HM

Franchising

Module 1: An Introduction to Franchising

Introduction
Franchising—the most dynamic business arrangement––has become the,
dominant force in the distribution of goods and services in the United States as
well as in many other countries. National and international experts believe that
franchising has become the primary method of doing business worldwide.
Paradoxically, in spite of its popularity and distinct impact on the economy,
franchising still remains a relatively obscure concept. Some view it as an industry
in itself, while others associate it with a particular type of business, such as fast
food restaurants. Much of the confusion stems from franchising being an umbrella
term that covers a wide variety of business arrangements and activities. It is not
restricted to a particular type of business, rather it is a method that is applicable to
a variety of business dealings.
In fact, its strength lies in its adaptability to an ever-expanding array of
industries, markets, products, and services. In addition to being responsive to
economic development and consumer demands, it is flexible enough for the
distribution of goods and services as conditions demand. This is one of the
primary reasons why franchising is commonly referred to as a method or channel
for distributing goods and services.

HISTORY AND DEVELOPMENT

Franchising in principle, if not in its current form, has existed for many
centuries. In early ages, kings and rulers granted the right to certain individuals to
collect taxes. In the Roman Republic, officials referred to as publicani were
responsible for collecting taxes, a portion of which they withheld as compensation.
In the medieval period, churches granted individuals privileges to conduct
business enterprises within their jurisdiction. In England, many companies
received charters of incorporation from the crown. The rapid development of
franchising started in the late 1800s, coinciding with the Industrial Revolution.
Changes became evident in the way business was conducted, and innovative
distribution methods were sought.
All these industrial and business changes, coupled with the mass movement of
populations to cities and suburbs, led to the development of franchising. Individual
enterprises found it profitable to expand into larger franchises, particularly in real
estate, hardware, auto repair, and other retail businesses.
In the year 1851, when Isaac Singer accepted fees from independent
salesmen to acquire territorial rights to sell his recently invented sewing machine.
Singer Sewing Machines had experienced difficulty in marketing the innovative
new product; there was a need for representatives to go out and educate
consumers regarding its versatility. Because Singer did not have the capital to hire
such a large workforce, agents working on commission were the most logical
choice. Franchising gained much broader recognition with the marketing efforts
planned by the automobile industry. General Motors Corporation sold its first
franchise in 1898, after which franchising became common throughout the
automobile and gasoline industries.

Franchising in the Early 1900s

 The success of franchising in the auto and petroleum industries opened
the door for its use in other types of retail businesses.
 development of the Ben Franklin general merchandise store in 1920
 A&W walk-up root beer stands in 1925.
 In 1925, Howard Johnson offered three flavors of ice cream in a drugstore
in Massachusetts.
 first Howard Johnson Restaurant appeared on a turnpike in 1940
 first Howard Johnson Motor Lodge opened in the year 1954.
 Baskin-Robbins opened its first ice cream stores in 1940. Thus major
growth in franchising was witnessed after World War II.
 It was in 1930s that the foodservice industry got involved with franchising.
The first recorded case of franchising is when Howard Johnson established
its first franchise. They had two ice cream businesses and a restaurant but
did not have enough capital to open additional restaurants. Johnson agreed
to help his former classmate open a restaurant and sell ice cream supplies
as a Howard Johnson’s franchise.

Franchising in the 1950s

 Colonel Harlan Sanders initiated his first Kentucky Fried Chicken franchise
in 1950 and built a chain of more than 600 restaurants during the decade.
 The greatest success story in restaurant franchising is often credited to the
salesman Ray Kroc, who sold Multimixers to a small hamburger stand in
San Bernardino, California. The owners of this restaurant were Dick and
Mac McDonald. Ray Kroc was impressed by the volume of business at this
walk-up stand and encouraged the McDonald brothers to expand their
business. He volunteered to franchise the McDonald’s concept and
founded the McDonald’s Corporation in 1955. Mr. Kroc originally founded
McDonald’s Systems, Inc. in 1955, which was a predecessor of McDonald’s
Corporation, which was founded in 1960. Even though this was not the first
restaurant franchise in the United States, it was a significant landmark in
the history of
 In 1959, the International House of Pancakes initiated the breakfast
concept. Other franchisors, including Dairy Queen, Orange Julius, Tastee-
Freeze, and Dunkin’ Donuts, established franchises, mainly along the
growing interstate highway network.
.
Franchising in the 1960s
The success and rapid development of franchise chains, coupled with
an expanding economy, led to a surge of franchising activities in 1960s

