Seminar paper

Franchising: an introduction to the system of business success.

Study program: Packaging Technology and Sustainability

Course: Innovation, Entrepreneurship & Strategy

Author (ID number): Benjamin Smits (C1910844026)

Date 16.04.2020
I. Table of Contents

I. Table of contents 1
II. List of abbreviations 2
III. List of figures and tables 2
IV. Abstract 2
1. Introduction & research problem 3
2. Aim 4
3. Literature Review 4
3.1. A short introduction to franchising 4
3.2. Franchising and entrepreneurship 5
3.3. Current trends and developments in regards to franchising 6
3.4. Business expansion through franchising 7
3.5. Key understandings of a franchise operation 9
3.6. Advantages and disadvantages of the franchise system 12
3.6.1. Advantages for franchisors 13
3.6.2. Disadvantages for franchisors 13
3.6.3. Advantages for franchisees 14
3.6.4. Disadvantages for franchisees 15
4. Discussion 15
5. Conclusion 17
6. References 18

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II. List of abbreviations

Business Franchise Format (BFF)

III. List of figures and tables

Figure
1. Relationship between profit and turnover in a franchise system 12

IV. Abstract

This dissertation focuses on the subject of franchising and the how it is used in
regards to business expansion. I make note of the use of franchising over the years
until its popularity by the fast food industry in the mid 1950’s. Having reviewed
literature and in regards to elements of the franchise system, current trends and
identify advantages and disadvantages for both franchisees and franchisors. The
paper discusses how the franchising system can help established business owners in
further expanding their business while simultaneously providing opportunities for
entrepenures to buy into a business system that is also focused on their success.
While there are many types of franchises operating in many sectors, this dissertation
looked at the common elements and themes in order to give the reader a short
overview of the world of franchising and how the system can aid business success.

Keywords

Business, Expansion, Franchise

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1. Introduction

Franchising is a relationship between a franchisor (business owner) and franchisee

(business operator) who have a mutual goal of successful business operation.
Engaged in a business expansion strategy, businesses owners have turned to the
franchising system as a source of low risk financing to aid their growth strategy.
Contrary to what most people think when they hear the word “franchise”, the method
of business operation is neither an industry in itself nor is it exclusive to the fast food
industry.

A franchisee is critical to the success of the business owners expansion as they will be
responsible for undertaking the day-to-day activities of the business franchise.
Through purchasing of the franchise system in a selected operational territory, the
franchisor exchanges exclusive use of trademark and business systems and in depth
operational training and network support for a lump sum payment and ongoing royalty
fees for the life of the agreement.

The franchisee is also responsible for securing the location in which the franchise will
operate, manage staff hiring and training, ensure quality standards set by the
franchisor are adhere to and business operations are followed as set out in the
franchise manual or handbook.

While the franchisor may not be generating the equivalent revenue of the store as if
they were operating it themselves, it does allow the possibility to relinquish staff,
management and operational costs. By outsourcing these activities, the business
franchisor can concentrate on marketing and advertising activities, networking and
training exercise and searching for additional locations and franchisee who are likely
candidates to operate additional franchise units.

Through a franchise system, franchisors can expand their business operations and
budding business owners can pay to join the franchise network, run the franchisors
business for them and be in business for themselves, with the benefits that come with
corporate training and networks.

Despite been dominated by the franchise industry, there are many industries in which
this business system has been successfully implement. Franchises not only offer the
opportunity to grow a business, but also the opportunity to develop a new range of
skills. For the business person looking to expand their business through franchising,
they will be less likely to be undertaking the activities and skill sets that enabled them
to build their business in the first place as they will be transitioning into a role that
requires effective training and coaching, management and business development
skills.

For the franchisee, this may be an opportunity to up-skill into a new position such as a
business operator, manager human resources or financial manager. They may still be
required to undertake the day-to-day operations of the franchise, however their
potential to learn and grow with their franchise may provide opportunities that may not
be available if they were to instead start their own business.

Yet despite the opportunities a franchise system may present for business success, it
is not guaranteed. The franchise business can be restrictive to franchisees in that
operating outside the business system is not allowed by the franchisor. Pricing

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systems and promotions may not be implemented in a store by store basis unless
there is agreement with the franchisor. The key to a successful franchise and brand
value is the consistency in which the business operations are conducted.

