Chapter 15

Franchising
Bruce R. Barringer
R. Duane Ireland

©2010 Pearson Education 15-1

 Chapter Objectives
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1. Explain franchising and how it differs from other

forms of business ownership.
2. Describe the difference between a product and
trademark franchise and a business format
franchise.
3. Explain the differences among an individual
franchise agreement, an area franchise agreement,
and a master franchise agreement.
4. Describe the advantages of establishing a franchise
system as a means of firm growth.
©2010 Pearson Education 6-2
 Chapter Objectives
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5. Identify the rules of thumb for determining when

franchising is an appropriate form of growth for a
particular business.
6. Discuss the factors to consider in determining if
owning a franchise is a good fit for a particular
person.
7. Identify the costs associated with buying a
franchise.
8. Discuss the advantages and disadvantages of buying
a franchise.
©2010 Pearson Education 15-3
 Chapter Objectives
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9. Identify the common mistakes franchise buyers

make.
10. Describe the purpose of the Franchise Disclosure
Document.

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 Introduction to Franchising

• Introduction
– Franchising is growing in popularity.
– Nearly 910,000 franchise outlets operate in the U.S.
– Franchises account for 1/3 of all retail sales in the U.S.
• History
– The word “franchise” comes from an old dialect of French
and means privilege or freedom.
– Many of the most popular franchises, including KFC
(1952), McDonald’s (1955), and H&R Block (1958) started
as early as the 1950s.

©2010 Pearson Education 15-5

 What is Franchising?

• 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 another business or individual (franchisee) in
exchange for a franchise fee and an ongoing royalty
payment.
– Some franchisors are established firms (like McDonald’s)
while others are first-time enterprises being launched by
entrepreneurs.

©2010 Pearson Education 15-6

 Two Types of Franchise Systems
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• 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.
– This approach typically connects a single manufacturer
with a network of dealers or distributors.
• For example, General Motors has established a network of dealers
that sell GM cars and use the GM trademark in their advertising
and promotions.
• Other examples of product and trademark franchisors include
agricultural machinery dealers, soft drink bottlers, and beer
distributorships.

©2010 Pearson Education 15-7

 Two Types of Franchise Systems
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• Business Format Franchise

– An arrangement under which the franchisor provides a
formula for doing business to the franchisee along with
training, advertising, and other forms of assistance.
– Fast-food restaurants, convenience stores, and motels are
well-known examples of business format franchises.
• Business format franchises are by far the most popular form of
franchising, particularly for entrepreneurial firms.

©2010 Pearson Education 15-8

 Two Types of Franchise Systems
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• Panera Bread is an example

of a business format franchise.
• Panera provides its franchisees
a strong brand and a method
for doing business.
• In return, each franchisee must
pay an initial franchise fee and
ongoing royalties.

©2010 Pearson Education 15-9

 Types of Franchise Agreements
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Individual Franchise Agreement

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 Types of Franchise Agreements
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Area Franchise Agreement

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 Types of Franchise Agreements
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Master Franchise Agreement

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 When to Franchise
From the Franchisor’s Point of View
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• Approach Franchising With Caution and Care

– Establishing a franchise system should be approached
carefully and deliberately.
– Franchising is a complicated business endeavor, and an
entrepreneur must look closely at all its aspects before
deciding to franchise.
• Regulations
– An entrepreneur should also be aware that over the years a
number of fraudulent franchise organizations have come and
gone and have left financially ruined franchise owners behind.

©2010 Pearson Education 15-13

 When to Franchise?
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• When Is Franchising Most Appropriate?

– Franchising is most appropriate when a firm has a strong or
potentially strong trademark, a well-designed business
method, and a desire to grow.
– A franchise system will ultimately fail if the franchisee’s
brand doesn’t add value for customers and its business
method is flawed or poorly developed.

©2010 Pearson Education 15-14

 Steps to Franchising a Business

©2010 Pearson Education 15-15

 Qualities for Look for in Prospective
Franchisees

• Good work ethic.

• Ability to follow instructions.
• Ability to operate with minimal supervision.
• Team oriented.
• Experience in the industry in which the franchise competes.
• Adequate financial resources and good credit history.
• Ability to make suggestions without becoming upset if the
suggestions are not adopted.
• Represents the franchisor in a positive manner.

©2010 Pearson Education 15-16

 Ways Franchisors Can Develop the
Potential of Their Franchisees

• Provide mentoring that supersedes routing training.

• Keep operating manuals up-to-date.
• Keep product, services, and business systems up-to-date.
• Solicit input from franchisees to reinforce their importance in
the larger franchise system.
• Encourage franchisees to develop a franchise association.
• Maintain the franchise system’s integrity.

