Module 5 Franchising

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HM F Elec 8-Franchising

Module 5: SIGNIFICANT ELEMENTS OF A BUSINESS FORMAT


FRANCHISE
Introduction

Franchising is a universally accepted and successful business format that has


revolutionized the way small business is run and has contributed extensively to
entrepreneurship, skills transfer and job creation. One of the two most universally
accepted forms of franchising is the Business Format Franchise. It is defined
as a distribution network operating under a shared trademark or trade name with
franchisees paying the franchisor for the right to do business under that name for
a specified period of time. In exchange, the franchisee is able to use the
franchisor’s entire business system or format, including the name, goodwill,
product and services, operating manuals and standards, marketing procedures,
systems and support facilities. The franchisor, in turn, is obliged to give initial and
ongoing services and support.

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

I. SIGNIFICANT ELEMENTS OF A BUSINESS FORMAT


FRANCHISE
The following is a discussion of the most significant elements of a business format
relationship. These elements are found in and are important to most business
format franchise relationships.

1. Trademarks and Trade Dress


An important element of each franchise is the license of a trademark or service
mark by the franchisor to the franchisee. Not all words and symbols are
protectable or registerable as trademarks. In the United States, trademarks
become valuable by extensive use and promotion. If a trademark is a collection of
letters with no meaning (e.g., EXXON, KODAK and XEROX), a generic word used
for an unrelated product or service (APPLE for computers) or suggestive (but not
descriptive) of a product or service (e.g., 7-ELEVEN for convenience stores,
MATERNALLY YOURS for maternity clothing stores and SNEAKER CIRCUS for
retail shoe stores), it may be protected against infringements and registered on
the Principal Register of the
United States Patent and Trademark Office without proof of long-time or extensive
use and thereby gain significant legal protection. On the other hand, if a term is
descriptive of a product or service (e.g., BEEF & BREW for restaurants, HOLIDAY
INN for motels), it must generally be widely used and promoted for several years
in order to acquire "secondary meaning" (i.e., the consuming public learns to
associate the trademark with a single source (a single company or a company and
its licensees) rather than as a term merely describing a product or service. (United
States trademark law contains a rebuttable presumption that secondary meaning
is acquired after five years of continuous, substantially exclusive, use and
promotion).
A trademark owner acquires "common law" rights in its mark in the geographic
area in which it conducts business by virtue of its use, even if the mark is
unregistered. However, prior to filing an application for a federal registration of a
trademark, anyone else who in good faith (i.e., without knowledge of the prior
user) uses the same or a confusingly similar trademark outside the geographic
trading area of the first user may gain superior rights in the subsequent user's
geographic market. Therefore, the owner of an unregistered trademark, and its
licensees, may face one or more other users that possess superior rights to the
trademark in potentially large
geographic trading areas. An unregistered "common law" trademark is, therefore,
significantly less valuable than a trademark that is registered on the Principal
Register. Registration of a trademark confers certain legal rights. It does not,
however, create commercial value. Commercial value can only be established by
substantial use and promotion over an extended period.

The McDonald's trademark is an example. McDonald's operates and franchises


more than 25,000 restaurants in well over 100 countries. Its trademark has very
high recognition in these countries (and in the geographic areas that McDonald's
has not yet entered) and is a key element in the high value of the McDonald's
franchise. A start-up franchisor that owns a mark that has not been extensively
used prior to offering franchises usually does not have a commercially valuable
trademark (even if it is registered on the Principal Register) and its franchise will
have a correspondingly lower value. This lower value will be reflected in greater
difficulty selling franchises and usually in lower fees. It is typical for a franchisor to
gradually
increase the royalties that its franchisees are required to pay as its network
expands and its franchise gains value.

