Franchising

A continuing relationship in which a franchisor provides a licensed privilege to the

franchisee to do business and offers assistance in organizing, training,
merchandising, marketing and managing in return for a monetary consideration.

Types of Franchises

There are three major types of franchises – business format, product, and
manufacturing – and each operates in a different way.

 A business format franchise is a franchising arrangement where the

franchisor provides the franchisee with an established business, including
name and trademark, for the franchisee to run independently.
 A product franchise is a franchising agreement where manufacturers allow
retailers to distribute products and use names and trademarks.
 A manufacturing franchise is a franchising agreement where the franchisor
allows a manufacturer to produce and sell products using its name and
trademark.

Types of Franchises

While there are many ways to differentiate between different types of franchises
(size, geographic location, etc), we will be looking at how different franchisors
allow franchisees to use their name. On this basis, there are three different types of
franchise:

 Business format franchises

 Product franchises
 Manufacturing franchises

Business Format Franchises

In business format franchises (which are the most common type), a company
expands by supplying independent business owners with an established business,
including its name and trademark. The franchiser company generally assists the
independent owners considerably in launching and running their businesses. In
return, the business owners pay fees and royalties. In most cases, the franchisee
also buys supplies from the franchiser. Fast food restaurants are good examples of
this type of franchise. Prominent examples include McDonalds, Burger King, and
Pizza Hut. McDonalds: McDonalds is perhaps the most famous franchise in the
world.

Product Franchises

With product franchises, manufactures control how retail stores distribute their
products. Through this kind of agreement, manufacturers allow retailers to
distribute their products and to use their names and trademarks. To obtain these
rights, store owners must pay fees or buy a minimum amount of products. Tire
stores, for example, operate under this kind of franchise agreement.

Manufacturing Franchises

Through manufacturing franchises, a franchiser grants a manufacturer the right to

produce and sell goods using its name and trademark. This type of franchise is
common among food and beverage companies. For example, soft drink bottlers
often obtain franchise rights from soft drink companies to produce, bottle, and
distribute soft drinks. The major soft drink companies also sell the supplies to the
regional manufacturing franchises. In the case of Coca Cola, for example, Coca
Cola sells the syrup concentrate to a bottling company, who mixes these
ingredients with water and bottles the product, and sells it on.

Ten advantages of franchising

 The risk of business failure is reduced by franchising. Your business is

based on a proven idea. You can check how successful other franchises are
before committing yourself.
 Products and services will have already established a market share.
Therefore there will be no need for market testing.
 You can use a recognised brand name and trade mark. You benefit from
any advertising or promotion by the owner of the franchise - the 'franchisor'.
 The franchisor gives you support - usually as a complete package including
training, help setting up the business, a manual telling you how to run the
business and ongoing advice.
 No prior experience is needed as the training received from the franchisor
should ensure the franchisee establishes the skills required to operate the
franchise.
 A franchise enables a small business to compete with big businesses, more
so than an independent small business, due to the pool of support from the
franchisor and network of other franchisees.
  You usually have exclusive rights in your territory. The franchisor won't
sell any other franchises in the same territory.
 Financing the business may be easier. Banks are sometimes more likely to
lend money to buy a franchise with a good reputation.
 You can benefit from communicating and sharing ideas with, and receiving
support from, other franchisees in the network.
 Relationships with suppliers have already been established.

Eight disadvantages of franchising

 Costs may be higher than you expect. As well as the initial costs of buying
the franchise, you pay continuing management service fees and you may
have to agree to buy products from the franchisor.
 The franchise agreement usually includes restrictions on how you can run
the business. You might not be able to make changes to suit your local
market.
 You may find that after time ongoing franchisor monitoring becomes
intrusive
 The franchisor might go out of business.
 Other franchisees could give the brand a bad reputation, so the recruitment
process needs to be thorough
 You may find it difficult to sell your franchise - you can only sell it to
someone approved by the franchisor.
 All profits (a percentage of sales) are usually shared with the franchisor.
 The inflexible nature of a franchise may restrict your ability to introduce
changes to the business to respond to the market or make the business grow.

