Franchising

Franchising is a kind of licensing arrangement wherein a business owner, known as the "franchisor," distributes or markets a trademarked product or service through affiliated dealers, who are known as "franchisees." While these franchisees own their establishments, terms of franchising agreements typically require them to share operational responsibilities with the franchisor.

Over the past few decades, franchising has emerged as an integral part of America's commercial landscape. Indeed, companies as diverse as McDonald's, The Gap, and Jiffy Lube owe their ubiquitous presence in the marketplace to the practice. Department of Commerce figures indicate that franchises exceeded $1 trillion in annual sales in the year 2000. The International Franchising Association (IFA) estimates that 40 percent of all U.S. retail sales took place in franchise outlets in the early 2000s. Although the U.S. Census Bureau has not counted franchises in previous Economic Censuses, International Franchise Association President Matthew Shay announced in a late 2005 press release that plans were being finalized by the Bureau to include questions about franchising in the 2007 Census of Business.

Franchising has been embraced by many entrepreneurs eager to run their own company. But the characteristics of a franchising business are dissimilar in some crucial respects from those of other start-up businesses. Some businesspeople have even gone so far as to characterize franchisees as glorified employees of the franchisor, the company that owns the trademark and business concept that the franchisees use. Other observers find this description of the relationship to be misleading and simplistic, but they also acknowledge that there are many aspects of franchising that a prospective small business owner should learn about before entering into such an agreement.

Three different kinds of franchising arrangements are commonly found in the United States today. Business format franchises are the most popular of the franchise types. Under this arrangement, the franchisee pays an initial fee and an ongoing royalty to the franchisor in exchange for a proven business operation and identity. Benefits of this package include the franchisor's name and its product line, marketing techniques, production and administration systems, and operating procedures. A second option is to pursue a product or trade name franchise in which the franchisee becomes part of a franchisor's distribution network. Some small business owners choose to combine their resources under the banner of a single operating network. These affiliate franchises are thus able to pool their assets together for purchasing, advertising, and marketing visibility purposes.

BENEFITS OF FRANCHISE OWNERSHIP

There are many significant advantages to franchise ownership. In most instances, an entrepreneur who decides to buy a franchise is purchasing a business concept with a proven track record of success. In addition, a franchise agreement provides instant name recognition for the business, which can be a huge advantage if the name enjoys a solid reputation in the marketplace. But franchising provides benefits in many other areas of business operation as well. These include:

Advertising and Promotion Franchisees benefit from any national advertising campaigns launched by the corporation with which they have gone into business. In addition, many franchisors provide their franchisees with a wide range of point-of-sale advertising materials, ranging from posters to mobiles to brochures. Since such materials are often expensive to produce, they would otherwise be beyond the reach of some individual franchisees.

Operations Franchisors provide franchisees with a wide range of help in the areas of administration and general operations. The entrepreneur who becomes a franchise owner is instantly armed with proven products and production systems; inventory systems; financial and accounting systems; and human resources guidelines. Many franchisors also provide management training to new franchisees, and ongoing seminar workshops for established owners.

Buying Power Franchisees are often able to fill inventory needs at discount prices because of their alliance with the franchisor, which typically has made arrangements to buy supplies at large-volume prices. This is an increasingly great advantage because today one has to compete with national chains, conglomerates, buying consortiums, and other large franchises. The small-business person who purchases in small quantities can not easily compete in terms of buying power. By becoming a franchisee, a business has the collective buying power of the entire franchise system.

Research and Development Most small business owners are able to devote little time or money to research and development efforts. Franchising, then, can provide a huge lift in this regard, for many franchisors maintain ongoing research and development systems to develop new products and forecast market trends.

Consulting Services It is in the franchisor's best interests to do all it can to ensure the success of all of its franchisees. As a result, the entrepreneur who decides to become a franchisee can generally count on a wide range of training and consulting services from the larger company. Such services can be particularly helpful during the startup phase of operations.

DRAWBACKS OF FRANCHISE OWNERSHIP

While the benefits of franchising are many and varied, there are well-documented drawbacks that should be considered as well. These include:

Cost The initial franchise fee, which in some cases is not refundable, can be quite expensive. Some fees are only a few thousand dollars, but others can require an up-front investment of several hundred thousand dollars. In addition, some franchisors require their franchisees to pay them regular royalty fees—a percentage of their weekly or monthly gross income—in exchange for permission to use their name. Some franchisors also require their franchise owners to help pay for their national advertising expenditures. Other costs include insurance, initial inventory purchases, and other expenses associated with equipping a new business.

Limited Control

Franchisees are subject to many franchisor regulations concerning various aspects of business operation and conduct. As the Federal Trade Commission (FTC) acknowledged to prospective franchisees in its Consumer Guide to Buying a Franchise, "these controls may significantly restrict your ability to exercise your own business judgment." Areas in which franchisors generally wield significant control include the following:

Site Approval—Many franchise agreements include stipulations that give the franchisor final say in site selection. Some franchisors also limit franchise territories, and while such restrictions generally prevent other company franchisees from impinging on your territory, they can also act to restrict your ability to relocate once you have become established.

Operating Restrictions—Franchise agreements include many instructions on the ways in which a franchisee must conduct business. These encompass all aspects of a business's operation, from operating hours to accounting procedures to the goods or services that are offered. "These restrictions may impede you from operating your outlet as you deem best," admitted the FTC. "The franchisor also may require you to purchase supplies only from an approved supplier, even if you can buy similar goods elsewhere at a lower cost."

Appearance Many franchisors cultivate a certain readily recognizable look to their outlets, for they know that such standards, when applied consistently, contribute to national recognition of the company name and its products and services. Franchisees generally accept these regulations willingly, for these standards of appearance in the areas of decor, design, and uniforms have proven to be part of a winning formula elsewhere. This is just as well, for the franchise owner who does wish to make changes in his business's appearance often has little freedom to do so.

Association with the Franchisor For the small business owner whose franchise is attached to a highly regarded, financially robust franchisor, the association can be a powerful positive in his or her business. Business experts note, however, that a franchise outlet can suffer severe damage if its franchisor is beset with financial difficulties or public relations problems. "If the franchisor hits hard times, you'll most likely feel them as well," noted the editors of the Small Business Advisor. "You are inevitably tied to the franchisor, not only by contract, but by concept, name, product, and services sold."

Prospective franchisees, then, need to weigh many factors in their decision making about entering the burgeoning world of franchising. But most small business consultants acknowledge that these factors usually boil down to a couple of fundamental concerns. The choice of becoming a franchisee or starting a stand-alone business hinges on the answers one gives to two important questions: Is risk sufficiently mitigated by the trademark value, operating system, economies of scale, and support process of the franchise to justify a sharing of equity with the franchisor? Is my personality and management style compatible with sharing decision-making responsibilities with the franchisor and other franchisees?"

SELECTING A FRANCHISE

It is imperative for prospective franchise owners to make an intelligent, informed decision regarding franchise selection, for once a contract has been signed, the franchisee has committed himself to the enterprise. But the selection process can be a bewildering one for the unprepared entrepreneur. Franchise opportunities are available in a wide array of industries, each of which offers its own potential benefits and drawbacks. Moreover, every franchisor has its own strengths and weaknesses. Several business areas, then, need to be investigated as part of any effective franchise selection process.

