General Franchise and Franchising Information

The principle of franchising is simple, some companies choose to grow by granting a license to others to sell their product or service instead of developing their business in the conventional way. This works by agreement in which a person permits the distribution of goods or services under that persons trademark, service mark or trade name.

Before you go ahead, you must have confidence in the Franchisor you choose and ask them key questions about the business and the structure of the organisation at the early stages.

• Is the franchisor financially sound?
• What is the director's background?
• What did they do previously and why did they go into franchising?
• Does a comprehensive operations manual support the training?
• Has the franchisor run outlets in similar areas to yours?
• How successful is the franchisor and existing franchisees?
• How thorough is the training at the start-up stage and thereafter?
• How many franchises have they opened in the last 12 months?
• How many applicants do they reject?

You should visit existing franchisees to learn from their experiences and to find out their opinions on the services provided by the franchisor. Good franchisors will always allow you free access to any franchisees in their network and, in most cases, existing franchisees will be happy to talk things over with you.

Some of the questions you should ask are:

• Is your franchise profitable now?
• Is the franchisor aware of changes in the marketplace and quick to adapt?
• If there is illness, does the franchisor offer to help?
• What kind of on-going support do you get?
• Did you get good training, systems and manuals?
• Is the franchisor keeping their end of the bargain?
• How long did it take to recoup your investment?
• Does the franchisor welcome suggestions from franchisees?

Franchising also has drawbacks and it is important that you give them full consideration before making any sort of commitment.

The drawbacks fall into three categories:

• Lack of independence
• Inflexibility
• Risk associated with the franchisors performance

LACK OF INDEPENDENCE

An important feature of franchising is that every aspect of the business format is defined and each outlet is operated strictly in agreement with this format. Not everyone would be happy to operate a business under such constraints and you must consider how well you can accept this aspect of the franchising system.

Discipline:
Being a franchisee means working within a system in which there is little freedom or scope to be creative. Almost every aspect of operating the business is laid down in the manuals.

Franchisor Monitoring:
Regular field staff monitoring visits are welcome initially, but as time passes you will feel able to do your own trouble-shooting and you may come to regard the franchisors interest as an intrusion - it is after all your business.

Service Charges:
At first these services are necessary and franchisees do not mind paying for them. However as time goes on, if less use is made of the franchisors services then franchisees can resent making the continuing payments.

Reputation:
Each franchisee affects the reputation of the whole system depending on their performance and ability. In many franchises there is a wide gulf in the quality of product or service between the best and the worst franchisees. Thus any franchisee can harm the reputation of all outlets in the chain.

INFLEXIBILITY

Responding to the market:
Franchising tends to be an inflexible method of doing business as each franchisee is bound by the franchise contract to operate the business format in a certain way. This can make it difficult for a franchisor to introduce changes to the business format, refit outlets, or introduce new types of equipment. In some franchises it can be difficult for a franchisee to respond to new competition or to a change in the local market.

The job itself:
What may seem an attractive challenge now could become boring after a few years so it is important that you choose a franchise in which you will enjoy the work, or which has potential for growth.

RISK ASSOCIATED WITH FRANCHISOR PERFORMANCE:
It is important to recognise that not all franchises are soundly based or well run. In signing the franchise agreement you are formally binding yourself to a particular franchisor and it is therefore vital to select one which is competent and ethical.

There are 4 different categories of franchisor:

• The Established Franchisor
• The New Franchisor
• The Unethical Franchisor
• The Incompetent Franchisor

Some should be avoided at all costs others will vary in attractiveness according to the level of risk you are prepared to take.

The Established franchisor:
This represents the least risky type of franchise opportunity. The business format will have been fully tested in a number of locations and although the initial cost of such a franchise may be relatively high, a franchise with this type of company will be highly attractive to anyone for whom security is important.

The new franchisor:
There is nothing intrinsically wrong with a new franchise but great care must be taken in deciding to invest in any particular franchise. As franchisors incur high initial costs, they need a minimum number of franchises to break even. When a franchisor has fewer than the break-even number of franchises it is likely that:

• More effort will go into selling franchises than into providing support services.
• There will be some deficiencies in services in order to keep costs down.
• Financial resources will be strained.

