CHAPTER 1 Franchising provides a powerful incentive to align

the interests of the principal (franchisor) and the

Franchising - is a business model that comprises agent (franchisee).
contractual agreements between
two groups of entrepreneurs. History of Franchising

Franchisor - who created a venture to advance an The word franchise is derived from the old French,
entrepreneurial opportunity. meaning “privilege” or “freedom,” franchising is
not a new or recent concept; its origins can be
Franchisees - who purchase the right traced back thousands of years across different
to use the brand name, operating process, and continents.
marketing system of that venture
in new geographic markets. ➢ Zhou (Chou) dynasty
The kings set up the FengJiang system, giving
In such a relationship, the franchisor not only grants large domains of land to warriors and relatives in
a license to a third party in exchange for homage and resources.
order to conduct business under their trademark, ➢ Middle Ages in Europe
and specify the products and Kings and lords granted specific individuals
services to be offered by franchisees, but provide (fiefdoms) the right to hunt or conduct business
them with an operating on their lands. Just like today’s
system, brand, training, and marketing and logistic franchises, these landowners set up mutual
support. agreements with tax collectors who would keep
a percentage in exchange for
Licensing - refers to an agreement whereby a their services.
company (the licenser)grants the right to utilize ➢ United States around the 19th century
intangible assets as a brand, such as intellectual Franchising became a formal business model
property or an operation process, in exchange for Singer Company was the first occurrence of
buying and selling the company’s products or franchising in the United States when it used
services. franchising to distribute its sewing
machines.
Major Theoretical ➢ 1920s
Frameworks The more traditional form of franchising began
in the 1920s when industry trailblazers such as
Scholars have utilized several theoretical A&W Root Beer
frameworks to explain the nature, antecedents, and and Howard Johnson appeared on the scene.
consequences of franchising strategies. A&W remains in business today while Howard
Two main examples are resource scarcity and Johnson operates a chain of hotels and motels.
agency theory. ➢ 1950s and 1960s
Early researchers proposed resource scarcity to The popularity of franchising ballooned, due in
explain why firms would exchange firm ownership part to the expansion of the U.S. economy and
with financial capital to grow their business and the growth of the interstate highway system.
increase market shares. However, this framework ➢ 1966 to 1969
fell out of favor when increasing studies illustrated Approximately 100,000 new franchises
the lack of empirical support for the resource commenced operations. These newly emerged
scarcity perspective. franchises were often in
the quick-serve and hospitality sectors, based
Agency theory became the dominant framework on their ability to package business operations
that explains the usage of franchising strategy. It and branding into systems that could be
was originally developed to explain duplicated in multiple locations.
the interplay between two stakeholders, the ➢ As we enter the 21st century
principal and the agent. the franchising model
continues to be an essential growth strategy for
entrepreneurs. The diffusion of the franchising Franchising Business Models
business model has spread across a variety of
industries According to a recent study, 72% of The International Franchise Association
emerging franchise systems cover a wide range describes two types of franchising business
of industries, including personal services, models that are standard within the franchise
quick-service restaurants, commercial and industry:
residential real estate, along with Business Format franchises and Product
automotive, and retail food. The franchising Distribution franchises.
business model has proven to be
resilient. Even in a challenging economic Business Format franchising is the most
climate, franchise outlets continue to grow. common and recognizable form of franchising.
In a business format franchise, the franchisor
Franchising Regulations and supplies the franchisee with a trade
Associations name, products, and services. A business format
franchisee can expect to receive site selection
• In 1956 the federal government support, operating manuals, training, operating
established the Automobile Dealer standards, marketing, and
Franchise Act and in 1968 the Federal support services from the franchisor.
Petroleum Marketing Practice Act. Brands such as KFC, McDonald’s, Marriott,
Both statutes led to the implementation LA Fitness, Dunkin, and Burger King are
of freestanding franchise legislation in examples of such franchises.
federal and state laws.