The operating systems of many Franchisors also include distinctive, nonfunctional


elements that constitute proprietary trade dress. Trade dress can be comprised of
color schemes, distinctive shapes, music composed for and owned by a
franchisor, decor and display items and distinctive clothing. Typically, trade dress
must be distinctive to be protectable. Distinctiveness can be acquired through
extensive promotion and use so that consumers recognize the trade dress and
associate it with one source. Trade dress also can be "inherently distinctive,"
a combination of elements that is so unique or unusual or unexpected that
one can assume, without proof, that the elements will automatically be
perceived by customers as indicia of origin. Though functional items are
generally not protectable as proprietary trade dress, a distinctive arrangement of
functional items has been accorded trade dress standing (e.g., a food preparation
area situated behind a glass wall in full view of customers). Whether inherently
distinctive or not, the scope and extent of use and promotion plays a role by
creating secondary meaning (where required) and by enhancing consumers'
association of the trade dress to the franchised network. Therefore, the more well-
known and distinctive the trade dress elements, the more legally protectable the
trade dress and the greater value the trade dress will have as an element of a
franchisor's operating system. Trade dress is generally less important and
valuable than a trademark in attracting customers to a business, though highly
distinctive trade dress can partially compensate for a weak and unknown trade
mark.

2. Business Format and Operating System


In addition to a trademark, franchisors license to their franchisees a business
format and operating system. As in the case of trademarks, the more established
and successful the franchisor's format and system, the greater the value of the
franchise. The operating system of a franchisor will frequently include elements
and operating information that constitutes a trade secret of the franchisor. Many
franchisors are careful to protect their trade secrets by obligating franchisees (and
requiring franchisees to obligate their managerial employees) to maintain the
confidentiality of such trade secret information (e.g., by signing confidentiality
agreements) and prohibiting franchisees from owning an interest in or maintaining
any relationship with a directly competing business during the term of the
franchise and for one or two years following the expiration or termination of the
franchise. Such restrictions may also apply to members of the franchisee's
immediate family and other members of the franchisee's management. The failure
to protect trade secrets from disclosure or use in a competing business will cause
them to lose their status as trade secrets and become part of the public domain.
Only certain types of information will qualify as a trade secret. For example,
recipes and formulas for food products, ingredients and methods of preparation
may be protectable trade secrets. However, the layout of a restaurant, the
materials used to construct and decorate the premises, the type of seating, the
method of ordering and paying for food products, the type of cash register used,
the use of a drive-up window and a myriad of other details of the facility and its
operations that are observable by persons who have lawful access to the facility
(e.g., customers) cannot become trade secrets because they are not and cannot
be secret. A business format and operating system usually evolves over time as
the franchisor gains experience, technological changes occur and competitive
pressure forces a reevaluation of formats, operating systems, equipment,
standards, products, services and operating procedures.

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 history of franchising is replete with examples of franchised networks that


failed to continue to be effective competitors in a highly competitive industry. This
risk is greatest when the franchise is acquired from a new franchisor that does not
have an established record of improving its format and operating system and
maintaining a competitive position.

4. Site Selection and Business Facility Development

If your franchise involves a restaurant or other business in which location is a key


factor in franchise sales, you will want to have someone assist your franchisees in
selecting sites. Most franchisors require their franchisees to conduct preliminary
research on potential sites. In most cases, real estate brokers or shopping center
managers can provide the demographics and other commercial information
pertaining to each potential site.

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.

4. Advertising and Marketing

The success of most franchise brands is a result of innovative marketing that


ensures that the spread of franchisees is backed by effective advertising and
promotion. In most cases funds pooled by franchisees goes towards national
advertising campaigns aimed at benefiting both the brand and the individual
franchises.

5. Training

The great majority of franchisors furnish training to each franchisee, and


frequently to the managerial personnel of the franchisee's business. Training is
usually a combination of classroom instruction and actual hands on experience in
an operating business. The comprehensiveness and effectiveness of the initial
training of franchisee personnel is generally believed to be critical to the
successful development and operation of the franchisee's business.

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.

