Franchising is a form of marketing and distribution in which a parent company (Franchiser) grants an individual or a small company (franchisee) the right to do business in exchange for revenues from the fees or royalties.
The rights may include a permission to sell the Franchiser’s products and to use his name, symbol, special ingredient, or a store layout.
Franchising is one of the major contributors in the development of retailing in the recent years.
It is a contractual agreement between a franchiser and a franchisee that allows the Franchisee to operate a retail outlet using a name and format developed and supported by the Franchiser.
In a contract, the Franchisee pays a lump sum and a royalty on all sales for the right to operate a store in a specific location.
Learn about:- 1. Meaning of Franchising 2. Definitions of Franchising 3. Concept 4. Types 5. Methods 6. Factors Influencing 7. Examples of Franchising Brands 8. Establishing a Franchising System 9. Steps of Franchising a Business 10. Purchasing a Franchise
11. Types of Franchise Arrangements 12. Possible Drawbacks of Franchise Arrangements 13. Franchising Success Factors 14. Benefits to the Franchisers 15. Benefits to the Franchisees 16. Constraints on the Franchisees and Other Details.
Franchising: Meaning, Definitions, Concept, Types, Methods, Factors Influencing, Advantages and Disadvantages
Contents:
- Meaning of Franchising
- Definitions of Franchising
- Concept of Franchising
- Types of Franchising
- Methods of Franchising
- Factors Influencing Franchising
- Examples of Franchising Brands
- Establishing a Franchising System
- Steps for Franchising a Business
- Purchasing a Franchise
- Types of Franchise Arrangements
- Possible Drawbacks of Franchise Arrangements
- Franchising Success Factors
- Benefits to the Franchisers
- Benefits to the Franchisees
- Constraints on the Franchisees
- Franchisee-Franchiser Relationship
- Major Causes of Conflict in the Franchisor-Franchisee Relationships
- Franchising and Entrepreneurship
- Franchising in India
- Legal Requirements of Franchising in India
- Advantages and Disadvantages of Franchising
Franchising – Meaning
Franchising is fast emerging in India as a popular way of establishing distribution channels. According to the franchise trade associations, the total value of sales through franchising operations in India amounted to about Rs.73,000 crore in 2010.
According to Hunt (1972), franchising is a ‘vertical marketing system in which one form (the franchisor) provides another individual or firm (the franchisee), for consideration, a licensed privilege to do business in a specified geographic area, along with assistance in organizing, training, merchandising, and management’.
The involvement of a franchisor in a franchisee relationship is in that sense much deeper and greater in scope than is typically found in a conventional distribution channel. According to Hunt (1972), in any franchisee network, there will actually be three ongoing sets of relationships.
These are discussed below:
i. Legal Relationships:
Any franchisee arrangement is based on a legal contract. In conventional distribution channels, there is no need for a binding legal contract between parties where the relationship is based on transactions and mutual understanding. However, what distinguishes a franchisee relationship is the legal contract with its different provisions binding on both the parties.
The legal contract gives greater stability and consistency in the functioning of the franchisee network with all the members of the franchise network being treated in the same manner.
ii. Business Relationships:
Like any other channel arrangement, a franchise network is also in essence a distribution channel. Hence, like any other distribution channel there is a business relationship at the core of the arrangement. The parties to the franchise network agree to work together, primarily based on the attractiveness of the business proposition that underlies the relationship. While the legal relationship is static, the business relationship is dynamic.
As the market situation varies, the business relationship may undergo changes. For instance, the demand for a service offered through the franchisee network was much higher than what was anticipated during the negotiations for the franchisee contract, the legal contract may have to be changed in order to divide the responsibility between the parties to cater to a larger order (such as, the need for more staff, or a warehouse).
iii. Non-Business Relationship:
Similar to any other channel system, there will be significant levels of non-business relationships between parties in a franchisee network. The non-business relationships typically take the form of personal relationships between entities within the franchise network. They often have even more impact on the overall management of the franchise than the legal or commercial relationship.
Franchising – Definitions Provided by The German Franchise Association
There are various definitions of this term. The dictionary meaning is if franchise is right to vote, citizenship and authorization to sell company’s products.
Following terms are used:
Franchisee is a person with franchise or authority to sell.
Franchiser is the person who gives this authority. He can be a manufacturer, wholesaler or a service provider.
Franchising is a form of marketing and distribution in which a parent company (Franchiser) grants an individual or a small company (franchisee) the right to do business in exchange for revenues from the fees or royalties. The rights may include a permission to sell the Franchiser’s products and to use his name, symbol, special ingredient, or a store layout.
The Deutsches Franchise-Verband e.V. (German franchise association), defines ‘franchise’ as follows:
“Franchising is a vertical co-operatively organized sales system of legally independent entrepreneurs based on an ongoing contractual obligation. This system has a uniform market identity and is characterized by a work sharing performance program of the Franchisee and the Franchiser as well by an instruction and control system that ensures behaviour in conformance with the system.”
This term has come from French word “franchise” that refers to the allocation to the traders of privileges such as exemption from customs duty and other levies.
It is an extended version of Licensing. A franchisee is an independent businessperson. Increased levels of disposable income, a growing demand for the consumer goods and services, expanding urbanization, and higher consumer mobility are the reasons behind the attractiveness of franchising across the globe.
Franchisee invests his own capital, runs the business and enjoys the profits or bears the losses. The Franchisee is normally appointed to save resources or to benefit from the Franchisee’s expertise in the field. Franchisees, like other channels share the risk.
The Franchiser gets compensation from the Franchisee in different forms like – the initial fee/deposit, a royalty on gross sales, rent on equipments, material supplied by the Franchiser, a share of the profits, regular license fee, etc.
The Franchisee operates with his own name and for his own account. His financial stake entitles and obliges the Franchisee to use the franchise package. His contribution is his working power, capital and information.