Analysis of Self

Experts counsel prospective franchise owners to evaluate their own personal strengths and weaknesses before signing any franchise contract. Prospective franchisees should also have an understanding of their ultimate business and personal objectives before beginning the search for an appropriate franchise. The entrepreneur who is most interested in achieving financial security may want to look in an entirely different industry than the entrepreneur who hopes to land a franchise that will enable him or her to devote more time to family life.

Analysis of Industry and Market

Prospective franchise owners need to evaluate which industries interest them. They also need to determine whether the franchisor's principal goods or services are in demand in the community in which he or she hopes to operate. Other industry-wide factors, such as the cost of raw materials used and the amount of industry competition, need to be weighed as well. The latter issue is a particularly important one, for it can be a fundamental factor in a franchisee's success or failure. The presence of some competition, for instance, often indicates a healthy demand for goods or services in that industry area. A dearth of competitors, though, might indicate that demand is low (or nonexistent). Similarly, the presence of several competitors might necessitate an examination of whether the market can support another provider in that area, or whether you might have to take meaningful market share from already existing businesses in order to survive.

Analysis of Franchisor

Entrepreneurs interested in franchising should be knowledgeable about the strengths and weaknesses of companies that offer such arrangements. Factors that should be considered include the franchisor's profitability, organizational structure, growth patterns, public reputation, litigation history, financial management capabilities, fee requirements, and relationship with other franchisees.

Perhaps the best source of information on these and many other issues is the franchisor's disclosure document. This important document, which must be given to prospective franchise owners at least ten business days before any contract is signed or any deposits are owed, usually takes the form of the Uniform Franchise Offering Circular (UFOC). The UFOC contains important information on key aspects of the franchisor's business and the nature of its dealings with franchisees. Information contained in the UFOC includes a franchise history; audited financial statements and other financial history documents; franchise fee and royalty structures; background on the franchise's leading executives; terms of franchise agreements; estimated start-up costs for franchisees (including equipment, inventory, operating capital, and insurance); circumstances under which the franchisor can terminate its relationship with a franchisee; franchisor training and assistance programs; franchisee advertising costs (if any); data on the success (or lack thereof) of current and former franchisee operations; and litigation history.

Some prospective franchise owners pay less attention to a company's litigation history than other information included in the UFOC, but a company's past litigation experiences can, in some cases, provide important insights into the franchisor's business ethics and/or operating style. "The disclosure document tells you if the franchisor, or any of its executive officers, has been convicted of felonies involving, for example, fraud, any violation of franchise law or unfair or deceptive practices law, or are subject to any state or federal injunctions involving similar misconduct," noted the Federal Trade Commission. "It also will tell you if the franchisor, or any of its executives, has been held liable or settled a civil action involving the franchise relationship. A number of claims against the franchisor may indicate that it has not performed according to its agreements, or, at the very least, that franchisees have been dissatisfied with the franchisor's performance. Be aware that some franchisors may try to conceal an executive's litigation history by removing the individual's name from their disclosure documents."

The inclusion of other information on a franchisor's business dealings with franchisees is up to the discretion of the franchisor. For example, while franchisors are required by law to provide prospective franchisees with documentation of expected start-up costs, they are not required to provide long-term earnings projections. Those who do provide such information are obligated by the FTC's Franchise Rule to have a reasonable basis for the claims they make and provide prospective franchisees with written information substantiating their projections.

It is important, then, to utilize other sources of information in addition to the disclosure document when pondering a move into the world of franchising. For example, small business consultants often urge prospective franchisees to conduct interviews with franchisor representatives about various business issues. Other sources of information often cited include financial institutions (for financial evaluations of the franchisor), state agencies (for information on franchisee rights in the state in which the franchisee is operating), the Better Business Bureau (for news of possible complaints against the franchisor), industry surveys, and associations (such as the Franchise Consultants International Association and the International Franchise Association).

Many experts also encourage prospective small business owners to interview current and former franchisees associated with the franchisor. Would-be franchisees can thus gain first-hand information on a great many business subjects, including: likely size of total investment, hidden or unexpected costs, satisfaction with franchisor performance (in training, advertising, operating, etc.), franchisee backgrounds, and business trends in the industry. Franchisee lists can be a valuable resource, but consultants caution their clients to make certain that they receive a complete list, rather than a list of selected franchisees who are compensated by the franchisor for giving positive appraisals of the company.

FRANCHISING LAWS

The United States has developed an extensive regulatory system designed to govern franchising practices throughout the business world. Chief among the federal guidelines are the FTC's Franchising and Business Opportunity Ventures Trade Regulation Rules and Subsequent Guidelines. In addition, many state governments have fashioned pieces of legislation that directly impact on franchising operations. A good many of the laws governing franchising—both at the state and federal level—are expressly designed to protect prospective small business owners from unscrupulous franchisors who misrepresent themselves.

Franchising experts commonly urge prospective franchisees to enlist the help of an attorney during the franchise selection process. Indeed, since franchising is such a complicated business, many entrepreneurs secure an attorney's services throughout the process. Legal assistance is especially helpful when the time comes to sign the franchise or license agreement, the document that lays out the terms of the partnership between a franchisee and a franchisor. "The franchise agreement is the foundation on which your franchise is built," stated the Entrepreneur Magazine Small Business Advisor. "The agreement gives both parties a clear understanding of the basis on which they are going to continue to operate."

The franchise contract covers all aspects of the franchisee-franchisor agreement, from record keeping to site selection to quality control provisions. The contract is designed to cover both relatively minor issues—such as sign display requirements—to matters of major importance—such as the franchisee's schedule of royalty payments and required insurance provisions. Franchise agreements also include a section devoted to detailing the length of the contract, and any possibilities for extending the terms of the contract beyond the termination date. Long term agreements (15 years or more) give franchisees more security, though this can be problematic if their relations with the franchisor take a bad turn. Since shorter terms do make it easier for franchisors to rid themselves of under performing or troublesome franchisees, some prefer to go this route. Others, however, place a higher value on securing the franchisee royalties that often pour in under the longer agreements.

Information included in the franchise contract includes the following:

• Accounting and recordkeeping provisions
• Existence (and terms) of any performance quotas
• Fairness of the franchise fee
• Fairness of the royalty arrangement
• Franchisor's continuing services to franchisee
• Insurance protection (if any) under franchisor's patent or liability insurance coverage
• Operating provisions (including quality control, human resource management, and other areas)
• Restrictions (if any) on business activities outside the franchise
• Restrictions (if any) on selling the franchise
• Start-up investment required
• Termination or default terms (as well as arbitration clauses)
• Terms of contributions, if any, to parent company's national advertising campaigns
• Terms of inventory and ordering practices
• Terms of renewing the franchise agreement
• Territorial protections

Given the scope of its coverage—and its importance as the binding legal document between franchisee and franchisor—the franchise contract is, in its final form, an imposing and complicated document. Again, the importance of the agreement makes it imperative that prospective franchise owners consult with an attorney before signing the contract.

see also Buying an Existing Business

BIBLIOGRAPHY

Blair, Roger D., and Francine LaFontaine. The Economics of Franchising. Cambridge University Press, June 2005.

