9.1       Introduction.

9.2       Franchising as a business model

9.3       Franchising – benefits and disadvantages.

9.4       Franchise failure.

9.5       Trends in franchising.

9.6       Franchising as part of entrepreneurial marketing.

References

 

“I was fascinated by the simplicity and effectiveness of the system they described to me that night. Each step in producing the limited menu was stripped down to its essence and accomplished with a minimum of effort.”

Ray Kroc,

partner and later sole-owner of McDonald’s Restaurants.

9.1       Introduction

Large franchise companies like McDonald’s and Burger King started in the 1950’s, but franchising has been around for much longer than that. In the 19th century the Singer Sowing Machine company already used franchising to create exclusive geographical areas for resellers but franchising has been traced all the way back to China, 200 B.C. At that time a Chinese shop-owner, Lo Kass, is said to have started several retail stores using the same name (Seid, 2013). Franchising as we most know it today became widely used as a way to create larger businesses throughout the 1960’s and 1970’s. Then more kinds of businesses, like convenience stores, clothing stores, businesses services and many others, started using business model franchises in order to supply their goods and services (Gitman and McDaniel, 2008: 112).

Franchising has become a global phenomenon and customers from countries all over the world are familiar with it. In Europe some countries (Slovenia) have as few as 107 franchise formulas, others up 1,369 (France). A lot of these franchises are domestic, local entrepreneurs have created them. In Slovenia 49% of all franchise formulas is home-grown, in France even 89%. The Netherlands is somewhere in the middle with 639 formulas of which 85% is home-grown. Table 9.1 shows figures of formats in other parts of the world.

China 2,800 India 1,800
South Korea 2,500 Brazil 1,643
USA 2,200 Canada 1,200
Turkey 1,876 Australia 1,000

Table 9.1 – number of franchise formats across the globe (EFF, 2011: 3)

Franchising has been called the “fastest growing method of doing business” but also “predominantly a retailing phenomenon” (DiPietro et al., 2008: 65-66). Many retailers use franchising as a way to expand their business and become a dominating factor in shopping areas. Not all shops or restaurants though are owned and operated by franchisees and for customers it is often difficult to determine which store is a franchise and which a company-owned store. In this chapter we will take a look at what franchising is and why entrepreneurs (both on the franchisee side as on the franchisor side) would want to share a franchise. We will find out how the franchise fits the topic of entrepreneurial marketing and finally discuss the future trends in franchising.

9.2       Franchising as a business model

First, franchising is defined with use of the formal definition used by the International Franchise Association.  “A franchise is a contractual relationship between the franchisor and franchisee in which the franchisor offers or is obliged to maintain a continuing interest in the business of the franchisee in such areas as know-how and training; wherein the franchisee operates under a common trade-name, format and/ or procedure owned and controlled by the franchiser and in which the franchisee has or will make a substantial capital investment in his business from his own resources.”

There are several ways to earn money using franchising as a business model. A business model is a representation of a firm’s underlying core logic and strategic choices for creating and capturing value within a value network (Schafer et al., 2005: 202), or stories that explain how companies work (Magretta, 2002 : 93). It answers the questions what value the company is selling to whom, and how the company makes money along the way. Franchise business models are based on offering third parties, the franchisees, the opportunity to use the products or services created by the franchisor. The most well-known example of franchising is McDonald’s, the fast-food franchise, but according to PwC in 2010 the number of American franchise outlets worldwide would exceed 900,000 locations and their combined revenues are expected to be more than $ 860 billion (PwC, 2009 : E1). According to their website the World Franchise Association represents more than 14,000 franchisors and 1.4 million franchisees through 38 national member-associations. Franchise business models can be found in more business areas than (fast-)food,  the PwC-study found at least ten lines of business varying from automotive-industries (motor vehicle parts and supply stores, tire dealers, automotive equipment rental and leasing etc.) to real-estate (self-storage units, real estate agents and brokers, property management etc.) and from business services (printing, business transportation, warehousing and storage etc.) to personal services (educational services, health care, entertainment and recreation etc.).

The basic business model in franchising is that the franchisee pays a certain amount of money to the franchisor and thereby obtains the right to distribute products, offer services and/or operate the company based on a set business formula (Van der Heiden, 1999: 15). The cooperation between the franchisor and the franchisee is based on several elements:

  1. Both franchisee and franchisor use the same trade-name or brand.
  2. The rights and obligations of both parties are set by contract.
  3. Both parties are separate legal entities and operate as stand-alone companies.
  4. The franchisor receives a certain amount of money from the franchisee and offers the use of the franchise formula and (management) aid in return.

