The Basics Of Franchising

By: Eddy Goldberg

Franchising is a business model that combines the best aspects of sole proprietorship and
Corporate America. It can be described as a hybrid model that fills the gap bet!een !or"ing for
somebody else #!hether a large corporation or a small business$ and !or"ing for yourself.
Franchising is not an industry in itself. %ather& it's a !ay of doing business that can be applied in
almost any sector. Today about (&))) established franchise brands operate in nearly *+) different
lines of business in the ,.-.
Franchising has t!o main forms. In product.trade name franchising& a franchisor o!ns the right to a
name or trademar" and sells or licenses the right to use that name or trademar". Business format
franchising& the type discussed here& in/ol/es a more comple0 relationship in !hich the franchisor
pro/ides franchisees !ith a full range of ser/ices and support& and franchisees sign an agreement
to conduct operations in conformity !ith specific rules laid out by the franchisor.
According to the International Franchise Association& Franchising is a method of distributing
products or ser/ices. At least t!o le/els of people are in/ol/ed in a franchise system: 1$ the
franchisor& !ho lends his trademar" or trade name and a business system2 and *$ the franchisee&
!ho pays a royalty and often an initial fee for the right to do business under the franchisor's name
and system.
Franchising is a team effort. For any franchisor to succeed& the /ast ma3ority of its franchisees #all&
ideally$ must operate profitable indi/idual franchise units o/er the long term. A brand's success
depends on an ongoing partnership bet!een franchisor and franchisee. One of the most common
sayings in franchising is: Franchising means !or"ing for yourself& but not by yourself.
For many& franchising's greatest appeal is the opportunity for an indi/idual to control their destiny
and secure their future. In its earlier days& franchising !as a !ay for an independent4minded
business person to buy a 3ob 4 a sand!ich shop or a home repair ser/ice& for e0ample& and
sho!ing up e/ery day as a hands4on operator.
In recent years& the franchise model has caught on as an attracti/e business opportunity for
!ealthier indi/iduals and in/estors !ho buy many units at once2 or !ho buy the rights to de/elop a
geographical area or territory and de/elop a certain number of units !ithin a specified timeframe.
These multi4unit o!ners& area de/elopers& or area representati/es #some of !hom also recruit ne!
franchisees and support them !ithin their territory$ are part of a gro!ing trend in franchising& and
account for about +) percent of all franchised units in the ,.-. today.
5ulti4brand franchisees are also on the rise. These franchisees operate different brands under a
single organi6ation& creating efficiencies& economies of scale& and mar"et penetration to increase
sales and profitability. The primary reasons successful franchisees see" additional brands are 1$
they ha/e built out their territory for their current brand& and.or *$ they are see"ing a ne!&
complementary brand to smooth out the ups and do!ns of business or seasonal cycles.
Franchisors& too& are combining se/eral different brands under one roof& and fre7uently offer
discounts to current franchisees !ho ta"e on a second #or third$ brand.
Co4branding& in !hich a franchisee operates t!o brands from the same location& is another
recent trend. Co4branding sa/es on real estate or leasing costs& allo!ing more profit per s7uare
foot and often balancing out day parts #brea"fast& lunch& dinner$. An increasing number of
franchisors no! offer se/eral different brands& and often pro/ide incenti/es to franchisees to co4
brand.
5uch of !hat prospecti/e franchisees are see"ing to buy in a franchise brand is peace of mind.
They !ant to "no!& !ith as much certainty as possible& that if: 1$ the franchise opportunity is
presented accurately and realistically by the franchisor2 *$ they ta"e the time to perform due
diligence by spea"ing !ith current franchisees& reading the Franchise 8isclosure 8ocument #F88$
carefully !ith the aid of an e0perienced franchise attorney2 ($ after comparing the brand and sector
under consideration !ith the competition #franchised or not$2 then 9$ their chances of ma"ing
money and building a successful business are better than if they started a business from scratch.
:et for many aspiring entrepreneurs loo"ing at the franchise business model for the first time 4
especially those coming from a corporate bac"ground 4 the business proposition can seem
ludicrous: "Why should I pay tens of thousands of dollars before I even start, and then 8 or 10
percent off the top every month for 10 or 15 years?"
For those !ho in/estigate further& the ans!er is clear: they can ma"e more money faster through
franchising than on their o!n2 and they reali6e the potential for a greater long4term return on their
in/estment as !ell 44 despite paying an up4front franchise fee and a percentage each month of
gross sales for royalties and a company4!ide ad/ertising.mar"eting fund. Franchise fees range
from a fe! thousand dollars to tens of thousands& depending on the concept& !hile royalties
generally run + to ; percent and the mar"eting.ad/ertising fund an additional 1 to ( percent.
<egally& franchisees do not o!n the franchise they buy. They are granted& or a!arded& a license
that gi/es them the right to operate and manage their franchise business. =o!e/er& franchisees do
o!n the assets of their company& and as long as they adhere to the franchise agreement ha/e
specific rights under state and federal la!. Franchisees can form franchisee associations that can
participate in corporate decision4ma"ing if the franchisor is amenable& or band together to oppose
decisions they see as detrimental to their operation and the brand in general
Franchiser 4 franchise > franchisee >
Trainer > trainee
Employee
?resentee
1. Why franchise?
Businesses franchise for different reasons, not all of which are apparent in advance, and which may change in their relative importance over time as the
business develops
.
1.1 To accelerate growth and increase market share
Franchising can provide a business with opportunities to open in markets not previously accessible. As a method of growth, franchising has the potential to
facilitate rapid expansion into new markets that would otherwise be difficult or impossible to access under the constraints of a corporate model.
Not only does this provide growth, but it also enhances first mover advantage that uniue window of opportunity to secure a following for a brand and its
services and products before the inevitable arrival of !me"too! competitors.
#n the race to dominate a niche, franchising $when done well% may provide the necessary boost to create new market or reinvent an old one. &he
involvement of engaged and motivated local market specialists $ie. franchisees% can maximise the penetration and potential of a brand.