Caffey, Andrew A. "Now You're Cooking." Entrepreneur. January 1999.

Federal Trade Commission. Consumer Guide to Buying a Franchise. Available from http://www.ftc.gov/bcp/conline/pubs/invest/buyfran.htm Retrieved on 9 March 2006.

Goldstein, Joel. "Successful Franchisees Investigate before They Invest: Why franchise shows are invaluable to the decision-making process." Franchising World. November 2005.

"Great Business—Why Not Franchise it?" Inc. 29 May 2001.

Harris, Pat Lopes. "Fickle Franchising: Buying a Franchise May Seem Like a Low-Risk Way to Becoming a Successful Entrepreneur, But It's Not Necessarily a Sure Thing." Washington Business Journal. 6 November 1998.

Hill, Terry, and Amy Bannon. "Economic Census will Count Franchise Business." Press Release. International Franchising Association. Available from http://www.franchise.org/article.asp?article=1290&paper=93&cat=303 22 November 2005.

"Many Franchises are Services, Fitness." UPI NewTrack. 5 March 2006.

                                   Hillstrom, Northern Lights

                                    updated by Magee, ECDI

FRANCHISING

Franchising is an arrangement whereby a supplier, or franchiser, grants a dealer, or franchisee, the right to sell products or services in exchange for some type of consideration. It is a business arrangement involving a contract between a manufacturer or another supplier and a dealer that specifies the methods to be used in marketing a good or service. The franchiser may receive some percentage of total sales in exchange for furnishing equipment, buildings, management know-how, and market research. The franchisee supplies labor and capital, operates the franchised business, and agrees to abide by the provisions of the franchise agreement.

Historically, franchising was a grant by a king to allow a citizen an exclusive right to sell a product or render a service. For this right, the sovereign protected the exclusivity and the subject paid the government an appropriate tribute in service, food, goods, or money. Franchising in the United States started shortly after the Civil War (1861–1865), when the Singer Company began to set up sewing-machine franchises. The concept became increasingly popular after 1900 in the automobile industry. Because of this, other automotive franchises developed for gasoline, oil, and tires. In the 1950s, food operations made a dramatic entrance into franchising with the development of McDonald's, currently one of the world's largest franchise organizations.

Franchising operations account for billions of dollars in annual sales, with more than 500 outlets employing millions of people. A new franchise opens somewhere in the United States every six minutes. Franchising accounts for approximately 40 percent of all U.S. retail sales. Because of changes in the international marketplace, shifting employment options in the United States, the expanding U.S. economy, and corporate interest in more joint-venture activity, franchising will continue to increase rapidly.

Franchising represents the small entrepreneur's best chance to compete with the giant companies that dominate the marketplace. Without franchising, thousands of businesspeople would never have had the opportunity to own their own businesses.

The largest percentages of franchise operations are in the recreation, entertainment, and travel fields, followed closely by business services, nonfood retailing, and automotive products and services. Popular franchises include Subway, McDonald's, Wendy's International, Jackson Hewitt Tax Service, KFC, UPS Store, TCBY Treats, Taco Bell, and Jani-King.

TYPES OF FRANCHISE AGREEMENTS

Retail franchise agreements fall into three general categories. In one type of arrangement, a manufacturer authorizes a number of retail stores to sell a certain brand-name item. This franchise arrangement, one of the oldest, is common in the sales of cars and trucks, farm equipment, shoes, paint, earthmoving equipment, and gasoline. About 90 percent of all gasoline is sold through franchised independent service stations, and franchised dealers handle virtually all sales of new cars and trucks.

In the second type of retail franchise, a producer licenses distributors to sell a given product to retailers. This arrangement is common in the soft-drink industry. Most national manufacturers of soft drinks—such as Coca-Cola, Dr. Pepper, and PepsiCo—grant franchises to bottlers, which then service retailers.

In the third type of retail franchise, a franchiser supplies brand names, techniques, or other services, instead of complete products. The franchiser may provide certain production and distribution services, but its primary role in the arrangement is careful development and control of marketing strategies. This approach to franchising, very common in the early twenty-first century, is used by such organizations as Holiday Inn, AAMCO, McDonald's, Dairy Queen, KFC, and H&R Block.

A good franchise system can offer the prospective franchisee a diversified array of business savvy. In most instances, the franchisee enjoys the benefit of a nationally recognized trade name, national recognition, and the instant collective goodwill of the franchise. Standard quality and uniformity of a product or service coupled with an existing—and successful—system of marketing and accounting are other benefits. In addition, expert advice on location, design, capitalization, and operational issues is provided by the franchiser. Specialization on a national level is done in order to maintain the necessary research and market analysis that will enable the franchisee to remain competitive in an ever-changing marketplace. In other words, a business framework is supplied that reduces the number of risks that may arise when starting a new business. Most often these risks are associated with the financial investment involved. The franchise agreement, however, often offers a cost savings by sharing a centralized purchasing system, and in some instances, direct financial assistance.

ADVANTAGES AND DISADVANTAGES OF FRANCHISING

Franchising offers several advantages to both the franchisee and the franchiser. It enables a franchisee to start a business with limited capital and to benefit from the business experience of others. Moreover, nationally advertised franchises, such as ServiceMaster Clean and Burger King, are often assured of customers as soon as they open. If business problems arise, the franchisee can obtain guidance and advice from the franchiser at little or not cost. Franchised outlets are generally more successful than independently owned businesses. Fewer than 10 percent of franchised retail businesses fail during the first two years of operation, whereas approximately half of independent retail businesses fail during that period. The franchisee also receives material to use in local advertising and can benefit from national promotional campaigns sponsored by the franchiser. At the start of the twenty-first century, Taco Bell franchisees profited from a national advertising campaign featuring a Chihuahua demanding "Yo quiero Taco Bell" ("I want some Taco Bell"). The ads helped boost same-store sales at Taco Bell by 3 percent in an otherwise flat industry. The talking dog was especially popular among teenagers, who spend more than $12 billion per year at fast-food restaurants.

The franchiser gains fast and selective product distribution through franchise arrangements without incurring the high cost of constructing and operating its own outlets, thus giving it more capital for expanding production and advertising. It can also ensure, through the franchise agreement, that outlets are maintained and operated according to its own standards. The franchiser benefits because the franchisee, being a sole proprietor in most cases, is likely to be very highly motivated to succeed. Success of the franchise means more sales, which translate into higher income for the franchiser.

Despite these numerous advantages, franchise arrangements also have drawbacks for both parties. The franchiser can dictate many aspects of the business: decor, design of employees' uniforms, types of signs, and numerous other details of business operations. In addition, franchisees must pay to use the franchiser's name, products, and assistance. Usually franchisees must pay a one-time franchise fee as well as continuing royalty and advertising fees, often collected as a percentage of sales. For example, Subway requires franchisees to come up with $70,000 to $220,000 in start-up costs. Franchisees often must work very hard, putting in twelve-hour days, six or seven days a week. In some cases, franchise agreements are not uniform; one franchisee may pay more than another for the same services. The franchiser also gives up a certain amount of control when entering into a franchise agreement. Consequently, individual establishments may not be operated exactly the way the franchiser would like.