Franchising – Concept
Franchising is one form of marketing channel; rather it is the fastest growing form of retailing. Franchising is one of the major contributors in the development of retailing in the recent years. It is a contractual agreement between a franchiser and a franchisee that allows the Franchisee to operate a retail outlet using a name and format developed and supported by the Franchiser. In a contract, the Franchisee pays a lump sum and a royalty on all sales for the right to operate a store in a specific location.
The Franchisee is given the right to use the Franchiser’s products, symbols, merchandise, and overall expertise in a defined territory. The Franchisee has to operate the outlet in accordance with the procedures prescribed by the Franchiser. The Franchiser provides the assistance in setting up the store, advertising and management training.
Even though the Franchiser gives the franchise, i.e., authority to sell his brand, he is keen and has a close check on the quality of services provided by all franchisees, to maintain his reputation. All franchisees share the cost of advertising, product development, and’ system development with the Franchiser.
Franchising – 4 Major Types: Manufacturer-Retailer Franchise, Manufacturer-Wholesaler Franchise, Wholesaler-Retailer Franchise and Service Sponsor-Retailer Franchise
The Franchiser can occupy any position in the marketing channel such as wholesaler or retailer.
Following are the popular types of franchise systems:
1. Manufacturer-Retailer Franchise:
Franchisee acts as a retailer who sells directly to the consumers. This is the most common form of the franchise system, e.g., McDonald’s, Raymond’s, etc.
2. Manufacturer-Wholesaler Franchise:
Franchisee acts as a wholesaler who distributes to the retailers, e.g., Coca Cola, Pepsi. The companies get license for bottling of these brands.
3. Wholesaler-Retailer Franchise:
Wholesaler gives franchise to individual retailer or a group of retailers. Retailer sets up a franchise system and shares the ownership and operations of a wholesaler. This system works well when the wholesaler is more powerful and influential than the manufacturer. Big wholesalers who are established can give franchise to the retailer to sell their product assortments.
4. Service Sponsor-Retailer Franchise:
A service firm licenses individual retailers to offer specific service packages to consumers. For example, VSNL gives license to many small computer firms to sell its Internet Connection Service/ Internet Service Provider (ISP) facility.
Franchising – 5 Common Methods: Single-Unit Franchising, Sequential Franchising, Area Development, Sub-Franchising and Area Representation
Most franchise systems drawn from five common methods of franchising are discussed below:
Method # 1. Single-Unit Franchising:
This is the most familiar method of franchising. It would involve person, partnership or company buying a franchise business from the Franchiser. Every Franchisee would then operate the business in a particular location or area. This is called single-unit franchising. The result is often a Franchiser with a number of Franchisees owning and operating individual stores in different locations.
Method # 2. Sequential Franchising:
It is an alternative type of franchising arrangement. One Franchisee can appoint another Franchisee. Using sequential franchising, these additional franchises are granted on a one-at-a-time basis. In other words, after establishing the second franchise, first one would need to prove he is capable of operating both stores, before being allowed a third franchise.
The implication of this type of arrangement is that it becomes increasingly difficult for the Franchiser to maintain direct involvement in each of his businesses. Therefore, he would need to hire and manage employees to run the different stores.
Method # 3. Area Development:
A variation on sequential franchising is area development. If the Franchiser uses this method of franchising, the Franchisee would become an “area developer.” Unlike sequential franchising where the first Franchisee could gain an additional franchise only after proving his capability, the Franchiser would then expect the first Franchisee to establish and manage these stores himself, with the assistance of hired employees.
Using this method of franchising (and the following two), the Franchiser may also require Franchisees to establish a certain number of stores within an agreed time frame.
Method # 4. Sub-Franchising:
The method of franchising is often called master franchising. Sub-franchising involves two levels of franchises- Sub-Franchisers (often called Master Franchisees) and Sub- Franchisees. Sub-Franchisers are like a Franchiser who is often responsible for recruiting and providing ongoing support to operating Franchisees. However, in contrast to the Franchiser with nationwide interests, they are responsible for a smaller area.
Method # 5. Area Representation:
Less common than sub-franchising is area representation. Like sub-franchising area, representation has two levels of Franchisees. The main difference is that the Master Franchisees (called area representatives in this instance) are delegated less responsibility than Sub-Franchisers by the Franchiser. Specifically, the Franchiser will often play an important role in recruiting and providing ongoing support to Franchisees, within an area representative’s region.
There is considerable variation in the methods of franchise agreements available. For both parties, it is necessary to consider what method is the most appropriate for their individual circumstances. Each method has certain merits and demerits.
Factors such as the level of available investment, managerial ability and ambition are likely to play an important role in determining what type of franchising opportunity would be most suitable for people interested in buying a franchise.
Franchising – Factors Influencing the Franchising Business: High Competition, Technology, Customer’s Tastes, Legal Environment, Cultural Factors and a Few Others
There are different factors that affect the franchising business at different locations.
Following are some of the common factors influencing the franchising business:
1. High Competition:
High competition refers to one of the most crucial factors affecting the franchise business. With an increasing flow of franchising business, the level of competition especially in fast food chains and retail outlets has set a challenging phase in India. This led the franchisors to implement some new marketing strategies to cope with ever- increasing competition and prove their own standard.
2. Technology:
Technology plays an important role in franchising a business. In today’s automatized world, all the business largely depends on internal communication and software systems. Any fault or failure of technology may hamper the process of franchising business.
3. Customers’ Tastes:
It signifies an important factor of in franchising a business. An enterprise can be successful if it is focuses on fulfilling the requirements of customers. However, in today’s dynamic world, the tastes and preferences of customers change frequently. Therefore, both the franchisor and the franchisee should consider the tastes and preferences of customers before making any franchising agreement.
4. Legal Environment:
It indicates building proper and authentic procedures to expand franchising business in different locations. An authentic legal aspect helps both the parties of franchise to continue their business in an effective manner.
