Where it all began. The evolution of franchising.

By
Carl J. Kosnar, Managing Partner

There are references in American history to early business relationships which, while
possibly not meeting the current FTC definition, were without a doubt,
franchise/licensing relationships. These relationships existed in the selling of wares
from town-to-town by peddlers, licenses granted for general stores at military
outposts, and certain livestock sales and other goods in which exclusive territorial
rights were granted to the "franchisees" by the holder of the rights. Unfortunately,
while the relationships are mentioned in the literature, the names of these early
franchise founders and the structure of the business arrangement are not.
Throughout its long history, there have been four constants that have fueled the
growth of franchising, the desire to expand, the lack of expansion capital, the need
to overcome distance, and managing people from a distant location.
The use of franchising can be traced to the expansion of the church and as an early
method of central government control, probably as far back as the Middle Ages.
Some have written that it may indeed date back as far as the Roman Empire or
earlier and given the necessity of large territorial controls, coupled with the lack of
modern transportation and communication at the time, there is reasonable basis for
this assumption.
Franchising was also used in England and Europe, where Royalty granted land rights
to powerful individuals. In exchange for these land grants, the noblemen were
required to protect the territory for the monarchs by establishing an army and were
free to set tolls and establish and collect taxes, a portion of which was paid to the
monarch. As it was an agrarian society, the control over the land represented
enormous power and was the foundation for the feudal system. It occurred to me
recently, that the movie Robin Hood, starring Errol Flynn, was simply the tale of a
franchise relationship that went bad, with King Richard as the franchisor, Prince John
as the master franchisee and the Lockslie family as the vociferous, disenchanted
franchisee.
This system of governmental control existed in England until it was outlawed at the
Council of Trent in 1562. With the economic opportunities presented by the discovery
of the New World, colonialism of the period, and the emerging international trading
opportunities, franchising was again used by government to expand and exercise
control.
The Dutch East India Company was founded in 1602 by the Dutch Republic to
conduct all trade between the Cape of Good Hope and the Straits of Magellan. The
Company was capitalized by stock valued at 6.5 million guilders. The company,
acting as a sovereign power, conquered territory from the Portuguese and
established its headquarters in Jakarta in 1619. From that base, it created a
monopoly of trade with Japan in 1641 and fought off British attempts to break into
the spice trades. Turning west, the company engaged the services of Captain Henry
Hudson in 1609, who was formerly in the employ of the English Muscovy Company, a
franchisee of England, to find the Northeast Passage, giving the Dutch claims over
the Hudson Valley in upstate New York as far as Albany. In 1799 the Dutch East
India Company filed for bankruptcy and its possessions and rights were assumed by
the Dutch Republic.
In 1607 the London Company was granted a charter for Virginia by England and
hired Captain Christopher Newport to locate and settle the area. The story of
Jamestown, the first permanent British settlement in North America, and Captain
John Smith, who succeeded Captain Newport in managing Jamestown, is well known.
Following the massacre of 347 settlers by the Powhatan Indian Confederacy on
March 22, 1622, the British Crown, charging mismanagement of the area by the
London Company, withdrew its charter in 1624 and the Colony of Virginia came
under direct British control.
Much of the colonization and exploration by the British and European powers was
conducted under similar "franchise-type" relationships.
Franchising, as a business concept, was transplanted into the United States from
England and Europe where it was used "commercially" in the tavern and brewery
industries. Tavern owners, in exchange for financial assistance from the breweries,
agreed to sole purchase agreements with the breweries. The breweries did not
exercise any controls over the operation of the local tavern except for the sole
purchase arrangement.
It is important to understand in examining the birth of franchising in the United
States that prior to franchising there was limited experience in chain operations.
Chain operations would ultimately form the foundation for the franchise method of
distribution.
Not surprisingly, transportation and the growing mobility of Americans were the
impetus for the establishment of retail and restaurant chains and franchising in the
manufacturing segments of the economy.
The earliest known restaurant chain in the United States was founded in the 1850's
by Frederick Henry Harvey, an Englishman who opened his first restaurant in 1852.
This initial restaurant failed during the Civil War. In 1876, Frederick Harvey opened
the first of the Harvey House restaurants in a terminal of the Atchison, Topeka &
Santa Fe Railroad. The railroad wanted to open depot restaurants for its passengers
and provided Frederick Henry with locations and free transportation of restaurant
supplies. By 1887, there was a Harvey House restaurant every hundred miles along
the 12,000-mile-long Atchison, Topeka, & Santa Fe line. Frederick Harvey believed
strongly in quality control and established regular field visits to his restaurants
similar to those used today by franchisors.
