FRANCHISE OPPORTUNITIES FOR SMALL BUSINESS
Thomas W. Dooley, Lewis University ABSTRACT Franchising represents a significant opportunity for small business to attain rapid success - either as a franchisor or as a franchisee. However, the details of structuring a franchised relationship are far from monolithic. This paper considers various circumstances under which a franchise relationshipmay or may not be viable and addresses itself to the specifics of various types of franchise organization, attempting to analyze which framework is most attuned to specific types of industries and small businesses. WHAT IS FRANCHISING? There is no simple, single definition of franchising. There are, however, many explanations which describe what takes place in a franchise relationship. For example, the International Franchise Association defines franchising as "a continuing relationship in which the parent provides a licensed privilege to do business, plus assistance in organizing, training, merchandising and management in return for a consideration from the franchisee." Essentially, one who owns or has developed a business marketing plan or system (the franchisor) grants to another (the franchisee) the abilities to offer, sell, or distribute those products or services which are substantially associated with the franchisor's system, trademark, service mark, tradename logo, advertising, or other commercial symbols. Franchising per se is not a business or an industry - rather it is a method of doing business. Franchising is a method of distribution in which a supplier grants to another party the rights or privilege to market its product or service under mutually agreed-upon conditions, over a certain period of time, and in a specified location or area. The supplier is the franchisor; the receiver of the right, the franchisee, and the right or privilege, the franchise. The network or chain of units individually owned by franchisees and headed by a parent firm or franchisor, is called the franchise system. Throughout the years, and partially due to State and Federal regulations and requirements, certain elements have been established which determine whether or not a business should consider themselves a franchising company. These elements are: 1. Allowing others the use of your name. 2. Allowing others the use of your system, which may involve training. 3. Receiving the payment of a fee in return for those privileges. All these together constitute a franchise - regardless of what you want to call it. If these explanations seem broad, it is because they are... Franchising, by its very nature, is complex. Regulations and Government restrictions have made it even more complex.
The History of Franchising Many people ask, "Where did it all start?" However, few really know the answer. During the Civil War, the first modern franchise system was developed when the Singer Sewing Machine Company established a system of loyal dealers worldwide to market their sewing machines. Since that time, other aggressive companies have employed the franchising methods to expand into markets that would otherwise be unreachable because of the high costs and risk factors involved in mass expansion. The reasons for franchising in those days were no different than they are today. Franchising limits the risk factor, saves vast amounts of operating capital, and paints a more attractive profit picture. The Small Business Administration and Dun & Bradstreet have revealed from studies and statistics that the average independent business operation has a 90% chance of failure within the first ten years of operation and that many of them fail in the first few years. On the other hand, the Department of Commerce reports that through the concept of franchising the individual franchisee has a 90% chance for success because they are in business for themselves, not by themselves, with the guidance and supervision constantly provided by the franchisor. During testimony before the Senate Small Business hearings, John Brown Jr., then of "Kentucky Fried Chicken," estimated that over $400 million dollars would have had to be spent to build the stores which they had under franchise at that time. Franchising provides the means for the small business person to own his or her own business through joint cooperation, which provides for buying, advertising, selling, and image advantages otherwise unavailable to the individual operation. Additionally, proponents of franchising proclaim, "there is no form of compensation greater than that of proprietorship." It is an established fact that company managers and employees do not exhibit the same degree of motivation as the person who has both income and investment to lose should the operation not succeed. The success stories are endless. McDonalds, Burger King, Aamco, Midas, Culligan, Century 21, Singer Sewing Machine, Kentucky Fried Chicken, General Motors, and Coca-Cola are only a few of the most visible examples. Today, doctors, dentists, opticians, attorneys, accountants, sales-people, and most types of operations you can imagine are profiting from the franchise system. The benefits to be gained through the proven methods of franchising are a matter of history. Correctly designed and implemented, proper franchising methodologies leave very little to risk. According to statistics provided by the U.S. Department of Commerce, franchising will generate over 500 billion dollars by 1985, which represents over a third of our nation's gross retail sales. If the present trend continues, it is predicted that within the next fifteen years franchising could account for up to 80% of all U.S. retail sales.
The development of modern day franchise techniques have also enabled many U.S. companies to penetrate the distant international markets which were previously beyond reach. In 1984 over 200 U.S. companies will have established international operations. From the franchisor's viewpoint, some of the principal advantages of franchising as a method of expansion are the following: 1. Reliance on the motivation and proprietary interests of the franchisee. The franchisee is not a salaried employee, but rather a businessperson intent on making a profit. He is willing to exert a concerted effort to follow directions and is not likely to walk away or deviate from the business and risk his investment. 2. The ability to generate capital for rapid expansion. Rather than the parent funding the expansion, the franchisee, because of proprietorship, owns the business and is responsible for the capital requirements. 3. Economies of scale. A franchisor with a considerable number of franchised units can take advantage of quantity discounts, through purchasing and greater market visibility because of the financial contributions the franchisees make towards advertising, thus providing the opportunity for greater profitability - both for the franchisor and the franchisees. 4. The advantages of local identification of ownership. A franchisee who is known by the local community is much more likely to receive favorable consideration than are outsiders. 5. Labor relations are less difficult. Each franchisee establishes his or her own relationships with employees, following guidelines provided by the franchisor. 6. There is generally greater flexibility and abilities to meet local market conditions through a franchise system than within a company which imposes policy from some distinct central office. 7. The ability to penetrate new markets faster and better. Each new market is penetrated more effectively because the franchisee is responsible for the investment and the business, and the franchisor becomes the administrator and overseer. In general, the disadvantages of franchising to a franchisor are: 1. Selecting good, capable franchisees. Technical and business savvy must be either possessed or acquired by the franchisee. The successful franchisee must be willing to be trained in the franchisor's method of doing business and not to be so independent as to deviate from operational patterns established by the franchisor. 2. Breakaway franchisees. Sometimes, franchisees, especially if they have enjoyed some fair measure of success, think they can and should "go it alone" no longer feeling the need to comply with stipulations of control contained in the franchise agreement. 3. There is somewhat less control by the franchisor in dealing with franchisees who are independent business people than what exists in corporate entity where management is dealing directly with employees. Franchising Requirements What Elements Make Up a Franchise?