1.2 To increase outlet efficiency
'ven with exceptional operating systems and processes for recognising and rewarding outstanding performance, outlets owned and operated by a
corporate chain are unlikely to meet the levels of performance that can be achieved through a franchised operation.
Franchisees are strongly profit motivated more so than any employee with responsibilities for managing an outlet, irrespective of how strong his or her
profit share incentive might be.
Because franchisees have their own money invested in the business $unlike an employee%, they choose to be profit focussed because their true reward
from the business is the profits that they make, as well as the capitalised value of those profits when the business is sold.
For this reason, franchisees are likely to work longer, harder and more diligently to make their businesses profitable. &hey see the rewards from building
sales, reducing costs, and eliminating waste. By following the franchise system and applying their labour, capital and commitment, franchisees can achieve
significantly better outcomes at store level than company"owned chains.
1.3 To overcome capital constraints
A ma(or barrier to the growth of any business is the ability to fund growth. #f a business owner is incapable of or unwilling to raise debt or sell euity in the
business, then franchising may be the only option for growth without fundamentally changing the business model.
Not only do franchisees contribute their own capital to open additional outlets under the franchisor)s brand and business model, they also bring a focus and
commitment which should far exceed that of employed staff. #t follows that where both a financial and emotional investment have been made in a brand,
that franchisees will work more diligently than employees to get a return on that investment.
1.4 People ask to uy a franchise
&he first three reasons for franchising a business are all relatively proactive, however businesses may be prompted to go into franchising because of
repeated reuests from customers and other brand advocates to buy a franchise. &his is a reactive reason for going into franchising, and may lead to a
failure to consider alternative means of growth, an inaccurate assessment of the speed of growth that may be provided, and the premature expansion of a
business model that may not yet be robust enough to deliver adeuate returns to all stakeholders.
2. When should a usiness franchise?
2.1 !ollowing proof of concept
'ntrepreneurs are often impatient and keen to grow their businesses uickly. Franchising can be seen as the means for doing this, but it is essential to first
prove that the specific concept to be franchised will actually work. For example, it is not enough to assume that a coffee shop franchise will work simply
because there are many other existing coffee shop franchises. *ompetition in any market segment can create barriers to entry that may be impossible to
overcome. +hat must be proven is that the specific type of coffee shop concept will prosper in a highly competitive market by being sufficiently uniue and
distinctive. ,roving that a concept is viable reuires patience and a commitment to change if part or all of the concept is unsuited for its target market. #n
general, this may involve operating outlets in multiple locations over a reasonable period of time $up to several years% to prove that the concept is viable.
2.2 "fter consideration of alternative methods of growth
Franchising is not the only method of growing a business and may not always be the most appropriate growth method, depending on the business owner)s
ob(ectives. *reating a franchise network as a stand"alone sales channel for a business) goods or services potential ignores other sales channels which may
already exist, and which may provide a faster and more comprehensive method of reaching the target market.
Alternative sales channels might include distribution via an established network, direct to consumers via mail order and the internet, or the licensed
production or sale of the goods or services by third parties. 'ach of these growth methods has their own limitations, and may not provide the full brand
experience that may be an important part of the relationship with the target market.
2.3 #nce outlets are profitale after allowing for fees
Assuming that the business to be franchised has been established in more than one outlet as it seeks to establish proof of concept, it must further be
established that the individual outlets are capable of generating profits after franchise royalties have been taken into account.
For example, a business that returns a profit of -./ of turnover will no longer be profitable if it has to pay franchise royalties of -./ of turnover. #n
preparing a business for franchising, the potential franchisor must carefully assess the costs of supporting franchisees in determining their franchise
royalties, and set the royalties at such a level that there is sufficient profitability in the business for a franchisee to get an acceptable return on their
investment.
3. $ow should a usiness e franchised?
3.1 Through education aout franchising
&he first thing a business owner should do is to learn about franchising. 0any books have been written about franchising $including some written by the
founders of very successful franchise brands% which provide valuable lessons and insights. &here are also a number of formal and informal education
seminars, workshops and courses available.

3.3 Through advice from suitaly %ualified and e&perienced advisors
&he process of franchising a business is one which usually reuires external guidance, advice and support. &hrough a lack of education, excess
enthusiasm and unnecessary haste, entrepreneurs may choose inexperienced or unualified advisors, and fail to appreciate the difference between good
and bad advice until problems occur $and in some cases, very early in the process%.
'ntrepreneurs should seek to deal only with franchise consultants, lawyers and accountants with proper credentials, ualifications and experience in the
sector, and who committed to upholding the highest professional standards in their service to clients.
Franchising a business is possible, but not always viable. &his article has outlined some key factors to consider along the way. 'ntrepreneurs considering
franchising their businesses should heed these points and explore each in greater depth.
Jason Gehrke is a director of the
Franchise Advisory Centre
and has been involved in franchising for 20 years at
franchisee, franchisor and advisor level. He provides consulting services to both franchisors and franchisees,
and conducts
franchise education programs
throughout Australia. He has been awarded for his franchise
achievements, and publishes
Franchise News & Events
, Australias only fortnightly electronic news bulletin on
franchising issues