2. Aim

The purpose of this review is to better understand the franchising system in regards to
cost effective business expansion. Despite extensive use by governments as a means
of public procurement, it was not until the 1950’s that the franchising system was
adopted by privately owned companies as a means of rapid business expansion.
Having been adopted by a wide range of industries and business sectors throughout
the decades, franchising has since become an attractive business strategy to aid
expansion into new markets. By exploring the factors that contribute to a successful
business franchise we can better understand how the franchise system works and
determine the elements that contribute to franchise success. In doing so, this review
will explore the advantages and disadvantages of the franchise system, identify the
key elements crucial to the franchising contract and understand how franchising can
be used as a cost effective business expansion strategy.

3. Literature Review

3.1 A short introduction to franchising

The term “franchise” can be used to describe the relationship between the franchisor
(a private individual or company) and a franchisee (person granted a privilege) who is
granted the right to operate in a selected territory by taking advantage of the
companies trademarks, business operating system and brand support in order to
conduct business operations. Essentially, the (franchisor) gives to the latter part
(franchisee) the grant to become part of its franchising chain Alberto (2016). A
franchising contract is one tool adopted by business to reduce the risk associated with
entering a new market. The benefits are mutual, allowing the franchisor to expand
business operations in a new territory while providing franchisee can start a new
business bypassing the need for outlaying large amounts of capital contribution. As
such, the franchising system can be considered a mutually beneficial business
collaboration between to identities toward business success and profit generation.

In its purest form, “franchising” would have been practiced from early civilization
where a ruler or authority delegated privileges to those who could provide a service in
return for other services or money. This could have been through wealthy land owners
bestowing land rights to military services or authorizing a person to collect taxation in
the kingdom with a small portion passed up to the ruler.

Franchising has also been used by governments in the procurement of public services,
however it is a relatively recent adoption by the privately-owned business community
as a means of distribution and business expansion. Initially, manufactures in the
private sector used franchising as a means to sell their products into new markets.
The McCormick Harvesting Company and Singer Sewing Machine Co. adopted the
practice as a means of expanding the distribution of their products across the United
States by granting exclusive distributorships around the 1860’s. The early 1900’s saw
a proliferation in automobile developments. Lacking human and monetary resources
to operate company owned retail outlets, manufacturers turned to franchising to
develop their retail outlets in a short period of time.

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Oil companies shortly followed this trend around the 1930’s. Having initially relied
upon exclusive company operated service stations, they use the franchising and this
rapidly turned into their primary distribution method and then adopted by independent
wholesalers and retailers in a bid to remain competitive against chain stores.

Business Format Franchising (BFF) has become the modern form of franchising which
saw serious development in the 1950’s and accounts for “most of the explosive growth
in franchising that has occurred in the past five decades” according to DLA Piper US
LLP (2003). BFF is the licensing of a trademarks, business format and operation
procedures that many franchised businesses operate under today. A modern
franchise will include a comprehensive management for business operation, codes of
conduct and trade identity. It therefore becomes a comprehensive interdependent
business relationship. And while becoming a prominent form of business expansion, it
should be noted that franchising remains a business method and not an industry in
itself.

3.2 Franchising and entrepreneurship

So what, or who is an entrepreneur? Jose de la Torre, J (2015) describes an

entrepreneur as a starter - someone who is driven, initiates and challenges. A creator
of either a business or a company and bring their ideas from conception to reality.
They are in charge, a leader and has the ability to inspire their team to follow. They are
also willing to be held accountable and take responsibility.

Yet they don’t necessarily need to hold equity in a company. They are more suited in
leadership positions, are agile and dynamic in running their project or operation and
have the stamina to take on challenges in regards to meeting their goals Jose de la
Torre, J (2015).

The franchising model is well suited for individuals who want to take charge of a
business, without having to build in from the ground up. Unlike traditional business
development, a franchise allows individuals to partner with established companies to
take advantage of existing branding, networking and marketing.

For the franchisor, franchising is a powerful tool for economic development. With
adequate planning, the system can be used to penetrate new markets and empower
outside want-to-be business personal who would otherwise have “lack of capital,
training, or access to professional assistance” in regards to establishing their own
business as according to Gharajedaghi, J. (2011).

And it is not just suited to the obvious restaurants and fast food outlets that one think
about when they hear the word ‘franchise’. The franchise system has been
successfully applied businesses in more than 70 industries from food preparation and
service, through to home maintenance, automotive repairs and financial services.
Pairing the right people with the right skills with the right franchising opportunity has
the potential to expand businesses into new markets.

