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Chapter 15

Franchising

Bruce R. Barringer

R. Duane Ireland

Chapter Objectives�1 of 2

1. Explain franchising and how it differs from other forms of business ownership.
2. Describe the difference between a product and trademark franchise and a business format franchise.
3. Explain the differences among an individual franchise agreement, an area franchise agreement, and a master franchise agreement.
4. Describe the advantages of establishing a franchise system as a means of firm growth.

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Chapter Objectives�2 of 3

5. Identify the rules of thumb for determining when franchising is an appropriate form of growth for a particular business.

6. Discuss the factors to consider in determining if owning a franchise is a good fit for a particular person.

7. Identify the costs associated with buying a franchise.

8. Discuss the advantages and disadvantages of buying a franchise.

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Chapter Objectives�3 of 3

9. Identify the common mistakes franchise buyers make.

10. Describe the purpose of the Franchise Disclosure Document.

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Introduction to Franchising

• Introduction
• Franchising is growing in popularity.
• Nearly 910,000 franchise outlets operate in the U.S.
• Franchises account for 1/3 of all retail sales in the U.S.
• History
• The word “franchise” comes from an old dialect of French and means privilege or freedom.
• Many of the most popular franchises, including KFC (1952), McDonald’s (1955), and H&R Block (1958) started as early as the 1950s.
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What is Franchising?

• Franchising
• Franchising is a form of business organization in which a firm that already has a successful product or service (franchisor) licenses its trademark and method of doing business to another business or individual (franchisee) in exchange for a franchise fee and an ongoing royalty payment.
• Some franchisors are established firms (like McDonald’s) while others are first-time enterprises being launched by entrepreneurs.

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Two Types of Franchise Systems�1 of 3

• Product and Trademark Franchise
• An arrangement under which the franchisor grants to the franchisee the right to buy its products and use its trade name.
• This approach typically connects a single manufacturer with a network of dealers or distributors.
• For example, General Motors has established a network of dealers that sell GM cars and use the GM trademark in their advertising and promotions.
• Other examples of product and trademark franchisors include agricultural machinery dealers, soft drink bottlers, and beer distributorships.

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Two Types of Franchise Systems�2 of 3

• Business Format Franchise
• An arrangement under which the franchisor provides a formula for doing business to the franchisee along with training, advertising, and other forms of assistance.
• Fast-food restaurants, convenience stores, and motels are well-known examples of business format franchises.
• Business format franchises are by far the most popular form of franchising, particularly for entrepreneurial firms.

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Two Types of Franchise Systems�3 of 3

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• Panera Bread is an example

of a business format franchise.

• Panera provides its franchisees

a strong brand and a method

for doing business.

• In return, each franchisee must

pay an initial franchise fee and

ongoing royalties.

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Types of Franchise Agreements�1 of 3

Individual Franchise Agreement

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Types of Franchise Agreements�2 of 3

Area Franchise Agreement

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Types of Franchise Agreements�3 of 3

Master Franchise Agreement

When to Franchise�From the Franchisor’s Point of View�1 of 2

• Approach Franchising With Caution and Care
• Establishing a franchise system should be approached carefully and deliberately.
• Franchising is a complicated business endeavor, and an entrepreneur must look closely at all its aspects before deciding to franchise.
• Regulations
• An entrepreneur should also be aware that over the years a number of fraudulent franchise organizations have come and gone and have left financially ruined franchise owners behind.

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When to Franchise?�2 of 2

• When Is Franchising Most Appropriate?
• Franchising is most appropriate when a firm has a strong or potentially strong trademark, a well-designed business method, and a desire to grow.
• A franchise system will ultimately fail if the franchisee’s brand doesn’t add value for customers and its business method is flawed or poorly developed.

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Steps to Franchising a Business

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Qualities for Look for in Prospective Franchisees

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• Good work ethic.
• Ability to follow instructions.
• Ability to operate with minimal supervision.
• Team oriented.
• Experience in the industry in which the franchise competes.
• Adequate financial resources and good credit history.
• Ability to make suggestions without becoming upset if the

suggestions are not adopted.

• Represents the franchisor in a positive manner.

Ways Franchisors Can Develop the Potential of Their Franchisees

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• Provide mentoring that supersedes routing training.
• Keep operating manuals up-to-date.
• Keep product, services, and business systems up-to-date.
• Solicit input from franchisees to reinforce their importance in

the larger franchise system.

• Encourage franchisees to develop a franchise association.
• Maintain the franchise system’s integrity.

