Lecture Notes _9_ Pricing_Estimating

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250-387 Entrepreneurship Lecture 11 10/30/01

Franchising: Where and How Being a franchisee and being an entrepreneur are not necessarily the same thing. Franchising - a business opportunity by which the owner, producer, or distributor (franchiser) of a service or trademarked product grants exclusive rights to an individual (franchisee) for the local distribution of the product or service, and in return receives a payment or royalty and conformance to quality standards. The choice of becoming a franchisee should revolve around two questions 1. Is risk sufficiently mitigated by the trademark value, operating system, economies of scale, and support process of the franchise to justify sharing of equity with the franchiser?


2. Is my personality and management style amenable to sharing decision making responsibilities in my business with the franchiser and other franchisees? 5-10% of dishonest franchisers are considered

Disadvantages for the franchisee 1. Restrictions 2. Termination 3. Unrealistic expectations 4. “Forced” promotions 5. Costs  franchise fee (purchase)  start-up  royalties  advertising fee  fees for services


Example – Holiday Inn, 100 room, 2 story Franchise fee $15,000 Building $4,000,000 Furnishings $1,000,000 Inventory $150,000 Working capital $125,000 Sign $40,000 Training $20,000 Promotion $30,000 Reservation system $20,000___ TOTAL $5,400,000 PLUS - real estate, licenses, & prof. Fees Benefits for the franchisee  82% of franchisees reported they were satisfied with their work  75% said they would purchase their franchise again 1. Relatively quick ownership 2. Recognition and a faster break even point 3. “Error free” system


What franchisers should provide 1. A proven product or service with an established continuous demand 2. Brand name appeal 3. Routinized operations 4. Centralization of all relevant activities (economies of scale)  buying power 5. Territorial protection 6. Successful chain of “pilot” stores  franchiser product & systems testing 7. Start-up & operational assistance  site selection  facilities layout  financial assistance (indirect)  consistent pricing policy  management & employee training  employee selection & recruitment  training aids & assistance 8. Standardized quality 9. National advertising 10. Base-line for judging success of the business 11. Continual operational improvements


Sources of information on franchises 1. Franchise Opportunities Handbook, U.S. Dept. of Commerce 2. Entrepreneur magazine, “Franchise 500,” January issue Entrepreneur annual yearbook 3. Franchise Handbook, CESA Publications 4. Money magazine, Wall Street Journal (Thursday), etc.


Investigating franchises, the four “Ps” Product, Process, Profitability, and People 1. Product or service  Reputation (quality)  Customer need (value)  Growth potential (demand)  Barriers - patents, guarantees, etc. 2. Process (business format)  Brand recognition/advertising/marketing  Training  Site selection  Number of franchisees 3. Profitability - FTC requires disclosure of sales  Franchise fee + PV of royalty = PV of the increased net income from the value of the franchise trademark 4. People - contract works through interaction and cooperation  Franchiser’s reputation  Franchisee association


Disclosure documents (FTC Rule 436)  Uniform Franchise Operating Circular  23 topics 1. Litigation (all) 2. Costs (all, but generally does not include the costs of actually building and opening the franchise) 3. Training/startup assistance 4. Territory/location (protection)  Franchisers generally reserve all rights to establish additional franchises wherever they wish 5. Term and renewal, generally 5-20 years  “good cause” for rejection  repurchase conditions 6. Number of franchised locations, including franchisee names and addresses 7. Franchiser’s financial statement Franchising is a symbiotic relationship!


Real money 1. Timing 2. Master/Area franchisee 3. Conversion franchising 4. Piggybacking outlets