In this start-up phase the franchisor is vulnerable to financial problems if franchises cannot be sold quickly enough.

Franchises in this take-off phase are potentially those, which will earn the highest returns, for example if the product or service is outstanding in some way a large territory can be covered. With a franchisor you are in a position near that of an independent business - greater return. Depending on the risks you are prepared to take, this type of franchise may be attractive, or one to be avoided.

The Unethical Franchisor:
Unfortunately some franchisors have no intention of entering a long-term support relationship with the franchisee, instead they have heard that franchising is a way to make money quickly out of gullible franchisees. This is done by setting up a shell franchise - lots on offer but nothing to back it up, then selling such franchises to those who are so keen to become a franchisee that they fail to make a thorough appraisal of the business on offer. Make sure that you spot this type of franchise, take time to investigate different opportunities. You cannot afford to learn from your mistakes.

The Incompetent franchisor:
These are franchisors who are not offering franchises to perpetrate fraud but who are incompetent in one or more of the following ways:

• The basic business is unsound.
• The franchisor is under-resourced.
• The franchisor is inept.

A business will be unsound if the product or service on which it is based is unable to generate an adequate level of sales or profit. A competent franchisor will test the business concept both through market research and by operating a pilot outlet before offering franchise opportunities for sale. An incompetent franchisor is unlikely to do either of these things.

In addition, it is expensive to become an ethical and competent franchisor. If the business format is tested thoroughly, the franchisor will need to carry the establishment costs for up to two years before being in a position to generate income by the sale of franchises. An under-resourced franchisor will be unable to fund this need adequately. Not only will start-up assistance and operating manuals be of poor quality, but the franchisor is also unlikely to be able to provide a high standard of support.

This can be particularly important if you are considering a franchise opportunity where your outlet will be located far from most of the franchised area. In these circumstances the cost of providing services can be heavy for a franchisor that does not have many outlets near you.

It is important to recognise that the franchise is a long term relationship, and that the franchisor company may change direction, for instance if it is taken over or moves into international markets.

The Inept franchisor:
This type of franchisor may be enthusiastic about the concept of franchising but has little understanding of how and why the system works or of the services that will be provided. This type of franchisor can cause untold harm to the viability of the franchisee business. You should recognise that many franchises on offer will fall short of ideal.

TERMINOLOGY

Franchisor
The parent company that grants, for a fee and other considerations, the right to use its name and system of business operations.

Franchisee
A person or entity to whom the right to conduct a business is granted by the franchisor or licensor.

Franchising
Neither an industry nor a business, but a method of doing business within a given industry. At least two parties are involved in franchising: the franchisor and the franchisee. Technically, the contract binding the two parties is the franchise.

Master Franchisee
Describes an individual or company owning the exclusive rights to develop a particular territory for the franchising company.

Franchise Agreement
A written contract detailing the mutual responsibilities of franchisors and franchisees. It is usually for a several-year term, and when the term is up, the contract expires and must be renewed. Some state laws require the contract to be renewable at the franchisee’s option. Usually a franchise agreement may not be sold, transferred, or otherwise assigned without the franchisor’s permission.

Franchise Fee
An up-front entry fee, usually payable upon the signing of the contract (franchise agreement) for the right to use the franchisor’s name, logo, and business system. Often, the franchise fee is also the consideration paid for initial training, site selection, operations manuals, and other help given by the franchisor before the opening of the business. Franchise fees can be amortized over the life of the franchise agreement.

Estimated Initial Investment
A detailed listing of all fees and expenses you can expect to incur in starting your franchised business. This listing represents the total dollar amount that you would need to pay or get financing for, including fees paid to the franchisor; estimates for furniture; fixtures and equipment; opening inventory; real-estate costs; insurance inventory; etc. This estimate should include a provision for working capital through the start-up phase.

Royalty
A continuing payment to the franchisor that is payable on a periodic basis (usually weekly, biweekly, or monthly) throughout the term of the franchise agreement. In theory this royalty payment is for:

• Compensation for the continuing services given by the franchisor (for training, field services, etc.)
• Payback financing of the true market value of the franchise. Royalty payments can be either fixed amounts, based on percentage of gross sales, or based on a sliding scale, with graduated breakpoints.