Advantages and Disadvantages of Franchising As a Method of Business Expansion

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Advantages

Disadvantages

• Rapid, low-cost market expansion.
• Income from franchise fees and

royalties.

• Franchisee motivation.
• Access to ideas and suggestions.
• Cost savings.
• Increased buying power.

• Profit sharing.
• Loss of control.
• Friction with franchisees.
• Managing growth.
• Differences in required business skills.
• Legal expenses.

Buying a Franchise�From the Franchisee’s Point of View�1 of 3

• Buying a Franchise
• Purchasing a franchise is an important business decision involving a substantial financial commitment.
• Potential franchise owners should strive to be as well informed as possible before purchasing a franchise and should be aware that it is often legally and financially difficult to exit a franchise relationship.

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Buying a Franchise�2 of 3

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Answering the following questions will help determine if franchising is right for you

• Are you willing to take orders? Franchises are typically

very particular about how outlets operate.

• Are you willing to be part of a franchise “system” rather

than an independent businessperson?

• How will you react if you make a suggestion to your

franchisor and your suggestion is rejected?

• What are you looking for in a business? How hard do you

want to work?

Buying a Franchise�3 of 3

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Answering the following questions will help determine if franchising is right for you

• How willing are you to put your money at risk?
• How will you feel if your business is operating at a net

loss but you will have to pay royalties on your gross

income?

The Costs Involved With Buying a Franchise�1 of 3

• Initial Franchise Fee
• The initial fee varies depending on the franchisor.
• Capital Requirements
• The costs vary but may include the cost of buying real estate, the cost of putting up a building, the purchase of inventory, and the cost of obtaining a business license.
• Continuing Royalty Payment
• Typically 3% to 7% of monthly gross income.

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The Costs Involved With Buying a Franchise�2 of 3

• Advertising Fees
• Franchisees are often required to pay into a national or regional advertising fund.
• Other Fees
• Other fees may be charged for various activities, including:
• Training additional staff.
• Providing management expertise when needed.
• Providing computer assistance.
• Providing a host of other items or support services.

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The Costs Involved With Buying a Franchise�3 of 3

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Initial Costs to the Franchisee of a Sample of Franchise Organizations

Advantages and Disadvantages of Buying a Franchise

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Advantages

Disadvantages

• A proven product or service within

an established market.

• An established trademark or

business system.

• Franchisor’s training, technical

support, and managerial expertise.

• An established marketing network.
• Availability of financing (varies).
• Potential for business growth.

• Cost of the franchise.
• Restrictions on creativity.
• Duration and nature of commitment.
• Risk of fraud, misunderstandings, or

lack of franchisor commitment.

• Poor performance on the part of other

franchisees.

• Potential for failure.

Steps in Purchasing a Franchise

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Watch Out! Common Misconceptions About Franchising

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• Franchising is a safe investment.
• A strong industry ensures franchise success.
• A franchise is a “proven” business system.
• There is no need to hire a franchise attorney or an accountant.
• The best systems grow rapidly and it is best to be part of a rapid-growth

system.

• I can operate my franchise outlet for less than the franchisor predicts.
• The franchisor is a nice person—he’ll help me out if I need it.

Legal Aspects of the Franchise Relationship

• Federal Rules and Regulations
• The offer and sale of a franchise is regulated at the federal level.
• According to Federal Trade Commission (FTC) rule 436, franchisors must furnish potential franchisees with written disclosures that provides information about the franchisor, the franchised business, and the franchise relationship.
• In most cases, the disclosures are made through a lengthy document referred to as the Franchisor Disclosure Document (FDD).
• The FDD contains 23 categories of information that give a prospective franchisee a broad base of information about the background and financial health of the franchisor.

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More About Franchising�1 of 2

• Franchise Ethics
• The majority of franchisors and franchisees are highly ethical.
• There are certain features of franchising, however, the make it subject to ethical abuse. These features are as follows:
• The get rich quick mentality.
• The false assumption that buying a franchise is a guarantee of business success.
• Conflicts of interest between franchisors and franchisees.

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More About Franchising�2 of 2

• International Franchising
• International opportunities for franchising are becoming more prevalent for the following two reasons:
• The markets for certain franchised products in the U.S. have become saturated (i.e., fast food).
• The trend towards globalization continues.
• Steps to take before buying a franchise overseas:
• Consider the value of the franchisor’s name in the foreign country.
• Get a good lawyer.
• Determine whether the product or service is salable in the foreign country.
• Find out how much training and support you will receive from the franchisor.
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