MONEY AND TIME COMMITMENTS

When entering into a franchise agreement, franchisees must be prepared to make major commitments of both money and time. They must be prepared to invest a substantial amount of money, both in the initial franchising fee and in start-up costs and carrying funds to provide a cash flow sufficient to operate the business during the beginning months or, if necessary, years. Most franchisees average a net profit of approximately $30,000 the first year of the contractual agreement with increase in residual profits annually the second year forward.

The second commitment is that of time; in the beginning, the proprietor will be obliged to devote long hours to the details of the business operation. Experience has shown that this commitment is the common denominator to many successful franchise operations. Franchisees must rely to a large extent upon their own aptitude and drive in order to learn the business. They must also rely upon the product, services, and business skills of the franchiser.

KEY CONSIDERATIONS

In deciding whether or not to enter into a franchise agreement, there are several key points that need to be considered. The first consideration is price and costs. What is the total cost? What are the initial fees? What are the ongoing costs? Are there any hidden extras? Are franchisees restricted in their right to purchase other goods?

The second consideration is the location. Where will the franchise be located? What is the territory that it will serve? What are the protections and limitations? Who will the competition be?

The third issue involves control and support. What controls will be in place? What policies and regulations govern the franchise agreement? What training and ongoing support will be supplied?

Advertising is the fourth consideration. The franchisee needs to determine what national and regional advertising will be supplied, as well as what the franchisee pays for and what the franchiser finances.

The last area of concern involves profits and losses, transfer and death, and duration and termination. Potential franchisees need to determine not only what protection they will receive for their earnings if they are successful, but also what obligations they will be responsible for if the franchise fails. In addition, they need to find out whether, in the event of their death, the franchise agreement can be transferred to their heirs or automatically reverts to the franchiser. Finally, they need to determine what stipulations, penalties, and other responsibilities are involved in terminating the contract with the franchiser should they no longer wish to continue in the business.

THE FRANCHISING SECTOR

A franchise is like any other business property in that it is the buyers' responsibility to know what they are buying. Poorly financed or poorly managed franchise systems are no better than poorly financed or poorly managed non-franchise businesses. It is important to remember that there are trends in franchises, just as in other types of businesses. Popular areas for franchising include auto rental, fast-food, haircutting, health and fitness, and real estate businesses.

The growth of the franchised fast-food industry has been truly spectacular. These franchise operations are second only to automobile dealerships and gasoline stations in gross volume of sales. Most often located at key intersections or on busy highways, fast-food enterprises enjoy a high visibility.

In this segment of the franchise industry, the majority of franchise operators have already owned other businesses before entering into a fast-food franchise. Many successful operators are college graduates, but the significant number of successful franchisees with only a high school education suggests that education alone is not a determining factor. A fast-food franchise is the type of venture in which both husband and wife can contribute to the success of the business.

Most fast-food franchisers consider geographic location to be an important factor in the success of the operation. And, like franchisers in other fields, they cite the importance of adequate capitalization, the efficient operation of the franchise system, good customer relations, quality employees, and the contributions of the franchisees, such as their management skills and especially their hard work.

According to Cassano's Pizza and Subs, a franchiser with twelve outlets in four states, the successful franchise operator must have several traits:

• an excellent attitude toward customer service and customer relations
• an entrepreneurial ability and spirit combined with good business techniques
• a willingness to take a hands-on attitude toward the business

Newcomers to the Cassano's franchised fast-food business must have prior retail management experience and previous food-service experience. All new franchisees are trained at the home office in Dayton, Ohio, for one month. After that, the franchise provides ongoing training and managerial assistance.

GLOBAL FRANCHISING

Franchising is growing rapidly abroad, with hundreds of franchise companies operating in thousands of outlets overseas. Canada is the largest of these markets, followed by Japan, Europe, Australia, and the United Kingdom. In 1995 Subway signed a deal with Japanese financiers to open 1,000 franchise outlets in Japan. Subway tailored its products to fit the local tastes—for example, offering the Japanese market fried pork sandwiches.

Franchising can be a workable way for small firms to enter foreign markets, especially markets where there are few competitors. For example, Automation Paper Company, a small New Jersey-based supplier of high-technology paper products, used franchising to gain exclusive representation in target markets. The franchisees received rights to the company's trademark, as well as training for local staffs and the benefit of the firm's experience, credit lines, and advertising budget.

The problems facing franchise companies in international transactions are relatively less formidable than those facing other service sectors. Franchisers must comply with the same local requirements as other businesses, and the franchise agreements must comply with local contract law, antitrust law, and trademark and licensing laws. Aside from language and cultural differences, many of the problems of conducting business in foreign countries are the same as those involved in the United States. The success or failure of foreign franchising will depend in large measure on the soundness of the franchiser's domestic market position and on the franchiser's ability to provide the necessary expertise to others in another part of the world.

Some franchises popular in the United States actually started in another country. For example, Molly Maid started in Canada in 1980 and came to the United States four years later.

FRANCHISING TRENDS

All trends indicate that franchising will continue to expand both domestically and internationally, creating great opportunities for existing and new businesses; developing new entrepreneurs, new jobs, new products, new services; and providing export opportunities. Rising personal income, stable prices, high levels of consumer optimism, and increased competition for market share are turning many companies, both small and large, to franchising. Education will play an important role in the future of franchising, as both high schools and colleges increase the number of courses that are taught in marketing, business management, and entrepreneurship. In addition, changing patterns in American demographics, coupled with the increased number of women in the workforce, are influencing the number of new franchises each year.

Furthermore, shifting demographic patterns and the use of new technology have intensified competition among franchise companies. These factors have increased the number of mergers and acquisitions in the franchising system, and it was expected that this merger/acquisition trend would persist for several years. Creativity and imagination in the treatment of goods and services are the focus of most business ventures today. Education, computers, and the ability to work with and manage people will be profitably used by emerging businesses. All these developments suggest that franchising will be one of the leading methods of doing business as the first decade of the twenty-first century progresses, even in an environment of mixed signals in the economy. These signals include the economic trend of consumer demand for service-sponsored arrangements, which are currently the fastest growing type of franchise. Examples include Snelling and Snelling Inc. (employment service) and H&R Block (tax services).

ECONOMIC IMPACT OF FRANCHISING

In 2005, the total number of franchise establishments in the United States totaled 767,483. This means that nearly 3.2 percent of all US businesses operate as a francise. These franchises are also responsible for providing more than 9.7 million jobs in the economy, with an annual estimated payroll that totaled close to $230 billion. According to the International Franchise Association, franchised businesses provided more jobs than durable-goods manufacturers. These include franchises in industrial equipment/machinery; communications; lighting and other electrical equipment; trucks, cars, planes and other transportation equipment; lumber and wood products; furniture/fixtures; and computers.

see also Marketing

bibliography

Blair, Roger D., and Lafontaine, Francine (2005). The economics of franchising. New York: Cambridge University Press.

Hoy, Frank, and Stanworth, John (Eds.) (2003). Franchising: An international perspective. New York: Routledge.

Kaufman, D. (2004, August). New study reveals an extraordinary economic reach. New York Law Journal, p. 3.