Extra for reference & reading

Advantages of Franchises

A franchise agreement can have many benefits for both the franchisor and the
franchisee.

 Benefits to the franchisor include regular royalty payments, expansion with

reduced financial risk, and a greater geographical presence.
 Franchisee benefits include lower risk, lower startup costs, existing brand
recognition, and parent company marketing support.
 Potential franchisees can select a franchise based on their location, interests,
resources, and needs, which means that entering into a franchising
arrangement can be a flexible process.
  – Royalty payments
 Franchisee benefits include:
 – Higher chance of success due to tried and tested business model
 – Franchisor support, training and expertise
 – Brand recognition and national marketing

Benefits for the Franchisor

Franchisors benefit from franchise agreements because they allow companies to

expand much more quickly than they could otherwise. A lack of funds and workers
can cause a company to grow slowly. Through franchising, a company invests very
little capital or labor because the franchisee supplies both. The parent company
experiences rapid growth with little financial risk.

A company can also ensure it has competent and highly motivated owners and
managers at each outlet through franchising. Since the owners are largely
responsible for the success of their outlets, they will put in a strong and constant
effort to make sure their businesses run smoothly and prosper. In addition,
companies are able to provide franchising rights to only qualified people.

Other benefits include:

 Franchising allows a business to have an international presence.

 Franchisors can experience economies of scale.
 Franchisors can benefit from growth without worrying about running costs.
 Franchisors receive royalty payments that are set as a percentage of profits.

Benefits for the Franchisee

The franchisee also has numerous advantages that come from entering a
franchising agreement, including:

– There is a low risk due to the tried and tested formula. Buying a franchise
business provides a higher chance for success. They get the benefit of owning a
proven business formula that has been tested and shown to work well in other
locations. In addition, they receive the support from the main company toward
establishing the business, and the training to operate it successfully.

– There are lower start-up costs since the business idea was already developed.
– They are buying a name and brand that is recognized by the public. So they have
a big advantage over starting a business from scratch, as they already have an
established customer base.

– A franchise gives more security from the beginning. New independent businesses
are known to have as high as a 90% failure rate, often causing the business owner
heavy losses and at times bankruptcy.

– When you start a business from scratch, you spend huge amounts of time trying
to operate the business without being successful because you may not have the
necessary skills for that particular area. When you purchase a franchise, all the
necessary groundwork has been done already. In addition, the franchisee gets
training and head office support from the franchisor; this may be essential if the
franchisee is new to running a business and has no experience or business
knowledge.

– The franchisee gets the support of national marketing which a small business
would not normally be able to afford. In some cases of larger brands, they may
have customers waiting for their doors to open (for example in a new McDonalds).

– Since all the product selection and the marketing have been already developed,
you simply have to take care of the daily operations of the business. Your goal will
be to grow from an established foundation and expand from there.

– The new franchise owner gains many benefits from the association with the main
franchise company. The franchisor offers a great deal of business experience that
would take years for the average business person to acquire.

– There are a lot of part-time franchising opportunities, which are perfect if

someone has a small amount to invest and wants to support themselves and
maintain their investment. They may be able to sell the franchise to someone else
once they no longer wish to run it.

Disadvantages of Franchises

A franchise agreement can also have disadvantages for both the franchisor and the
franchisee.

 Disadvantages to franchisors include a lack of control over franchisees,

reputational risks, and slow growth through franchising compared to
mergers and acquisitions.
  Disadvantages to franchisees include high costs and royalty payments, strict
product rules, and other start up challenges.
 Entering into an agreement with an interested franchisor is important.
Uninterested franchisors will not provide adequate support, and are only
interested in collecting fees and payments from franchisees.
 Franchisee disadvantages may include:
 – High entry costs, which include fees and start-up capital, and ongoing
royalty fees
 – Lack of support from uninterested franchisors
 – Lack of flexibility in how to trade, as well as where to locate

Disadvantages to the Franchisor:

Of course, no business arrangement is without potential risks and disadvantages.