5. Cultural Factors:
Cultural factors refer to one of the crucial factors that affect the franchising business to a large extent. Both the franchisor and the franchisee should consider the culture and values of people of a country in which the franchising business is to be operated. For example, a franchisor cannot go for franchising a product in a particular location or community where it creates cultural chaos and puts negative impact in the market.
6. Relationship between the Franchisor and Franchisee:
The relationship plays a key role in establishing a franchising business. A cordial relationship can be maintained between the franchisor and the franchisee if there is mutual understanding between them. In addition, both of them should work jointly according to the franchising agreement.
For example, it is important for a franchisor to fulfill his/her promises for a better market image and identify the potential of the franchisee. On the other hand, the franchisee should ensure that he/she fulfills the desired criteria as per the terms of the entire franchising agreement.
Franchising – Examples of Franchising a Brand: Product Distribution Franchises, Business Format Franchises and Manufacturing Franchises
1. Product Distribution Franchises:
Ford is an American automaker whose vehicles are visible on roads throughout the world. The enterprise employs more than 14,000 and supports a large network of ear sales and service locations. Ford offers many benefits to its franchisee retail dealers. These include minimum vehicle stocking requirements, entry to main dealer and national stocks as a member of the Ford Dealer network, training and the support of an experienced and professional Ford Main Dealer.
2. Business Format Franchises:
KFC has established a strong identity of its brand over the years. It is one of the most favorite fried chicken brands in the U.S. It has built a strong customer base with its quality service. There are different benefits to own a KFC franchise. One of the major benefits that a potential KFC franchise owner may take is the huge support network offered by the Brand itself. McDonalds continues to be a leading franchising enterprise around the world. More than 75% outlets of McDonalds are owned and operated by its franchisees worldwide.
The following are some recognition comments made by a number of renowned magazines:
i. McDonalds has been recognized as one of the Top 10 franchises in the world by Entrepreneur Magazine
ii. Franchise Times Magazine has ranked McDonalds number one on its list of top 200 franchises.
iii. According to USA Today “McDonalds has been selected by the National Minority Franchise Initiative (NMFI) as one of the 50 top franchises for minorities.”
iv. McDonalds was listed as one of the 40 best franchises for African Americans by Black Enterprise Magazine.
7-Eleven is the premiere convenience store retailers in the world with a long and proud history over 75 years. The Franchise System of 7-Eleven is different from other franchising systems in the country. It is a proven retail process with a world-famous trademark, and the average initial cash investment is reasonable.
Some other popular format franchises are:
i. Restaurant – Pizza Hut, Taco Bell
ii. Retail – Blockbuster Video, GNC Franchising
iii. Business Services – H&R Block, Mail Boxes Etc.
iv. Education – Dale Carnegie Training, Barbizon School of Modeling
v. Real Estate – Century 21, Coldwell Banker, Re/MAX International
vi. Convenience – Family Mart.
Health & Beauty – Supercuts, Cost Cultures Family Hair Care.
3. Manufacturing Franchises:
Since 1969, SealMaster has made a proven record of in supplying pavement repair equipment to contractors, sells concrete products, sport surfacing, traffic paints, tanks, machines, pumps, and other tools. SealMaster arranges training and seminars for contractors and potential franchisees. Its seal coating products have become the prominent choice for pavement maintenance among the property owners and managers. Over 60 SealMaster manufacturing and distribution centers have made the brand the most recognized name in pavement maintenance.
Franchising – Establishing a Franchising System
Franchising is a complex process, thus, requires lots of supervision and attention. Franchising a business requires various managerial functions, such as training, supervising, and assisting franchisees. Therefore, an entrepreneur needs to be careful and should look deeply in all the aspects, before deciding to franchise its business.
We all are familiar with globally renowned enterprises, such as McDonald’s, which established around 18,000 franchised restaurants all over the world in 2004. Franchising may be unacquainted concept for various new businesses. In recent years, several fraudulent franchise enterprises entered in the market and vanished in a shorter span of time. The fraudulent activities of franchise enterprises made franchisees financially ruined. Therefore, an entrepreneur needs to look squarely at the regulations involved in the franchising business.
In spite of challenges, franchising is the commonly used, fastest method of expanding a business. Therefore, an enterprise needs to make franchising agreement cautiously.
On the other hand, a franchisor should consider the following factors, before going to establish a franchise system:
i. Identifying the uniqueness – It involves recognizing the special attributes of a brand that distinguishes it from other available brands in the market. A unique brand automatically drives an enterprise to expand its market and generate more franchising opportunities.
ii. Anticipating the expected profitability – It involves determining the actual worth of a brand in the market. A consistent scope for profitability of a brand raises the confidence of both the franchisor and franchisee.
iii. Maintaining transparency – It involves providing a clear picture of business processes of both the franchisee and the franchisor. Transparency in business processes leads to a smooth relationship between the two parties. Before establishing a franchising system, both the parties should be clear about the previous business records and reputation of each other.
Franchising – Steps Involved in the Franchising Process: Generating a Franchising Business Plan, Seeking Professional Advice, Selecting a Location and a Few Others
Different enterprises follow different processes to start-up their franchise business.