• In 1978, the Federal Trade Commission Product distribution franchise business
(FTC) enacted the FTC Franchise Rule model is more complex and requires
requiring every franchise to disclose franchisees to have access to
specific information about its business substantial capital compared to most business
operation model. format. franchises. Also known as trade name
• In addition to federal and state franchising, is that type of franchising wherein
regulations, two franchise trade a manufacturer grants a franchisee the right to
associations monitor and prevent sell its products, but with no
fraudulent franchising activities in the method of doing business. Examples of
United States, representing the traditional or product distribution franchising
perspective of franchisors or include beverage bottling, gasoline, automotive,
franchisees: and other manufacturing businesses.
• In 1960, the International Franchise
Association (IFA) was founded by a Advantages and Disadvantages of
group of franchisors. Its objective was Franchising for Franchisors
to remove fraudulent franchisors from
the industry and reduce unsavory sales Advantages
practices by salespeople. The founder • Franchising allows franchisors to achieve
of Dunkin’ Donuts, William faster growth by franchisees utilizing their
Rosenberg, was the leading force capital, managerial
behind the formation of the IFA. skills, and local knowledge, allowing
• The Coalition of Franchisee Associates franchisors to build faster growth in locations,
(CFA) founded in 2007 is comprised of resulting in brand
franchisee association leaders dedicated recognition and improving the efficiency of
to the development and growth of their their business operations.
own organizations. The CFA provides a • Enables motivated and qualified entrepreneurs
forum for its members to share best to administer multiple units more effectively.
practices, knowledge, and resources for • Strong brand recognition
the benefit of the entire franchisee • Commitment
population.
Disadvantage 2. Commercial and Residential Services
• A recent study of emerging franchisors found This sector includes various franchise
that a number of new brands had difficulty categories that include services for office
growing past the early stages and ceased buildings and homeowners.
operations altogether. For example, 30.6% of Examples include Service Master, California
franchisors had only one franchise location Closets, Mr. Rooter, Paul Davis Restoration,
after 4 years of operation, and after 10 years, and Rainbow International LLC.
52.4% of that group had 50 or fewer locations. 3. Quick-Service Restaurants
• The threat of litigation This is the largest franchise sector and includes
• Limited ability to motivate locations where customers order food for
• Limit new development takeout or sit-down dining. QSR franchises
require customers to order directly without
Advantages and Disadvantages of table service. Well-known franchise brands
Franchising for Franchisees include McDonald’s, Subway, Burger King,
Dairy Queen, and Taco Bell.
Advantages 4. Full-Service Restaurants
• Brand recognition This sector includes restaurants and other
• Marketing and sales programs establishments primarily engaged in providing
• Management and leadership food services to patrons who order and are
experience served by waiters/waitresses. Brands include
• Opportunity for expansion Fridays, Captain D’s, Potbelly
• Resale potential Franchising, Buffalo Wild Wings, and Hooters.
• Proven operating system 5. Retail Food
• Training and support This sector includes retail food and beverage
• Low overhead stores. Recognized brands include 7-Eleven,
• Cooperation from the franchise Circle-K, and AM/PM.
System 6. Lodging
This sector is sometimes referred to as the
Disadvantages Hospitality Sector and includes hotels, motels,
• Buying a flawed franchise and other accommodations. Examples of well-
• Lack of franchisor support known franchise brands include Marriott,
• An unproven franchise Holiday Inn, Red Roof Inns, and Hilton Hotels.
• The franchisor focuses on selling 7. Real Estate
more franchises This sector includes real estate, real estate
• A franchise may be restrictive and agents, and brokers. Franchises include Century
Confining 21 Real Estate, Re/Max, and Coldwell Banker.
8. Retail Products and Services
Franchise Industry Statistics This sector includes a variety of products used
by customers. These products can also be
For students of franchising, it is essential to found in nonfranchise businesses such as
understand the types of businesses that department and small retail businesses.
comprise the franchise industry, system size, Franchise brands include Ace Hardware, GNC,
growth, and investment. Merle Norman Cosmetics, and Hobby Town
Here are the ten franchise sectors and the bases 9. Business Services
for including franchises categories This sector provides a variety of services that
into each sector. businesses utilize in the operation of their
1. Automotive business. Franchise examples include
This sector includes franchise categories that FASTSIGNS, The UPS Store, Pop-A-Lock,
provide services pertaining to automobiles, Murphy
trucks, and other motor vehicles. Notable Business, NerdsToGo, and Financial Services
brands include Christian Brothers Automotive, and Action Coach.