Franchising in the 1970s

 The glamour of franchising and the rush to get into this type of business
led to numerous franchise offerings that were hastily structured, ill-conceived,
poorly capitalized, or, in some cases, blatantly fraudulent.
 A growing number of public complaints, class action suits, and business
failures resulted. Based on the hearings by the Small Business Committee
of the U.S. Senate and the House of Representatives, and with the support
of the franchising industry, several states adopted disclosure/registration
requirements for franchised businesses in early 1970.
 In 1979, the Federal Trade Commission passed the Franchise Disclosure
Act, which identifies the 20 sections that a franchise disclosure document
must have. This document, commonly referred to as a prospectus, is given
to prospective franchisees by the franchisor.

Franchising in the 1990s and Beyond

 A variety of economic, demographic, and social factors continue to
influence the growth of both the service sector and franchising.
 The aging of the baby boom generation, the increase in numbers of women
entering the workforce, the growing population of active retirees, and the
continued rising trend in two-income families have created a demand for
services most logically supplied by franchising.
 Changing attitudes toward convenience, technological advances, mass
advertising methods, emergence of electronic devices for home and
business, and an emphasis on quality are all encouraging the development
of franchised businesses.

THEORIES OF FRANCHISING
Despite the rapid growth of the franchising concept, there is still a lack of
understanding and a consensus on the theoretical determinant and creation of this
business strategy. For the past four decades, franchising research has placed
particular attention on an explanation of the franchising phenomenon (Inma,
2005). The plausible explanation for the creation of the franchise business
concept resulted in focusing on several fundamental issues related to franchising,
such as reasons why firms franchise (Rubin, 1978; Shane, 1998), the implication
of franchise life cycle (Carney and Gedajlovic, 1991; Combs and Castrogiovanni,
1994; Oxenfelt and Kelly, 1968) and franchising as an effective vertical integration
strategy (Brickley and Dark, 1987; Falbe and Welsh, 1998; Mathewson and
Winter, 1985). Out of these inquiries, two dominant theories emerged: the agency
theory and the resource scarcity theory.
Agency Theory
In general, franchising theorists argued that the agency theory could be a
rationale behind the wide spread use of franchising (Mathewson and Winter, 1985;
Rubin, 1978; Shane, 1998; Lafontaine, 1992). The agency theory considers an
existence of an agency relationship where one party (the principal/ franchisor)
hires an individual or an organization (the agent/franchisee) to provide a service. If
a franchisor hires a manager to run its outlets, he/she may not put her best
interest in the business, which may result in suboptimal performance. On the other
hand, a franchisee has a lot of financial investment and commitment to
contributing to the success of the business relationship. Thus franchising provides
powerful incentives for the franchisee to be successful. Also, there is less need for
monitoring by the franchisor and increased chances of better performance of the
business. This theory also postulates that franchising is not a low risk or cheaper
way for obtaining capital as claimed by the resource scarcity theory. The risk
concentration was in the hand of the franchisees and not on franchisors. In
franchising, franchisees take risks by contributing capital and paying franchise and
royalty fees. As a result, the franchisor would be more risk averse than the
franchisee. Other factors include the cost of motivation, training, and monitoring of
different outlets owned by franchisees. Firms employed franchising in an attempt
to reduce the agency problems that existed with the company-owned manager by
making the franchisee (agent) responsible for the gain or loss of the proceeds of a
retail outlet (Brickley and Dark, 1987; Lafontaine, 1992).
Resource Scarcity Theory
The resource scarcity theory postulates that expanding firms use
franchising to secure scarce capital (from the franchisees) in a mutually cost-
effective way. It views franchising as a mechanism to ease financial and
managerial constraints on the growth of a business, whereas the agency theory
views franchising as a mechanism for improving the alignment between firm- and
unit-level incentives. However, these two theories are not contradictory; since a
firm must attract resources as well as align incentives.

Learning Outcomes
At the end of this chapter the students should be able to:
1. Describe the relationship of franchisee and a franchisor.
2. Understand the origin of franchising
3.

