Module 5 Franchising
Module 5 Franchising
Module 5 Franchising
Learning Outcomes
At the end of this chapter the students should be able to:
1. Explain the basic concept of business format franchise
2. Specify the significant elements of a business format franchise and
determine its effect in establishing a successful franchising business.
3. Compare alternative distribution structures with franchising.
Learning Content
All businesses evolve over time and franchised businesses are under continuous
competitive pressure to improve their formats and operating systems. The entry
barriers are low in many of the businesses in which franchising is the predominant
form of distribution. Food service is an example of low barriers to entry. Dozens
of companies emerge each year as food service franchisors. Some of these
companies are established food service operators who have decided to expand by
franchising. Others are new companies with one or two prototype food service
facilities. Each presents at least the potential to be a competitive threat to
established food service franchisors. The most successful franchised networks are
those in which the franchisor (frequently working effectively with its franchisees)
has made a continuous effort to improve its business format and operating
system. The greatest risk assumed by a person who acquires a franchise is that
his or her franchisor will not make the investment and effort required to improve its
format and operating system and, as a consequence, will fail in the future to be an
effective competitor.
The primary reason for making your franchisees responsible for site selection is
not only to make the franchisee thoroughly familiar with the pros and cons of each
potential site location, but also to help alleviate any liability you may face if you are
the sole selector of the site and the franchise subsequently fails. Many franchisees
who fail will blame the choice of site selection as the primary reason for their
failure, even though the failure may be entirely the franchisee’s own fault.
Therefore, most franchisors require the franchisees to make their own site
selection, with the franchisor acting as the final approving authority.
To ensure that the franchisee has picked an appropriate site, however, you should
have a qualified broker or other expert evaluate the suitability of the chosen site.
This person should be qualified in real estate matters and have some experience
in franchising and in the particular business being franchised. In some cases, a
new franchisor may act as the site selection appraiser assisting the franchisee;
however, most franchisors retain real state consultants rather than hire full-time
personnel, at least in the initial stages.
5. Training
The beauty of the franchise system is that it comes with complete training in the
business that it offers – from a technical, operational and managerial aspect. As
part of the business format, the franchisor undertakes to train the franchisee in the
operation of the system prior to the opening of the business, and assist with the
opening of the business.
You must select each of the franchisee carefully. Never sell a franchise to anyone
you do not consider completely qualified for the job. The franchisee is also a
manager of your business extension, so you should never choose a franchisee
someone you would not hire as a manager. A good selection of franchisees will
diminish the chance of franchise failure, especially early transfers and
terminations. Treat the franchisee like a member of your team and regard the
franchising system as an extension of your marketing arm. It is your services or
products that are being sold under your service mark or trademark. You would not
hesitate to assist one of your company managers when in trouble or even to
remove him or her if it were in the best interest of the company-owned office.
If you look upon the franchisee as a replacement for your company-owned office
9. Other Significant Terms and Conditions
There are other significant terms and conditions found in franchise agreements.
These include the territorial protection to be granted to the franchise (i.e.,
restrictions on competition in the franchisee's trading area by the franchisor and its
other franchisees) and territorial and customer restrictions on the franchisee
(i.e., limitations on where and to whom the franchisee may advertise and/or sell);
covenants not to compete applicable to the franchisee (and members of his or her
immediate family and senior management of the franchised business) during the
term of the franchise and subsequent to its expiration or termination; the
conditions under which the franchise may be terminated by the franchisor and the
franchisee; and dispute resolution procedures. Though these terms and conditions
can affect the value of a franchise, the impact on the value of a franchise of such
terms and conditions is less than the impact of the value of the franchisor's
trademark and trade dress, business format and operating system, system
standards, site selection and facility development services, advertising and
marketing programs, training and continuing assistance and guidance, and the
term for which the franchise is granted, the franchisee's renewal rights and the
franchisee's right to transfer the franchise.
10. Fees
Virtually all business format franchise relationships involve the payment of fees by
the franchisee to the franchisor. Such fees are usually in the form of an initial
franchise fee that is intended to reimburse the franchisor for services furnished to
the franchisee in connection with the establishment and opening of the franchised
business, and a continuing fee (a "royalty" or a "royalty and service fee"). The
continuing fees payable by a franchisee are the significant consideration
paid by the franchisee for the rights granted and services furnished by the
franchisor . In a typical franchise relationship, the cumulative total of the
continuing fees paid over the term of the franchise will greatly exceed the initial
fee for the grant of the franchise. Continuing fees are usually calculated as a
percentage of the gross sales (exclusive of sales taxes) of the franchised
business. Though the fees in business format franchise relationships vary, they
usually do not exceed eight percent of gross revenue. For some franchises, the
continuing fee may be considerably higher, due to the fact that it compensates the
franchisor for additional services. For example, in temporary employment agency
franchisees, it is common for the franchisor to act as the employer of all the
temporary employees, to pay their wages each week and to bill the employers to
whom the franchisee has sold temporary help services (who usually pay once a
month). The franchisor is performing administrative and financing services for its
franchisees and the continuing fee reflects these additional services. In other
cases a continuing fee may combine the actual fee and an advertising and
marketing contribution by the franchisee or the payment for other goods or
services furnished by the franchisor.