The steps involved in the franchising process are explained as follows:
i. Generating a Franchising Business Plan:
It refers to the first and foremost step of franchising a business. A franchising business plan states the goals and objectives of franchising a business. In addition, it also includes methods and processes that an enterprise would follow to carry out its day-to-day franchising business activities.
ii. Seeking Professional Advice:
It involves getting suggestions and guidelines from franchising experts, attorneys, consultants or certified public accountants. They advise the, franchisor about the prospects, market value, and popularity of the brand as well as risks involved in a particular franchising business. This helps the franchisor to make correct decisions, before entering into the franchising business.
iii. Selecting a Location:
It involves assisting the franchisee regarding the selection of the location where the franchising business is to be operated. Location acts as one of the most important factors of any business; therefore, the franchisor should help the franchisee to select a location and open the franchise business.
iv. Conducting Intellectual Property (IP) Audit:
It involves determining IP owned by an enterprise and ensuring whether it is duly registered and protected. The audit also involves ensuring whether the artistic works, such as audiovisual material, written documents, training manuals, and brochures, of an enterprise are copyright protected. Moreover, the franchisor should make sure that he/she is not breaching any law of IP.
v. Creating Franchising Documents:
It involves generating documents necessary to initiate a franchising business. A franchisor should prepare the franchising documents in a simple and meaningful way. Franchising agreement is an important part of franchising documents. Therefore, it should be prepared carefully.
vi. Initiating the Advertising Strategy:
It refers to one of the most crucial steps of the franchising process. A franchisor needs to inform the potential franchisee about the franchising system, price, and prospects. This can be done by advertising or promoting the franchising business. Advertising strategy indicates different channels available to the franchisors to solicit and influence potential franchisees. Franchise trade fairs, newspaper ads, publications, online ads, are some of the examples of these channels.
vii. Building up a Training Team:
It involves forming a team of efficient and skilled individuals. The team should be able to provide assistance to the franchisee to start their franchising businesses. In addition, it should provide training and guidance to the franchisee.
Franchising – 6 Major Steps for Purchasing a Franchise
Purchasing a franchise involves making a right decision at right time. Owing a franchise is an expensive and labor intensive process; therefore, requires a thoughtful consideration and attention. If a franchisee, before signing the franchise agreement, finds any second thoughts or doubts, the entire franchising process may be stopped till the time the concerns and issues of the franchisee are addressed.
Purchasing a franchise involves the following steps:
1. Making regular visits at the franchisor’s outlet by the prospective franchisee before making the franchise agreement
2. Consulting a franchise attorney for reviewing the terms and conditions of the franchise agreement
3. Comparing the actual status of the franchisor with what mentioned in the agreement by visiting the franchisor’s office
4. Signing the franchise agreement, if everything is smooth at this point
5. Attending training sessions and receiving guidance given by the franchisor
6. Starting the franchise business at the decided location.
The initial cost of a franchise varies according to the brand image, profitability, and the fees structure designed by the franchisor. It also depends on the capital requirements of the franchisor and brand value of the franchisor. In the U.S., the average initial investment for every eight out of ten franchise unit is less than $250,000 (excluding the real estate cost).
Some franchisors ask their franchisees to purchase land, buildings, and other required resources to run their franchise outlets. On the other hand, brands, such as McDonalds, provide land and buildings for their each unit of franchisees. A franchisor should consider all the costs involved in franchising a business, while evaluating the cost structure of the franchise business. He/she is required to show all the cost-related documents to the franchisee as per the law. This document is called Uniform Franchise Offering Circular (UFOC).
Both the parties should consider the following costs involved in purchasing a franchise:
i. Initial Fees – It involve the initial fees paid by a franchisee to the franchisor to purchase a franchise.
ii. Variable Costs – Variable costs indicate the cost that varies from one to other franchisor. These costs include amount paid for purchasing land and buildings, construction and renovation, initial inventory, and getting business licenses. Many franchisees need to pay a certain amount as a grand opening fee to start franchise businesses.
iii. Royalty Fees – Royalty fees refer to ongoing amount of money paid by the franchisee to the franchisor for using the trademark of the franchisor. The payment may be made on the bases of weekly or monthly gross income of the franchisee. As the royalty is paid from the gross income, the franchisee is required to pay the amount even the business runs on loss. These fees are around 5% of gross income.
iv. Promotional Expenses – Promotional expenses refer to cost involved in advertising and promoting the brand.
v. Other Additional Expenses – It refers to expenses involved in other franchising activities, such as training, computer assistance, and support services.
The fees charged by the franchisor should be consistent and as per the value of his/her brand. If the cost is designed as per the worth of the brand, then it may be fair and acceptable, otherwise the franchisee may go for negotiation or look for some better option.
Franchising – Types of Franchise Arrangements: Tied-House Franchising System, Product/Trademark Franchising and Business Format Franchising
Within the broad framework of a franchise contract, a variety of different franchise arrangements are possible. These arrangements could vary from simple exclusive distribution contracts, to complex franchise contracts that deal with the intricacies of the business process, such as the procurement of specific ingredients, staff recruitment, interior decoration, or training.
However most of the franchisee contracts can be classified into three broad types- (i) a ‘tied-house’ franchising system (ii) product/trademark franchising, and (iii) business format franchising.
(i) Tied-House Franchising System:
In tied-house franchising, the oldest franchising format, the franchisee agrees to source one category of products from one particular producer. This format of franchising started in Germany in the eighteenth century when certain pubs contracted with some brewers to sell their brand of beers exclusively, at discounted prices.
Such types of franchise arrangements are still in existence with certain hotels advertising that they use a particular type of oil to cook products or ingredient brands. An example of franchise arrangement is the Intel Inside campaign, where manufactures of personal computers (PCs) which use Intel components stick an ‘Intel Inside’ logo in order to promote the Intel brand name jointly with the brand name of the PC manufacturer.
(ii) Product/Trademark Franchising:
Product trademark franchising involves a branded manufacturing house arranging to distribute its brand(s) exclusively with a franchisee in a particular geographic area. This is the most popular mode of franchising today. It is estimated that around 50 per cent of sales of all products in the US is through such trademark franchising arrangements. The most popular example is car dealerships.
Most-of the car dealerships are product/trademark franchisees with the car manufacturers appointing exclusive dealers in geographically defined areas through legally binding agreements. For a branded manufacturer, this is the easiest way to achieve market penetration as such arrangements basically allow the manufacturer, to increase its geographic foot print without any significant investment.
Such legal contracts could include provisions that prevent the franchisees from selling competing brands, or investing in facilities that may sell competing brands. However in order to attract significant number of potential franchisees, the manufacturer needs to have a good brand equity to begin with.