MAACO, Midas, and Jiffy Lube.
10. Personal Services (2) The Franchise Trade/Service
This sector has emerged as one of the fastest- • The Franchise Trade/Service represents a
growing franchise sectors and consists of major part of a franchiser’s IP. These consist of
services that are provided to individuals. recognizable words, phrases, names, slogans, or
Personal services include 24-Hour Fitness, logos that distinguish products or services of a
Visiting Angels, Great Clips, Sylvan Learning franchise from its competitors.
Centers, and Planet Fitness. • Trademarks represent the foundation of a
franchise system since they identify
Chapter 2: and differentiate the brand, its products, and
Fundamentals of Franchising services from other franchises and
independent businesses.
The franchise business model consists of a • The value and use of a franchise
franchisee acquiring the rights to use the trademark may be enhanced by effective
trademarks and operating system of the marketing strategies, including the use of a catchy
franchiser by paying an initial franchise fee and or attractive slogan and price
remitting a continuous fee or promotions.
royalty based on a percentage of the operating • Another strategy is to tie a trademark to
revenue or profit. A franchise consists of the decor and design of a franchise location. The
specific components that make the franchise colors and design of a franchise trademark and
business model unique. logo should relate to the components of a
franchise’s products or services. Businesses
The following are the most critical component invest considerable resources in developing their
of franchise. brands so that consumers recognize and
distinguish their products and services from
1) Franchise Intellectual Property others.
• Franchise Intellectual Property (IP) • All trademarks are brands but not all
refers to the property category of creations by brands are trademarks. The franchise brand is
humans that underlie the operation of a franchise what the public sees, while a trademark is a
business. distinct aspect of the brand that signals not only a
• IP may be separated from individual particular standardization of the franchise system
entrepreneurs and traded in the open market, but carries legal protection because it is a unique
making it an effective tool to protect and identifier for the franchise.
transfer the value of a franchiser’s intangible • A franchise trademark is a valuable tool
assets. to promote and advertise a franchise system.
• The primary forms of IP are copyright, These identifiers should result in customer
trademark, patents, and trade secrets. expectations of product/service quality
• Franchisers have IP rights in the areas of The impact of a franchise trademark is
brands, copyrights for training and maximized when it is associated with a quality
promotional materials, and patents for franchise system
proprietary inventions.
• Franchisers use tools such as What happens when franchisers fail to uphold the
nondisclosure and noncompete agreements, and system standards?
when necessary, litigation to protect their IP. The result can be irreparable harm to the brand
• Franchisers need to ensure that key and the franchisees. If a franchiser fails to take
operating ingredients and proprietary knowledge appropriate steps to protect its brand, lax
remain confidential in order to prevent others enforcement of franchise standards may lead to
from utilizing it, as well as avoid confusion on damaging outcomes for the franchiser,
the part of customers. franchises and, most importantly, the value of the
franchise brand.
Examples:
Coca-Cola’s Trade Secret and KFC’s recipe for
fried chicken.
(3) The Franchise Operating System of an initial franchisee training program is
• The Franchise Operating System refers to scheduled training.
standardized processes and policies which the If training is done too early, a new franchisee may
franchisee must follow in order to manage, not retain much of what they learned.
market, and operate a franchise. Conversely, if the training is too late, a franchisee
• The franchise operating system is another may make important decisions regarding
part of franchise IP and is what sets the staffing, equipment, vendor relationships, and
franchising business model apart from other marketing programs before they are fully trained.
businesses. It prescribes the formula for how a A franchise that is not complex may still require
franchisee should operate their franchise units in a separate site location. Training should be
a consistent manner, and represents a compilation scheduled right before the franchisee has signed
of processes which, in combination, can result for the location lease. (Home-based
in a successful franchise operation franchise) Complex franchise concepts such as
• The operating system includes such food, retail or lodging franchises should schedule
details as opening hours, store appearance, training in
sanitation requirements, suggested retail pricing, stages.
authorized products and services, employee job Stage 1: basic of franchise operation (staffing).
descriptions, financial obligations, compliance Stage 2: find an acceptable site and
with regulatory authorities, food menus, recruit staff and vendors.
recipes and ingredients, and other activities that Stage 3: combination onsite and classroom
are integral to the daily operation of a franchise training.