Business models can differ due to the freedom franchisees have to change certain characteristics of the product or service but also due to the level of management and marketing aid the franchisor gives to the franchisee. Franchise-arrangements that are strict and have no level of freedom for the individual franchisees are called hard franchises; examples are McDonald’s, KFC, and Burger King. Franchisees have to follow the rules and procedures although this might lead to dissatisfaction under franchisees as illustrated in box 7.1. Soft franchises leave more room for franchisees to manage and organise their own business. Often the franchisees share a (franchise) brand name, marketing resources and buy inventory together. The way they operate is less formalized and business-owners can make their own choices in assortment. Examples are Decorette, Livera and Intersport[1].

Franchisees pay three different fees to the franchisor: an entrance fee, royalty fees, and advertising fees. In the opening case, New York Pizza asks an entrance fee of € 100,000 and royalty fees of 6.5 percent and marketing fees 3.5 percent of the total sales respectively. This clearly shows the franchisor’s business model includes selling the business process not just selling pizza’s through more distribution points.

The international franchise literature makes a distinction between three types of franchise. The product distribution franchise in which the franchisee acquires the rights to sell specific products using the name of the franchisor. Examples are car dealerships (like a Toyota of Volvo dealer) and fuel stations (like a Shell or BP station). The trade mark franchise in which the franchisee acquires the rights to produce specific products using the franchisor’s production system. Often the franchisor stays responsible for the marketing. An example of this type of franchising is Coca Cola, but also other soft drink distributors. The third franchise type is the business format franchise. The franchisee acquires not just the products or services, the name and logo or production system but the whole business format consisting of business policies and procedures too. The most famous example is (of course) McDonald’s but entrepreneurs can also obtain franchises in a lot more industries than only the food industry like art, beauty, cleaning & maintenance, fitness, pets, and travel.

Product distribution franchising and trade mark franchising, the so-called first generation franchising, are not considered as franchising in some countries and therefore not included in the statistics (Croonen, 2005: 4). Comparing the size and economic impact of franchising between countries should be done with caution.

Box 9.1 – Growth and Challenges for McDonald’s, Burger King and the Biggest U.S. Retail Franchise Chains

By Barbara Farfan,

FRAGMENT

(…)

April 15th marked the 58th anniversary of the opening of the first McDonald’s franchise location. And just a few days later, the results of a survey conducted with 25 of the biggest McDonald’s franchisors in the U.S. were released which revealed dissatisfaction with the corporate mandates McDonald’s was handing down to its franchisees regarding its value menu. McDonald’s corporate has been battling with its franchisees about value menu mandates since 2009. Remember, that’s the same time that Burger King franchisees banded together in an enough-is-enough protest against a $1 double cheeseburger Value menu promotion. The class action lawsuit that was filed on behalf of more than 800 Burger King franchisees, took about two years to settle, and was characterized in the end as a Burger King corporate “win.”

It’s amazing and amusing that Burger King leaders never realized in that two-year period that when you’re fighting against the people who are in direct contact with your customers, if you win, you lose. (While fighting against its own franchisees, Burger King lost it’s #2 hamburger chain position to Wendy’s.) Even the fact that there is anything so bad that franchisees feel the need to battle it in court indicates that franchisors have already lost sight of who’s working for who.

(…)

Source: About.com Guide April 23, 2013 (http://retailindustry.about.com/b/2013/04/23/2013-best-retail-franchises-growth-and-challenges-for-the-gap-smashburger-mcdonalds-burger-king-and-the-biggest-franchise-chain-gps-mcd.htm; 24-5-2013: 8:26PM)

9.3       Franchising – benefits and disadvantages

Both the franchisor and the franchisee experience benefits and disadvantages from the use of a franchise. The franchisor benefits through being able to grow faster, especially in the early stages of company, due to the access of additional resources, both financial resources and human resources. The franchisee has to pay an upfront entrance fee and works as an entrepreneur, so no salaries needed, in the business. The franchisor can also delegate certain operational tasks to the franchisee and focus on the strategic tasks of the company. As a whole the franchise formula is bigger and can therefor compete more easily with larger companies.

Franchisees benefit by being able to use an already existing brand and business model. It’s easier to set up a profitable hamburger restaurant if it’s called McDonald’s than if it’s called Van der Meer’s. Starting a franchise is often cheaper than setting up a new business (format) from scratch. It’s easier to enter the market when the brand is already known to people. Franchisees can get advice and training from the franchisor instead of discovering everything themselves.

Except for these benefits, franchising has some disadvantages too. The franchisor is not the franchisee’s employer and the franchisee cannot be forced to follow instructions like in a normal employer – employee relationship. Next, it is difficult for the franchisor to monitor the franchisee and make sure the franchisee follows the standardised rules and procedures needed to keep a uniform service or product. It may also be difficult to “fire” a franchisee due to the franchise contract and so the franchisor might need to buy the franchise back.

