Franchising is a continuing relationship in which a franchisor provides a licensed privilege to the franchisee to do business and offers assistance in organizing, training, merchandising, marketing, and managing in return for a monetary consideration.
Franchising is a form of marketing and distribution in which the franchisor grants to an individual or company (the franchisee) the right to run a business selling a product or providing a service under the franchisor’s business format and identified by the franchisor’s trademark or brand.
Learn about:- 1. Introduction to Franchising 2. Meaning and Definition of Franchising 3. Concept 4. Salient Features 5. Types 6. Importance 7. Forms 8. Working 9. Franchising in India 10. Four Ps
11. Franchise Development Model 12. Checklist of Basic Franchise Agreement Terms 13. Master Franchise and Master Franchisee 14. Selection 15. Assistance Provided by Franchisor 16. Franchise Relationships (Between Retailer and Manufacturer) 17. Advantages and Disadvantages.
Franchising – Meaning, Concept, Features, Advantages, Disadvantages, Four Ps, Types, Model, Forms and Importance
Franchising – Introduction
Franchising is a continuing relationship in which a franchisor provides a licensed privilege to the franchisee to do business and offers assistance in organizing, training, merchandising, marketing, and managing in return for a monetary consideration. Franchising is a form of marketing and distribution in which the franchisor grants to an individual or company (the franchisee) the right to run a business selling a product or providing a service under the franchisor’s business format and identified by the franchisor’s trademark or brand.
A modern franchise includes a format for the conduct of the business, a management system for operating the business and a shared trade identity. Franchising can be described as a pooling of resources and capabilities; the franchisor contributes the initial capital investment, know-how and experience; the franchisee contributes the supplementary capital investment, motivated effort, and operating experience in a variety of markets. Franchising is a comprehensive business relationship, not just a buyer-seller relationship. There is considerable interdependence between the franchisor and the franchisee. Some examples of today’s popular franchises are McDonald’s, Subway, Domino’s Pizza, and Bata.
Essentially, a franchisee pays an initial fee and on-going royalties to a franchisor; in return, the franchisee gains the use of a trademark, on-going support from the franchisor, and the right to use the franchisor’s system of doing business and sell its products or services. In addition to a well-known brand name, buying a franchise offers many other advantages that are not available to the entrepreneur starting a business from scratch. Perhaps the most significant is that you get a proven system of operation and training in how to use it.
New franchisees can avoid a lot of the mistakes that start-up entrepreneurs typically make because the franchisor has already perfected daily operations through trial and error. Reputable franchisors conduct market research before selling a new outlet, so you will feel greater confidence that there is a demand for the product or service. The franchisor also provides you a clear picture of the competition and how to differentiate yourself from them.
Finally, franchisees enjoy the benefit of strength in numbers. You will gain from economics of scale in buying materials, supplies and services, such as advertising, as well as in negotiating for locations, and lease terms. By comparison, independent operators have to negotiate on their own, usually getting less favourable terms. Some suppliers will not even deal with new businesses or will reject your business because your account is not big enough.
Franchise is a form of business organization in which the franchisor, who has a successful product or business model, enters into a continuing contractual relationship with other businesses called franchisees, which operate under the franchisor’s trade name and usually with the franchisor’s guidance, in exchange for a fee.
Companies adopt the franchise model to expand their distribution by tying up with partners who open company stores in towns. The retail space is owned or rented by the local partner while the company supplies the business know-how and a proven business model.
Thus, a franchise business is a method that companies use to distribute products or services through retail outlets owned by an independent, third party operator, called the franchisee. The company that grants the right to the franchisee to do business under its trade name and techniques is known as the franchisor.
The franchisee conducts business using the marketing methods, markets branded goods and services, and is able to leverage on the goodwill of the franchisor. The franchisee pays an initial fee and royalties to the company, depending on the franchise agreement.
Franchising is a system by which goods and services are distributed through outlets owned by the retailer or dealer. In this system, through a patent or a trademark license, the owner markets products and services under a brand name as per the predetermined terms and conditions. Franchiser is the company that owns the product/service or brand.
Franchisee is the partner who operates the same with permission from the owner. The process of functioning between a franchiser and a franchisee is governed by the framework defined above as franchising. Franchising is a medium through which scale can be achieved without making large investments in creating internal infrastructure.
Franchising – Meaning and Definition
A franchise is an agreement or license between two parties, which gives a person or group of people (the franchisee) the rights to market a product or service using the trademark of another business (the franchisor).
Franchising can be defined as “a contractual agreement between or license between two parties (Franchisor & Franchisee) for the purpose of organizing and managing business, where the parties are mutually benefited”.
Franchise is one form of exclusive retailing. It in fact, is not just a method of retailing. It is a method of marketing which is lying between entrepreneurship and employment. A franchiser is an independent business person who abides by the marketing plan of the financier and pays him a fee for the use of his brand and known-how.
Franchise is a form of business organization in which a firm which already has a successful product or service (the franchisor) enters into a continuing contractual relationship with other businesses (franchisees) operating under the franchisor’s trade name and usually with the franchisor’s guidance, in exchange for a fee.
The franchising concept can be understood as license type transactions. In India, all the contracts come under the purview of the Indian Contract Act, 1872, which is based mainly on the English Law Principles. The agreement to the franchise is a standard printed agreement which deals with rights and obligations of the licensor and licensee. The term ‘franchise’ has its origin in the French word ‘affranchir’ which means to ‘to free’.