Learning Content

I. WHAT IS A FRANCHISE?

The term franchise has its origin in the French word meaning “free from
servitude.” Roughly translated that would mean that a businessman is free to run
his own business. It is used as a noun as well as a verb. Strictly from the business
point of view, a franchise is a right or privilege granted to an individual or a group.
Franchising is a form of business arrangement which originated from France
in the 18th century. The term franchising in French also means “a granting of
right” or “an exemption.” Strictly from the business point of view, a franchise is a
right or privilege granted to an individual or a group. Franchises may be granted
by government or private bodies. From the point of view of economics, a franchise
is a right granted to operate a business under the general regulation of one who
grants its. Simply defined, a franchise is a legal agreement in which an owner
(franchisor) agrees to grant rights or privileges (license) to someone else
(franchisee) to sell the product(s) or services under specific conditions. This
method of doing business is referred to as franchising and, like marketing or
distributing a product or service, may be adopted and used in a wide variety of
industries and businesses.
 A franchise is the agreement or license between two legally independent
parties which gives:
• a person or group of people (franchisee) the right to market a product or
service using the trademark or trade name of another business (franchisor)
• the franchisee the right to market a product or service using the operating
methods of the franchisor
• the franchisee the obligation to pay the franchisor fees for these rights
• the franchisor the obligation to provide rights and support to franchisees

1. Product distribution franchises simply sell the franchisor’s products and

are supplier-dealer relationships. In product distribution franchising, the
franchisor licenses its trademark and logo to the franchisees but typically
does not provide them with an entire system for running their business. The
industries where you most often find this type of franchising are soft drink
distributors, automobile dealers and gas stations. Some familiar product
distribution franchises include:
✔ Pepsi
✔ Exxon
✔ Ford Motor Company

Although product distribution franchising represents the largest

percentage of total retail sales, most franchises available today are
business format opportunities.
2. Business format franchises, on the other hand, not only use a franchisor’s
product, service and trademark, but also the complete method to conduct the
business itself, such as the marketing plan and operations manuals. Business
format franchises are the most common type of franchise.

USA Today reported that the 10 most popular franchising opportunities are in
these industries:
◆ fast food
◆ retail
◆ service
◆ automotive
◆ restaurants
◆ maintenance
◆ building and construction
◆ retail—food
◆ business services
◆lodging

Types of Franchise Arrangements

Because so many franchisors, industries and range of investments are
possible, there are different types of franchise arrangements available to a
business owner.
Two types of franchising arrangements:
1. single-unit (direct-unit) franchise
2. multi-unit franchise:
• area development
• master franchise (sub-franchising)
A single-unit (direct-unit) franchise is an agreement where the franchisor grants
a franchisee the rights to open and operate ONE franchise unit. This is the
simplest and most common type of franchise. It is possible, however, for a
franchisee to purchase additional single-unit franchises once the original franchise
unit begins to prosper. This is then considered a multiple, single-unit relationship.

A multi-unit franchise is an agreement where the franchisor grants a franchisee

the rights to open and operate MORE THAN ONE unit.
There are two ways a multi-unit franchise can be achieved:
a. an area development franchise or
b. a master franchise.

Under an area development franchise, a franchisee has the right to open

more than one unit during a specific time, within a specified area. For example, a
franchisee may agree to open 5 units over a five year period in a specified
territory.

A master franchise agreement gives the franchisee more rights than an area
development agreement. In addition to having the right and obligation to open and
operate a certain number of units in a defined area, the master franchisee also
has the right to sell franchises to other people within the territory, known as sub-
franchises. Therefore, the master franchisee takes over many of the tasks, duties
and benefits of the franchisor, such as providing support and training, as well as
receiving fees and royalties.