(iii) Business Format Franchising:
The third type of franchising involves franchising an entire business format. The most well-known example is that of McDonald’s which has successfully franchised its fast-food restaurant format to thousands of units across the world. In this type of franchising, an entire business concept is franchised.
The franchisee not only ends up using the brand, but will also agree to operate in a manner agreeing to all the operational procedures and processes specified by the franchisor. The contract could include clauses that govern the procurement of raw materials, purchase of machinery, recruitment of personnel, training, remuneration, and interior decoration. The franchise gains because it only has to implement a proven operational business model.
Franchising – Possible Drawbacks of Franchise Arrangements
a. In return for the benefits franchisees receive, they have to pay fees and royalties to the franchisers, or the franchiser may demand a share of the franchisees’ sales revenues, which can be a major expenditure and need to be checked thoroughly because it may reduce the economic benefits of the investment.
b. Other additional start-up costs may include purchase and preparation of site, signs, fixtures, equipment, other infrastructure, management assistance, and training.
c. Franchisers may impose continuing royalty fees as profit-sharing devices. This is a percentage of gross sales with a required minimum, or a flat-level fee levied on the franchise. The variable royalty fee, which increases as sales increase, is popular among some franchises.
d. Franchisers may impose some other types of continuing fees, for instance, continuing fees for advisory services, sharing management expertise, advertising, rent, and technical assistance. So a franchisee needs to find out which type of support is required and determine what benefits and services the fees cover. To determine this, franchisees itemize what they are getting for their investment and then find out whether the cost corresponds to the benefits provided.
e. In addition to the payment of fees and royalties, franchisees are expected to give up some control over their own businesses and lose their own identity.
f. Franchisees are often subjected to tight supervision by the franchiser. Although the franchisee owns the business, he or she does not have the complete autonomy of an independent owner.
g. Franchisees usually need to follow guidelines given by franchiser and conform to the standard operating procedures recommended by the franchiser. The compliance with standards is usually determined by periodic inspections, which sometimes become a burden to the franchisee.
h. Moreover, franchisees usually cannot implement changes without franchisers’ approval. In most of the cases, the franchise agreements specify that the franchise can sell only those products that are approved by the franchiser.
For instance, if a coffeehouse franchise that sells only beverages and pastries cannot serve customer demand for sandwiches. Hence, it cannot offer them anything extra without the consent of the franchiser. In few other instances, the franchisee may be required to implement specific rules even though it believes they are inappropriate or unfair in specific conditions or market scenarios.
i. One cannot deny the possibility of franchisee falling victim to the franchiser company’s circumstantial problems. So while a particular business owner may be doing well, the franchiser itself may encounter business problems, perhaps because of operational issues, management inefficiency, financial issues, and problems in business environment, or any other reason that affects the business.
j. In such cases, the turnaround becomes very difficult because of the complete reliance on the franchiser.
Franchising – Franchising Success Factors According to Peiton
According to Peiton et al. (1997), the main ways in which a franchisee could ensure a success of the franchisee arrangement are as follows:
1. Insisting on mutual sharing of information about the commercial aspects of the franchise arrangement. It is always important to ask for a frank and honest estimate of all the investments required and expected to arise during the operation of the franchise arrangement.
From a franchisee’s point of view, totally unexpected and unanticipated requests for investments of additional funds leads to an erosion of trust with the franchisor and should be avoided. Ideally the franchisor should present all the possible investment required and an honest forecast of the business expected before the signing of the contract. This could build mutual trust and greater commitment.
2. It is also in the franchisee’s interest to conduct extensive research on the financial background of the franchisor. Even when the franchisor has a strong brand name and reputation, if there is a definite weakness in its financial situation, there is always a possible threat to the smooth running of the franchise agreement.
For instance, if the franchisor has excessive debts in its balance sheet, any financial commitment promised may not materialize. Further, future investments in the brand or on products might not happen. A franchisee should therefore be convinced about the financial strength of the franchisor before entering into the franchising agreement.
3. The franchisee should also enquire with other existing franchisees wherever possible to understand the operation of the franchise agreement. There could always be some hidden traps which can only be revealed by the existing franchisees.
4. Franchisees should also consider all the provisions in the contract very carefully to fully understand the implications. While many of the explicit provisions will be straightforward, it is important to understand the implications. For instance a provision like ‘all the employees will be appointed by the franchisor’ looks very straightforward, but in the future this might create a problem.
A sample situation is when the franchisee is not happy with some of the employees appointed by the franchisor and wants to appoint someone who is considered to have a very high level of local knowledge but does not have the educational qualifications insisted by the franchisor.
Franchising – Benefits to the Franchisers or Manufacturers
Franchising benefits both the Franchiser and the Franchisee. Consumers and societies too are beneficiaries.
Manufacturers (Franchisers) enjoy following benefits:
1. They can cover more territories.
2. They get the marketing support from the entrepreneurs (who work hard for their higher profits).
3. Franchising is the key to rapid growth as Franchisees cover wide areas and expand market.
4. Once the network of Franchisees is set up, the company enjoys regular income in the form of royalty without much fresh investment and additional efforts.
5. Franchisees’ familiarity with the local market and prevailing terms and conditions helps the Franchiser in establishing a brand quickly with less risk for budding brands.
6. Generally big giants through franchising can create entry barriers for competitors. Franchisees act as Category Killers.
7. Franchisers need not invest heavy amount, which is otherwise extremely essential in the areas like sales force management costs. Franchisees being independent business organizations involve and invest in these activities. They try to carry out these activities more effectively. Hence, it is more cost effective to the Franchiser.
8. Many companies find it difficult to control the enterprise us they grow. Many of them find it comparatively easier to influence, manage and control each Franchisee.
9. The Franchisee act more as a consultant, who works out some solutions for the Franchiser’s problem and generates new ideas.
However, the Franchiser must ensure uniformity of service and also make sure that operations of each outlet will reflect favourably on the organization as a whole. They must clearly define exclusive territory for each franchisee so that the Franchisee can develop the demand without fear of encroachment by other franchisee and channel conflicts can be minimized.