©2010 Pearson Education 15-17

Advantages and Disadvantages of Franchising
As a Method of Business Expansion
Advantages Disadvantages

• Rapid, low-cost market expansion. • Profit sharing.

• Income from franchise fees and • Loss of control.
royalties.
• Friction with franchisees.
• Franchisee motivation.
• Managing growth.
• Access to ideas and suggestions.
• Differences in required business skills.
• Cost savings.
• Legal expenses.
• Increased buying power.

©2010 Pearson Education 15-18

 Buying a Franchise
From the Franchisee’s Point of View
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• Buying a Franchise
– Purchasing a franchise is an important business decision
involving a substantial financial commitment.
– Potential franchise owners should strive to be as well
informed as possible before purchasing a franchise and
should be aware that it is often legally and financially
difficult to exit a franchise relationship.

©2010 Pearson Education 15-19

 Buying a Franchise
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Answering the following questions will help

determine if franchising is right for you

• Are you willing to take orders? Franchises are typically

very particular about how outlets operate.
• Are you willing to be part of a franchise “system” rather
than an independent businessperson?
• How will you react if you make a suggestion to your
franchisor and your suggestion is rejected?
• What are you looking for in a business? How hard do you
want to work?

©2010 Pearson Education 15-20

 Buying a Franchise
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Answering the following questions will help

determine if franchising is right for you

• How willing are you to put your money at risk?

• How will you feel if your business is operating at a net
loss but you will have to pay royalties on your gross
income?

©2010 Pearson Education 15-21

The Costs Involved With Buying a Franchise
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• Initial Franchise Fee

– The initial fee varies depending on the franchisor.
• Capital Requirements
– The costs vary but may include the cost of buying real estate,
the cost of putting up a building, the purchase of inventory,
and the cost of obtaining a business license.
• Continuing Royalty Payment
– Typically 3% to 7% of monthly gross income.

©2010 Pearson Education 15-22

The Costs Involved With Buying a Franchise
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• Advertising Fees
– Franchisees are often required to pay into a national or
regional advertising fund.
• Other Fees
– Other fees may be charged for various activities, including:
• Training additional staff.
• Providing management expertise when needed.
• Providing computer assistance.
• Providing a host of other items or support services.

©2010 Pearson Education 15-23

 The Costs Involved With Buying a Franchise
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Initial Costs to the Franchisee of a Sample of Franchise Organizations

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 Advantages and Disadvantages of Buying a
Franchise
Advantages Disadvantages

• A proven product or service within • Cost of the franchise.

an established market. • Restrictions on creativity.
• An established trademark or • Duration and nature of commitment.
business system.
• Risk of fraud, misunderstandings, or
• Franchisor’s training, technical
lack of franchisor commitment.
support, and managerial expertise.
• Poor performance on the part of other
• An established marketing network.
franchisees.
• Availability of financing (varies).
• Potential for failure.
• Potential for business growth.

©2010 Pearson Education 15-25

 Steps in Purchasing a Franchise

©2010 Pearson Education 15-26

 Watch Out! Common Misconceptions
About Franchising

• Franchising is a safe investment.

• A strong industry ensures franchise success.
• A franchise is a “proven” business system.
• There is no need to hire a franchise attorney or an accountant.
• The best systems grow rapidly and it is best to be part of a rapid-growth
system.
• I can operate my franchise outlet for less than the franchisor predicts.
• The franchisor is a nice person—he’ll help me out if I need it.

©2010 Pearson Education 15-27

Legal Aspects of the Franchise Relationship

• Federal Rules and Regulations

– The offer and sale of a franchise is regulated at the federal
level.
• According to Federal Trade Commission (FTC) rule 436,
franchisors must furnish potential franchisees with written
disclosures that provides 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 Franchisor 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.

©2010 Pearson Education 15-28

 More About Franchising
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• Franchise Ethics
– The majority of franchisors and franchisees are highly
ethical.
– There are certain features of franchising, however, the
make it subject to ethical abuse. These features are as
follows:
• The get rich quick mentality.
• The false assumption that buying a franchise is a guarantee of
business success.
• Conflicts of interest between franchisors and franchisees.

©2010 Pearson Education 15-29

 More About Franchising
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• International Franchising
– International opportunities for franchising are becoming
more prevalent for the following two reasons:
• The markets for certain franchised products in the U.S. have
become saturated (i.e., fast food).
• The trend towards globalization continues.
– Steps to take before buying a franchise overseas:
• Consider the value of the franchisor’s name in the foreign country.
• Get a good lawyer.
• Determine whether the product or service is salable in the foreign
country.
• Find out how much training and support you will receive from the
franchisor.

©2010 Pearson Education 15-30

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©2010 Pearson Education