Following World War I, the advance of the automobile gave birth to another
restaurant innovation, the drive in. In 1919, Roy Allen purchased the formula for his
root beer recipe from a pharmacist and, together with Frank Wright, started A&W
Root Beer. Needing capital to expand, Allen bought out his partner in 1924 and
began franchising the A&W concept. A&W offered car-side service with "tray boys".
Later A&W added female "car hops" on roller skates to service its customers.
One of A&W's early franchisees was Sherman and J. Willard Marriot who opened
franchises in Fort Wayne, Indiana, and Washington, D.C. in the 1920's. The Marriots'
first A&W in Washington was owned by J.W. Marriot and his partner Hugh Colton and
grossed $16,000 in its first year. As with many of today's franchise systems, it was
the Marriots as franchisees of A&W who brought innovation to A&W when they
requested permission to add food to the restaurant to increase the unit sales.
Using the automobile, curb service, and an innovative hamburger cooked on onions,
Billy Ingram and Walter Anderson opened their first White Castle restaurant in 1921
in Wichita, Kansas. White Castle is credited with many innovations in the fast food
industry, particularly in their use of advertising and discount marketing, the first
take-out packaging to keep the food warm and the folded paper napkin. While it is
still a company-owned operation in the United States, White Caste has commenced
international expansion via franchising. Copying the White Castle format, in 1932
R.B. Davenport opened the first Krystal restaurant and began franchising in 1990.
During that same period, Howard Dearing Johnson acquired a pharmacy in Quincy,
Massachusetts, and began to sell three flavors of ice cream together with a limited
menu of cooked items. In 1935 Howard Johnson awarded its first franchise to
Reginal Sprague. Over the years the concept increased to an expanded menu and to
28 flavors of ice cream. Developing a distinctive roadside presence from orange
roofed locations, and featuring one of the first pylon signs with its name and logo,
the company secured the first turnpike contract on the Pennsylvania Turnpike.
While it was the innovation of the restaurant pioneers that established their menus,
methods of operations and standards, it was the automobile and the movement of a
growing nation that created the opportunity for these early restaurant chains to
grow.
Many of the legendary franchised restaurant chains that began franchised operations
over the next three decades included Carvel, established in 1934; Kentucky Fried
Chicken, established in 1930; Dairy Queen, established in 1940; Dunkin Donuts,
established in 1950; Burger King, established in 1954; McDonald's, established in
1955; and The International House of Pancakes, established in 1958. The stories of
these early pioneering concepts have been the basis for many books over the years
and the lessons learned are evident in the many food service chains that followed.
Tracing back to the late 1800's, the automobile and the growing mobility of
Americans again become the basis for other early developments in franchising.
The earliest non-food franchises were relationships in which manufacturers
established licensed selling and service locations for their manufactured goods
through franchising. This can be seen in the establishment of Singer Sewing Centers
and McCormack Harvesting Machine Company Dealerships in the 1850's and 1860's
and the birth of the automotive franchises at the turn of the century by General
Motors and Ford. The first franchise for General Motors was issued in 1898 to William
E. Metzger of Detroit.
The American Industrial Revolution began the mass production of consumer goods.
It was mass production which created the opportunity for these companies to
produce manufactured goods at lower costs which fueled consumer demand and the
need to sell and distribute the products efficiently and cost effectively. Many methods
of sale and distribution were tried before franchising including direct factory sales,
sales through non-branded locations such as pharmacies, direct mail and traveling
salesmen. While all proved to be insufficient to satisfy the needs of the company,
local salesmen were the most effective.
By selecting franchisees, and providing them with exclusive territories, hard goods
manufacturers were able to effectively and efficiently bring their products to market.
As the automobile manufacturers solved their distribution problems through
franchising and began the changeover from steam engines to internal combustion
engines, there became a need to establish locations for these vehicles to obtain fuel.
Lacking the capital required to purchase the real estate and establish an adequate
distribution system to meet the needs of the growing number of automobiles, over
the next 30 years the oil industry began to establish dealerships through franchising.