• The elements of a franchise operating Franchisee training curriculums may vary,
system are essential to the success of a depending upon the age and size of the
franchise because when properly followed, franchise system and its location.
franchisees can deliver the franchise
products/services with consistent quality that (5) The Franchise Operations Manual
meet consumer expectations regardless of the • The Franchise Operations Manual is a
franchise location. critical depositary of training and franchise
• Chick-Fila, McDonald’s, Burger King, operating information that includes how to start
and Marriott Hotels are notable franchises with and prepare a franchise to open for business.
operating systems that result in a consistent It sets forth essential components of the operating
consumer experience across various locations. system, key franchisee obligations, and serves
• Franchisers can improve and enhance the as a policy and training guide for franchisees.
quality and effectiveness of their operating While it may not effectively prevent the
systems through feedback obtained from disruption of a franchise system, the Manual is a
franchisees on a regular basis. pivotal component of the franchise operating
system since it fulfills several essential functions,
4) Franchise Training from serving as a training guide to how to recruit
• Franchise Training refers to educational and hire the most qualified franchise staff.
and instructive programs designed to teach and The entire Franchise Operations Manual can
improve the efficiency and effectiveness of consist of several separate manuals including a
franchisees and their employees in 1. Franchise Startup Manual,
operating a franchise system. 2. Franchise Operations Manual, and
3. Franchise Marketing Manual
• Franchisee training may consist of a
franchisee classroom and onsite training,
franchiser bulletins, newsletters, webinars, • The term Manual is used in the singular
conferences, and annual conventions. The initial form in Franchise Disclosure Document (FDD)
training that a new franchisee receives is critical but still refers collectively to more than one
to prepare them to set up and operate Manual Mary Ann McConnell, President of
a franchise for the first time. Franwise a franchise consulting firm states that
the Manuals serve four main purposes:
• One of the most important requirements
1. Faster and better franchise development and 7 Payroll, accounting, and computer systems
performance, 8 Marketing and advertising guidelines
2. Definition and detailed compliance processes 9 Customer service
for all brand standards and contractual 10 Management procedures
obligations, so franchisees know what is
expected, what resources are available and how (6) The Franchise Marketing
they • Franchise Marketing refers to activities
can measure their progress, and resources devoted to communicating,
3. Reduced strain and need for franchisor staff delivering and exchanging goods or services with
and potential customers.
4. Franchisors can rely on the manual for legal • Marketing activities enable franchisees
compliance and defense. to promote and publicize a franchise brand in a
consistent manner to existing and potential
The Manual should be available in digital format customers. One of the most important objectives
for ease of delivery and to facilitate updates and of franchise marketing is to build and enhance
important changes. The Manual includes the franchise brand recognition.
standards and procedures that franchisees follow Franchise marketing includes promotional
to operate their franchise and meet the advertising, grand opening programs, creation,
expectations of the franchise brand. and production of marketing materials, public
The Manual can include such individual manuals relations campaigns, and customer research.
as Preopening, Startup, and Most franchisers require that franchisees
Marketing. contribute to an advertising or marketing fund in
addition to franchise royalty payments.
• It provides guidance by documenting Such contributions can be fixed dollar amounts
franchise policy on human resources, or, more commonly, a fixed percentage of
financial reporting, marketing, and accounting franchise revenues. Marketing strategies are often
policies. It serves as a training based on the creative contributions of an
guide, reference, and resource for franchisees. advertising or public
Due to its importance, the Federal Trade relations firm
Commission (FTC) requires that the
table of contents from the Manual be included as (7) The Franchise Development
an exhibit to a Franchise Disclosure Document. • Franchise Development refers to the
Manuals can be intricate or straightforward. recruitment of qualified franchisee candidates
• Franchisers may allow prospective and the sale of new franchises.
franchisees to view the Operations Manual It includes activities required to build and grow
before purchasing a franchise. However, since the the franchise system.
information in an Operations • Selling a first franchise can be a
Manual is deemed confidential by the franchiser, challenge for some startups, requiring that
it will require that the prospect sign franchise development be properly organized and
confidentiality and nondisclosure agreements staffed.
before viewing the Manual. • Franchise development provides the
assets necessary to support the business model,
The contents of an Operations Manual will vary research and develop new products and services,
depending on the type of business, but typical and strengthen the foundation of the franchise
issues addressed include the following: system.
