What is Franchising?
By Udo Schlentrich, Ph.D.
Director, Rosenberg International Franchise Center
Key Words: franchisor, franchisee, FDD, business format, product/trade name format, multi-branding
The word "franchising" is derived from the French verb, franchir, which means to make free or give liberty to, and often referred to freedom from some restriction, servitude or slavery. Franchising can be divided into two major categories: business format franchising and product / trade name format franchising. Business format franchising is defined by the International Franchise Association (IFA) as a marketing method in which the owner of a product or service, known as the "franchisor," offers the right to operate and manage his product and service to others, the "franchisees," in return for a fee and ongoing royalty payments. This is the preferred format of franchising in the hospitality industry. Product / trade name format franchising, on the other hand, concerns the relationship between a franchisor and a franchisee in which the franchisor grants to the franchisee the right to distribute a product and/or use a trade name. This format is most frequently employed in the soft drink, automobile and gasoline distribution industries.
History of franchising
In the Middle Ages, kings or local sovereigns granted rights to church officials, farmers and tradesmen to collect taxes, brew ale, operate markets or hunt on their land and, in return, obtained a fee for these rights. Probably the earliest example of consumer goods franchising was recorded in 1850 when the Singer Sewing Machine Company granted agents the right to sell and repair its line of sewing machines within specific territories. Howard Johnson is recognized as the first person in the hospitality industry to use the franchising model. In the 1940s, he expanded his original ice cream business into the Red Roof coffee shops and later expanded further into motor lodges.
In 1961, Ray Kroc acquired a limited service restaurant from Dick and Mac McDonald for $2.7 million. Today, McDonald's is the world's leading fast food retailer, operating over 30,000 restaurants in 119 countries and serving 47 million customers a day. Ray Kroc successfully used franchising as a growth strategy to expand globally. Over 80% of McDonald's restaurants worldwide are owned and operated by local businessmen and women. Other pioneers adapted Ray Kroc's franchising business strategy of providing high standards of quality, friendly service, cleanliness and value.
Although franchising was originally an American business strategy, it is now being adopted by companies all over the world. The French company, Accor, is Europe's leader of franchised hotels and restaurants with nearly 4,000 budget to upscale hotels worldwide. The British company, Bass, which started out as a brewing company, has also entered the franchise market by acquiring established US brands such as Holiday Inns and InterContinental. Another British company, Allied Domecq PLC, acquired Dunkin' Donuts in 1989 and also owns Baskin-Robbins and Togo's , a sandwich franchise brand.
A recent franchising phenomenon is multi-branding, a strategy in which one company owns several franchise brands that it markets under one roof, for example, in the food courts of malls, in airports or in gas stations. This strategy was pioneered by the US company, Yum!Brands, proprietor of Kentucky Fried Chicken, Pizza Hut, Taco Bell, Long John Silvers and A & W. Although franchised fast food concepts have expanded rapidly worldwide, they have recently come under attack by consumers and government agencies for offering unhealthy, high calorie foods. This sector is now responding by offering healthier food options and consumer nutrition awareness programs.
The franchising system
The franchising system is designed to provide a formula for operating a successful business by providing a uniform product and service concept, thereby offering to the consumer a recognized standard of what to expect and a higher perceived value. A successful franchisor will have tested and specified all product and service delivery systems prior to launching the franchise program. In addition, franchisors assist franchisees during the launch of their new business and also provide continuous product, concept and marketing assistance in order to ensure the long-term success of the franchise. William Rosenberg, founder of Dunkin' Donuts, said of franchising, "In business for yourself, but not by yourself."
The investment required for the acquisition of a franchise varies greatly depending primarily on the scale of the physical facility and whether the real estate is purchased or leased. Typical startup costs range from $25,000 to over $3 million.
Although franchising is now recognized as a global business model, its initial growth began in the United States. The US Federal Trade Commission drafted the first regulations aimed at protecting franchise applicants. Franchisors are required to make an extensive disclosure document available to each potential franchisee before the franchisee signs a franchise agreement. This document is called Franchise disclosure document (FDD) it covers twenty-three important disclosure statements that give details about a franchise system's business experience, any outstanding litigation, fee and investment requirements, franchisee and franchisor obligations, territory and trademark regulations, restrictions on what the franchisee may sell, renewal and termination clauses, etc. Inaccuracies or misrepresentations by franchisor's contained in FDD documents may result in civil and/or criminal penalties.