In its simplest terms a franchise can be considered a license from owner of trademark or trade name permitting another to sell a product or service under that name or mark. The usefulness of franchising lies in the fact that it helps the mega corporations to expand their business and popularize their brand names without investing large amounts of money. These corporations act as ‘franchisers’.
It is the local dealer who acts as a ‘franchisee’ and operates at a lesser cost by using his local market, knowledge. The franchisee will be able to do business successfully without risks by utilizing the good-will attached to the brand name of the franchiser.
According to the International Franchise Association (IFA) of America, “A franchising operation is a contractual relationship between the franchiser and franchisee in which the franchiser offers or is obligated to maintain a continuing interest in the business of the franchisee in such area as know-how and training; wherein the franchisee operates under a common trade name, format and 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”.
Brand visibility is one of the important activities of every company. Today, competition in every field has become cut-throat and everyone wants to stay ahead in the race. One can remain ahead or get an advantage over the competitors is by indulging in business. One of the best techniques to make the business survive in today’s competitive environment is to grab onto one of the numerous franchise business opportunities.
India has emerged as a major economy with consistent economic growth is truly impressive. Even the global meltdown of 2008 did not hurt India the way it hit western countries. That indicates resilience of the economy.
India is one of the biggest emerging markets for various goods and services, ranging from bare necessities to expensive luxuries. Until 1991, due to the archaic Foreign Exchange Regulation Act, 1973 (FERA), almost all sectors of goods and services relating to the consumer markets in India were secure from the grasp of foreign investors. After the repeal of FERA and the coming into force of the Foreign Exchange Management Act, 1999 (FEMA), foreign investors found their passage into India with rules for entry becoming far more favourable.
From the above mentioned definition we can interpret that:
i. Franchising is all about issuing an agreement for a specific period of time.
ii. Both parties must be mutually beneficial to each other.
iii. Emotional bond has to exist between the franchisor and franchisee to maintain and develop the long-term relationship of the business.
i. Boom in real estate prices
ii. Less Legal formalities
iii. Growing Disposable income
iv. Mushrooming of Malls
v. Fostering the spirit of entrepreneurship skills.
The franchisee has the rights to market the product or service using the operating methods of the franchisor. The franchisee has the obligation to pay the franchisor certain fees and royalties in exchange for these rights.
The franchisor has the obligation to provide these rights and generally support the franchisee. In this sense, franchising is not a business or an industry, but a method used by businesses for the marketing and distribution of their products or services. Both the franchisor and franchisee have a strong vested interest in the success of the brand and keeping their customers happy. Typically, there are two types of franchise methods. There is “business format franchising” and “product and trade name franchising.”
Franchising – Concept
All of us have heard of booming franchise business. Every other day we witness increasing number of franchise food chains or retail chains in malls or popular marketing hubs. A franchise is a right granted to an individual or group to market a company’s goods or services within a certain territory or location.
In other words, when a company decides to distribute its products or services to an independent third party operator on a contract basis, it is known as franchise business. In today’s cut-throat competition market everyone wants to stay ahead in the race. One of the ways to get an advantage over the competitors is by indulging in franchise business.
Franchisee is the independent third party operator using registered products and services whereas the company that grants the rights to the franchisee to use its products and techniques. The best contribution of franchises is in developing independent entrepreneurs who want to be their own boss. There are plenty of franchise businesses available worldwide which are being operated by self-driven individuals.
However, before one decides to buy a franchise business, he must be aware of all the pros and cons involved with it. He must have proper understanding of franchise business. Franchise business is no doubt lucrative, but its success is very much dependent upon the strength of the brand and how it is being operated.
The term ‘franchise’ means an arrangement under which a manufacturer grants to an individual or an enterprise the exclusive right to sell the former’s product or service in a specified locality subject to the terms and conditions of the agreement. The firm which grants the right is called “franchiser”. The person or enterprise to which the right is granted is known as the “franchisee” or franchise holder. The agreement which contains the terms and conditions of sale by the franchisee is franchise agreement.
The terms and conditions of agreement vary widely. But generally, the franchiser agrees to maintain a continuing interest in such areas of the franchisee’s business as site selection, staff training, financing, marketing and promotion. He also allows the use of his brand or trade name, and standard operating procedure. In return, the franchisee agrees to operate under the specified conditions.
He makes capital investment in the business, promotes and sells the product in the specified manner and agrees to pay commission or royalty to the franchiser. Thus, franchising is a contractual relationship between a franchiser and a franchisee. McDonald (fast food chain), Bata (shoes), NIIT (Computer training) and Apollo Clinics (Healthcare), are some examples of franchising in India.
Franchising – 7 Salient Features
The salient features of the franchising system are given below:
(i) Two Parties – In a franchise there are at least two sides – the franchiser and the franchisee. There can be more than one franchisee.
(ii) Written Agreement – There is an agreement in writing between the franchiser and the franchisee.
(iii) Exclusive Right – The franchiser owns a brand or trade mark and allows the franchisee to use it in a specific area under a license.
(iv) Payment – The franchisee makes an initial payment for the license and becomes a part of the franchiser’s network. He also pays a regular license fee which may be an agreed percentage of sales or profits.
(v) Support – The franchiser provides assistance to the franchisee in marketing, equipment and systems, staff training, record keeping. The franchiser initially sets up the business to be run by the franchisee.
