Franchising refers to a business relationship in which the owner of a business (a franchisor) provides an independent business or an individual (franchisee) with a licensed privilege to operate under its trademarks and name. In this arrangement, the franchisor may provide the franchisee with a varied assistance, depending on the type of a contract the two entities have signed. Some of the assistance extended to the franchisee by the franchisor include organizational training, marketing strategies and resources, and an access to the franchisor’s business concepts. Franchising is attractive to small businesses because it offers an opportunity to start a business easily. Its attractiveness results from the support afforded by the franchisor. Moreover, since the franchisor is experienced in the business, the franchisee gets a chance to use tested concepts and receives a constant guidance. The franchisor, on the other hand, benefits because franchising provides a cheap way of expanding business since a little investment is required. Therefore, the agreement is a win-win strategy for both parties. Since the development of this concept, many businesses have adopted it because it helps businesses penetrate markets at a faster rate than when using their own subsidiaries. The franchisee, especially in the international market, is a local business. As such, the franchisee knows and understands the market better than the franchisor. Culture is an aspect that has had a great impact on international organizations when entering foreign markets. The failure to understand culture may prevent an organization from successfully penetrating a foreign market. The presence of a franchise that is conversant with the local culture helps in identifying and serving the local needs efficiently.

Types of Franchises

There are two main types of franchises, which include product distribution franchise and business format franchise. Product distribution franchise provides the franchisee with the rights and license to distribute its products in designated regions. The distributor uses the company’s logos and trademark, which identifies the franchise as an authorized dealer of the manufacturer. In this type of franchise, the franchisor does not provide the franchise with the entire system to help in running the business. This type of franchise is found in soft drinks, gasoline and automobile industries. To operate a product distribution franchise, the owner of the franchise must pay a specified fee or purchase a certain amount of products from the franchisor.

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The business format franchise is the most popular form of franchising and involves full rights to the franchisor’s business processes. The franchisor provides the franchisee with a full access to its business format, a quality control process, methods of operations, a marketing strategy, a license for its trade name, a two-way communication system and services, as well as some products to be sold. In addition, the franchisor can help the franchisee set up the facility within which the franchise will operate. This is the fastest growing type of franchise across industries.

Franchising Arrangements

  • Single-Unit Franchise

Business owners have different arrangements under which they can operate franchise businesses. The most common arrangement is known as a single-unit franchise where the franchisor permits the franchisee to operate one franchise unit (Awe, 2006). Once a single-unit franchise has become operational, the franchisee can buy additional single-units. This is known as a multiple or single-unit relationship.

  • Multiple-Unit Franchise

The second arrangement is known as a multiple-unit franchise. It is divided into two sub-units. The first sub-unit is called an area development. In the area development relationship, the franchisee can open more than one unit in a specified area. The franchisor provides the franchisee with exclusive rights to develop the chosen territory.
The second sub-unit is known as a master franchise. In this relationship, the franchisor grants the franchisee more rights than the area development franchisee. In master franchise arrangement, the owner of franchises can have multiple units and has the right to sell them to other people within the franchise territory. This arrangement transfers most of duties, tasks, responsibilities and benefits formerly enjoyed by the franchisor to the operator of master franchise.

  • Representative Franchise

In addition to these two main arrangements, there may arise another hybrid relationship known as an area representative franchise. The area representative purchases a territorial franchise to service and sells it as unit franchises. The contract signed by the representative is not with the unit franchisees, but with the franchisor. This representative receives a portion of the fees paid by the unit franchisee to the franchisor. The fee received by the representative is as a result of servicing the unit franchises in the territory.

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How to Evaluate a Franchise

Starting a franchise involves some risks because the investor wishing to operate it must invest and pay fees to the franchisor. Moreover, since the franchise agreement allows the operation for a specified period, the franchisee must be cautious when choosing the franchisor with whom to enter into an agreement. The franchisee must make sure that, by the time the franchise is terminated, the business has earned some profits and returned on investment.

There are two essential qualities that determine a successful franchise, i.e. trust and understanding between the franchisee and the franchisor. Therefore, the franchisee must assess the opportunities available and the trustworthiness of all the franchisors. The second aspect that the business person wishing to start a franchise must assess is a financial position and track record of the franchisor. Financial records are crucial because they indicate the profitability of the franchisor, which may provide a possible prediction parameter for the franchisee’s profitability.

