Franchising is a form of business by which the owner (franchisor) of a product, service or method obtains distribution through affiliated dealers (franchisees). This type of license grants a franchisee access to a franchisor's proprietary business knowledge, processes, and trademarks, thus allowing the franchisee to sell a product or service under the franchisor's business name. In exchange for acquiring a franchise, the franchisee pays the franchisor an initial start-up fee, management and/or annual licensing fees.
The franchise business model has an interesting history in the United States. The concept dates to the mid-19th century, when two companies - the McCormick Harvesting Machine Company (we were an agrarian economy in those days) and the I.M. Singer Company - developed organizational, marketing and distribution systems recognized as the forerunners to franchising. These then novel business structures allowed McCormick and Singer to sell their reapers and sewing machines to an expanding domestic market.
The earliest food and hospitality franchises were developed during the boom of the 1920s and the bust years of 1930s; evidencing how the model would withstand the fluctuations or economic cycles. A&W Root Beer launched franchise operations in 1925. Howard Johnson Restaurants opened its first outlet in 1935, expanding rapidly and paving way for the restaurant chains and franchises that define the American fast-food industry until this day.
There are two different types of franchising relationships. Business Format Franchising is the type most familiar to us. In these business format franchises, the franchisor provides to the franchisee its trade name, products, and services, as well as an entire operating system. The franchisee generally receives site selection and development support, operating manuals, training, brand standards, quality control, a marketing strategy and business advisory support from the franchisor. While less identified with franchising, Traditional or Product Distribution Franchising is larger in total sales than business format franchising. Bottling, gas stations and automotive are the most familiar examples of Product Distribution Franchising.
A franchisor’s brand is its most significant asset and consumers spending patterns often lean towards businesses on what they know, or think they know, about the brand. A McDonald’s Big Mac has the exact same taste and appearance on both the west coast as well as the northeast. This consistency in brand expectations creates brand loyalty.
Tremendously successful franchisors provide streamlined systems, tools, and support so that their franchisees have the ability to live up to the system’s brand standards and ensure customer satisfaction. Franchisors as well as other franchisees under that brand’s umbrella expect each member will independently manage the day-to-day operation of its businesses in a manner to enhance the reputation of the company within that market area.
Franchise contracts can be complex and vary for each franchisor. Typically, a franchise agreement includes three categories of payment to the franchisor. First, the franchisee must purchase the controlled rights, or trademark, from the franchisor in the form of an upfront fee. Second, the franchisor often receives payment for providing training, equipment, or business advisory services. Finally, the franchisor receives ongoing royalties or a percentage of the operation's sales.
A franchise contract is temporary, akin to a lease or rental of a business. It does not signify business ownership by the franchisee. Depending on the contract, franchise agreements typically last between five and 30 years, with serious penalties if a franchisee violates or prematurely terminates the contract.
In the U.S., franchises are heavily regulated at the state level. However, the Federal Trade Commission (FTC) established The Franchise Rule in 1979 - a legal disclosure wherein a franchisor must fully disclose any risks, benefits or limits to a franchise investment. This information covers fees and expenses, litigation history, approved business vendors or suppliers, estimated financial performance expectations, and other key details except the ingredients to the special sauce.
“A creative man is motivated by the desire to achieve, not by the desire to beat others.” by Ayn Rand
Luigi Rosabianca of Shield Advisory Group