Franchisees also encounter disadvantages like losing their entrepreneurial freedom and independence concerning strategic choices. They have less possibilities to change the product range and are dependent on marketing and publicity (including negative publicity) done by the franchisor or other franchisees. Starbucks got a huge amount of negative publicity in Great Britain in 2012 due to tax evasion issues. Consumers started to avoid Starbucks’ restaurants, not just the ones owned by the company itself but also the franchise restaurants.

9.4       Franchise failure

An often mentioned reason to start as a franchisee is that the success rate of a franchise is higher. Due to the aid of the franchisor and the use of an already existing business format the entrepreneur will gain higher sales from the start and make more profit, partly due to lower labour costs. Welsch et al. (2011: 14) find this to be partially true; franchisees do have higher sales but do not have lower labour costs nor higher profits in the first year of operating. Other research indicates that franchise survival is dependent on the age of the franchise system; entry costs; size, early legitimacy and efficiency, market entry and the pioneering, expansion strategies, hybrid arrangements, exclusive territories, level of conflict with franchisees, and the timing of buy-back decisions of franchised outlets (Welsch et al., 2011: 6).

Franchises as a whole might also close down. Some research shows that 75 percent of all franchise formulas have gone within the first 10 years (Holmberg & Morgan, 2003: 407). Franchise failure, or closing a complete franchise, doesn’t happen overnight though. There are seven warning signals along the way that indicate the franchise might not succeed and closes down (Holmberg & Morgan, 2003: 405). These indicators (including closure) are:

  • franchisee core competency misfit;
  • franchisee – franchisor dissatisfaction;
  • franchisee discontent;
  • royalty delinquency;
  • complaints to trade commissions or other governing commissions;
  • turnover or termination of franchise;
  • defaults/ other losses to creditors;

9.5       Trends in franchising

As mentioned before, franchising has been around for quite some time but it seems to have become increasingly popular during the last century and some even say that chains will continue to be a dominant business model in the coming years and “eventually come to dominate every service industry that is characterized by some direct contact between customer and organization.” (Ingram & Baum, 1997: 69) According to Baron and Shane (2008: 259) current trends in franchising include smaller outlets in non-traditional locations (in schools, airports, other companies etc.), co-branding franchising (see Box 9.2), domestic franchises crossing the borders and a large expansion in the kinds of business being franchised (gardening services, temporary storage, renting boxes etc.).

Box 9.2 – The Co-branding Franchise Trend

“Allied Domeq Retailing USA, a large franchising company, has recently adopted a three-brand opportunity which would best illustrate the example of co-branding strategy. They have Dunkin Donuts as their first franchise brand, which attracts the breakfast crowd and some late-night eaters who are attracted by the donuts, bagels and coffee offered. They have a second brand, Baskin-Robbins, which has a wide variety of ice-cream and yogurt flavors and other cold desserts which cater to the needs of the lunch hour until closing time for the outlet. The third brand, Togo’s eatery, a sandwich and salad concept attracts heavy business during lunch hours and to a lesser degree at dinnertime.  Combining these three concepts, Allied Domeq Retailing created maximum satisfaction for the customers of the outlet by offering meals and items for all working hours to their customers. The franchisee thus has the benefit of opening his outlet throughout the day and still gets business no matter what time it is.”

Source: http://www.franchisehelp.com/blog/the-co-branding-franchise-trend (27/5/2013: 8.48AM)

Changing demographics are also a driving force within the franchise industry. Franchises need to change in order to meet the needs of the minimal, the minorities, the baby boomers and the seniors. Finally, changes in technology and computing lead to changes in the market. New franchises based on new technologies are for instance tech consultants such as ‘Geeks on call’ offering services to business and consumers. Other growing franchise industries can be found in the (speciality) coffee market, children’s enrichment and tutoring programmes, senior care, weight control and fitness (Gitman and McDaniel, 2008: 112-113).

9.6       Franchising as part of entrepreneurial marketing

The final question to be answered is: “Why does franchising belong to marketing?” In the traditional marketing literature franchising is part of the distribution-mix choices (Kotler & Armstrong, 2012). Like in the introduction case, New York Pizza uses the franchise stores next to their own stores to sell pizza in more places than just Amsterdam. That way they do not only sell more pizza’s but they also have more places to sell pizza and have a larger geographical scope at the same time.

Next, the business-model franchise is a product in itself. The franchisee sells a product and service to entrepreneurs looking for a business. The entrance fee together with the royalty and marketing fees are the price the franchise entrepreneurs have to pay to be part of this business. That way New York Pizza not only makes money on the pizza’s the franchisees have to buy from the franchisor but also on the business format.

References

 

[1] These three are all part of Euretco, a Dutch retail-service organisation.