1 The history, goal, or vision of the franchisor • Failure to develop a franchise system
2 Procedures for finding and developing a may impair the financial health of the franchiser
franchise location and prevent the support and assistance that
3 Preopening procedures franchisees require.
4 Equipment and inventory requirements
5 Daily operating procedures
6 Administrative and reporting obligations
 • To achieve franchise system growth 9) Vendor Purchasing Programs
requires the execution of certain activities • Vendor Purchasing Programs refer to
including advertising to prospective franchisees, arrangements made by franchisers with vendors
processing franchise inquiries, qualifying for the procurement of marketing materials, menu
franchise candidates, and completing a franchise ingredients, products for resale,
transaction. equipment, fixtures, point of sale equipment, and
• Successful franchise development certain services used by a franchisee
requires the formation of a Franchise Disclosure in the operation of their business.
Model appropriate for the franchise business An effective vendor purchasing program enables
model. The franchise development process franchisees to purchase equipment,
begins with an initial contact between the products, services, and supplies at discounted
candidate and the franchise representative. prices. Some vendor purchase programs include
• In addition to recruitment, in order to services such as insurance brokers, advertising
properly develop a successful franchise network, firms, printing services, and real estate brokers
the franchise must have a competent staff that can used by children’s tutoring services, real
effectively screen and pre-qualify estate, homecare franchises, and other
candidates. Franchise staff should present the nonproduct franchises.
advantages of the program and respond to the The relationship between franchiser and vendor
concerns and questions of prospective may be contractual in nature, or a
franchisees. When obtaining the feedback of vendor recommendation may be provided to
existing franchisees, a franchisee training franchisees.
program is a significant part of the evaluation
process. If franchise training is evaluated poorly Vendors can be classified into two groups.
by existing franchisees, a prospective franchisee 1. Required Vendors, includes vendors a
may decide not to invest in that franchise. franchisee must buy from under the terms of
the franchise agreement. By using Required
(8) The Franchiser Support Vendors, the franchiser can set up a
• Franchiser Support is defined as the reputable franchise model that supplies franchise
collective help, resources, advice, customers with a consistent
leadership, and operational support that a experience, regardless of which franchise they
franchiser supplies to franchisees. visit.
Franchise support is vital because it enables a 2. Recommended or Approved Vendor. These are
franchisee to improve its vendors that a franchisee doesn’t
operation. A lack of franchiser support is one of have to use, but if franchises do use them, they
the major issues that hinder a franchisee’s can take advantage of favorable pricing
chance of success. and the vendor’s familiarity with the franchise
• Franchise support is critical, especially program.
when franchisees encounter operating Purchasing supply analysts found that a buying
problems or experience a shortfall in revenue. system can save 2%–5% in purchase
Franchiser support will vary, depending upon the savings. Franchisers and franchisees may realize
type of franchise system, something that is often a cost savings of up to 8% through a
industry specific. purchasing cooperative.
• Hotel, motel, and food franchises are
often complex by virtue of the number (10) Competitive Analysis
and type of services they provide. They are • Competitive Intelligence (CI) refers to
among the most needy franchise the collection, analysis, and distribution of
systems in terms of franchiser support. information related to the products, customers,
Medical staffing franchises, children’s competitors, and environmental factors
educational services, and residential that enable franchisees to make strategic
services require less oversight because their decisions. It includes competitive product and
business models are less complex. pricing knowledge, site location expertise, new
product introduction, and competitive marketing the franchiser is free to open both franchise and
practices. company owned outlets near an existing franchise
• Franchise marketing and promotional location. The franchiser can use alternative
programs are enhanced and more effective when channels of distribution whenever it wants.
