement of independent businesses through limits on "formula businesses."^[10]

Conflicts

Another problem is that the franchisor/franchisee relationship can easily cause conflict if either side is incompetent (or not acting in good 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.

Legal aspects

United States

In the United States, franchising falls under the jurisdiction of a number of state and federal laws. Franchisors are required by the Federal Trade Commission to have a Uniform Franchise Offering Circular (UFOC) to disclose potential franchisees about their purchase. This disclosure must take place 10 business days prior to solicitation (franchisor agrees to offer the prospective franchisee a license). Each state may require the UFOC to contain specific requirements. This means that many franchisors have a unique UFOC for each state or sometimes are able to include all state specific requirements into one document.

The franchise agreement is a standard part of franchising. It is the essential contract signed by the franchisee and the franchisor that formalizes and specifies the terms of the business arrangement, as well as many issues discussed in less detail in the UFOC. Unlike the UFOC, the franchise agreement is a fluid document, crafted to meet the specific needs of the franchise, with each having its own set of standards and requirements. But much like a lease, there are elements commonly found in every agreement.

Most franchise agreements should discuss the following issues:

1. The monetary costs involved in the bestowal of the franchise
2. Property issues including the building, location, supplies, and equipment
3. Operational procedures and practices, and how these preserve and protect the franchise system
4. Territorial concerns
5. The services and aspects earned from payment of the franchise fee
6. The exact nature of the training and assistance provided to the franchisee
7. The nature of the franchise marketing program
8. Recurring fees and recurring fee structures
9. Bookkeeping requirements

The key clauses that most UFOCs have in common are:

1. Identifying information as to franchisor.
2. Business experience of franchisor's directors and executive officers.
3. Business experience of the franchisor.
4. Litigation history.
5. Bankruptcy history.
6. Description of franchise.
7. Initial funds required to be paid by a franchisee.
8. Recurring funds required to be paid by a franchisee.
9. Affiliated persons the franchisee is required or advised to do business with by the franchisor.
10. Obligations to purchase.
11. Revenues received by the franchisor in consideration of purchases by a franchisee.
12. Financing arrangements.
13. Restriction of sales.
14. Personal participation required of the franchisee in the operation of the franchise.
15. Termination, cancellation, and renewal of the franchise.
16. Statistical information concerning the number of franchises (and company-owned outlets).
17. Site selection.
18. Training programs.
19. Public figure involvement in the franchise.
20. Financial information concerning the franchisor.

SOURCE:^[11]

There is no federal registry of franchising or any federal filing requirements for information, rather, states are the primary collectors of data on franchising companies, and enforce laws and regulations regarding their spread.

Because litigation is expensive, the majority of franchisors have inserted mandatory arbitration clauses into their agreements with their franchisees. Since 1980, the U.S. Supreme Court has dealt with cases involving direct franchisor/franchisee conflicts at least four times, and three of those cases involved a franchisee who was resisting the franchisor's motion to compel arbitration. Two of the latter cases involved large, well-known restaurant chains (Burger King and Subway); the third involved Southland Corporation, the parent company of 7-Eleven.

Russia

In Russia, under ch. 54 of the Civil Code (passed 1996), franchise agreements are invalid unless written and registered, and franchisors cannot set standards or limits on the prices of the franchisee’s goods. Enforcement of laws and resolution of contractual disputes is a problem: Dunkin' Donuts chose to terminate its contract with Russian franchisees that were selling vodka and meat patties contrary to their contracts, rather than pursue legal remedies.

Social franchises

In recent years, the idea of franchising has been picked up by the social enterprise sector, which hopes to simplify and expedite the process of setting up new businesses. A number of business ideas, such as soap making, wholefood retailing, aquarium maintenance, and hotel operation, have been identified as suitable for adoption by social firms employing disabled and disadvantaged people.

The most successful example is probably the CAP Markets, a steadily growing chain of some 50 neighborhood supermarkets in Germany. Other examples are the St. Mary's Place Hotel in Edinburgh and the Hotel Tritone in Trieste.

Related

• Franchise consulting

References

External links

• U.S. Federal Trade Commission - Disclosure requirements and prohibitions concerning franchising and business opportunity ventures.
• International Franchise Association
• Franchise Business Review