Kotler, Philip, and Armstrong, Gary (2006). Principles of marketing (11th ed.). Upper Saddle River, NJ: Pearson Prentice Hall.

Moore, Lisa (1991, June 10). The flight to franchising. U.S. News & World Report, pp. 78–81.

Pride, William M., and Ferrell, O. C. (2006). Marketing concepts and strategies (Rev. ed.). Boston: Houghton Mifflin.

U.S. Bureau of the Census. (2006). Statistical abstract of the United States. Washington, DC: Author.

Patricia A. Spirou

Franchising

When an individual has the desire and drive to be an entrepreneur but lacks a strong idea for a company, franchising a proven business can be extremely rewarding. Franchising is an agreement or alliance between two organizations—the franchisor and the franchisee. The franchisor has the business model, training materials, and other materials for the business. The franchisee is the entrepreneur who agrees to operate a branch of the business while paying the franchisor various fees and royalties for the use of the business idea or model.

TYPES OF FRANCHISING

Business-format franchising exists when a franchisor allows someone to market products or services, using the business name or trademark, in return for fess and royalties. When franchising is mentioned, most people think of business-format franchising, like McDonald's, AAMCO Transmission, or Molly Maid. There is also product or trademark franchising. This is a limited franchise where a manufacturer may grant another party a license to sell goods produced by the manufacturer. This might include sale of cars through dealerships (e.g., Ford dealerships), sale of gasoline through service stations (e.g., Shell stations), and sale of soft drinks through local franchising (e.g., Coca Cola bottlers). A final type of franchising is conversion franchising. This franchising model is designed to bring formerly-independently-operating businesses together under the collective power of a national name and advertising. An example of conversion franchising is Century 21 Realtors, an affiliation of previously-established real estate agents.

FRANCHISE START-UP

Franchise fees typically include a lump-sum entrance fee and other charges for regular services, including royalties on sales, advertising fees, and marketing. In exchange for these licensing fees, the franchisor retains control over the delivery of the products and services, as well as marketing and the operational and quality standards of the franchise. The franchising company's revenue is generated through the franchisee that pays these on-going sales royalties, typically averaging 5 percent of sales. The contract, or franchise agreement, is signed by both parties and establishes the relationship between the franchisee and the franchisor. The contract also details the responsibilities and privileges of both parties.

Franchises include such popular names as H&RBlock, McDonald's, 7-Eleven, Body Shop, Pizza Hut, and Jiffy Lube. These franchise operations have well-established names, brands, and reputations. The best franchises provide a strong brand or trademark of the concept, a proven business system, extensive training and product development, along with a number of initial and on-going managerial support services. Some help the franchisee secure funding and offer benefits, including discounted supplies. Typically, the franchised business is less risky than other forms of new venture creation because the business idea has been tested and there are mutual advantages to both parties. The Service Corps of Retired Executives (SCORE), a volunteer group involved in counseling would-be entrepreneurs, reports that franchises are safer than other business formats. Franchises experience less than a 5 percent failure rate compared to an 80 percent five-year failure rate for independent businesses and a 90 percent failure rate for independent restaurants. Banks are also supportive of the franchising business model and many will offer up to 70 percent of the initial capital costs.

WHY FRANCHISE?

Franchising allows a business to rapidly expand beyond its original owners. Franchisees pursue a new business, experience the advantages of running their own business and being their own boss, and gain wealth through a proven business idea. They provide the management skills to run the business, and contribute the capital to fund the opening and on-going operations. The franchisor also benefits from the partnership and gains economy of scope advantages as more franchises are established. National or international advertising becomes possible and the franchisor can more easily expand business locations with help and capital from the franchisee. The franchisee helps to build brand awareness through market proliferation. The franchisee has a unique opportunity to run a business with a greater chance of success. There is experience from the franchisor for starting the business and many of the initial

mistakes have already been made, learned from, and corrected.

Franchisees create their own jobs and often create a number of new jobs in operation areas as they hire employees. As the franchise becomes successful, the franchisee may choose to open other stores to create even more wealth. Franchising is popular in the United States and abroad. Franchising is at a mature level in the United States, Europe, and Australia, while Asia, South America, Mexico, and Central America report rapid growth. China, too, is experiencing franchise business growth.

RESEARCHING FRANCHISES

It is important to carefully perform initial due diligence and to thoroughly examine any franchise offering. A Federal Trade Commission (FTC) rule was created and adopted in the mid-1970s that requires franchisors to disclose to franchisees very specific information, including information about themselves, the business, and the terms of the relationship. This document is the Uniform Franchise Offering Circular (UFOC) and provides important legal information about the franchisor and its franchising program.

When deciding on a franchise, it is important to first ascertain personal goals for business ownership and to examine the franchise offering to find a compatible opportunity. While there are no guarantees in franchising, a well-developed operating plan is often an advantage. An entrepreneur should consider a number of issues regarding a possible franchise. For example, is the franchise in only one local market, or does it have a regional, national, or international presence? Lower-risk franchises have a national or global presence and benefit from the size advantage. The franchisee will also want to consider if most of the existing outlets are profitable, and whether the franchise is the market leader with the largest market share among competitors. The entrepreneur should evaluate the presence of a national marketing and purchasing program. The lower-risk franchises also have documented training, manuals, field support, marketing and promotion, standardized operating procedures, and on-going feedback channels between the franchisor and the franchisees. The terms of the license agreement vary from less than ten years to more than twenty years and some have automatic renewal. Capital requirements for obtaining the franchise also vary. Other factors to consider include territory limitations, failure rates, and any relevant litigation history against the franchise. Investment requirements should also be clearly disclosed.

It is often a good idea to interview existing franchise owners to determine if start-up costs and processes are realistic. Legal counsel may be required to negotiate and interpret the franchise agreement contract. SCORE also recommends that potential franchising clients plan and analyze their options. This planning and analysis should include researching Chamber of Commerce and Better Business Bureau records for a given franchise. SCORE agrees that the most important step for choosing a franchise is also considering the entrepreneur's interests, skill set, and experience. It is easier to evaluate an established franchise than a new franchise. There may be few, if any, owners with whom to speak about the franchise. It is important that the new franchise have strong franchisee support and a proven business system. The business strategy should also be examined carefully.

FRANCHISING AND THE ECONOMY

In 2005 more than 11 million people were employed by franchised businesses. This group of approximately 3,000 franchised names—ranging from automobile dealers to food operations—generates nearly 5 percent of gross income in the United States. Giving nearly 8 percent of able-bodied workers a job, curbing unemployment during tough economic times, and creating wealth where there previously was none, these businesses are clearly important to the economy. The IFA reports that for franchising the start-up costs can range from less than $5,000 to more than $1,000,000. Growth in the franchise sector is on an upward trend even during otherwise questionable economic times. For this reason, PricewaterhouseCoopers suggests the outward growth of franchises may not necessarily have an end in sight. IFA offers information on franchising, including newsletters about events and discussion forums and educational materials. It also includes information on government regulations for franchising.

In a 2004 study conducted by PricewaterhouseCoopers (for the International Franchise Association Educational Foundation) on the economic impact of franchised businesses, more than 760,000 franchised businesses exist in the United States and generate some $1.53 trillion yearly. This represented 9.5 percent of the private sector economic output in the United States. These franchises generate one out of every seven jobs in America.