Seid, M. (2009) suggests a business that is ready to expand through franchising

usually has a goal to do so, is financially capable of supporting that goal and can
support growth of the operation, has the managerial expertise to oversee the
operation and has the ability to support locations in multiple market places.
Franchising is often the fastest way to grow for businesses as this is taken on by

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franchisees. Outsourcing the growth of the business provides the franchisor with
financial leverage in exchange for guidance and training.

According to Siebert, M. (2004) additional outlets after paying an initial franchise fee in
return for the rights to open and operate a business under the franchise trademark
and for training in how to operate the business. This can be an appealing offer to
people who do not wan to purchase a business outright, but do not want to start a
business from scratch. Siebert, M. (2004) suggests here are many benefits to buying
into a franchise. Operators can take immediate advantage of brand recognition,
system operation and training offered by the franchisor and in turn avoid a lot of
common mistakes faced by start-up businesses. Siebert, M. (2004) asserts “The
franchisor has already perfected daily operations through trial and error” which gives
the franchisee an easy barrier to entry in regards to running a business.

But why would a company want to franchise? Simply, companies decide to franchising
for one of three reasons: lack of money, people or time. Capital is the primary barrier
of expansion experienced by today’s entrepreneurs. Franchising allows a company to
grow without taking on the risk of debt. Siebert, M. (2004) states “franchisees provide
the initial investment at the unit level, franchising allows for expansion with minimal
capital investment on the part of the franchisor”. Risk to the franchisor is reduced as
the franchisee is the one searching for the property and committing to various other
contracts, while the business benefits from additional exposure and work force. But
while capital remains the number one barrier to expansion, retaining competent
managerial staff is a close second. The franchising system allows franchisee owners
to become unit managers of their outlets and thus reducing the risk of them been hired
by the competition. Siebert, M. (2004) makes an interesting point that a “franchisee
has both an investment and a stake in the profits,” they are more likely show greater
motivation leading to better performance of the franchise unit.

And finally, the time it take to secure additional locations takes time that is not
available to people operating a business. The franchisee is responsible for hiring of
staff, purchasing equipment and sourcing inventory and is able to dedicate resources
to ensure it is done properly.

3.3 Current trends and developments in regards to franchising

The market place is ever changing dude to the wants and needs of modern
consumers and successful franchising opportunities must meet these demands in
order to retain market share. The greatest factors impacting franchises is the change
in demographics. Goldberg, E. (n.d) identifies a change in population will affects
buying habits, purchasing power and products and services required to fulfill
consumer needs and suggests ‘franchisors and franchisees alike must adapt to this
changing customer and employee base to find opportunities for growth.’

Changes in demographics not only transfer wealth to different consumer segment, but
also affect the labor market. With new products and skills required for the digital age
likely to impact younger generations, the needs of older generations are also shifting,
with opportunities for franchises to target a growing number of services required to
meet peoples change in lifestyle. Goldberg, E. (n.d) suggests millenials are an
“economic force” in their own right. With a heightened focus on technology and health
and well-being, there exists plenty of opportunities to target the tech-savvy generation.
The Baby Boomer generation will require health, fitness and financial advice services

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while the Seniors will drive a demand in assisted living and home care systems to
cater to ageing bodies. With the rise in globalism and migrating populations, minorities
will drive change in markets regarding food, fashion and real estate services in
particular.

With the rise of the internet and consumer awareness, brings with it a rise in conscious
consumption. Green business is on the rise and the rise and Goldberg, E. (n.d)
suggests that this trend is applicable to the most popular franchising businesses
crossing food and retail services, building and maintenance and lifestyle and fitness
related industries.

As the work force changes, so do employment preferences. Younger people have

different motivations regarding the workforce as opposed to their predecessors. In a
poll conducted by the Center for Women and Business at Bentley University, 84
percent of millennials said that making a positive difference in the world was more
important than professional recognition. According to Briody. B. (2020) they are
choosing to work for themselves and the appropriate franchise will likely appeal to the
younger generation. Boroian, D. D and Callaway, L. P. (2008) suggests millenials are
also likely to appeal young people as they are more knowledgeable of their online and
social media habits, are able to appeal to people of similar age groups and know how
to appeal to their conscious and green purchasing habits.