The investor wishing to operate a franchise must analyze the market within which this franchise will operate (Bisio & Kohler, 2011). Market evaluation is critical because the franchisee will be able to determine whether the prospective market has some potential customers that will be willing to purchase products at the expected prices. Moreover, this assessment can enable the investor to analyze the trend of the population purchasing the products to ensure that the market is expanding and not shrinking.

Comparing disclosure statements from various franchisors helps an investor to relate the fees, benefits, restrictions and risks associated with every potential franchisor. Therefore, such an evaluation guides the investor to make an informed decision on the right franchisor to work with based on the details contained in disclosure statements. The prospective franchisee must assess the potential franchisor on the type of activities involved in the business. The business activities may require special skills that the franchisee may not have. The franchise must match the skills and capabilities of the franchisee so that the management will be excellent and profitable.

Another assessment criteria to use is whether the franchisor has been market tested. During an initial business setup, the franchisor must have tested the business model through pilot tests in the market. Such a study must have been guided by professionals. On the other hand, the market testing could be based on the number of years the franchisor has been operational and successful. Market testing is crucial because a tested franchisor is likely to survive in the market for a longer time than a new one.

The franchisee must also assess how existing franchisees are operating and their level of satisfaction with the franchisor. The franchise system may look viable on paper, but frustrating in practice. To have the practical information on what it takes to operate a franchise with the franchisor, evaluating existing franchisees is essential.

The business model of the potential franchisor is crucial to the prospective franchisee because it can determine whether the business is based on a fashionable foundation or a permanent base. Every investor would wish to have the security assurance that the business in which to invest will be in existence for a long time. A franchisee must, therefore, assess the permanence of a franchisor before investing.

It is essential for a prospective franchisee to understand the amount of capital required to start a franchise with different franchisors. Different organizations have different capital requirements for their franchises. The franchisee, therefore, should evaluate potential franchisors and choose depending on the amount of the capital available. In addition to evaluating the minimum capital requirements, the capital required in a worse case scenario should be assessed.
Different franchisors provide support services to franchises, but there is no uniformity in this provision. The type of relationship between the franchisor and franchisee may determine the level of support available for the franchisee. The support services extended to the franchise can either increase or decrease its chances of survival. The more the support services provided the higher the chances of surviving and becoming profitable.

Advantages of Operating a Franchise to a Franchisee

Professional Guidance

In a franchise relationship, the franchisor is experienced in the field of management and operating businesses. On the other hand, the franchisee may not have managed a business before, which means that there is the lack of expertise on the side of the franchisee. Depending on the level of assistance provided by the franchisor to the franchises, the franchisee can get some technical and managerial assistance from the franchisor. This assistance can be provided before the franchise is launched and during its operations. The advantage in operating a franchise is that the franchisor provides training and offers the progressive assistance in the course of the franchise’s operations. The technical help that the franchisor can provide the franchise with includes a business layout, design, equipment, purchasing and location.

  • Efficiency

The efficiency of operating a franchise is high compared to a start up business because the franchisor has leant through the own experience where problems were arising during a business start up. The franchisee is, therefore, provided with the information that will help the franchise evade common mistakes that lead to high start-up capital requirements (Hetten, 2011). As s result of having a prior knowledge on the processes to avoid and those to focus on, the franchise that is being efficient expands easily.

  • Opportunity To Learn

The presence of experienced franchisors in a franchise relationship enables investors to operate a business without any prior knowledge and experience. This advantage is crucial to people who decide to change their careers. They can own a franchise without any experience in the field of business. Some of the organizations sell that franchise with the operations to people with no prior knowledge. Such people are trained from scratch and are able to adapt to the system’s culture at a faster rate than a person who has worked in an organization with a different culture. Therefore, the franchise allows the franchisee to learn how to operate a business practically.

  • Recognized Standards

Franchisors require standardization in many aspects of their operations to be adopted by franchises. These aspects have been tested either through experience or a research and have proven to work for the franchisor. One such aspect is quality control. The quality of products can differentiate a business from another and initiate customer loyalty. The application of these uniform standards in all the franchisor’s operations differentiates brand names and create preferences among customers. Although franchisees have the limited independence, the compliance requirement helps them to apply proven methods and practices, which lead to increased revenues and profitability.