In establishing the level of continuing fees, a franchisor takes into consideration
both the amount of revenue it will require from each franchisee, in order to furnish
essential services, expand its network and realize a profit, and the percentage of
revenue that the franchisee can afford to pay. If a franchisee's business achieves
sales substantially above the average for the network, its continuing fees will
decline as a percentage of its operating profit (because the incremental sales will
produce a higher operating profit, but the same percentage of continuing fees).
Conversely, if a franchisee's business achieves sales substantially below average
for the network, its continuing fees will consume a higher share of operating profit
or eliminate profit.
The standard method of calculating fees thus places a franchisee at some risk that
its continuing fee obligations will force it to operate an unprofitable business for
some period. Though other formulas for calculating continuing fees do exist (e.g.,
fixed periodic fees subject to adjustment for inflation; gross profit sharing formulas;
fees based on the number of units of a product or service sold or purchased used
by the franchisee), a fee denominated as a percentage of the gross revenues of
the franchisee's business is by far the most common.
2. Joint Ventures
A business may also be expanded by developing joint venture relationships.
A joint venture is a business entity created by two or more parties, generally
characterized by shared ownerships, shared returns and risks, and shared
governance. Companies typically pursue joint ventures for one of four reasons: to
access a new market, particularly emerging markets; to gain scale efficiencies by
combining assets and operations; to share risk for major investments or projects;
or to access skills and capabilities. Joint ventures may take the form of limited
partnerships, general partnerships, limited liability companies or corporations. In
one type of joint venture, the sponsoring company manages each outlet and
the joint venture partner is a passive investor that contributes capital. Such
relationships are found in the lodging industry. The hotel management
company contributes know-how, development plans, its reservation system, its
trademark and management services, and its joint venture partner(s) contributes
capital to develop, equip, staff and operate the hotel. The hotel management
company will generally receive a base fee and will share profits with its joint
venture partner(s). In a much less common form of joint venture, the sponsoring
company acts as a passive investor, furnishing capital for outlet development,
along with its joint venture partner, who has responsibility for the management of
the outlet. This relationship differs from a company-owned outlet whose manager
shares in profit or cash flow, because the joint venture manager has an actual
ownership interest in the outlet he manages, not just a compensation package that
includes a share of profits. Automobile manufacturers have entered into
relationships of this type with owners of automobile dealerships as a means of
financing the dealership. The manufacturer and the dealer intend that the
manufacturer's ownership interest in the dealership will be redeemed by the
dealership out of its profits. A variation of the joint venture is the combination
franchise-management contract. The franchisor actually grants a franchise to an
investor and simultaneously enters into a second agreement providing for
management of the franchisee's business by the franchisor. Though
significantly different in legal structure from a joint venture, it is similar in practical
application to a joint venture in which the sponsor assumes responsibility for
management of each retail outlet. Combination franchise-management
arrangements may be subject to regulation under both franchise laws (as
franchises) and securities laws (as investment contracts). The joint venture
business structure has been used mainly in the lodging industry and to a lesser
extent in automobile distribution and food service.
3. Independent Dealerships
Some companies can effectively expand their distribution network with exclusive
distributorship or dealership.
What is a Distributor
The distributor is considered an independent selling agent. This means that the
distributor or wholesaler has permission or exclusive rights to sell the products of
a manufacturer or a supplier, usually within a specified territory as specified in the
contract, but is not entitled to use the trade name as part of its business. The
distributorship agreement may also specify that the distributor is bound to sell the
supplier’s products exclusively, meaning it cannot sell similar products from
another supplier. Large-scale distributors are often referred to as “wholesalers.”
Exclusive Distributorship
A distributor that is granted exclusive distribution rights is guaranteed to be the
only dealer or retailer of a specific product in a specified area, or to be the only
dealer or retailer to supply the product to a specified group of people. Contracts
for exclusive distribution are most commonly seen in high-end products that
require the sales staff to have some degree of training. An exclusive
distributorship agreement gives the manufacturer or supplier greater control over
how its product is sold. Additionally, exclusive distribution provides some
protection to the distributor against other individuals or entities who might attempt
to sell the same product at a more competitive price.
Dealership
Another type of distributor is called a “dealership.” While both entities sell the
products of another company (the supplier), there is an important difference: use
of the supplier’s name. A distributorship can sell the products of the supplier, post
images and advertising proclaiming that it sells the supplier’s products, but the
distributorship cannot include the supplier’s name in the name of its own business.
