CHAPTER 15
Franchising

What Is Franchising and How Does It Work?

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 other businesses (franchisees) in exchange for an initial franchise fee and an ongoing royalty.

What Is Franchising?

The word franchise comes from an old dialect of French and means “privilege” or “freedom.” Franchising has a long history.  In the Middle Ages kings and lords granted franchises to specific individuals or groups to hunt on their land or to conduct certain forms of commerce. In the 1840s, breweries in Germany granted franchises to certain taverns to be the exclusive distributors of their beer for the region. Shortly after the U.S. Civil War, the Singer Sewing Machine Company began granting distribution franchises for its sewing machines and pioneered the use of written franchise agreements. Many of the most familiar franchises in the United States, including Kentucky Fried Chicken (1952), McDonald’s (1955), Burger King (1955).

How Does Franchising Work?

There is nothing magical about franchising. It is a form of growth that allows a business to get its products or services to market through the efforts of business partners or “franchisees.” As described previously, a franchise is an agreement between a franchisor (the parent company, such as Uptown Cheapskate or Comfort Keepers) and a franchisee (an individual or firm that is willing to pay the franchisor a fee for the right to sell its product, service, and/or business method).

Establishing a Franchise System

Establishing a franchise system should be approached carefully and deliberately. An entrepreneur should also be aware that over the years a number of fraudulent franchise organizations have come and gone and left financially ruined franchisees in their wake. Because of this, franchising is fairly heavily regulated.

When to Franchise

Retail firms grow when two things happen: first, when the attractiveness of a firm’s products or services become well known, whether it is a new restaurant or a fitness center, and, second, when a firm has the financial capability to build the outlets needed to satisfy the demand for its products or services.

Steps to Franchising a Business

Let’s assume that as an entrepreneur you have decided to use franchising as a means of growing your venture. What steps should you take to develop a franchise system?

Advantages and Disadvantages of Establishing a Franchise System

There are two primary advantages to franchising. First, early in the life of an organization, capital is typically scarce, and rapid growth is needed to achieve brand recognition and economies of scale. Franchising helps a venture grow quickly because franchisees provide the majority of the capital. Second, a concept called agency theories argues that for organizations with multiple units (such as restaurant chains), it is more effective for the units to be run by franchisees than by managers who run company-owned stores. The primary disadvantage of franchising is that an organization allows others to profit from its trademark and business model.

Buying a Franchise

Now let’s look at franchising from the franchisee’s perspective. 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 well aware that it is often legally and financially difficult to exit a franchise relationship.

The Cost of a Franchise

The initial cost of a business format franchise varies, depending on the franchise fee, the capital needed to start the business, and the strength of the franchisor. When evaluating the cost of a franchise, prospective franchisees should consider all the costs involved. Franchisors are required by law to disclose all their costs in a document called the Franchise Disclosure Document and send it to the franchisee.

Advantages and Disadvantages of Buying a Franchise

There are two primary advantages to buying a franchise over other forms of business ownership. First, franchising provides an entrepreneur the opportunity to own a business using a tested and refined business model. Second, when an individual purchase a franchise, the franchisor typically provides training, technical expertise, and other forms of support.

Steps in Purchasing a Franchise

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