Franchising – Benefits to the Franchisees: Initial Benefits and Ongoing Benefits
Today many business aspirants find it much safer to buy a franchise instead of starting an altogether new business or even taking over an existing one. The Franchisee when buys the Franchise, i.e., authority to sell, he enjoys some initial benefits as well as on-going benefits from the Franchiser.
1. Management Training Programs
2. Market Survey
3. Operating Manuals
4. Financial Assistance
5. Training to the Franchisee’s employees
1. Centralized planning
2. National and co-operative advertising
3. Auditing and record keeping
4. Merchandising, promotional Pont-Of-Purchase (POP) materials
5. Group insurance plans
They enjoy following benefits from buying a franchise:
1. The Franchisee can quickly en-cash the market opportunities being connected with reputed brand and can expect good returns in a short period.
2. Risk of the Franchisee is reduced being associated with the Franchiser having proven expertise.
3. The Franchisee may get financial assistance from the franchiser. In most cases the franchiser’s name itself is so valued that the financial institutions do not hesitate in financing the project.
4. Franchising provides excellent business opportunities to the entrepreneurial ambitious individuals having sincere urge for business, certain amount of capital and capacity to bear some risk, but lacking in expert’s advice and management support. The franchiser personnel assist, train, motivate, share and work with the Franchisees. Thus, franchising can solve all startup problems of business aspirants and thus leads to entrepreneurship development.
5. The Franchisers have general vision, which needs to be altered for adaptation to local circumstances. The Franchiser does not have know-how of local conditions and he is not willing to change the vision too frequently. Here the Franchisees do it for the Franchiser.
Thus, franchising is a versatile and generalized system in marketing channels.
Franchising – Constraints on the Franchisees
Even though buying a Franchise is much safer and attractive business option, many times the Franchiser enforces an unnecessary pressure and control on the Franchisee than required.
The Franchisees have to face various limitations and work under several constraints, which are discussed below:
1. To buy the franchise of a reputed brand, initial investment could be very high and other business terms could be tedious. That may discourage many small business aspirants with limited financial strength.
2. The Franchisee has to pay a one-time fees and royalty, usually on a monthly basis. Even though the sale is not good, there is burden on the Franchisee.
3. The Franchisee has a little freedom in implementing his own business ideas in running the outlet as he has to work strictly in accordance with the guidelines and framework laid down by the Franchiser.
4. The Franchisee should remember that noncompliance of guidelines means sure and speedy loss of a business.
5. There is a threat to the Franchisee from other franchisee in the vicinity, who may cross his own territory and encroach other franchisee’s territory. Dual distribution strategy of the Franchiser can be another threat to the Franchisee.
6. The Franchisees can suffer badly due to the wrong strategic decisions taken by the franchiser. It includes erratic changes in the prices by the Franchiser.
7. In case of the conflicts between two or more franchisees, if the Franchiser remains indifferent and does not take right and timely action, it could spoil the Franchiser’s brand name. All franchisees, too suffer immensely.
8. In most of the franchise agreements, exit clause is not very easy to enforce and not in favour of the Franchisee. Hence, the Franchisee should know and understand all the clauses in the agreement thoroughly, before entering into the agreement with the Franchiser.
Franchising – Franchisee-Franchiser Relationship
Both the Franchiser and the Franchisee can enjoy the benefits through franchising provided they have regular communication and share sound relationship. A break in the relationship is harmful for both.
Following points should be considered:
1. The Franchiser and the Franchisee both should avoid all such acts and misunderstanding, which may cause any conflicts between them.
2. None of them should do any such activity that goes against each other’s interest. Both the ends should strive to keep the relations in order.
3. There has to be mutual understanding and regular communication between them that help each other to grow.
4. Agreements should not create any ambiguity and should clearly mention responsibilities and demarcation of areas of operations.
5. They should share the cost and carry out advertisements and promotional activities jointly to avoid duplication of work and cost.
6. They should consider each other as business partners and no one should behave like a dictator and try to rule the other.
7. Oversaturation and area crossing should be strictly avoided by all franchisees as that kills everyone’s business. Hence, the Franchiser should be very keen while designing and allocating territories to a number of franchisees.
Franchising – Major Causes of Conflict in the Franchisor—Franchisee Relationships
Though a franchising arrangement could provide win-win situations for both the franchisor and the franchisee, in reality there could be several hiccups in the relationships. Storholm and Shueing (1994) identified some of the major issues for conflicts.
These arise around the following:
1. Release of proprietary information to outside parties – Franchisees often get access to some proprietary information such as formulations of products and business format, which could sometimes be misused.
2. Non-payment or short payment of royalties – Often franchisees are unable to pay the royalties in time or in full. It is not easy for the franchisor to use legal provisions to get the outstanding amounts from the franchisee every time.
3. Refusal to adhere to standardized conditions – Often franchisees are short on complying with several standardized conditions, such as appointment of adequate number of staff, basic cleanliness of the premises, and paying adequate salary to the staff. These could adversely impact the larger franchisor brand.
4. Often the franchisees are also dissatisfied with the franchising agreement due to several iniquitous provisions in the agreement, as well as the skewed operationalization of the agreement.
Some of the important issues for potential conflict in this regard include the following:
i. Tying Agreements:
In many franchisee situations, the franchisor is bound to source supplies from an assigned supplier nominated by the franchisor. Sometimes this is a method for the franchisor to generate additional revenue from the franchisee agreement by supplying products through this supplier at a higher rate. If the products are typically priced at around 10 to 15 per cent above the market rate through this supplier, the franchisee carry this additional burden, thereby reducing their profitability.
ii. Capricious Termination:
This is often called as the Achilles’, heel of the franchisee agreement. Franchisee contract could be either nor renewed or arbitrarily terminated due to non-conformance to some of the provisions. The franchisees are always therefore under the constant fear of being terminated. This prevents them from committing greater resources to the franchise enterprise.