  • Potential for Growth

The learning and experience gained by operating one franchise can help the franchisee to operate other franchises elsewhere. An opportunity to operate the franchise in another location may arise. Franchisees with experience and knowledge can expand their operations to new locations where they would increase their profits and a scope of operations.

  • Distinctive Trade Identification

A franchise has an advantage over other start-up businesses because its association with a recognized franchisor improves its goodwill in the market. The franchise, therefore, enjoys the success in market penetration by being associated with a known brand. Since building a brand name is costly and dependent on time, franchises become famous within a limited time and using fewer resources than other start-up businesses.

  • Advertisement Programs

Advertisement is crucial for the success of any organization, irrespectively of the products being sold or the industry in which the business belongs to. An advertisement consumes large portions of marketing budgets and reduces profits and returns on investments. The franchise is exempted partly from the advertisement costs because when the franchisor advertises on a massive scale, the franchise benefits for being associated with the brand name.
Disadvantages of Operating a Franchise to a Franchisee

  • Cost of Franchise

Although the franchises are assisted during the start-up and the progress of business by the franchisor, the help comes with the price. Once the business becomes operational, the franchisor starts charging loyalty fees in the form of sales revenue percentages. This cost is invisible during the start-up, but becomes evident once the business starts making profits. Since the charges are continually charged, they become a burden to the franchise because the business has to ensure sales up to a certain limit to guarantee that the business can pay the fees.

  • Risk of Misunderstanding or Fraud

Not all franchisors are genuine in their business. Some of them promise many things to franchises, but rarely fulfill them. Franchisees may not see the need to involve an attorney in the transactions, but it is crucial because the contract may contain faults that only people involved into the legal profession can understand. Therefore, franchises represent opportunities and risks in an equal measure to franchisees.

  • Over-Dependence

The help that franchises receive from franchisors may limit the involvement of franchisees in managing the business. The franchisor may not understand the unique needs of the customers in local regions. This means that methods and means used by the system may not apply to some localities. At such times, the franchisee should decide on how to serve the needs of such customers without relying on the franchisor. The control exercised by the franchisor on the franchise may make the franchisee over-dependent on the franchisor to the point of not being able to adapt to unique methods that would fit localities.

  • Restricted Creativity and Freedom

Franchisors place numerous restrictions on the way their franchises conduct their businesses. They have to follow procedures and standard ways of doing things. Any creative franchisee cannot conduct a business differently without offending the franchisor. Moreover, franchises are geographically restricted because they may enter another franchise territory. The restriction can be destructive such that even when the franchisee notices that some products are not suited to the market. They have no remedy because the franchisor has the final word to say.

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Negative Effects from Other Franchises’ Poor Performance

When other franchises licensed by the same franchisor perform poorly in terms of quality or customer service, the effects can be felt even by those franchises that perform well. Since the franchises have the same brand name, customers aggrieved by one franchise are likely to view other franchises with contempt. This may lead to poor sales in high performing franchises. Therefore, franchising may be detrimental to franchises when the franchisor allows low standards in some of its business units.

  • Termination or Transfer Problems

A franchise is a contract between two parties and has a time frame within which it can be terminated. Either party may decide to end the contract even when the other party does not wish to end the relationship. This is a disadvantage, especially to the franchisee who has devoted time and energy to build the business. Another aspect that is problematic in this relationship is the transfer of ownership. During the contract signing, the franchisee may not have considered that the business may need to be transferred to another person such as a family member. For this reason, a clause detailing the procedure of such a transfer may not have been included in the contract. It, therefore, becomes difficult to transfer the ownership to another person.

  • Advantages of Operating a Franchise to a Franchisor

The franchising relationship is like a double-edged sword because it benefits and receives disadvantages both the franchisee and the franchisor. From the franchisor’s point of view, the following advantages result from the relationship:

  • Rapid Expansion with Little Capital Investment

In conventional business models, expansion requires a heavy capital investment. However, this is different when franchising is concerned. The franchisee comes up with the capital to invest. It is given the assistance in establishing the franchise using the money by the franchisor. This means the franchisor can reach new markets at a faster rate without investing capital. The relationship is, therefore, beneficial to the franchisor because the inputs are few, but the outcomes are numerous.