At the turn of the century, because of the high cost of transporting the finished
product and the reusable glass bottles, American soft drink bottling was a localized
industry. By shipping syrup concentrate to its franchisees, and requiring the local
franchisees to bottle under strict formulas and processes, bottlers were able to
control the quality of their product in distant markets, and expand rapidly without
the need for the capital which company ownership would have required. Franchisees
obtained the rights to exclusive markets and a valuable trade name and the bottlers
were able to overcome the transportation issues that had to that time restricted their
growth. In 1901 Coca Cola issued its first franchise to the Georgia Coca Cola Bottling
Company.
Most of the early franchises were all based on a product line sold to its franchisees.
During the 1850's and 1860's both Singer Sewing Machine and McCormack
Harvesting Machine Company began franchising the sales and service of their
equipment. In 1902 Louis Liggett formed a manufacturing cooperative with 40
independent drug stores, each investing $4,000 to start the manufacturing
cooperative under the Rexall name. Following the end of World War I, the Rexall
cooperative began to franchise independently owned retail outlets under the Rexall
trade name, supplying franchisees with branded Rexall products.
One of the great innovations in franchising came in 1909 with the establishment of
the Western Auto franchise. Up to that time, product franchisers sought franchisees
with industry experience and, except for the supply of branded product, did not
provide any significant business related services. While still relying on the mark-up
on product sales to its franchisees rather than royalties on sales, Western Auto
provided its franchisees with many of the same services which modern franchisors
provide today. These included site selection and development, retail training,
merchandising, marketing assistance and other continuing services. Western Auto
also sought franchisees without industry experience as many franchisors do today.
While franchising continued to grow up until the beginning of World War II, the truly
explosive growth in franchising began at the end of the war.
Franchising emerged as a force to be reckoned with in the post war 1950's, taking
advantage of pent up consumer demand, available franchisees, ideas from the
returning veterans and capital provided by separation pay and the GI bill. The
growth of franchising in America was further advanced when prospective franchisees
were assured of safety using federally protected trademarks and service marks,
essential to the successful local operation of a nationally established franchise
system.
Before Congress enacted the Trademark Act of 1946, better known as the Lanham
Act, trademark protection was at best inconsistent and uncertain.
Once potential entrepreneurs became confident of trademark and logotype integrity
and protection, more and more individuals flowed into the selling stream of
franchising in the 1950s and 1960s.
The franchising boom in the 50's and 60's achieved almost mystical stature.
Franchisors of convenience goods and services grew. Companies like McDonald's,
Kentucky Fried Chicken, Laundry and Dry Cleaners, Hotels, Rental Cars, automotive
aftermarket and temporary help companies proliferated in the marketplace. By 1965
McDonald's had grown to approximately 1000 units in only ten years and made their
first public offering opening at $22.50. It closed the same day at $30 and closed the
first month at $50. Nate Sherman's Midas Muffler during the same period had grown
to 400 locations, Kemmons Wilson's Holiday Inn grew to 1000 locations and Jules
Lederer's Budget Rent A Car opened their 500th franchise.
The growth in franchising did not come without problems. By the latter half of the
1960's the bloom was off the rose. Many franchisor companies focused more on the
sale of franchises than on operating their franchise systems. Some franchisors made
misrepresentation in attracting franchisees; some based their sales effort on the use
of celebrity names and endorsements and failed. Some even sold franchises for
concepts that didn't exist.
Due to the problems of the 50's and 60's several states led by California began to
enact laws governing the disclosure of information provided to potential franchisees.
These states required the franchisor to deliver to a potential franchisee a disclosure
document providing information explaining the opportunity. It was not until the
summer of 1979 that the federal government promulgated Federal Trade
Commission Rule 436 which established minimum uniform disclosure requirements
throughout the United States.
Today, the format and content of the disclosure documents are undergoing change
to further strengthen disclosure and there are new laws being proposed at the
federal and state level to further regulate franchising. Some would say that the
pendulum has swung too far and unduly burdens legitimate franchise companies
from utilizing the franchise system to establish new channels of distribution.
Today, more than 3,000 franchisors and over a half-million franchisees testify to the
increasing growth of an industry that has burgeoned forth from roots dating back at
least 2,000 years.
The evolution of modern franchising, created by the innovative companies and the
pioneers that have led them, is an exciting tale in itself. The future, energized by still
unimagined new concepts, new business techniques and international expansion,
promises to add still more dynamic chapters to the continuing and growing
adventure of franchising.

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