Another trend to enter the franchising space is the rise of multi-brand franchises.
These franchises exist with two or more brands operating under one central
management . For example, Yum! the buyer of KFC, Taco Bell, and Pizza Hut has
successfully implemented this strategy under one roof. By employing one manager,
provided common seating and one kitchen in a single building has been an effective
way to reduce costs and appease customers with a diverse appetite. Boroian, D. D
and Callaway, L. P. (2008) pointed out Dunkin’ Donuts as having followed a similar
route in rolling out franchise units with additional brands to attract different customers
throughout the day. This is likely to continue as franchisees who have maxed out
available territories wish to grow their revenues, will seek to include additional brands
to diversify their offerings, protecting their incomes from changes in market behaviour
and generate make additional revenue stream from different customers segments. Yet
this is not limited to the restaurants and the food service industry. Automobile services
have begun to combine aftermarket sales and services into one stop locations to
serve a multitude of customer needs.

While franchising is typically thought of exclusive to the food service industry, there
are many industries in which franchising systems have been successfully been
implemented. With the change of consumer demographic, Goldberg, E. (n.d)
points to a steady uptake of franchises fulfilling needs in the health, fitness and
personal care sectors. Libiva, J. (2020) points out that the new generation of
consumers will be catered for in regards to healthy, sustainably and ethically sourced
coffee, foods and delivery franchises to full the growing trend of online shopping and
fulfillment.

3.4 Business expansion through franchising

The franchise system allows a company to develop a larger number of operating

outlets in a shorter period of time than if they were to expand with their own invested
capital. Investments of time and resources to locate an appropriate outlet are

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therefore licensed to a budding franchisee who would like to take on the role of
business owner/operator. DLA Piper US LLP (2003) notes that there are many
industries in which intensive retail outlets have used franchisee as a source of cheap
and willing capital.

While franchising crosses many different businesses in many different sectors, Libiva,
J. (2012) identifies the following as the most popular industries in which franchising is
used:
 Food service and restaurants, including most of the worlds most recognized fast
food outlets;
 Retail;
 Lodging including hotels, motels and bed and breakfast;
 Home services such as lawn and garden care, cleaning and home maintenance
and repairs;
 Automotive services including routine maintenance, oil and tire changes and
automobile rentals;
 Business to business operations including marketing, advertising, financial and
training services;
 Children's services like tutoring, learning and recreation centers;
 Health and fitness operations such as health clubs, spas and gyms; and
 Green franchises such as energy auditing, green technology installations and
energy efficient product distribution.

And while franchise opportunities exist between industries they also cater for different
personal traits, skill sets, and initial capital investment. The opportunity to own what
one does rather than relying on a direct boss for direction is a liberating feeling to
which many seek as a way of generating an income.

Another attraction to obtain a franchise is the relatively low barrier to entry regarding
business ownership as suggested by DLA Piper US LLP (2003). While there still exist
moderate business acumen and capital criteria, this is far less than otherwise starting
a business on ones own.

Franchising offers people the opportunity to independently own and operated a

business with the advantage of an integrated networks to provide skill and guidance in
regard to advancing their business. While Libiva, J. (2012)suggests franchising offers
people the opportunity to, as DLA Piper US LLP (2003) puts it, “own what you do” it
allows franchise's to benefit of a capital free financed growth while foregoing the costs
of centralized management.

There are many examples in which franchising has been implemented over the years.
The Singer Sewing Machine Company is one of the earliest adopters of early
franchising in regards to distributing their machinery. According to Li, J.Y. and Xia, H.S.
(2019) the American company expanded their distribution network in as early as 1851.
Through the licensing of authorized dealerships, they were able to pedal their goods
across the country without having to outlay the financial capital required to establish
retail outlets in towns and cities throughout Northern America.

McDonald’s is perhaps the most recognized business franchise in the world.

Popularized by Ray Croc in the 1950’s, Croc was able to turn the fast food restaurant
into a global success using what Li, J.Y. and Xia, H.S. (2019) describes as “the most
important business model of the 21st century”.

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Haig, M. (2004) points out McDonald’s success hinging on its comfort in familiarity.
Their fast service and world famous burgers are what people over the globe have
come to expect every time they visit a restaurant. Their franchise system describes
the operations of the kitchen, the construction of their hamburgers, customer service
and methods of cleaning and maintaining records.

Another contended in the fast food service space is Subway Restaurants. Started as a
single sandwich shop in 1965 has grown into one of the biggest franchises and health
food alternatives not usually associated with the fast food industry. The simplicity of
the Subway offering and the small use of space in order to create a customers
sandwich has made it a successful franchise implemented the world over. According
to Haig, M. (2004), Subway succeeds with its brand name focusing on its main
product offering, offering consistency in product line and service and is considered a
threat to the unhealthy rivals to which it is competing in the fast food space.