The IFA established a Franchise Index to track the market performance of the top fifty U.S. public franchisors. The index has increased steadily since January 2000, compared to a drop of 20.1 percent in the Standard and Poors (S&P) 500 Index over the same period. Interestingly, the franchise index has grown during tough economic times. Thus, franchising is a major economic force with a significant impact on the nation's economy.

The franchising business model attracts a number of qualified individuals, particularly in times of recession or slow business growth. Individuals are attracted to franchising and the opportunity to create their own jobs. While franchising is not a get-rich-quick proposition, many do have attractive returns on investment. Most analysts agree a three- to five-year period of hard work and dedication is

needed before the franchised business is profitable. Over the years, more individuals are touting the advantages and value of franchising. These franchises pick up on key business trends that affect—and are affected by—social and demographic changes and changing lifestyles. Healthy fast food, at-home care for the elderly, pet care, Internet education, personal services, automotive services, green living, and travel services are all industries that have grown because of changing attitudes. Many of these industries offer exclusive territories in a given market.

Additional advice on finding and comparing franchising opportunities is available on the franchise-broker Web sites (e.g., www.FranNet.com, www.FranChoice.com, and www.francorpconnect.com). FranNet.com is a franchise-broker Web site representing franchise consultants. Some potential franchisees prefer using a broker to find a franchise.

While there are many advantages to franchising, there are some disadvantages. Once a business grows beyond a certain size, it could make more money if it were wholly owned, since a percentage of the profit goes to the franchisor. Even if a franchise is capable of making large profits, the franchise manager must deal with the franchisor as well as business operations. The franchisee must be committed to the idea and business model. The franchisee must also be supportive of the franchisor's system, as the key to a successful franchise operation is consistency. Customers expect a similar product or service from all branches of a franchise. Entrepreneurs who do not want to follow the predetermined structure and operating procedures of a franchise may not be successful.

The franchising arrangement is a balance of entrepreneurial spirit, standard business procedures, and following instructions. The venture, like other start-ups, will require a serious time and energy commitment. It can be difficult for a franchisor to find a franchisee with drive, energy, and the experience necessary to run a business according to franchise guidelines. A franchise also needs an appropriate location. Aside from who runs the franchise, where it is located is of the highest importance. A franchise location must be researched thoroughly to determine its growth potential.

The combination of franchisor guidance, franchisee know-how and determination, reasonable capital investment, and well-researched location will almost always result in successful franchise operation regardless of economic climate, season, or trends. A strong business model coupled with a determined business owner are the keys to success in franchising.

SEE ALSO Business Plan; Due Diligence; Entrepreneurship; Strategy Formulation

BIBLIOGRAPHY

Caplin, J. “How Do I Find the Right Franchise?” Money 33, no. 5 (2004): 55.

Doehrman, Marylou. “Pros and Cons of a Franchised Business” Daily Record and the Kansas City Daily News–Press, 3 January 2005: 1.

Inma, Chutarat. “Purposeful Franchising: Re-Thinking of the Franchising Rationale” Singapore Management Review 27, no. 1 (2005): 27–48.

Lymbersky, Christoph. “Market Entry Strategies” Hamburg, Germany: Management Laboratory, 2008.

Ng, L. “Unfolding Franchising” Malaysian Business, 1 September 2004, 50.

Timmons, Jeffry A., and Stephen Spinelli. New Venture Creation: Entrepreneurship for the 21st Century. Boston: McGraw-Hill Irwin, 2004.

Zaragoza, S. “Due Aims to Take Pain Out of Franchising” Dallas Business Journal 28, no. 17 (2004): 12.

FRANCHISE

A special privilege to do certain things that is conferred by government on an individual or a corporation and which does not belong to citizens generally of common right, e.g., a right granted to offercable televisionservice.

A privilege granted or sold, such as to use a name or to sell products or services. In its simplest terms, a franchise is a license from the owner of atrademarkortrade namepermitting another to sell a product or service under that name or mark. More broadly stated, a franchise has evolved into an elaborate agreement under which the franchisee undertakes to conduct a business or sell a product or service in accordance with methods and procedures prescribed by the franchisor, and the franchisor undertakes to assist the franchisee through advertising, promotion, and other advisory services.

The right of suffrage; the right or privilege of voting in public elections. Such right is guaranteed by the Fifteenth, Nineteenth, and Twenty-fourth Amendments to the U.S. Constitution.

As granted by a professional sports association, franchise is a privilege to field a team in a given geographic area under the auspices of the league that issues it. It is merely an incorporeal right.

Government Franchises

The consideration that is given by a person or corporation in order to receive a franchise from the government can be an agreement to pay money, to bear some burden, or to perform a public duty. The primary objective of all grants of franchises is to benefit the public; the rights or interests of the grantee, the franchisee, are secondary. A corporation is a franchise, and the various powers conferred on it are also franchises, such as the power of an insurance corporation to issue an insurance policy.Various types of business—such as water companies, gas and electric companies, bridge and tunnel authorities, taxi companies, along with all types of corporations—operate under franchises.

The charter of a corporation is also called its general franchise. A franchise tax is a tax imposed by the state on the right and privilege of conducting business as a corporation for the purposes for which it was created and in the conditions that surround it.

Power to Grant The power to grant franchises is vested in the legislative department of the government, subject to limitations imposed by the state constitution. A franchise can be derived indirectly from the state through the agency that has been duly designated for that purpose, such as the local transportation agency that can grant a franchise for bus routes. Franchises are usually conferred on corporations, but natural persons can also acquire them. The grant of a franchise frequently contains express conditions and stipulations that the grantee, or holder, of the franchise must perform.

Not every privilege granted by a governmental authority is a franchise. A franchise differs from a license, which is merely a personal privilege or temporary permission to do something; it can be revoked and can be derived from a source other than the legislature or state agencies. A franchise differs from a lease, which is a contract for the possession and profits of property in exchange for the payment of rent.

Regulation Once a franchise is granted, its exercise is usually subject to regulation by the state or some duly authorized body. In the exercise of police power—which is the authority of the state to legislate to protect the health, safety, welfare, and morals of its citizens—local authorities or the political subdivisions of the state can regulate the grant or exercise of franchises.

Right to Compete While a franchise can be exclusive, exclusiveness is not a necessary element of it. Nonexclusive franchises—including those to function or operate as a public utility—do not include the right to be free of competition. The grant of such a franchise does not prevent the grant of a similar franchise to another entity, or lawful competition on the part of public authorities. The holder of a nonexclusive franchise is entitled to be free from the competition of an entity that does not have a valid franchise to compete. The holder can institute a proceeding for an injunction—a court order that commands or prohibits a certain act—and monetary damages for the unlawful invasion of the franchise.

Duration The legislature can prescribe the duration of a franchise. The powers of local authorities or political subdivisions of the state depend upon the statute that confers the power to make grants and upon any constitutional limitation.

A franchise can be terminated by the mutual agreement of the state that is the franchisor, and the grantee or the franchisee. It can be lost by abandonment, such as when a corporation dissolves because of its fiscal problems. A mere change in the government organization of a political subdivision of a state does not divest franchise rights that have been previously acquired with the consent of local authorities. A franchise cannot be revoked arbitrarily unless that power has been reserved by the legislature or proper agency.