Franchising – Franchising and Entrepreneurship
With a wide range of rewarding business prospects in the country, the business fraternity has experienced a boom over the past few years. The concept of franchising has created a stir in the business sector, offering many business opportunities to young entrepreneurs to climb up the ladder of success. This has prompted entrepreneurs and other investors to leap forward to spend time, efforts, skills, expertise, and money to establish their own business.
Entrepreneurship involves several kinds of risks—strategic, financial, and operational— associated with it. An entrepreneur undertakes the risk ranging right from the inception of the business idea until the time the business is established and operational in the current scenario of cutthroat competition. Hence, it is obvious to state that choosing an option that is not only rewarding but also less risky is a wise man’s decision that has less financial tolerance to the uncertainty.
It requires a great deal of efforts to start a business in any sector. But a budding concept for any entrepreneur is to tread on the franchise route. Hence in today’s global economic scenario, the growth of franchising is inevitable because it offers aspiring new business owners the best possible chance of succeeding.
1) Good Deal for Beginners:
By presenting a proven business model, coupled with hands-on training, franchising is capable of transmuting novices into accomplished entrepreneurs.
2) Sense of Independence:
Franchising means you are the owner. Hence, it gives you a satisfaction of establishing something on your own. This is the route that leads you to become a professional entrepreneur.
3) Proven Blueprint:
After venturing into franchising, an entrepreneur is legally entitled to adopt the tried-and-tested business model and format, procedures, processes, practices, and overall code of conduct developed by the franchiser. Thus, an entrepreneur will reap the benefits of a proven track record of the franchiser.
4) Reduction in Risk:
The risk of failure is comparatively lower than starting a new business. This is so because when entrepreneur buys a franchise, he or she buys the system that works.
5) Easier Finance:
An entrepreneur receives financial assistance from the franchiser, as they make arrangements with the banks and other financial institutions to lend money.
6) Low Cost and High On Returns:
The primary benefit that a franchisee reaps is the low cost of investment. This is due to the reduction costs and the savings made in administrating, promoting, and advertising the franchise brand/outlet. In addition, association with an established brand-name ensures assured profits and ROIs.
7) Mentor and Peer Support:
With this professional support from the franchiser, which acts as a mentor, an entrepreneur becomes competent to operate its set of business activities and operations, in a relatively comfortable atmosphere of shared risk factor.
8) Platform for Business Development:
Once the entrepreneur gets associated with an established brand-name, it becomes easy to win and earn the targeted customers. This can be achieved with the help of the brand strength/image and consumer loyalty toward that brand.
9) Exclusive Territorial Rights:
By venturing into a franchise, the franchiser guarantees predetermined territory to the franchisee that assists in succeeding within that region.
Hence, franchise investment is one of the safest business heavens that demands less cost and risk. Besides these characteristics, indulging in business franchising is a win-win situation for the three parties involved- franchiser, franchisee, and the end user of the product/service.
Franchising – Franchising in India: Examples of Popular Brands Using Franchising Concept in India
In India, Franchising is still in the infant stage. It started with Computer Training Institutes and it is becoming popular in the Apparel and Fast Food industries. Organized retailing was initiated in South India. During the past three-four years, many global giants are attracted toward the Indian retail trade. McDonalds, Domino’s, Benetton were the pioneers. They found IT hubs like Chennai, Hyderabad and Bangalore as the right places for initial set up. There is tremendous potential for growth of big shopping malls in these metros.
And they have already captured a higher share of organized retail formats and cut across all categories, e.g., McDonalds, Pizza. Hut in Fast Food, Cafe Coffee Day, Barista in coffee. Hence, many international ready- made garments and food retailer brands have opened exclusive outlets by giving franchisees in these metros. In the North they are now focusing on Delhi, Noida, Gurgaon and Chandigarh. However, they are gaining popularity in all big cities and metros throughout India.
Franchising is not restricted to only multinational or giant brands. This concept is even used by the small companies having limited coverage and initially focusing local market. These companies have very exclusive or altogether different but successful product range. They can appoint franchisees for better and effective coverage and meeting increasing demand.
For example, Chitale Bandhu Mithaiwale Private Limited is the most popular sweet mart in Pune. The company has established brand in Pune and well-known for the taste and quality. Initially company was operating through only two centrally located outlets owned by the company itself. Customers from far places also used to make the special trips and wait for hours to get the products.
But now, considering the increasing demand for the company’s products from the customers in different parts of the city and suburbs, company has given the Franchise to the retailers from different parts of the city. Now, brand loyal customers get their favorite sweets at the convenient places, without making special efforts and waiting in the queues for the hours.
Same is the case with Kaware Ice Creams. It is one of the oldest, popular and successful local ice-cream brands in Pune. Initially it had only company’s own outlets. Now, company has given the Franchise to retailers who have opened Kaware Ice Cream parlours at different locations in the city.
Some popular brands using Franchising concept in India are given below:
McDonald’s, Pizza Hut, Domino’s Pizza, Barista Coffee, Cafe Coffee Day, Monginis Pastries, Vadilal, Dinshaw’s, Baskin & Robins, Naturals Ice Creams.
Nirula’s in New Delhi (Nirula’s has 11 outlets in Delhi and serves about 40,000 customers everyday. It has 3 restaurants in Nepal and 1 in Muscat).
Subway Sandwiches has 16,000 restaurants across the world and it operates in more than 74 countries.
(a) Big and international Courier companies such as FedEx, DHL, DTDC, First Flight, etc. as well as many small, local Courier and Cargo Companies.
(b) Telephone, cellular services like BSNL, BPL Mobile Galleries, Reliance InfoWorld, etc.
(c) Employment/placement agencies, matrimonial services such as ‘BharatMatrimony(dot)com Pvt. Ltd.’ also has given their franchise.
NIIT, Aptech, CMC, CMS Computers, Kid Zee Nursery School.