Advantages and disadvantages of franchising
The primary advantages of franchising from the perspective of the franchisee are the provision of a recognizable consumer brand, tested product and service concepts, technical assistance in the areas of site selection, facility construction and interior design, training, marketing support and financial controls. Franchisors often assist franchisee applicants in obtaining financing and/or lease agreements. Although all business models encompass a certain amount of risk, proven franchise concepts experience a considerably reduced level of failure. Given the extent of this support, even individuals without extensive prior experience in the field of a chosen franchise can often acquire and successfully manage a franchise business.
The primary disadvantages of franchising from the perspective of the franchisee are that the franchisee must pay a royalty fee and must comply with vigorous quality and control procedures established by the franchisor. Conflict may arise between the franchisee and franchisor when territorial exclusivity is breached or when trademark issues or renewal rights are disputed.
The primary advantages of franchising from the perspective of the franchisor are that it enables a company to establish a large number of outlets in a relatively short period of time. In addition, although the franchisor provides the business concept, it is the franchisee who is required to obtain financing to pay for the land, physical facility, inventory and working capital. The franchisor's costs are primarily related to administrative and support expenses, such as pre-opening assistance, training and quality control. Franchise companies are therefore leveraged to a lesser degree and are less vulnerable to cyclical fluctuations.
The primary disadvantages of franchising from the perspective of the franchisor are that, as its system grows, it is difficult to maintain high standards and effective communication with its franchisees. In addition, national and international growth often requires adaptation of the franchise system to local tastes and cultures.
Other franchise players
The International Franchise Association (IFA) is the most important membership organization representing franchisors, franchisees and suppliers. The association was founded in 1960 and is the world's oldest, largest and most important franchise organization. It has members from more than 100 countries. Its mission is to protect, enhance and promote all aspects of franchising. The association develops and administers education and certification programs, conducts research and holds an annual convention. The association is based in Washington, D.C.
The William Rosenberg International Franchise Center at the University of New Hampshire maintains the largest financial database of US and international publicly listed franchise companies. The center publishes a monthly index that tracts the market performance of the top 50 US public franchisors and compares the performance of these companies against those in the S&P 500. In addition, the H. Wayne Huizenga School of Business & Entrepreneurship at Nova Southeastern University in Ft. Lauderdale, Florida, offers executive education courses in the field of franchising.
Other key players in the franchise industry include consultants, search agencies, law firms, real estate and site finders, financing and leasing institutions, architectural and interior design firms, developers and contractors, and management companies.
The economic and social impact of franchising
According to a recent study on the economic impact of franchising commissioned by the International Franchise Association (IFA), the US franchise market generates over $1.4 trillion a year in revenue and thus accounts for over 45% of all retail sales. More than 75 industry sectors use franchising to distribute goods and services to consumers. Franchising provides direct employment for more than 9.4 million Americans. The total direct and indirect employment generated from franchising is projected at more than 18.6 million. Business format franchising has been the primary driver of the extraordinary growth of franchising.
In response to economic downturn cycles and corporate restructuring, many individuals have successfully made the transition from employee to employer by acquiring a franchise. Franchising plays an important role in providing employment to individuals without a higher education or specialized skills. It also provides first-time job seekers with an entry into the business world and provides the elderly with an opportunity to supplement their retirement benefits.
International Franchise Association (2004), Franchising Economic Impact Study, Washington, D.C., http://www.franchise.org/
Justis, Robert T. and Richard J. Judd, (2002), Franchising, 2nd Edition, Dame-Thomson Learning, Cincinnati, Ohio.
Rosenberg, William and Jessica B. Keener, (2001), Time to Make the Donuts, Lebhar-Friedman Books.
How can I learn more about franchising?
- For general information, browse the book abstract section on this website.
- See if information is available at your local library or through the university.
- Alternatively, you can buy the book.
Where can I find more information about the economic importance of franchising?
- An excellent source is the website of the International Franchise Association (IFA) http://www.franchise.org/ . The IFA is the world's leading franchise association, representing franchisors, franchisees and suppliers.
- The Fran 50 Index tracks the financial performance of the top 50 publicly listed franchised companies against that of the S&P 500. The Fran 50 is published quarterly by the Rosenberg International Franchise Center and can be found here on this website.