(vi) Restrictions – The franchisee is required to operate the business in accordance with the policies and procedures specified by the franchiser. He gives an undertaking not to carry on any competing business and not to disclose confidential information regarding the franchise. The franchiser cannot terminate the agreement before its expiry except for ‘good cause’.
(vii) Specified Period – The agreement is for a specific period e.g., five years. On the expiry of this period, the agreement may be renewed with the mutual consent of both the parties.
Franchising – 4 Major Types of Franchises (With Examples)
There are four major types of franchises:
a. Business Format Franchises,
b. Product Franchises,
c. Manufacturing Franchises, and
d. Business Opportunity Ventures.
a. Business Format Franchises:
This is the most common type of franchise. Here a company expands by supplying an established business concept/format, including its brand name, symbol, and/or trademark to independent business owners. In this arrangement, the franchisee acquires the right to use or follow a business format and also the best practices and processes associated with it.
The franchiser company generally assists the independent owners significantly in launching and operating their businesses. In return, the business owners pay fees and royalties to franchiser. Hence, the franchisee acquires the right to use all the elements of a fully integrated business operation.
Some of the examples are fast-food restaurants such as McDonald’s, Domino’s Pizza, and KFC. Such franchisees maintain the design and styling aspects determined by the franchiser in their retail environments, ranging from the product offered to store design, ambience, atmospherics, and internal infrastructure to service standards to deliveries.
b. Product Franchises:
In these franchise agreements, the franchisee gets the right to use the brand/trade names, trademark, and/or products from the franchiser. Through this kind of agreement, manufacturers allow retailers to distribute their products and use their brand names and trademarks. They also monitor and control on the way retail stores distribute their products. In return of these rights, store owners pay royalties/fees or buy a minimum quantity of products.
Some of the examples are Tommy Hilfiger, Arrow, Scullers, Cotton King Stores, Reebok stores and Bata stores who operate under this kind of franchise agreement.
c. Manufacturing Franchises:
In this case, franchiser offers the right to produce and sell goods to a manufacturer under its brand name and trademark. This type of franchise is generally popular among food and beverage companies.
For example, soft drink bottlers and canners often obtain franchise rights from soft drink companies to produce, bottle, and distribute soft drinks. The major soft drink companies supply the concentrate to them, which are further processed, packed, and distributed by the regional manufacturing franchises.
One example is Gemini Distilleries Pvt. Ltd, Goa, a manufacturing franchise of Bacardi Ltd for manufacturing of winery products.
d. Business Opportunity Ventures:
This concept works on the format in which an independent business owner buys and distributes the products from one company. The company supplies the business owner with clients or accounts, in return of which the business owner pays the company a pre-decided fee.
For example, the business owners may obtain vending machine routes and distribution rights, through this type of franchise arrangement (e.g., coffee vending machine).
Retailer brands and companies often look toward franchising as a key operating model for expansion from scale, geographical coverage, and time perspectives.
For example, Gap is looking forward to script a new story in India as it struggles to maintain customer loyalty in markets across the world. The company was set up in 1969 by Doris and Donald Fisher and has presence in around in 90 countries through around 3,300 company- operated stores and 400 franchise stores.
In India, its franchisee is Arvind Lifestyle Brands and opened its first store in Delhi, five years after its rival Zara did and a few weeks before H&M announced its plans. Zara, Gap’s Spanish rival, has JV with Tata’s Trent. Gap, Zara, and H&M are the brands that are popular even before they entered India. So Gap hopes to leverage the increasing fashion consciousness and latent awareness the Indian consumer has about its brands.
Under the franchise arrangement that the two have drawn up, Arvind has invested in infrastructure and Gap is providing support in terms of brand name, merchandise, layouts, fixtures, and so on. Arvind sources the merchandise from Gap’s global sourcing to which they have a direct access. Gap has manufacturing facilities in and around India, which is another strategic advantage.
Franchising – 4 Important Points which Help the Company to go for Franchising
There are various points which will help a company to go for franchising.
Following are the important points of franchising:
1. Market Growth:
Franchise is the key to rapid market expansion. It helps a company to growth rapidly and expands the range of markets in quick time and without incurring large investments. The computer education network of NIIT is a good example of rapid growth through franchising. It has able to build a network of over 100 branches across the country through franchising.
2. Helps in Brand Building:
Brand building is indeed a journey. Building a brand has everything to do with capturing the hearts and minds of consumers. A brand incorporates and conveys the values and traits that a company wants associated with their product or service. Establishing a strong brand can have significant value, and truly is a journey that companies should embark upon in their quest to be successful.
3. Choosing your Own Job Description:
The owner of a business can delegate certain aspects of the business to others and it creates a job description. A quality job description is one that not only works for your employees, but is legally compliant, and also fulfils many other requirements.
4. Lower Costs:
When someone is buying an existing company through franchising, it is almost always less expensive. The business owners live the scripture, “you reap what you sow”.
Franchising – Forms of Franchise Agreements
Following are the forms of franchise agreements under which franchising is practiced:
1. Individual franchise agreements where it involves the sale of a single franchise for a specific location.
2. An area level franchise that allows the franchisee to own and operate a specific number of outlets in a particular geography.
3. Master franchise agreement, which is similar to the area finance agreement with one major difference. Master franchise in addition to having the right to open and operate number of stores or units, also has the right to offer and sell the franchise to other people in the area. The people who buy franchise from a master franchisee are called sub-franchisees.