Forfeiture A franchise can be subject to forfeiture due to nonuse. Misuse or failure to provide adequate services under the franchise can also result in its loss. The remedy for nonuse

or misuse lies with the state. Persons other than the state or public authorities cannot challenge the validity of the exercise of a franchise unless they can demonstrate that they have a peculiar interest in the matter distinct from that of the general public.

Invasion of the Franchise A person or corporation holding a valid franchise can obtain an injunction to prevent the unlawful invasion of the franchise rights and can sue for monetary damages if there has been financial loss as a result of the infringement.

Transfer of Franchises Subject to applicable constitutional or statutory limitation, franchises can be sold or transferred. Where the franchises involve public service, they cannot be sold or transferred unless there is authorization by the state. The person or corporation purchasing the franchise in an authorized sale takes it subject to its restrictions.

Private Franchises

Certain written contractual agreements are sometimes loosely referred to as franchises, although they lack the essential elements in that they are not conferred by any sovereignty. The franchise system, or method of operation, has had a phenomenal growth in particular consumer product industries, such as automobile sales, fast foods, and ice cream. The use of a franchise in this manner has enabled individuals with minimal capital to invest to become successful members of the business community.

Under the most common method of operation, the cornerstone of a franchise system must be a trademark or trade name of a product. A franchise is a license from an owner of a trademark or trade name permitting another to sell a product or service under the name or mark. A franchisee agrees to pay a fee to the franchisor in exchange for permission to operate a business or sell a product or service according to the methods and procedures prescribed by the franchisor as well as under the trade name or trademark of the franchisor. The franchisee is usually granted an exclusive territory in which he or she is the only distributor of the particular goods or services in that area. The franchisor is usually obligated by contract to assist the franchisee through advertising, promotion, research and development, quantity purchasing, training and education, and other specialized management resources.

Before 1979 few state legislatures had enacted laws to protect prospective franchisees from being deceived by the falsehoods of dishonest franchisors. These laws, known as franchise disclosure laws, mandated that anyone offering franchises for sale in the state had to disclose material facts—such as the true costs of operating a franchise, any recurring expenses, and substantiated reports of profit earned—that would be instrumental in the making of an informed decision to purchase a franchise.

In states that did not have such legislation, the unsophisticated investor was at the mercy of the franchisor's statements. A victimized franchisee could sue a franchisor for breach of contract, but this was an expensive proposition for someone who typically had invested virtually all of his or her financial resources in an unprofitable franchise. Franchisors confronted with numerous lawsuits often would declare bankruptcy so that the franchisees had little possibility of recouping any of their investments.

The federal trade commission (FTC) received numerous complaints about inequitable and dishonest practices in the sale of such franchises. In late 1978, it issued regulations, effective October 21, 1979, that require franchisors and their representatives to disclose material facts necessary to make an informed decision about the proposed purchase of a franchise and that establish certain practices to be observed in the franchisor-franchisee relationship. These rules are collectively known as the Disclosure Requirements and Prohibitions Concerning Franchising and Business Opportunity Ventures, or more simply, the Franchise Rule.

A franchisor must disclose the background of the company—including the business experience of its high-level executives—for the previous five years; and whether any of its executives, within the last seven years, have been convicted of a felony, have pleaded nolo contendere to fraud, have been held liable in a civil action for fraud, are subject to any currently effective court order or administrative agency ruling concerning the franchise business or fraud, or have been involved in any proceedings for bankruptcy or corporate reorganization for insolvency during the previous seven years.

In addition, there must be a factual description of the franchise as well as an unequivocal statement of the total funds to be paid, such as initial franchise fees, deposits, down payments, prepaid rent on the location, and equipment and inventory purchases. The conditions and time limits to obtain a refund, as well as its amount, must be clear as well as the amount of recurring costs, such as royalties, rents, advertising fees, and sign rental fees. Any restrictions imposed—such as on the amount of goods or services to be sold, the types of customers with which the franchisee can deal—the geographical area, and whether the franchisee is entitled to protection of his or her territory by the franchisor must be discussed. The duration of the franchise, in addition to reasons why the franchise can be terminated or the franchisee's license not renewed when it expires, also must be explained. The number of franchises voluntarily terminated or terminated by the franchisor must be reported. The franchisor must disclose the number of franchises that were operating at the end of the previous year, as well as the number of company-owned outlets. The franchisee must also be supplied with the names, addresses, and telephone numbers of the franchisees of the ten outlets nearest the prospective franchisee's location, so that the prospective franchisee can contact them to obtain a realistic perspective of the daily operations of a franchise.

If the franchisor makes any claims about the actual or projected sales of its franchises or their actual or potential profits, facts must be presented to substantiate such statements.

All of these facts—embodied in an accurately, clearly, and concisely written document—must be given to the prospective franchisee at the first personal meeting or at least ten days before any contractual relationship is entered or deposit made, whichever date is first. The purpose of this disclosure statement is to provide the potential investor with a realistic view of the business venture upon which he or she is about to embark. Failure to comply with the FTC regulation could result in a fine of up to $10,000 a day for each violation.

Some states have also enacted laws that prohibit a franchisor from terminating a franchise without good cause, which usually means that the franchisee has breached the contract. In such a case, the franchisor is entitled to reacquire the outlet—usually by repurchasing the franchisee's assets, such as inventory and equipment.

In states without "good cause" laws, franchisees claim that they are being victimized by franchisors who want to reclaim outlets that have proven to be highly profitable. They allege that the franchisor imposes impossible or ridiculous demands that cannot be met to harass the franchisee into selling the store back to the franchisor at a fraction of its value. Company-owned outlets yield a greater profit to the franchisor than the royalty payments received from the franchisee. Other franchisees claim that their licenses have been revoked or not renewed upon expiration because they complained to various state and federal agencies of the ways in which the franchisors operate. Such controversies usually are resolved in the courtroom.

further readings

Andrews, Chris. 2003."Granholm Pushing for Financial Disclosure Law." Lansing State Journal (June 18).

Siatis, Perry C. 2000. "Assessing the FTC's Proposed Franchise Rule Provisions Involving Electronic Disclosure." Brigham Young University Law Review (May 20).

Franchise

What It Means

A franchise is a license allowing one party, the franchisee, to use the brand name and business processes already developed by a parent company, the franchisor. Acquiring a franchise usually involves paying a start-up fee and agreeing to pay a regular percentage of sales to the parent company. Franchises are an extremely popular way of starting a business in the United States, especially for those who want to compete in the fast-food, automotive sales and rentals, lodging, real-estate, and other retail industries. Specific corporations that engage in franchising include McDonald’s, Subway, Baskin-Robbins, Coca-Cola, Ford, Chevrolet, Toyota, Hertz, Avis, Thrifty, Holiday Inn, Howard Johnson, Days Inn, Century 21, and RE/MAX.

Franchises offer advantages and disadvantages for the entrepreneur. The use of an established brand name and/or a proven business model can significantly simplify the launching and operation of a business. This and other advantages may be outweighed, in some cases, by the sometimes-steep franchise fees that must be paid each month or year. Additionally, depending on the type of franchise and the particular company, a franchisee may have very little leeway in his or her decision-making.