  • Highly Motivated Franchisees

In terms of performance, franchising is likely to outperform other modes of investment because the franchisee has a personal interest in the business and is more motivated than a company’s employee. As such, the business of the franchisor can perform better than organizations that rely on the employees’ motivation. The performance of the franchise is high because of the motivation from franchisees.

  • The Expansion Is Controlled

Within a corporate chain, rapid expansion sometimes occurs and out-paces the central management of an organization. When this happens, the management may lose control of critical processes and its ability to control all the organizational aspects. In a franchise relationship, the expansion is controlled because franchises are territorial and limit the extent to which the franchise can operate. The franchisor is, therefore, able to control the expansion of the business and has a tight control over its operations.

  • Ability to Purchase in Bulk

Purchasing goods in bulk is cheaper than buying fewer items. The presence of many franchises allows the franchisor to purchase supplies and products at great discounts. These discounts increase the franchisor’s profitability and reduce franchisee’s costs.

  • Multiple Revenue Sources

Having different sources of revenue is the strength to any business because it diversifies risks. The various sources of income for franchisors include the fee that is paid upon signing a contract, revenue from sales of various products and a portion of franchise’s revenue. The arrangement differentiates the franchising relationship from other corporations and diversifies its sources of revenue.

Disadvantages of Operating a Franchise to a Franchisor

  • Franchisee Dispute

Conflicts are common between franchisees and franchisors regarding the payment of loyalty fees, hours of operation and expansion. Initially, the franchisee does not envisage such conflicts because the mind is usually focused on a positive side of the business. This changes when the reality of business dawns; and the franchisor starts demanding fees and other compliance issues. These disputes can disrupt business and harm trust, which is essential to the success of the franchise business.

  • Loss of Control

Although the franchisor controls several aspects of the franchise business, there is an individual aspect of the franchisee that must be respected. When the franchisor needs to implement changes, consultations between the parties involved must take place. The consultations do not always result into an agreement, and the franchisee may not agree with the franchisor. This makes it difficult for the franchisor to implement changes. The result of this loss of control is that the franchisor may be unable to respond to changing tastes and preferences in the market. In such a case, the franchisor turns to the company owned units. Any testing on a new product is done through these units. The results from the tests are crucial during the negotiations because they act as the evidence of success that can be achieved by the proposed changes.

  • Profit Sharing

Once the franchisee recovers the initial investment, subsequent earnings may represent 30-50% return on investments. Such high levels of return on investment are the indication of money that would have otherwise been earned by the franchisor using the company’s owned units. The franchisor would receive all the earnings taken by the franchisee through the company’s owned units. Therefore, franchisee’s earnings are foregone revenues for the franchisor.

  • Legal Issues of Franchising

The legal issues affecting franchising involve two documents. These include the Disclosure Document and Franchise Agreement. The state and federal laws in the United States govern the relationship between the franchisor and the franchise. To perform this role, the government requires the franchisor to supply the franchisee with the information that outlines the nature of the two parties’ relationship. The legal aspect of the franchising relationship is contained in two documents known as the Disclosure Document and the Franchise Agreement.

The Disclosure Document

The Disclosure Document provides the franchisee with information about the franchise system, the franchisor and agreement to be signed. The franchisee should be provided with the document before the contract is signed so that there is enough time to scrutinize the issues therein and make informed choices.

The law prohibits a franchisor from selling a franchise before presenting the disclosure document to the prospective franchisee. In the United States, 14 states require franchisors to register their disclosure document with the state to notify that they will offer franchises. This document is important to the prospective franchisee because the vital information that can affect the performance of the franchise is contained in it.

Some of the vital information that can help a prospective franchisee to make a wise decision is management’s experience in franchise management. The franchisor’s experience in managing the business can determine whether the franchise will have a prolonged future or not. A franchisor with the limited experience may not offer a profitable and reliable franchise.
Another vital piece of information contained in the disclosure document is the litigation history and bankruptcy records. The number of litigation cases in the document can inform the prospective franchisee on the type of legal problems the franchise is likely to face. The franchisor with a long history of legal cases is less attractive to franchisees. On the other hand, bankruptcy records can provide the essential information about the ability of the firm to remain profitable in future. The franchisor with several bankruptcy records indicates inefficiency in managing the business.