II. WHAT ARE THE ALTERNATIVES TO FRANCHISING?

In addition to franchising, there are two other popular methods by which
businesses expand their market and distribution channels:
1. Distributorships
2. Licensing
 In a distributorship, the distributor usually:
 has a contractual relationship with the supplier
 buys from the supplier in bulk and sells in smaller quantities
 is familiar with local markets and customers
 may do business with many companies,
 more than just the supplier/producer
 may not receive contractual support and
 training from the supplier/producer like a franchisee

Some distribution arrangements are similar to franchises, and vice versa. A

franchisee with a great deal of leeway in how to run the business may look like an
independent distributor. A distributor may be subject to many controls by the
supplier/producer and begin to resemble a franchise.
Some popular distributorships include:
 Amway
 Color Me Beautiful Cosmetics
 Mountain Life Spring Water
 Knorr Soup Vendor
 Campbell’s Soup Vending Machines

Licensing, on the other hand, allows a licensee to pay for the rights to use
a particular trademark. Unlike franchises, in which the franchisor exerts significant
control over the franchisee’s operations, licensors are mainly interested in
collecting
royalties and supervising the use of the license rather than influencing the
operations of the business.
Some popular licensors include:
 Netscape Communications
 Apple Computer
 Canon Inc.
 Woolmark
 Compaq Computer

III. WHAT ARE THE ADVANTAGES AND DISADVANTAGES OF

OWNING A FRANCHISE?
The many advantages and disadvantages of owning a franchise should be
carefully evaluated before deciding to purchase one.
Advantages:
✔ “Owning a franchise allows you to go into business for yourself, but not by
yourself.”
✔ A franchise provides franchisees with a certain level of independence where
they can operate their business.
✔ A franchise provides an established product or service which already enjoys
widespread brand name recognition. This gives the franchisee the benefits of
customer awareness which would ordinarily take years to establish.
✔ A franchise increases your chances of business success because you are
associating with proven products and methods.
✔ Franchises may offer consumers the attraction of a certain level of quality and
consistency because it is mandated by the franchise agreement.
✔ Franchises offer important pre-opening support:
• site selection
• design and construction
• financing (in some cases)
• training
• grand-opening program
✔ Franchises offer ongoing support
• training
• national and regional advertising
• operating procedures and operational assistance
• ongoing supervision and management support
• increased spending power and access to bulk purchasing (in some cases)

Disadvantages:
✔ The franchisee is not completely independent. Franchisees are required to
operate their businesses according to the procedures and restrictions set forth by
the franchisor in the franchise agreement. These restrictions usually include the
products or services which can be offered, pricing and geographic territory. For
some people, this is the most serious disadvantage to becoming a franchisee.
✔ In addition to the initial franchise fee, franchisees must pay ongoing royalties
and advertising fees.
✔ Franchisees must be careful to balance restrictions and support provided by the
franchisor with their own ability to manage their business.
✔ A damaged, system-wide image can result if other franchisees are performing
poorly or the franchisor runs into an unforeseen problem.
✔ The term (duration) of a franchise agreement is usually limited and the
franchisee may have little or no say about the terms of a termination.

IV.WHAT ARE THE LEGAL ISSUES OF FRANCHISING?

A good relationship between the franchisor and franchisee is critical for the
success of both parties. Since franchising establishes a business relationship for
years, the foundation must be carefully built by having a clear understanding of
the franchise program. Unfortunately, understanding the legal language of
franchising can be daunting. The advice of an experienced franchise attorney
should be sought to help a prospective franchisee understand the legal
issues and to protect them from making costly mistakes.
Franchising is governed by federal and state laws that require franchisors
to provide prospective franchisees with information that describes the franchisor-
franchisee relationship.
The two main franchising legal documents are the:
✔ the Disclosure Document, which may be in the format known as the UFOC.
✔ franchise agreement
The UFOC
The purpose of the UFOC is to provide prospective franchisees with information
about the franchisor, the franchise system and the agreements they will need to
sign so that they can make an informed decision. In addition to the disclosure part
of the document, the UFOC includes the actual franchise agreement as well as
other agreements the franchisee will be required to sign, along with the
franchisor’s
financial statements. The UFOC is designed to give you some of the information
you need in order to make an informed decision about investing in a particular
franchise. By law, a franchisor cannot offer a franchise until the franchisor has
presented the prospective franchisee with a Disclosure Document. In fact, 14
states require franchisors to register their UFOCs with the state or to notify them
that they will offer franchises before they begin to conduct any franchising activity
in the state.
The UFOC includes information about:
✔ the franchisor
✔ the company’s key staff
✔ management’s experience in franchise management
✔ franchisor’s bankruptcy and litigation history
✔ initial and ongoing fees involved in opening and running the franchise
✔ required investment and purchases
✔ territory rights
✔ responsibilities of the franchisor and franchisee
✔ other franchisees in the system with contact information
Receipt of the UFOC is governed by the “ten-day rule.” This is a cooling-off period
in which franchisors must give prospective franchisees 10 business days to think
about their decision before they are allowed to sign the franchise agreement.
The Franchise Agreement
The franchise agreement is more specific than the UFOC about the terms of the
relationship between the
franchisor and franchisee. A typical franchise agreement may include specifics
about:
✔ the franchise system, such as use of trademarks and products
✔ territory
✔ rights and obligations of the parties: standards, procedures, training,
assistance, advertising, etc.
✔ term (duration) of the franchise
✔ payments made by the franchisee to the franchisor
✔ termination and/or the right to transfer the franchise
The franchise agreement is the legal, written document that governs the
relationship and specifies the terms of the franchise purchase. Like the UFOC, the
franchise agreement also enjoys a “cooling off” period. Prospective franchisees
are legally entitled to have the final franchise agreement for at least 5 business
days before they are allowed to sign. This gives them time to review and consider
the terms of the agreement.

