By Rosemary Wallis

Franchises originated after the First World War with the development of petrol stations and motor vehicle dealerships. Today there are many examples of franchising, and it is particularly prominent in the food, service, and retail industries.

Franchises involve such diverse activities as key cutting, photocopying and print shops, sports shops, camera shops, clothing shops, sports arenas, rental cars, motels, health and fitness clinics, employment agencies, cleaning services, real estate agencies, automotive services and parts outlets, financial advisory services, fast food and set format restaurants. Shopping malls in both Australia and New Zealand have a large proportion of franchised outlets.


What is a franchise?

Franchising is a way of doing business and a marketing concept. It can be used in a number of different ways and even ranges as far as sporting concepts such as the Super 12.

However, there are 3 main categories of franchise.

1. Product and trade name franchises
Product and trade name franchises are arrangements where franchisees are granted the right to distribute a manufacturer's product within a specified territory or at a particular location, using the manufacturer's trade mark or trade name, in exchange for fees or royalties. Petrol stations are a prime example of this.


2. Manufacturing and production franchises
A process or manufacturing franchise is an arrangement where a franchisor provides an essential ingredient or know-how to a processor or manufacturer. Franchises of this nature are common, for instance, in the soft-drink industry.


3. Business format or system franchises
Business format or system franchises add an extra layer, through the imposition of a business format or an entire system for running a business, including a business plan, management system, location, appearance, image, and quality of goods and services.

In a business format franchise, each franchised outlet or business should look and act the same. It should provide an identical product or service of identical quality. While each is independently owned and operated, this should make no difference to what the customer receives. McDonalds' hamburgers should taste the same wherever you buy them.

The defining characteristics of a business format franchise are:

1. The ownership by the franchisor of a name and trade mark, an idea, a secret process, or a piece of equipment, and the goodwill and know-how that is associated with it.
2. The grant of a licence (the franchise) by the franchisor to another person (the franchisee) permitting the franchisee to exploit this.
3. The inclusion in the franchise agreement (and elsewhere such as a manual) of regulations and controls relating to the way the franchisee exploits its rights.
4. Payment by the franchisee to the franchisor for the right to operate the franchise. This can take various forms, such as a royalty on turnover, or a surcharge for the product supplied by the franchise.
5. Provision of trading and support by the franchisor to the franchisee to enable the franchisee to carry on its business according to the franchisor's system.


Advantages And Disadvantages Of Franchises

The benefit of a franchise system for a franchisor is that it develops and expands the coverage of its business and trade name without the need for the franchisor to find the capital and also to operate the individual business itself.

Franchises are often attractive to those who are inexperienced in business. Ready access to a business system with a developed brand and with expertise on call to see them through any problems offers considerable advantages.

It is no coincidence that the failure rate for start-up franchised businesses is much lower than it is for non-franchised start-up businesses. The new business does not have to learn by its own mistakes: any glitches in business methods should already have been ironed out by the franchisor.

The relationship between a franchisor and franchisee is a continuing one, in which each party is reliant on the other for their respective businesses to succeed.

While a franchise is very similar to a trade mark licence, it does have some significant differences.

First, while a franchise is a contract between the franchisor and franchisee, the franchisor also has contracts and relationships with a number of other franchisees. The franchisee can be seriously affected by the health of the relationship between the franchisor and its other franchisees. A group of disgruntled franchisees can damage the health of the franchise network, and have a seriously adverse affect on the successful operation of other franchises.

Secondly, where a trade mark owner licenses another party, that party is often chosen for its ability to adequately manufacture or distribute a particular product or service. The licensee is chosen for its skills in the area. In a franchise situation, a franchisor will frequently choose, and in fact often prefers, franchisees inexperienced in a particular industry, so that they are amenable to being taught the franchiser's tried and tested methods of operation.

Because the franchisor has already tested out the most successful methods of performing the particular service producing a particular product, the franchisee does not have to go through the process of trial and error that occurs in a new business. The success rate of franchises is therefore much higher. Of new businesses, only one in five survives the first five years, while 70-80% of franchised businesses successfully survive that initial five year period.