6. Continuing Assistance and Guidance


Whether it’s on the technical, operational or managerial level, franchisors must
continually provide direction in terms of where the business is heading, what
research and development needs to take place to take it to new heights and
always improve on management efficiencies

Substantially all franchisors furnish some degree of continuing assistance and


guidance to their franchisees. Continuing assistance and guidance takes several
forms, including:
(1) a comprehensive operations manual that is periodically updated (operations
manuals describe in detail the elements of the operation of the franchised
business and frequently are contained in several loose leaf binders consisting of
several hundred pages);
(2) periodic written and electronic communications that address developments in
the franchised networks' industry, information regarding competitors and
operational and marketing information relating to the franchised network;
(3) field visits by franchisor personnel, during which the franchisor's representative
(a) observes the franchisee's business facility and operations, explains any
deficiencies observed and formulates, with input from the franchisee, a time table
for the correction of such deficiencies; (b) consults with the franchisee with respect
to any operational or marketing problems that the franchisee is experiencing; (c)
discusses with the franchisee any changes in the franchisor's format, operations
or marketing that are under consideration or have been decided, including a time
table for their implementation; (d) and discusses with the franchisee any other
concerns or issues that the franchisee raises; and
(4) continuing communication by telephone (the great majority of franchising
companies maintain toll free numbers that their franchisees may use), telecopy
and
electronic mail. All forms of continuing assistance and guidance are highly
important to franchisees. As noted above with respect to advertising and
marketing, comprehensive and effective assistance and guidance is generally
present in successful franchised networks.
7. System Standards

Business format franchisors formulate specifications, standards and operating


procedures relating to the development and operation of the franchised business
(generally known as "system standards"). System standards are usually contained
in an operations manual that is made part of the franchise relationship and may be
periodically modified by the franchisor. The more complex the franchised
business, more comprehensive will be the system standards that apply to its
development and operation and the operations manual that codifies those system
standards. System standards include the appearance and maintenance of the
franchisee's business facility; authorized products and services; restrictions on
sources of supply for equipment and supplies; employee qualifications, training
and dress; operating hours; insurance requirements; use of trademarks;
production, presentation, packaging and delivery of products and services; use of
standard forms and accounting systems; signs and advertising; credit practices;
and other elements of the franchised business. Consistent enforcement of system
standards is important to the success of a franchised network and the most
successful franchisors almost always are diligent in correcting deficiencies in the
appearance and operation of franchisee operated outlets. If a franchising
company fails to consistently enforce standards, customer dissatisfaction with
substandard outlets will carry over to the network generally, the franchise will lose
value to complying franchisees (whose businesses are hurt by noncomplying
franchisees tolerated by the franchisor) and the network's competitive position will
decline. Franchisees thus have a strong interest in consistent enforcement of
system standards and consider such enforcement an element of value in a
franchise. System standards are enforced by means of inspections made by
franchisor field personnel, who are usually accompanied by the franchisee during
the inspection. Any deficiencies found are discussed with the franchisee. If the
franchisee fails to correct deficiencies, it is in default and its franchise is subject to
termination.

8. Term, Renewal and Transfer

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.

II. A Comparison of Alternative Distribution Structures with Franchising


Franchising is certainly not the only method for expanding a business. Alternatives
to franchising do exist and one or more alternative distribution structures may be
more suitable than franchising for a particular company. A company planning
expansion should investigate franchising merely as one of the available structures.
In examining available expansion relationships, a company should keep in mind
that franchising is a well-developed business relationship. The growth of
franchising since 1950 has been phenomenal and by every measure has been
beneficial to the economies and societies in which this growth has occurred. The
extensive development and growth of franchising is one of its strongest
advantages; franchising is an increasingly well understood business relationship,
which facilitates its utilization in the expansion of a distribution network. It is also
important to recognize that franchising relationships are quite varied, running the
spectrum from simple trademark licenses with minimal supervision and assistance
to comprehensive ongoing relationships with substantial franchisor assistance and
service. Franchise networks also vary widely in the relative investment made by
the franchisor and the franchisee in the franchisee's retail outlet. At one extreme,
the investment is made solely by the franchisee. At the other, the franchisor may
furnish all assets other than inventory and share the gross operating profit with the
franchisee (e.g., certain convenience store franchises). A company planning
expansion must not only consider the alternatives to franchising, but also which of
the variations of franchise relationships is most suitable to its type of business,
objectives and human and capital resources. Though franchising offers some
unique advantages over other methods, no company should decide to develop a
franchise expansion program without first considering other methods. Several
alternative distribution structures are discussed below.