While there are many advantages for the franchisor in entering a franchising
agreement, some of the potential risks are:

– Difficult to control activities of franchisees: In any franchise agreement

(particularly when there is geographical separation between the franchisor and the
franchisee), it can be difficult to control the activities of the franchisee and ensure
that their activities are up to standard.

– Huge risk in reputation by allowing other businesses to use their names: if a

franchisee does not live up to the quality standards of the franchisor (cleanliness,
customer service, pricing, quality of product, etc.), this can have a negative
reputational effect not just on the franchisee, but on the broader reputation of the
franchisor as well. Thus, there is a risk in allowing others not directly connected to
the business to use the business name and trademark.

– Not as quick a method of growth as mergers or acquisitions: M&A allows

companies to expand very rapidly, whereas entering into franchising agreements
means that the franchisor enters agreements with numerous individuals over time,
and has to wait for them to start up and begin operations (instead of taking over
existing operations). This method of expansion can be slow.

Disadvantages to the Franchisee

– High entry and ongoing cost: It can be more expensive to start a franchise than
an independent business. You can open your own burger bar for the fraction of the
cost of buying the rights to a McDonald’s franchise. Thus, franchising is often an
option open only to already wealthy businessmen.
– Franchisees have to pay a significant percentage of their revenues to the
franchisor: On top of the upfront money needed to start a franchise, the franchisee
must pay fees and royalties to the franchisor. The franchise fee may range
anywhere from $5,000 to over $1 million and hence can be a major expenditure for
the franchisee. Royalties are paid periodically during the life of the franchise
agreement. They are either a percentage of an outlet’s gross income—usually
under 10 percent of an outlet’s gross income—or a fixed fee.

– Other franchise costs: In addition to royalties and payments, the franchisee may
be required to buy certain items from the franchisor like computer systems and
software.

– Uninterested franchisors: Some franchisors may have little interest in their

franchisee’s success and may be more interested in just collecting the fees
associated with the franchise. Thus, support and marketing may not be adequately
provided.

– Strict product rules: Franchisees experience less flexibility to use their own
initiative due to restraints from the franchisor. Franchisees can only sell the
products of the franchise, and they may be tied into a national brand with a strict
set of instructions about how they should trade.

– Start up challenges: The franchisee may have to find or build the right location,
hire and train staff and install equipment. This may be difficult for someone with
limited business skills just starting out.
Outsourcing:
Outsourcing (also sometimes referred to as "contracting out") is a business practice
used by companies to reduce costs or improve efficiency by shifting tasks,
operations, jobs or processes to an external contracted third party for a significant
period of time. The functions that are contracted out can be performed by the third
party either onsite or offsite of the business.

Benefits of Outsourcing

 Outsourcing can free up cash, personnel, facilities and time resources for a
company.
 It can result in cost savings from lower labor costs, taxes, energy costs and
reductions in the cost of production.
 In addition to cost savings, a company may also employ an outsourcing
strategy in order to focus on its core business competencies. This allows the
company to devote more resources to what it does well, which can improve
efficiency and increase its competitiveness. Production can be streamlined
and production time shortened while reducing operational costs.
 Those non-core functions that are outsourced will usually go to outside
organizations for whom that function is a core business competency, further
benefiting the business through the improved management of those
functions.
 A company may also choose to outsource in order to avoid government
regulations or mandates, such as environmental regulations or safety
regulations and requirements.

Disadvantages of Outsourcing

 While outsourcing has many advantages, it also presents some

disadvantages. The relationship with the third party that takes on the
outsourced functions must be managed. This includes the negotiating and
signing of contracts, which requires time and the involvement of a
company's legal counsel, as well as the day-to-day communication with and
oversight of the outsourced work.
 Security is an important factor in outsourcing. The relationship will
inevitably involve the third party organization's access to sensitive business
data, trade secrets and other confidential information that is necessary for it
to perform its contracted function.
 There may also be some negative public relations impacts for a company
when outsourcing results in the loss of a large number of jobs.