At times one could take the rights from the franchiser to sell the rights to operate to other individuals. They act as sub-franchising units. This type of franchising is called sub-franchising. Multi- unit franchising allows the franchisee to open multiple units, this helps them strike a better per unit rate with the franchiser. In this type of operation, the franchisee is likely to oversee the functioning of the units at a higher level while appointing independent teams for running day-to-day operations.
Setting up of a franchise follows the following steps:
1. Developing a good business case for franchising
2. Create a business plan which will be a blue print
3. Aspects connected with Intellectual Property (IP)
4. Preparation of legal documents
5. Identifying the right franchisee
Franchising – Working of Franchising System
Franchising system depends upon a continuous contractual relationship between the franchiser and the franchisee. The franchiser may be a manufacturer or a service organisation. The franchisee is an independent business firm which buys the right to run and operate a business by using the franchiser’s brand name or trade mark.
A franchise agreement is based on a unique product or service owned by the franchiser.
The success of a franchising system depends upon mutual faith and trust between both the parties.
Before Becoming a Franchisee:
(i) Critically examine franchiser’s financial position
(ii) Look for a business or a product with considerable market presence
(iii) Research whether the franchiser’s business is temporarily fashionable or can be successful long term.
(iv) Ask an expert solicitor to double check the agreement with franchiser
(v) Compare notes with existing franchisees about their experiences with the franchiser
(vi) Consider the risk – not every franchisee may succeed in doing good business.
Franchising – Franchising Laws in India
Franchising is a popular way to start a new business yet like everything else in life it also has some pros and cons. One must be aware of all the concerning features of franchising business. There are plenty of lucrative franchising business opportunities. But the first thing one need to figure out is the type of business that he wants to get into.
The laws relating to franchising are excellent so far as western countries are concerned. In India the concept of franchising is in its nascent stages. So the rights and liabilities of the franchiser and the franchisee have not been dealt with elaborately under any law. Generally the law of contracts is applicable to franchise agreements. The franchise agreement must be lawful and not against the public policy in India. The franchising agreement is considered licensing contract in India with a single difference relating to the territorial operation of the business.
Some of the laws that indirectly cover the area of franchising in India are:
1. Intellectual Property Law and Franchising in India:
Intellectual Property rights should be protected very carefully in any country so as to make the franchising system successful. Otherwise when the franchiser enters into new territory with its products, its product may be copied, and brand name may be misused which in turn affects goodwill of the franchiser.
2. The Trademarks Act, 1999:
This Act has been enacted to provide for the registration and better protection of trademarks and for the prevention of the use of fraudulent marks on merchandise. The best way to protect a trademark must get it registered in India. India has made a step towards fulfilling its international obligations.
3. The Designs Act, 2000:
Design has now been defined as only the features of shape, configuration, pattern, ornament or composition of lines or colours applied to any article whether in two dimensional or 3D or in both forms. Application for design registration can be made in any class by the proprietor of the design. Registration is granted only in one class. The proprietor of the Design shall have copyright in the Design for 10 years from the date of registration.
4. The Copyright Act, 1957:
The Copyright Act can be used successfully by the franchiser when he wishes to protect his franchising manual. The manual contains the entire technique of running the franchise business. The manual should not be used unauthorized or improperly by any other person without having the permission of the franchiser as it amounts to violation of copyright being held by the franchiser.
5. Labour Laws and Franchising:
There are various enactments concerning labourers in India. All franchising contracts are amenable to labour laws in India. Labour laws govern the day-to-day conditions of employment in a franchising system. When a franchise outlet is closed or shut down, then the labour laws play a vital role in determining the compensation to be paid to the employees of that franchise outlet by the master franchisee, franchiser or franchisee.
Franchising – Four Ps of Franchising
The successful franchisee realizes quite early that there is a necessity of establishing and maintaining high standards and working with the four ‘P’s of franchising.
The four Ps are:
The product or service of the franchise operation is probably the most significant and important aspect of the successful franchise. A franchisee, must maintain the high quality and standards of the product or service being provided. It is absolutely essential that the franchise maintain a positive reputation and that you satisfy the customer needs. It must realize the importance of the product or service not only satisfying the current needs of the customers, but also their future needs.
The business format process is very important to the successful franchisee. These processes which must be carefully developed and supported include – marketing, promotion, brand recognition, management, training, accounting services, and financial support. The franchisee must develop proper processes to ensure the continued success of the franchise organization.
The franchisee is in business to ensure profitability. Franchisee are generally desirous of obtaining a profit, not only for the present day but also for a long time into the future. They must be able to ascertain the profits, revenues, and even costs of goods associated with your specific franchise business. For example, most pizza restaurants have costs of goods sold and labor costs, which do not exceed 50% of the total sales for the business.
Another example is that of certain sit-down quick service restaurants which provide food costs in the 29-32% range and labor costs in the 15-18% range. You need to be able to accurately determine what the important costs of goods sold, labor costs, and expenses are in your specific business.
The franchisee needs also to be able to ascertain all start-up costs, franchising fees, royalty fees, advertising fees, and other fees which must be paid by him to the specific franchisor. The ‘franchisee should go over this document in great detail to ensure exactly what costs and fees are associated with the operation of the business.