The information regarding territorial rights informs the prospective franchisee on how large the operation territory is. Sometimes, the franchisor may have many franchises competing for the operational territory. The disclosure document provides the franchisee with details of the geographical size within which the franchise is allowed to operate. The existence of numerous franchises sanctioned by the same franchisor within a small territory can limit the prospects of a new franchise. Such information is crucial because the franchisee prefers a large territory to serve because it provides a large market share.

The disclosure information outlines the responsibilities of both the franchisor and the franchisee. This information may be unclear to the franchisee when the document is not provided prior to the contract signing. Consequently, the relationship between the two parties may be strained in the future regarding their duties towards each other. The responsibilities such is the level of support available to the franchisee is crucial when the decision to operate a franchise has been made. The franchisee is likely to choose the franchisor who provides the best support among other considerations.

The Franchise Agreement

Compared to the disclosure document, a franchise agreement is more specific in defining the relationship between the franchisor and the franchisee (Selden, 2011). The agreement specifies how the system works and the extent to which the franchisee can use trademarks and products. This is essential because the franchisee can understand the extent to which the franchise will benefit from the use of trademarks and licenses.

In the franchise agreement, the rights and obligations of both parties are clearly defined and the standard procedures of operation outlined. The importance of this legal document is that the written procedures and standards illustrate the amount of control the franchisor exercises over the franchisee. When every activity of the franchise is strictly guided by operational procedures and standards, the franchisee has a little freedom and creativity curtailed. On the other hand, when the procedures only apply to some activities, the franchisor has limited control over the franchise. This is beneficial to the franchisee because the personal innovation can be incorporated into the business and improve its performance.

The franchise agreement contains the information that indicates when the franchise relationship will be terminated. The franchisee benefits from knowing when the franchise will be terminated because forecasts can be done to determine whether the business will have earned returns on its investment and profits. When the forecasts predict that the business will have earned substantial profits, then the franchisee can enter into an agreement with the franchisor. However, when the business is likely not to make any profits by the time of termination, the franchisee may opt not to operate the franchise with the franchisor.

The crucial information about the amount of money the franchisee should pay the franchisor is contained in the franchise agreement. The money to be paid out can affect the business performance; and it is, therefore, important to compare such payments across a number of franchisors. The cheaper the payments are, the more profitable the franchise is likely to be. This is because the money paid out to the franchisor either comes from the franchise profits or revenues. Having this information before signing the contract helps the franchisee get the best deal based on facts and figures.

The franchise agreement details the terms and the rights to transfer the franchise. At the initial stages of the franchise formation, the franchisee may not have thought about the transfer of the business to another person, such as a next of kin or selling it. However, the procedures required must be known before signing the contract because the agreement may omit such information or write in favor of the franchisor. Even when the franchise duration is long, the franchisee may wish to transfer ownership. The agreement details the procedures. The franchisee should engage a legal counsel when examining the agreement to ensure favorable terms regarding the franchise transfer that should be included in the contract before signing it.

Finally, the franchise agreement contains some information on how the franchisor conducts training of franchises; how the franchisor offers assistance and marketing strategies to the franchise. Training offers the franchise a good chance of survival than other forms of start-up businesses. The training methods that the franchisor uses are tested through experience and, therefore, provide the franchisee with the practical knowledge and skills that other start-up businesses lack. Some franchisors create advertisement programs that cover their franchises. The franchise agreement should detail the advertisement strategies used by the franchisor and the role of the franchise in the process. This knowledge helps the franchise plan the marketing budget.

Between the two types of franchises, the business format franchise is capital intensive and provides more opportunities than the product distribution franchise. The choice between the two ones may be determined by the amount of capital and skills the prospective franchisee has. The franchise arrangement adopted by the investor depends on the investor’s skills in management and capital availability. Investors with advanced skills and large capital reserves have the ability to operate multi-franchise units or an area representative franchise. From the analysis of the merits and demerits of franchise business to both the franchisee and franchisor, the advantages seem to outweigh disadvantages. This is why there is an increasing number of franchises being operated throughout the world. The choice of the franchisor, which is informed by the evaluation before signing the contract, can reduce the demerits and maximize the merits. Therefore, the prospective franchisee should carefully evaluate the franchisors using the identified criteria to choose the one that will meet the needs of the franchisee and profitably.

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