Definition of Terms:

Signature means a person’s affirmative step to authenticate his or her identity. It

includes a person’s handwritten signature, as well as a person’s use of security
codes, passwords, electronic signatures, and similar devices to authenticate his or
her identity.
Trademark includes trademarks, service marks, names, logos, and other
commercial symbols.
Written or in writing means any document or information in printed form or in any
form capable of being preserved in tangible form and read. It includes typeset,
word-processed, or handwritten documents; information sent via email; or
information posted on the Internet. It does not include mere oral statements.
business format franchise – this type of franchise includes not only a product,
service and trademark, but also the complete method to conduct the business
itself, such as the marketing plan and operations manuals
disclosure statement – also known as the UFOC, or Uniform Franchise Offering
Circular, the disclosure document provides information about the franchisor and
franchise system
franchise – a license that describes the relationship between the franchisor and
franchisee including use of trademarks, fees, support and control
franchise agreement – the legal, written contract between the franchisor and
franchisee which tells each party what each is supposed to do
franchisee – the person or company that gets the right from the franchisor to do
business under the franchisor’s trademark or trade name
franchising – a method of business expansion characterized by a trademark
license, payment of fees, and significant assistance and/or control
franchisor – the person or company that grants the franchisee the right to do
business under their trademark or trade name
product distribution franchise – a franchise where the franchisee simply sells
the franchisor’s products
without using the franchisor’s method of conducting business
royalty – the regular payment made by the franchisee to the franchisor, usually
based on a percentage of the franchisee’s gross sales
trademark – the franchisor’s identifying marks, brand name and logo that are
licensed to the franchisee
UFOC – the Uniform Franchise Offering Circular, UFOC, is one format for the
disclosure document which provides information about the franchisor and
franchise system to the prospective franchisee

5. Teaching and Learning Activities

6. Recommended learning materials and resources for supplementary

reading.
Check out www.licensing.org.

7. Flexible Teaching Learning Modality (FTLM) adopted

 Online (synchronous): Sedi, FB Messenger, Google Meet. Google
Classroom, Edmodo
 Remote (asynchronous): Module

8. Assessment Task
 Quiz/Assignment/Recitation
Assignment:
If you are to put up a business, would you choose a self-concept business
or a franchise business, why or why not?

9. References (at least 3 references preferably copyrighted within the last 5

years, alphabetically arranged)
Cerro, A et al (2019) Best Practices in Hospitality and Tourism Marketing and
Management, Gewerbestrasse 11, 6330 Cham, Switzerland: A Quality of Life
Perspective, Springer International Publishing AG
Jauhari, V. (2017) Hospitality Marketing and Consumer Behavior Creating
Memorable Experiences, Canada: Apple Academic Press Inc.
Kotler, P. et al (2017) Marketing for Hospitality and Tourism 7th edition Global
Edition, Malaysia: Pearson Education Limited
Minazzi, R. (2015) Social Media Marketing in Tourism and Hospitality,
Switzerland: Springer International Publishing
Kotler, P. et al (2014) Marketing for Hospitality and Tourism 6th edition Pearson
International New Edition, USA: Pearson Education Limited

ISUE__ __ Syl ___

Revision: 01
Effectivity: September 1, 2020