The greatest asset of the business will be the people with whom you work. These people are the individuals who will reach and obtain the high standards of performance which you desire within your organization. These people may share your vision if properly explained. These people are the ones who will work with you, or against you, in developing your business.
Many franchisees spend considerable amount of time away from their desks helping their employees during the peak periods of their business. This allows the franchisee not only to work actually with the different employees but to also to help them see his/her intense desire to provide quality service and products to the consumer. Quality is infectious. The franchisee needs to instill this desire for excellence through example in all employees.
Franchising – Franchise Development Model
The following comments generally apply not only to unit franchises, but also to development and master franchise agreements, unless expressly stated otherwise.
i. The Grant:
A franchise involves the franchisor in granting the franchisee certain rights over a certain area for a specified period. Exactly what those rights, the area and period are is a matter of negotiation between the franchisor and the intending franchisee.
Little, if anything, is open to negotiation with domestic franchising but, on the international scene, it is quite the opposite and both parties must carefully think that what they want out of the relationship to make it worthwhile.
ii. System and Intellectual Property Rights:
Any franchise agreement must permit the franchisee to use the franchisor’s system together with its name and trademarks. Clauses protecting this intellectual property and ensuring that the franchisees do not abuse it are necessary.
It is usual for the franchisee to want as large an area as possible so as to give him the largest possible return on its investment. The franchisor, however, must only decide upon what territory he is willing to grant after taking account of a number of criteria concerning the territory and the franchisee. The territory should be one geographical, political, cultural and economic unit, which allows a planned approach to development of the franchise.
A Memorandum of Understanding (MOU) is a legal document describing a bilateral or multilateral agreement between parties. It expresses a convergence of will between the parties, indicating an intended common line of action and may not imply a legal commitment. It is a more formal alternative to a gentlemen’s agreement, but in some cases, depending on the exact wording, lacks the binding power of a contract.
These are principles or regulations governing conduct, action, procedure, and arrangement.
A standard, model, or pattern regarded as typical: the current middle-class norm of two children per family. Rules are something that are supposed to be followed, norms are something that are just a typical happening.
vi. Joint Venture:
As the name suggests, these are cases where both the franchisor and the franchisee make joint investments into the business (the space typically would be provided by the franchisee). They would then divide operational responsibilities, working capital as well as profit-sharing in a manner acceptable to both the parties.
The franchisee will inevitably demand exclusivity in order to give him the comfort of knowing that he will not be in competition with a third party and that his investment is more secure. From the franchisor’s point of view, exclusivity should not be objectionable so long as the franchisee has been properly vetted, the size of the territory sensibly decided and a proper development schedule agreed upon.
It is common, but by no means universal, for franchisee agreements to be granted for a period of between five and ten years.
Services Provided by the Franchisor:
The franchisor provides the value-added services which help maintain and enhance your business operation throughout the entirety of your franchising experience.
Some of these services include start-up assistance, site location, building design, equipment purchase, store layout, standardized accounting systems, cost-control systems, record keeping systems, standard monthly operating statements, financial assistance, training programs, field support services, advertising programs, marketing programs, and promotional programs, new products, new services, customer service standards, and discount quantity purchases.
In many cases, the marketing and advertisement programs of the franchisor provide more than sufficient money through added sales and services to the business. For example, the advertisements by McDonald’s and Wendy’s are one of the main reasons why many people continue to go back to the stores and purchase the products. Advertising helps build top-of-the-mind awareness and keeps the products and service in the minds of the consumers.
The franchisor also provides quality field support services. These services normally include representatives from the headquarter organization visiting franchisees’ stores to analyze the product, presentation, as well as markets.
Franchising – Checklist of Basic Franchise Agreement Terms
Franchise agreements vary from franchise to franchise. It would be impossible to identify every term and issue that should be considered in every situation. However, this checklist should be a valuable tool if you’re interested in buying a franchise.
The checklist should be used in conjunction with the franchise agreement—the document that will set out all the terms and conditions that will govern your ownership of the franchise—which will be drafted by the franchisor. You can use this checklist either before you see the franchise agreement. In order to get an idea of what should be in it, or after you have a copy of the agreement, in order to review its terms.
In any event, while you can use the checklist to understand and review a franchise agreement, you shouldn’t sign it until you’ve discussed your options with your attorney.
Issues Pertaining to the Franchise Cost Terms:
i. What does the initial franchise fee purchase?
ii. Does it include an “opening” inventory of products and supplies?
iii. What are the payment terms – amount, time of payment, lump sum or installment, financing arrangements, etc.?
iv. Does the franchisor offer any financing, or offer help in finding financing?
v. Are there any deferred balances? If so, who finances and at what interest?
vi. Is any part or all of the initial fee refundable?
vii. Does the contract clearly distinguish between “total cost” and “initial fee”, “initial cash required”, or “initial cost”, etc.?
viii. Are there periodic royalties? If so, how much are they and how are they determined?
ix. How and when are sales and royalties reported, and how are royalties paid?
x. If royalty payments are in whole or part payment for services provided by the franchisor, what services will be provided?
xi. Are accounting/bookkeeping services included or available?
xii. How are advertising and promotion costs divided?
xiii. Is a specified amount of working capital required of the franchisee to cover operating costs until profits can be made?
xiv. Must premises be purchased or rented, and are there further conditions on either of these (from franchisor, selected site, etc.)?
xv. How and by whom will the building be financed, if purchased?
xvi. Does the franchisee have to make a down payment for construction and/or equipment?