What are the types of businesses that will adapt successfully to franchising? Business Formats For Franchise Franchising can be successfully integrated with any business format. Sole proprietorships, general partnerships, limited partnerships, corporations (regular, chapter S and 1244) have all been used efficiently and effectively by both franchisors and franchisees. An important element for success in a franchise system, regardless of its organizational structure is a spirit of entrepreneurship on the part of the principals within the franchisor entity. Because of the historically high frequency of entrepreneurship outside major corporate entities and the relatively infrequency of it inside corporate structures, a majority of successful franchises have been started by independent individuals or groups thereof. Start-up franchise success in a large corporate structure is not unattainable but usually requires the presence of an entrepreneurial ambiance throughout the organization is at least within the organizational unit imitating the franchise. While the start-up field in franchising tends to be heavily populated by entrepreneurial innovation, many successfully operating franchises of considerable size and scope, are controlled by large corporations, having been acquired from the entrepreneurial innovation by the corporation based on evidence of profitability and suitable return on investment. Franchising is no longer as simple as it once was when a franchisor could run an ad in a local paper and take someone's money. Federal and state requirements demand certain selling procedures and disclosure of pertinent information by the franchisor to the franchisee. The systems and procedures have become complex and must be adhered to on a strict basis, explained through manuals, reinforced with on-going support systems and continuing services programs designed to assure the franchisee's success. Additionally, there are personnel training and advertising programs that must be developed. Types of Franchising There are a number of methods in which franchising can be implemented. For instance: A two-tiered franchise is one in which the franchisor transfers a product or service directly to the individual franchisees without intermediation of another party. It is, in brief, a narrow-based distribution channel. A three-tiered franchise, however, is one in which an intermediating party is used in the distribution channel, between the franchisor and the individual franchisees. In terms of a broad analogy, the intermediator is a sort of wholesaler between the franchisor and the franchisee. In franchising terms, this intermediator is usually called a master franchisee, or a territorial franchisee, or a regional director. Often the terms are used interchangeably, although the "director" title also can apply to a franchisor employee responsible for a specific area in a two-tiered franchise. In addition to the generic advantages and disadvantages listed earlier, the three-tiered franchise has the following advantages:
1. Greater amounts of capital can be raised earlier by the parent franchisor because the intermediator usually acquires territorial rights to a relatively large geographic area, and renders an "up front" franchise fee commensurate thereto. 2. Communication systems involving the individual franchisees usually are stronger because the span of control between the intermediator and the franchisee is less than it would be if the parent franchisor was attempting to maintain direct liaison with a large group of individual franchisees. 3. Growth tends to be more rapid because of the somewhat substantial investment in money and interest on the part of the intermediator. Disadvantages of the three-tiered franchise, in addition to those found in all franchises, are: 1. Great dependency on the intermediator. The intermediator becomes a critical link and aspect of the success of the franchise system and must be monitored regularly. 2. A tendency for the franchisee to relate more to the intermediator than to the parent franchisor if the franchisor attempts to abrogate its rights. 3. Offsetting a larger initial cash flow to the parent franchisor is a lesser continuing revenue flow, because a portion of royalty payments from the individual franchisees are retained by the intermediary. In terms of structure of a franchise, there are various possibilities: a.) A product/service distribution franchise is one in which the extent of the right or privilege extended by the franchisor to franchisees includes only the actual product along with the systems necessary to purvey that product to ultimate customers and the right to use the name and identity associated with the franchisor and the franchisor's product or service. b.) A full replication or business format franchise is one in which the totality of the product/service, facility, operations, advertising, systems etc., developed by the franchisor are replicated by the franchisee, who in turn agrees to abide by specific controls. A McDonald's franchise is an excellent example of the full replication, entire business format franchise. The only variation found in these types of franchises as related to a franchisor prototype model are those necessitated by physical differences in the facilities housing the respective units. c.) A modified replication franchise is one in which the elements of a full replication may be modified somewhat to meet perceived differences in market conditions, geographic culture, etc., etc. that may be found in one area, but not in another. Usually, in a modified replication franchise, there are certain integral elements which may not, under any circumstances, be modified. d.) An add-on franchise occurs when an existing business of one type or another contracts with a franchisor to incorporate the product or service on the franchisor to the existing business of the franchisee. An example of this form of expansion would occur if Sportcare were to franchise its physical therapy product line to operators of health clubs, etc. e.) A conversion franchise is one in which the franchisee is already in the same business as the
franchisor, but wishes to change its identity, format and system of operation to model that of the franchisor. Perhaps the best known of this type of franchise is Century 21 Real Estate, where all franchisees were existing licensed and operating real estate brokerage firms who decided to make major modifications in their name, image and method of operation upon joining Century 21.