When Did It Begin

Sewing-machine maker I. M. Singer and Company (later called Singer Manufacturing Company), which was started by Isaac Singer in 1851, is generally considered the first company to engage in franchising in the United States. Singer enlisted independent dealers to sell his sewing machines in the early stages of his company’s development. Though the company ultimately abandoned the franchise model for a more centralized corporate structure, other companies adapted the original franchising strategy with better results. The Coca-Cola Company, which began operating on a franchise basis in the late nineteenth century, was one of the most successful early examples, and its operations today still technically follow the franchise model. (The parent company sells the condensed syrup that is the basis of the drink to franchisee bottlers, who mix it with water and sell it to retailers.) Franchising began to assume its modern form in the early 1900s, when A&W Root Beer began establishing fast-food restaurants on a franchise basis. The Howard Johnson’s hotel chain began selling franchises in the 1930s, bringing the trend to that industry. The popularity of franchises increased with the construction of the interstate highway system in the United States in the 1950s. Travelers were particularly likely to trust a brand-name hotel or restaurant over unknown local competitors. The expansion in franchising that led to the proliferation of chain stores seen all over the United States today occurred mainly after 1965.

More Detailed Information

There are two common models for franchises in the United States today. One type, called product franchising, is less restrictive for the franchisee than the other type, business-model franchising.

In product franchising relationships a parent company gives a franchisee the right to sell its products and use its brand name and trademarks, but it does not tell the franchisee how to run his or her business. Such arrangements are common in the automotive sales industry, in which car dealerships are franchises with the rights to sell certain brands but do not have to do so according to specific directions from the manufacturers of those brands. The arrangement between Coca-Cola and its regional bottlers is also an example of product franchising. Bottlers have the right to bottle and sell Coke, but they run their business affairs largely on their own. Product franchising generates about two-thirds of all the money brought in by franchises in the United States.

Business-model franchising comes with more specific guidance from the parent company. In this type of franchising the franchisee purchases more than the rights to a brand name. The franchisor often provides assistance with the launch and the operation of the business; the parent company may decide where the franchise should be located, what the physical layout will look like, what equipment should be used, and how employees should be trained, among other features of the business. In the fast-food industry business-model franchising is the norm, and it explains why each branch of most national chains (such as McDonald’s, Wendy’s, Burger King, Subway, and KFC) looks virtually identical to all others and conducts business in such a way that you can expect the same experience from franchises whether you are in Walla Walla, Washington, Tampa, Florida, or anywhere in between. Though business-model franchises are more widespread than product franchises, accounting for three-quarters of all franchised businesses, they bring in only one-third of the revenue generated by all U.S. franchises.

Entrepreneurs gain significant advantages when they choose to buy a franchise rather than start a business from scratch. Foremost among these advantages is the head start provided by an established brand name. Whereas a new business may spend years and huge amounts of money building its brand through advertising and customer interactions, a franchisee has the privilege of selling a brand consumers already recognize and seek out. Franchisees also commonly benefit from national advertising campaigns and other promotional efforts conducted by the franchisor. Highly visible marketing of this type is not otherwise available to small business owners, who generally operate on a limited budget. Most franchise agreements also include a provision giving the franchisee rights to be the only seller of the franchisor’s brand within a certain territory. This represents an important competitive advantage in many cases.

There are potential downsides to consider before deciding to purchase a franchise, however. One of the most serious of these negative aspects is the financial arrangement between the franchisor and the franchisee. In addition to paying the start-up expenses related to opening any business (such as rent, construction, labor, and product costs), a McDonald’s franchisee as of 2007 was required to pay a fee of $45,000 for the right to operate under the brand name for a period of 20 years. Beyond this initial investment a franchisee is further obligated to pay fees amounting to 12.5 percent of all sales to the franchisor. Burger King charges a higher start-up fee ($50,000) but requires a lower percentage of sales (4.5 percent). Other franchisors may offer lower fees, but this is typically because the brand is less established. McDonald’s can charge high fees because of its enormous consumer base. In any case, a franchisee should plan on handing over a substantial portion of whatever money he or she makes to the parent company.

Additionally, the success of franchises is based on conforming to a single business model. For the entrepreneur who wants to make his or her own decisions, this might not be a fulfilling environment. While the advantages of a proven business model are significant, they may undercut the personal satisfaction some entrepreneurs seek when they go into business for themselves. Further, the obligation to conform can become a liability if the parent company does not hold up its end of the bargain. If the advertising on behalf of the brand is ineffective or if the parent company otherwise fails to maintain high standards for the brand, the individual franchisee may be locked into a struggling business model at a time when individual creativity could help avert losses.

For established companies franchising offers a way to expand a brand without undertaking all of the costs of doing so in a more centralized fashion. A company intent on owning all of its own outlets must use its own money to buy equipment and hire workers with each new branch opening. This may mean putting off profitability for several years. By contrast, a franchisor’s expenses are minimal; willing franchisees undertake much of the financial burden of expanding the brand’s reach. The result is the possibility for extremely rapid expansion. For example, it took the real-estate franchisor Century 21 only eight years (1972–80) to establish 7,400 branches. The fast-food giant McDonald’s grew to 6,200 franchises and one of the world’s most recognized brands within 25 years (1955–77), and at its fiftieth anniversary in 2004, it had more than 31,000 outlets in 119 countries.

One of the risks of being a franchisor is that a handful of inept franchisees can cause serious damage to the overall brand. For example, the standardization of fast-food restaurants leads many consumers to consider the various branches interchangeable. Health-code violations or other scandals at a few franchises can affect consumer perceptions nationwide, cutting into profits at the corporate level.

Recent Trends

Franchises spread rapidly across the United States at the end of the twentieth century. During the 1960s and 1970s franchises reached most areas of the country, and a further boom in franchises occurred in the 1980s and 1990s as a result of increased wealth, the massive marketing campaigns of franchisors, and the widespread American belief in the value of entrepreneurship. By the early twenty-first century there were more than 2,000 franchisors in the United States and more than 500,000 franchisees. The 600,000 franchises owned by these franchisees generated roughly one-third of all retail sales in the country.

There were numerous critics of franchises and their place in American culture at this time. Some critics pointed to the fact that franchises generally paid low wages, employed most workers on a part-time basis, and almost never offered benefits such as health insurance. Since franchises were such a dominant force in the economy, many believed that their labor practices harmed the employment conditions for workers in general. At the same time, the poor pay and lack of benefits meant that franchisees often found it difficult to keep good employees.

An additional criticism of franchises was that they drained money away from local economies, since such a large portion of any franchisees’ profits went to the parent company. The ability of franchises to use their established brands to fight off local competitors meant, further, that it was harder and harder for strictly local businesses to compete, increasing the amount of money leaving individual communities over time.

Finally, many ordinary citizens disliked the fact that the growing presence of franchises nationwide made American towns and cities increasingly indistinguishable from one another. During the early twenty-first century an increasing number of towns began passing regulations meant to keep out franchises and other chain stores, in an attempt to preserve community values and provide opportunities for local businesses.