Issues Pertaining to the Franchise Location Terms:
i. Does the franchise apply to a specific geographical area? If so, are the boundaries clearly defined?
ii. Who has the right to select the site?
iii. Will other franchisees be permitted to compete in the same area, now or later?
Franchising – Viewpoint of the Franchisee and Franchisor
1. Franchisee’s Viewpoint:
(i) Capitalising on the well-established brand name, business model and knowhow
(ii) Leveraging on franchisor’s experience in business execution
(iii) Continuous support from the franchisor
(iv) Leveraging on the franchisor’s promotional activities
(v) Training and support from the franchisor
2. Franchisor’s Viewpoint:
(i) Franchising is the best way to establish in a new market without large investments in unfamiliar countries
(ii) Localisation of the brand and products become easy with local expertise
(iii) Manpower issues looked after by the franchise
(iv) Expansion in wider territory with limited investment
Franchising – Master Franchise and Master Franchisee
Franchising values uniformity and consistency. The entrepreneur is required to conform to the franchise agreement; this normally restricts the franchisee’s growth. Depending upon the potential the location offers, the franchisee’s growth potential gets limited. An enterprising owner often expands by purchasing franchise for additional territories or maturing in to a master franchise.
Franchise opportunities hand book (US Department of Commerce) defines a master franchise as a contract that allows an entrepreneur to establish multiple outlets within a given territory or geographic area. Herein the franchisee has the rights of a regional franchiser and can either open multiple outlets in the region or act as a sub franchiser who can contract independently and appoint franchisee for different locations in his territory.
Master franchisee are provided for several regions/countries. These master franchisee create regional management that takes into account the local requirements and diffuses distribution and decision-making control. Master franchisees are selected from well-established entrepreneurs (often existing franchisee) who have the ability to manage growth and resources to expand rapidly.
Franchising – Selecting of Franchise
Before an entrepreneur selects franchise he should ensure that he wants to be a franchisee rather than setting up his independent business from the scratch. He should seriously view the pros and cons of a franchisee vis-a-vis an independent business. He should also identify and define his skills and desires and ensure that these suit the requirements and role demands of a franchisee.
After ascertaining the market potential for the same he should choose the product or the service he is interested in and search for a suitable franchiser. The information about the franchisers can be obtained from various business and trade journals or from an existing franchisee. As the franchise territories are normally protected, most franchise owners will be willing to give information about the business and the people to be contacted for obtaining a franchise.
On approaching, a franchiser, the prospective franchisee will have to prove his bonafides as well as abilities and seriousness to the franchiser. A franchiser normally prequalifies a prospective franchisee before proceeding further and provides the sensitive business information only after evaluating the prospective franchisee.
The franchisee then seeks from the franchiser information that is suitable and sufficient for a thorough evaluation of the business. As per US federal law every franchiser is required to provide its “Uniform Franchise Offering Circular (UFOC)”, a disclosure statement to all prospective franchisees. This is to enable them to take an informed decision about the franchise. In India there is no law governing franchising. However, an entrepreneur contemplating to buy a franchise should ask for the information that would enable him to evaluate the prospects of the franchise he plans to buy.
Important Information an Entrepreneur should Seek from a Franchiser:
1. Financial statement of the franchiser for at least three previous years.
2. Information about the initial franchise fee and other payments including security deposits that may be payable.
3. An item wise estimate of franchise’s initial investment, i.e., opening inventory, working capital, fixed assets, real estate expense, furnishing, decor etc.
4. Royalties and profit sharing arrangements.
5. Audited performance data, e.g., sales volume, costs and profits.
6. A list of names and addresses of other franchisee.
7. Support services to be provided by the franchiser, i.e., training of staff, merchandising and advertising programmes, equipment purchase or lease options, on site constancy etc.
8. Detailed copies of all agreements including legally binding documents that the parties are required to sign.
The entrepreneurs proposing to buy a franchise should thoroughly study these documents and critically evaluate the franchiser. The information provided by the franchiser though essential for evaluation of the business proposal, yet is generally not sufficient for singing the contract. The entrepreneurs are advised to conduct their own market survey to satisfy themselves about the soundness of the business prospects. It is advised that where ever the entrepreneur has a choice to choose between two or more franchisers for similar product/service, the comparative data be studied and used for negotiations with the franchisers.
Armed with all these evaluations the entrepreneurs negotiate with the franchiser. Many entrepreneurs prefer to handle activities like accounting, purchasing, training of employee, leasing etc., themselves. They may prefer to make the location decision jointly with the franchiser. However, the negotiations provide very little latitude for the decisions about facilities and unique designs. Some terms like franchise fees, royalty, inventory, brand management, use of patents, trademarks etc., are general not negotiable.
The final step before signing the franchise is to get the negotiated proposal vetted by a chartered accountant or an attorney experienced in due diligence research. It is a standard practice with the franchisees in USA and is even more important in India where there is no law on disclosures by a franchiser or any other legislation governing any aspect of franchising.
The lawyer should inform the entrepreneur about his legal rights before he signs the agreements which are normally prepared by the franchisers. All contractual agreements are based upon exercise of good faith and fair dealing by both parties. “It is the duty of each party to any franchise to act in a fair and equitable manner towards each other, so as to guarantee each party’s freedom from coercion, intimidation, or threat of coercion”.