1. The Vertically Integrated Chain


A commonly suggested alternative to franchising is a vertically integrated chain of
distribution outlets. In microenvironment and management, vertical integration is
an arrangement in which the supply chain of a company is owned by that
company. Usually each member of the supply chain produces a different product
or (market-specific) service, and the products combine to satisfy a common need.
It is contrasted with horizontal integration, wherein a company produces several
items that are related to one another. Vertical integration has also
described management styles that bring large portions of the supply chain not only
under a common ownership but also into one corporation (as in the 1920s when
the Ford River Rouge Complex began making much of its own steel rather than
buying it from suppliers).
Vertical integration and expansion is desired because it secures supplies needed
by the firm to produce its product and the market needed to sell the product.
Vertical integration and expansion can become undesirable when its actions
become anti-competitive and impede free competition in an open marketplace.
Vertical integration is one method of avoiding the hold-up problem. A monopoly
produced through vertical integration is called a vertical monopoly.
On the assumption that a company can more effectively impose controls and
standards on retail outlet managers than on independent franchisees, the
vertically integrated chain may have an advantage over a franchised chain in
terms of maintaining quality control. A related advantage is the speed with which
the chain can react to changes in its market or in its costs of doing business
requiring modifications in format, image, products, services, equipment, pricing or
operating procedures. At least theoretically, vertical integration should facilitate
implementation of the requisite modifications. There are no independent
franchisees to convince (by persuasion or contract enforcement), merely
employees to direct. Proponents of franchising counter with the argument that not
even employees can be merely directed to adhere to standards and procedures or
to implement changes. Employees, like independent franchisees, must be
persuaded that they will benefit from following directions, or policies and standards
will not be effectively implemented.

Proponents of franchising further contend that controls on franchisees can take


several forms and, if reasonable and enforced, can effectively maintain the
standards established by the franchisor for the franchisee's business and adjust to
changes in the market for the franchise's product or service. The operations
manual is the documentation by which an organization provides guidance for
members and employees to perform their functions correctly and reasonably
efficiently. It documents the approved standard procedures for performing
operations safely to produce goods and provide services. Compliance with the
operations manual will generally be considered as activity approved by the
persons legally responsible for the organization.
The operations manual is intended to remind employees of how to do their job.
The manual is either a book or folder of printed documents containing the
standard operating procedures, a description of the organizational hierarchy,
contact details for key personnel and emergency procedures. It does not
substitute for training, but should be s ufficient to allow a trained and competent
person to adapt to the organization’s specific procedures.
The operations manual helps the members of the organization to reliably and
efficiently carry out their tasks with consistent results. A good manual will reduce
human error and inform everyone precisely what they need to do, who they are
responsible to and who they are responsible for. It is a knowledge-base for the
organization, and should be available for reference whenever needed. The
operations manual is a document that should be periodically reviewed and
updated whenever appropriate to ensure that it remains current
The franchise agreement and operations manual typically prescribe mandatory
specifications, standards and operating procedures relating to the franchisee's
facility, equipment, signs, maintenance, decor, supplies, personnel (e.g., training,
appearance, uniforms or type of dress); products and services offered; permitted
sources of supply (e.g., specifications and designated or approved suppliers);
bookkeeping, record keeping and reporting; business hours; and many other
aspects of the franchisee's business. These specifications, standards and
operating procedures ("system standards") are subject to change when required in
the judgment of the franchisor. Failure to comply with one or more of such
obligations, after notice, is generally sufficient legal grounds for termination of the
franchise. Franchisors have other means to motivate franchisee compliance, such
as offering additional franchises, new product and service opportunities and
renewal to those franchisees whose compliance record is good. There are, of
course, limits on the right of a franchisor to require franchisees to comply with
modified system standards. If such modifications will require a substantial capital
investment by the franchisee, materially increase its costs of operation or
otherwise significantly impact on the profitability of its business, and the franchisee
has not expressly agreed to such modifications in its franchise agreement, they
may be legally or practically unenforceable.