CI is available to complement the creation and Studies have shown that Open Territory models
execution of these programs. may not always lead to poor performance of
It is more difficult for franchise systems with a franchised units
large number of franchised outlets to
enjoy the benefits of competitive knowledge 12) Franchise Site
because it is costly. • Site selection should carefully include a
• Together, CI and marketing research number of factors, such as general location,
provide the necessary framework to demographics, traffic information, competition,
efficiently position a franchise’s and cost consideration. Franchise site location is
products/services and establish pricing a significant aspect of retail and food franchise
strategies based on current and projected market concepts, as both parties have a vested interest in
realities. identifying the best possible franchise location.
• CI can also be a source of information • The importance of site selection is a high
regarding franchise vendors. If another franchiser priority because it will have a direct impact on
utilizes certain vendors, they may meet franchise the performance of a franchisee who invests in a
vendor specifications and as a result enhance the rental lease or building purchase,
vendor evaluation process. along with remodeling, fixtures, and equipment.
The wrong site can be costly to correct since
(11) The Franchise Territory franchisees usually execute leases that run
• When a franchisee signs the franchise several years or longer.
agreement, they are granted a designated territory • Good site location is essential to
for the term of the franchise. Franchisers can customer accessibility, convenience, and the
define a franchise territory by boundaries using ability of the franchisee to effectively compete
geographical terms such as zip code, street, city, against both franchised and non-franchised
county, or geographical features such as a businesses.
highway or river, while others might use • Exposure to main roads is an important
demographic data such as people over consideration for site location.
the age of 65 for a homecare franchise territory.
• A franchise agreement can include a Important factors to consider are as follows:
sales quota or similar performance clause The demographics of the market and
to protect the franchiser from a franchise not fully surrounding area
developing its territory. Ease of customer access to the location
• A franchise territory may be Exclusive, and easy access and exit.
Protected, or Open. Sometimes used. Proximity to competitors
interchangeably, such terms have different Noncompetitive attraction to the site
meanings in franchising. Rental and site development costs
• When a franchise territory is Exclusive, relative to projected franchise cash flow
the franchise should be the only source of and pro forma income statements
products or services in the territory. Proposed future development adjacent to
If the territory is Protected, the franchiser may be the proposed site, which could be
allowed to sell through channels of positive or negative factors, such as new
distribution such as the internet and certain retail proposed commercial that could change
outlets. In both cases, the franchiser traffic flow
is not allowed to franchise or open a company-run
location within the designated territory.
• Some franchise systems do not supply
territorial protection. Under an Open Territory,
(13) The Initial Franchising Fee and • A few franchisers will grant an initial
Continuing Payments franchise term without renewals.
• The Initial Franchise Fee and Continuing For example, McDonald’s grants a 20-year
Payments refers to the financial resources franchise term with no renewals. The reasoning is
that franchisees are obligated to transfer to the based on the amount of the initial franchise
franchiser in exchange for franchise rights and investment and the expectation that knowing their
support. franchise will terminate after 20 years, the
• The initial franchise fee pays the franchisee will strive to maximize ROI.
franchiser for the rights to the trademark license,
training, support, and the Franchise Operations
Manual.
• Continuing fees are franchise royalty
payments for ongoing rights to market
products or services under the franchise brand,
and to reimburse the franchiser for
marketing and operational support. Continuing
payments include contributions to
an advertising fund for promotional and
advertising programs on a local, regional,
or national level.

Why do they need to pay the Royalty Fee?

Using agency theory, scholars have

shown that continuing payments, specifically
royalties, strengthen franchiser incentives to
support franchises. However, because continuing
fees are a recurring operating expense, a
franchiser should carefully examine whether
these fees are competitive with comparable
franchise systems, especially critical in the case
of a startup.
The continuing fees paid by franchisees
are the lifeblood of a franchise since these
payments enable the franchiser to promote,
support, and administer the franchise
system. Still, it’s important that continuing fees
are equitable for both the franchisers
and franchisees.

14) Franchise Term

• Franchise Term refers to the length in
years that a franchisee can run the franchise,
which can range from 5 to 20 years.
• In addition to this initial term, most
franchises have a renewal term of 5 years or more.
This is important to franchisees who value a
longer contract term since it provides more
security.
• The average initial franchise term is 10.4
years and the average renewal term is 8.6 years.