During negotiation of the franchise agreement the entrepreneur should consider and pay due attention to the following:
1. Total Investment in the Franchise:
An entrepreneur should estimate the total investment needed in setting up the franchise. He is required to estimate the hidden costs of franchise, e.g. –
i. Lease deposits.
ii. Modifications and refurbishing of the real estate.
iii. Franchise fee which is payable up front for purchase of the franchise.
iv. Working capital, i.e., money needed to buy stocks pay salary and wages to employees.
v. Funds to make lease payment.
vi. Fund to finance credit sales.
vii. Equipment and furnishing costs. Whether these costs are to be born by the franchisee or the franchiser will provide the same against regular payments to be made by the entrepreneur.
viii. Royalties as percentage of sales to be paid to the franchiser.
He should carefully prepare a feasibility report and calculate all the costs involved in buying and running a franchise. The entrepreneur has also to consider if the investment required is within his budget. He has to examine the assistance if any that the franchiser if to provide for raising the necessary financial resources.
Franchisers normally have a belter clout with the banks and financial institutions. They cart assist in negotiating a loan. Nationalised banks like State Bank of India and Canara Bank are providing debt finance to VLCC and Archie franchisees. ICICI Bank also extends loan to reputed franchisee if the franchiser agrees to be the guarantor. Sometimes the franchiser also assist by taking a minority stake in the equity of their franchisee.
2. Conditions and Cost of Pulling Out a Franchise Contract:
Entrepreneur should explicitly know what they may gain or lose if they decide to pull out of the franchise or if the franchiser opts to cancel the contract. He should understand the conditions under which the franchise contract can be cancelled.
Such conditions normally include:
i. Unability to meet the sales targets.
ii. Unability to meet the service standards set up by the franchiser.
iii. Misuse of patents, trademarks and name of the franchiser.
iv. Deficiency in providing the franchiser with reports, financial statements and documents as agreed.
3. Freedom to Sell out the Franchise before the Contract Runs out:
An entrepreneur should explicitly negotiate about the right to sell or transfer his franchise, back to the franchiser or to any other person. The franchiser can protect his patents, trademarks and other uniquely developed services but should not deprive the franchise from selling and transferring his business.
He should also ascertain if he can sell the business at the market price or at the price to be determined by the franchiser. In case he sells the business at market price to the highest bidder, is he required to share the proceeds with the franchiser or not? In case the price is to be determined by the franchiser, the entrepreneur should know whether he will get the book value in full or not, also how the goodwill be evaluated and the proportion in which he would be required to share it with the franchiser.
4. Support Services Offered by the Franchise:
An entrepreneur should evaluate the support services provided by the different franchisers to choose the best. One of the crucial item of support is the type of training the franchiser provides. Some franchisers-run special training programmes for the franchisee and their staff in their office, others arrange on the job training of new franchisee staff at one of the existing franchise while some send their team to the new franchisee for initial period (say a month) to train their staff. An entrepreneur should check if the franchiser has a regular training schedule to upgrade the skills of the franchisee’s managers and workers.
Besides, the entrepreneur should evaluate the support he is likely to receive in building sales. New franchisers often guarantee a certain level of sales which means if a franchisee is unable to meet the anticipated sales level, he will be compensated for the balance amount.
Franchising – Assistance Provided by Franchisor
Since franchise is a ready-made business available to an entrepreneur, it is an attractive proposition as compared to setting up an enterprise from the start. The franchisee gets a semi established business from the day one. The business is akin to the other enterprises of an established chain. The franchiser is required to provide the franchisee with all the assistance in starting and establishing the venture.
Normally the franchiser is expected to assist the franchisee in:
1. Advertising and providing a strategy for marketing
2. Training the manpower
3. Selection of the equipment
4. Office design, layout etc.
5. Standardised policy and procedures
6. Assistance in site selection and logistics
7. Assistance on legal matters.
In addition to the professional help, the franchisee also get lot of intangible benefits. Like all other things the franchise also has some disadvantages as they lack independence, individual identity, and have continuous obligation that is difficult of cancel. Franchises normally combine personal ownership with the systems of big business.
Franchising is also advantageous to the franchiser who grows rapidly using other people’s money. It helps him in expanding the business geographically into various location including the remote one. He can manage with less number of people and hence is saved of many a labour related problems. Franchisee being independent owner of various chain stores are more committed and work longer hours than managers.
Besides other benefits discussed above franchising provides an entrepreneur the ability to penetrate the market rapidly with limited finances. Even larger companies are being attracted to franchising, thus, making franchise a mere lucrative business for the franchisee. Franchise is becoming popular as it is regarded as a promise of instant success and is considered to be least risky way to become an entrepreneur. However with the mushrooming of franchising these benefits are limited to franchisee of a few reputed franchisers.
Yet, franchising has its own risks. When a large franchiser folds up, the effects on the rest of the network can be crippling. A few years ago an apparel company ‘Stencil’ had to close shop. Well over 100 franchisee found themselves out of business overnight. The same was the fate of Mother care franchisees when it pulled the stutters. The franchise relationship is an unequal one. A franchiser gets to call the shots. In US the law of franchise protects the interest of the franchisee while in India there is no law regulating franchising business and buyers of the franchise have to be extra cautious.
As per a study in USA, of the retailers who were in business in 1987, 45 per cent of young franchised retailers had failed by 1991 as against 23 per cent young independent retailers. A good number of established entrepreneurs are still shying away from franchising. The perception is that franchising adversely affects the quality of service. They are afraid of negative effect on their business because of inability on the part of some of the franchisee to maintain the quality standards.