4. Insurance and Financial Services:
Kotak Mahindra.
Holiday Inn, Taj International, ITC Group, The Oberoi Group of Hotels, etc.
Raymonds, Benetton, Arrow, Van Heusen, Weekender, Lee, Adidas, Reebok, Titan, Archie’s Gifts and Greetings, etc.
Franchising – Legal Requirements of Franchising in India
India has become the most important franchising business model for several confined enterprises of other countries. Globalization has paved the way for foreign enterprises to enter in the Indian market and earn high profits. Franchising a business is considered as a convenient method to enter into the vast and culturally different geographical locations by many enterprises.
Due to increasing scope of franchising in India, there are high chances of malpractices and fraudulent franchising activities by the franchisor or franchisee. Therefore, Foreign Exchange Regulation Act (FERA), 1973 was made, which prevented the misuse of franchises by the franchisor or franchisee. The act also secured enterprises involved in the consumer market from the grasp of foreign marketers.
After the abolishment of FERA, another law called Foreign Exchange and Management Act 1999 (FEMA) was enacted. According to FEMA, all the foreign enterprises entering into the Indian market need to follow the rules and regulations related to the payments in foreign exchange. In addition, this act looks into the matter of franchise arrangements, such as franchise fees, training expenditures, and advertisement contributions.
In India, the franchising is not based on a particular law or authorization rather it is governed by number of statutes, rules and regulations.
Some of the important aspects are described as follows:
i. The Indian Contract Act, 1872 – It governs the contractual relationship between the franchisor and the franchisee. According to this act, a franchise agreement is enforced under the Indian law unless it meets the desired criteria of a valid contract.
ii. Monopolies and Restrictive Trade Practices (MRTP) Act, 1969 – It regulates the agreement related to restricted trade practices. It is essential for both the parties to understand the applications of the act and the restrictive provision in a franchise agreement.
iii. Consumer Protection (CP) Act, 1986 – It provides remedial measures to consumers in case of any defective products. This act makes the service provider liable for any deficiency in their promised services.
iv. Competition Act, 2002 – It prevents the adverse impact of competition in India with respect to product, services, storage, and distribution of product. This act was enacted to replace the MRTP Act.
v. Trademark Act, 1999 – It refers to the act enacted for the registration of trademark for any franchising business. This act states the validity periods of trademark registration, which is for 10 years from the date of application.
vi. IP Rights – It prevents the misuse of franchisor’s IP, such as copyright, trademarks, patents, and trade secrets.
A sound franchise law is essential in Indian competitive market for the following reasons:
i. Making the entire franchising procedure simple and meaningful as application of different laws in a single agreement makes the franchising approach more complicated. In such a case, figuring out various issues and relevant remedies of such agreement becomes difficult.
ii. Eliminating chaos and confusions of franchisors and franchisees to select a particular law while franchising a business. Existence of number of laws may put both the parties into dilemma about which law to be selected for franchising the business. Apart from this, presence of a particular law would make the franchising process less time consuming.
iii. Maintaining transparency in the franchising agreement. In case of lack of specific franchising authorization, the franchisor may hide some relevant information from the franchisee. This problem can be solved by enforcing a particular law.
iv. Avoiding discrepancies in the agreement as absence of specific franchise rules and regulations enables the foreign franchisor to follow the laws of their own country, which creates a great level of incongruity in the agreement.
Franchising – Advantages and Disadvantages of Franchising
As franchising is emerging as an important business model for expansion, it is very important to analyse the advantages and disadvantages of franchising.
The most important advantage of franchising for a franchisor is the cost-effective and fast-paced method that it offers, to penetrate a geographically diverse market. As a model, franchising does not require much of an upfront investment for the franchisor and if successful, can ensure the establishment of an efficient marketing network in no time.
If the franchisor had considered setting up operations through some other means—like setting up their own sales offices—the time and investment involved would have been huge, in comparison to a franchise network. Further, franchisees are small firms who have a good knowledge of the local market. Through a franchising agreement, this knowledge and connections can be tapped at no additional cost.
Distributors or wholesalers who are not tied in with a legal contract on the other hand, may not be very keen to apply this knowledge for the benefit of the channel. Most franchise agreements require an upfront deposit or fees to be paid to the franchisor. This can generate significant amounts of funds to the franchisor to promote the franchisor brand at a higher level.
As the franchise network starts functioning, the franchisor does not have to take responsibility for day- to-day operational issues, and hence is free to promote the brand.
For the franchisee, the main benefit is the opportunity of an established brand and a proven business concept. A franchisee operation thus becomes a less risky proposition than setting up an enterprise with a completely new brand. A franchisee also benefits through exposure to superior management practices that can be applied to other business ventures in the future.
However, franchising also holds significant disadvantages to both the franchisor and the franchisee. The most significant disadvantage to the franchisor is the loss of control over operations. Often in a franchisee network, the only source of control is based on the provisions of the legal franchisee agreement. But, in a legal environment of delays and rising costs, it may not always be possible to enforce all the legal provisions of the agreement.
The local franchisee cannot therefore be easily controlled unless the franchisor commands immense brand power and other superior resources. Once the franchisee system starts functioning, mutual dependence between the franchisor and the franchisee creates goodwill. It practically erodes the ability of the franchisor to enforce all the provisions through a legal process.
For the franchisee, significant upfront investment is one of the main disadvantages which lead to creation of asset specificity. Most franchisee agreements will have tough non-withdrawal clauses that prevent a franchisee from leaving the franchise network.
Even when the franchise business is not providing the expected profits, the franchisee may not be able to easily quit the arrangement due to legal clauses, as well as asset specificity. This is especially important when there is a rapid or drastic change in the macro-economic situation and the franchise model becomes less profitable.
However despite these problems, franchising arrangements are on the whole very attractive, both to the franchisor as well as the franchisee. The popularity of franchising arrangements is testified by the growth in this sector and the willingness shown by thousands of players to enter this field.