Franchises do not suit everyone. Strict conformity with their franchisor's prescribed methods can be stifling to some franchisees who believe they can "do it better". The franchisee must be prepared to work in conformity with the franchise system, otherwise the franchise system will be weakened by a series of the franchisees each "doing their own thing".

This is not to say that the franchise system cannot change and be improved. One of the roles of the franchisor is to constantly add value to the system by bringing in innovation and improvement in methods and strengthening the brand, but this must be done consistently throughout the franchise network.


Franchising A Business

Not all businesses make successful franchises. A franchise needs to be something that is durable, and not a fleeting fad. A single-product franchise is a risky venture because that product may become obsolete.

There are however successful franchising systems at all levels of business from manufacturing to service and retailing.

A franchise system needs to have been thoroughly tested and proved in practice to be successful. The business also needs to have a distinctive name, branding, image as well as well-developed systems and methods of operation.

Without this sort of distinctiveness, it has nothing to differentiate it from an ordinary business, or to attract franchisees to it. Franchisors need to make sure that the system and business methods can be transferred to others and are not dependent upon a particular person. One of the difficulties in a franchise system dependent on one person is that if that person leaves the picture, then the franchise system may be at risk of collapse.

The franchise also needs to be able to be profitable. Franchisees should be wary of buying themselves a job, which is a risk with some service franchises. The returns may be enough for people to earn themselves a basic living, but not enough for profitable business.

An advantage for a franchisor of franchising its business is that it doesn't have to produce the capital for expansion itself. It has national coverage and a group of committed and focused franchise operators.

A disadvantage for the franchisor is that while the franchise system and the franchise agreement maintain a level of control over what happens in those businesses, the franchisor is at arm's length from the operation. It must be prepared to manage and deal with the relationships with franchisees who see themselves as being independent businesses.

Sometimes, distribution outlets are better than franchises, particularly where this involves particular types of products that do not require strong levels of associated services and particular methods of operation.


Cost Of A Franchise

When buying a franchise there will often be an initial franchise fee that may be substantial. That is the key to access into the franchise business including the system and the trade marks. There will also be ongoing fees such as royalties on turnover and advertising levies.

There are some franchise systems that make their money from collecting up-front fees, and rely far less on royalties. In such a situation, there may be less incentive for the franchisor to carry on improving the franchise system.

There are set-up costs such as fitting out of shop and buying equipment, uniforms, vehicles and so on.

Finally, it is important to remember the dollar signs.

One of the main problems in franchising is under capitalisation by both the franchisor and franchisee. Quite often, franchises extend themselves as far as they possibly can in order to get into the business. That means that there is little fat when times get hard. Similarly, a franchise network can fail, if its continuation is dependent on the sale of franchises, and insufficient investment is returned to the system from the royalties remitted by franchisees.

No business will last unless it makes a profit.


Questions For Franchisees - Checklist

There are a number of questions that a franchisee ought to ask when looking at a franchise:

-How well established is the franchisor?
-How long is the franchise term and is it exclusive?
-Do you have to buy premises?
-Is there adequate disclosure documentation?
-What are the operating manuals like?
-Are you able to pick out what fees you have to pay on an ongoing basis and are they reasonable?
-Where do you obtain products and services?
-What is the extent of training?
-What assistance in operating a business do you get from the franchisor?
-What reports must you submit?
-How can the franchise be terminated?
-What post termination restrictions are there?
-Can you sell the franchise and under what conditions?
-What dispute resolution procedures are there?
-Is the franchisor a member of the Franchise Association of New Zealand?
-Can you make a profit?


Selecting Franchisees - Handy Hint

This is one of the critical issues for a franchise. A franchisor needs to select franchisees who are capable of performing to a system, but who also have a lot of energy and drive. If the franchisor picks the wrong type of person, that person can disrupt the franchise system by causing trouble with other franchisees. For that reason, self-employed people who are used to doing things their own way may not necessarily make good franchisees.

This is a general summary only and should not be taken as a substitute for specific advice.

Web site: Baldwin Shelston Waters

Email: email@bsw.com
July 2001