VLCC a fourteen crore chain of personal grooming and fitness clinics, appointed franchisees eight years ago. Realising that their business was about people’s health and well-being, they were not very comfortable with the standards maintained by their franchisee. VLCC opted out of franchising to setup joint ventures with interested partners, keeping 60 per cent stake and the management control in their hands.
The other hurdle for the franchiser is that few entrepreneurs are willing to take on a new franchise without a guaranteed amount of sales. Minimum sales guarantee means that if the franchisee is unable to reach the anticipated sales level, the franchiser will compensate him for the balance amount. Some people feel that in our economy it is still a case of too many franchisers chasing a few potential franchisee. The scenario is yet to change as the franchising industry matures.
Another factor which restricts the franchising is that mostly the franchisee who are small businessmen, are unwilling/unable to grow with the franchiser. This puts a break on the pace of growth of the franchiser. Archie’s have realised the need for up grading the quality of their outlets in line with changing customer needs. The franchisee are required to invest more in up gradation. The franchiser is facing serious resistance from its 400 franchisees.
Franchising – Franchise Relationships (Between Retailer and Manufacturer)
The most common franchise relationship is between a retailer and a manufacturer or sometime a wholesaler, e.g., Car showrooms, Bata and Liberty shoes showrooms, Haldiram franchise etc. In India manufacturer-manufacturer franchise relationship is the oldest. Here one manufacturer produces goods for the other under licence. A large number of items are reserved for manufacture in SSI units. These franchise SSI units manufacturer the items as per the design, specifications and quality control of the franchiser.
They use the logo and trademark of the franchiser who is responsible for sales and marketing e.g., Singer Sewing Machines have three franchise manufactures in Ludhiana besides one in Hapur. Road Master Industries and Dewan Rubber are the franchise manufacturers of TI cycles for bicycle tyres and rims, Colgate and Hindustan unilever use franchisee for production of tooth brush as the item is reserved for manufacture in SSI sector. It also includes sub-contractor producing goods as per the design and technical specifications of the mother units, who provide them with all technical assistance.
Exclusive dealership is an example of manufacturer-wholesaler franchise relationship. The retail and service franchise are comparatively new relationships in India and differ widely from manufacturer- retail franchise system already prevalent in India. Retail-retail relationship tries to duplicate one retail outlet.
It can vary from the Kwality chain of restaurants, wherein the franchisee have a lot of independence and pay a royalty for using the name, to Wimpy or Pizza King wherein alt decisions including recruitment and training are reserved for the franchiser. Here the franchisee is an extension of the franchiser. Each franchise outlet clearly resembles that of the franchiser. It is akin to company outlets but with different owners and investors.
The franchise is like a marriage. The stakes are high on both sides. The franchiser gives up his precious asset, the brand and the franchisee forgoes his independence and right to operate alone. The implicit trust is the corner stone of the relationship between the franchisee and franchiser.
Franchise arrangements are usually either:
(i) Product or trade name franchises, or
(ii) Business format franchises.
The former involves product-distribution arrangement within a specialised geographic territory. For example, a petrol pump is a product and trademark franchise. A business format-franchise includes not only a product and trade name, but also operating procedures such as – design facilities, accounting procedures and practices, employee relations, quality assurance standard, and over all image and appearance of business, e.g., restaurants, convenient stores are often a business franchise.
Franchising – Advantages and Disadvantages
1. To the Franchiser:
(i) The franchiser can enter into foreign markets and new territories in the domestic market safely and easily.
(ii) The franchiser can expand his business without investing a large amount of money. The cost of new premises and extra staff is done by the franchisee.
(iii) A regular income is received by way of royalty or fee from franchisee.
(iv) With expansion of business, the franchiser can obtain economies of scale through bulk buying from suppliers.
(v) The franchisees have a financial stake in business. Therefore, they are likely to work very hard to make them succeed.
(vi) The franchiser retains control over the franchisees.
(vii) The franchiser can increase his goodwill by expanding his network. His brand name becomes popular.
(viii) The franchiser gets feedback about the needs and preferences of customers from the franchisees.
2. To the Franchisee:
(i) Support and advice is available from the franchiser in respect of staff training and marketing. Such support is available not only in the initial stages but also on a continuing basis.
(ii) The franchisee can start his business with less initial investment than what is required without a franchise.
(iii) The franchisee gains from the established name, brand and national advertising of the franchiser.
(iv) The chance of failure is minimum due to proven success of the product and its secure place in the market. Franchising allows people to start and run their business with less risk.
(v) Banks are more willing to lend money to a franchisee because documented information relating to the success of other franchisees with the same product or service is available.
1. To the Franchiser:
(i) The franchiser’s trade name and reputation may be tarnished if the franchisee does not maintain standards of quality and service.
(ii) The franchiser has to provide initial financial assistance and specialist advice.
(iii) There are ongoing costs of supporting the franchisee and national advertising.
2. To the Franchisee:
(i) The franchisee does not have complete independence in his business.
(ii) The franchisee has to make payment of royalties on a regular basis.
(iii) In some cases the franchisee is required to buy all supplies from the franchiser even though cheaper local alternatives may be available.
(iv) The franchisee may not be able to sell the business without the franchiser’s approval.