A dealership is a type of exclusive distributorship in which the distributor can use
the supplier’s name in its own business name.
For example, an authorized distributor in ABC tractors sells a wide variety of farm
equipment. The distributor could post promotional signs using the ABC logo and
name, but could not name his business “ABC Tractors.” A distributor granted
dealership status becomes an exclusive provider of the supplier’s products, often
offering sales and service, may call the business by the supplier’s name. For
example, a dealership for ABC Tractors may be named “ABC Tractors of
Farmington.” This is commonly seen in automotive dealerships.
4. Cooperatives.
A cooperative (also known as co-operative, co-op, or coop) is "an
autonomous association of persons united voluntarily to meet their common
economic, social, and cultural needs and aspirations through a jointly-
owned enterprise. In some industries (e.g., the manufacture of bedding products,
retail grocery and hardware stores) manufacturer and retailer owned cooperatives
are common. Several major bedding product lines in the United States are
manufactured by independently owned factories operating under patent and
trademark licenses granted by a cooperative owned (in equal or unequal
proportions) by its licensees. In one such cooperative network, the Sealy Mattress
Company, after years of bitter litigation between a large member-licensee and the
cooperative licensor (relating to the cooperative's acquisition of other member
licensees that the plaintiff member-licensee also sought to buy and related
territorial restrictions on where member licensees could establish factories and sell
their trademarked bedding products), resulting in a substantial verdict for the
licensee, the licensee purchased the cooperative and several of its remaining
licensees and become a vertically integrated chain. Similarly, there are a number
of large retailer owned grocery and hardware store cooperatives. The focus of a
cooperative is usually the economies to be gained from combined purchases of
goods and services and pooled advertising under a trademark owned by the
cooperative and licensed to each member. Some cooperatives also furnish a
variety of other services including financing the acquisition, expansion and
remodeling of member outlets and product research and development.
5. The Internet.
Finally, the internet must be considered as a business model that is a potential
alternative to franchising. The growth of the internet as (1) a source of all kinds of
information and entertainment services, (2) a method for a wide variety of
businesses to implement procurement programs that can improve the quality and
reduce the cost of the goods and services purchased and, sometimes
dramatically, the efficiency of the procurement process (so called B2B — business
to business — e-commerce) and (3) a method of selling directly to the consumer
(B2C — business to consumer e-commerce), is in a period of exponential growth.
That growth will undoubtedly continue. Of the three principal elements of internet
growth, B2C e-commerce is the most uncertain. The number of people buying on
line and the number of online sellers to consumers is rapidly expanding. However,
the business models that have developed in B2C ecommerce have only recently
demonstrated a clear-cut profit potential. If the evolution of these business models
does demonstrate profitability, the internet will certainly become a viable method
of business development and expansion for many goods and services. In
evaluating e-commerce as an alternative distribution model, it is important to keep
in mind a number of factors. Though a wide variety of products and services can
be sold on the internet, a system for delivery and post-sale service must be
established as an adjunct to such sales. The consumer must have a level of
confidence that he or she can return a product, within the terms of the seller's
return policy, and can secure reasonably convenient and affordable warranty and
post-warranty service for the product. For many products, a traditional dealer or
franchise network has supplied these functions. The explosive growth in mail
order commerce facilitated by the growth in the use of credit cards, has amply
demonstrated that for relatively small, moderate cost products, consumers are
willing to buy without a dealer network for
convenient return or service, relying on the mail or other shipping services to
return products that they decide not to keep. Interestingly, many successful mail
order companies have adopted ecommerce as an adjunct to — but not a full
substitute for — the periodic mailing of catalogs, but have also established chains
of retail outlets. Franchisors are increasingly utilizing e commerce to augment
marketing and sales, but not as a substitute for franchised outlets. Many services
can only be delivered at a specific location (e.g., lodging, food service and motor
vehicle repair and service) or physically performed in the consumer's home or
place of business (e.g., cleaning, repair and decorating services). Such services
can be sold on the
internet, but that method of selling does not eliminate the need for a delivery
system. and even fewer services.
Definition of Terms:
Agent – A person authorized to act on behalf of someone else, such as an
employee, broker, or sales representative.
Contract – An agreement between two or more parties in which a promise is
made to do or provide something in return for a valuable benefit.
Cooperative- is "an autonomous association of persons united voluntarily to
meet their common economic, social, and cultural needs and aspirations
through a jointly-owned enterprise.
Liability – A company’s legal obligations or debts that come up during the
course of business
Plaintiff – A person who brings a legal action against another person or
entity, such as in a civil lawsuit, or criminal proceedings
5. Teaching and Learning Activities
8. Assessment Task
Quiz/Assignment/Recitation
Assignment:
1. Why is business site should be strategically located? Is product name/trade
name more important than business location? Why or why not?
2. Cite one company in the hospitality and tourism industry which uses trade
dress. How can it be an effective tool in advertising and marketing their
business?