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.

Responsibilities of Each Party in a Distributorship


Most commonly, the manufacturer does not dictate how the product purchased
should be distributed. However, occasions arise where the manufacturer will offer
an agent training in order to use the product. The exact conditions and
responsibilities of each party are outlined in the distributorship agreement.

Distributorship and Liability


Even though the distributor is not responsible for manufacturing a product, it can
be held liable in the event of defects. Under strict product liability laws, the seller,
distributor, and manufacturer of a defective product can be held liable if a person
is injured due to the defect. Though manufacturers are typically most responsible
since they created the product, the liability can also fall to those that distribute or
sell the defective items.
This liability law prevents the plaintiff from the need to prove the chain of supply.
In order for any entity in the line of distribution to prove it has no fault, it would
need to show which entity is actually responsible for the defect.
In order to prove product liability, the plaintiff must prove:
 The product was sold with the defect
 The seller intended to provide the buyer with the product without making
changes
 The plaintiff suffered injuries due to the defective product

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.

Cooperatives have some of the advantages of franchise networks (e.g., the


acquisition of capital for the development or expansion of retail outlets), though
they may not be able to police system standards as well as franchisors and
generally do not furnish as much service. In certain franchise networks, the
franchisees were established business owners when they elected to join the
network. Real estate brokerage franchises are the best known example (e.g.,
Century 21, Re/Max and Coldwell Banker), but this type of franchising, known as
conversion or affiliation franchising, has been utilized or attempted by insurance
brokers, banks, painters, used car dealers, accountants, home remodelers, repair
services, medical professionals and other businesses. Cooperative systems might
have been adopted by these businesses as a form of organization. There have
been press reports of retailers of common products or services forming
cooperative associations for advertising and the purchase of goods and services.
The extent and permanence of such cooperative associations is unclear. The
substantial increase in the incidence of franchisee associations and advisory
councils, and the expanded role of such franchisee organizations in the planning
and operation of franchise networks, has somewhat narrowed the differences in
the operations of franchise networks and cooperatives. Franchisees have no
control over their franchisor by means of ownership, but in a growing number of
franchise networks the franchisees are gaining considerable influence, with
respect to both current operations (e.g., in advertising programs) and long term
planning, through associations and advisory councils.

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

6. Recommended learning materials and resources for supplementary


reading.
www.worldfranchising.com
www.franchise.org
https://www.fasa.co.za/understanding-the-business-format-of-franchising/
https://www.investopedia.com/terms/r/royalty.asp
https://en.wikipedia.org/wiki/Operations_manual
https://en.wikipedia.org/wiki/Joint_venture
7. Flexible Teaching Learning Modality (FTLM) adopted
 Online (synchronous): Sedi, FB Messenger, Google Meet. Google
Classroom, Edmodo
 Remote (asynchronous): Module

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?

9. References (at least 3 references preferably copyrighted within the last


5 years, alphabetically arranged)
Beshel, B. (2001) An Introduction to Franchising, New Yok Avenue Law Suite 900,
Washington DC: IFA Educational Foundation
Boroian, D.(2008) Franchising your Business, 20200 Governor’s Drive, Olympia
Fields IL, USA: Francorp , Inc.
Manasco, J. et al.(1993) How to Buy and Manage a Franchise, Rockfeller Center
1230 Avenue of the Americas, New York, New York: Francorp, Inc.
Murray, I. (2006) The Franchising Handbook: Cambrian Printers Ltd, Aberystwyth,
Wales

ISUE__ __ Syl ___


Revision: 01
Effectivity: September 1, 2020

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