Despite food service business making up the majority of well-known franchise

businesses, 7-11 is another famous franchise that is concerned with the retail market.
With over 66,000 outlets in operation across the globe they tend to operate
extended-hour retail convenience stores that provide a broad array of products
ranging from petroleum distribution through to products that are not available to
traditional retail outlets according to Franchise Direct (n.d).

3.5 Key understandings of a franchise operation

There are three main elements that are considered essential when looking to
purchase and operate a franchise business describes them as:

1. Payment of an initial franchise fee;

2. The right to use a trademark, service mark, or trade name; and,
3. An additional ingredient connecting franchisor and franchisee, called either a
marketing plan, significant assistance, or community of interest.

A franchise is therefore defined as the mutual business relationship which will

typically grant the franchisee the right to use protected trademarks, assistance
provided by the franchisor and the purchase of the franchise upon payment of an
initial franchisee six months before or after the commencement of the franchising
relationship according to Seid, M. (2009).

In this particular relationship, Libiva, J. (2012) describes the franchisor as the creator
of the system who wishes wishes to expand their business interest without investing
capital. The franchisor successfully achieves this by granting rights to the franchisee
to conduct their business with the use of their business system and trademarks. Seid,
M. (2009) suggests that upon payment, the franchisee an a separate individual or
company undertakes day-to-day business operations of the company in their funded
business location or territory. In particular cases a company owned location will look
and operate identical to the franchise system, but is run and managed by the company
directly. While the food service industry dominates the popularity of franchising
systems, there are many formats and industries in which franchising has been
implemented to accelerate business growth. One such category is product
franchising. Under this definition, Alberto (2016) describes this category as a goods
an independent dealer “given the right to distribute goods for a Manufacturer.” As such,
the dealer pays a royalty fee for the rights to sell the goods to market. Manufacturers

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will provide the business owner the right to produce certain goods and use of
trademark, brand recognition and processes in reselling the goods on the market. This
franchising relationship is typical of machinery goods and fashion items.

Alberto (2016) describes the manufacturing franchising relationship as a franchisor

(in this case, the manufacturer) giving the dealer (product finisher) an “exclusive right
to produce and distribute the product in a particular area.” This particular franchising
agreement is popular throughout the bottling industry and soft drink giants such as
Coke and Pepsi utilize this arrangement to further expand their distribution territories.
The parent company will license the patented manufacturing and product knowledge
to local producers and is particularly common in international commerce.

Business format franchising is a franchise category that typically involves to

granting the formal use of a trademark and operating system that is typical of the retail
market. DLA Piper US LLP (2003) identifies the franchisor in this regard as not typical
to the manufacturing of a product, instead supplying essential elements such as
equipment and ingredients, packaging material, software and promotional items to the
franchisee in necessary to undertaking their daily business operations. This type of
franchising model is typically performed in the food service and restaurant industry.
While this format will share certain characteristics with the product franchise system,
the franchisor typically will provide typical services to the franchisee including regional
or national marketing and advertising campaigns, training, production and updating of
operations manuals and updating of quality control standards. Alberto (2016)
suggests this is the most comprehensive franchise format in which the franchisor will
bestow the entire franchise package to the franchisee to operate.

Licensing is the agreement that typically grants one person or company (licensee)
the right to commercialize products of another party (licensor). In this regards, as the
licensee Alberto (2016) highlights tasked with undertaking the activities necessary to
promote the commercialization of the products for the licensor.

The use of protected trademark is granted for use by the franchisee to perform the
day-to-day operations of the franchise unit and typically include brand names and
identifiable logos, signage, interior design and point of sales elements and systems.

The most valuable element of the trademark is the brand name. Alberto (2016)
suggests well known brand names can charge higher prices for the franchise system
due to the value the name brings to the business. It is usually associated with history
and success, brand recognition and a greater knowledge and appreciation of the
product or service from the target consumer.

Typical of the business format franchise, the knowledge and systems required to
operate the franchise system is transferred to the franchisee through the operating
system. This system contains the information package essential to carrying out tasks,
operational systems and procedures which enable the franchisee to become a
successful member of the franchise system. This is typically the result of the
formalized process of work flows, broken down to sub-tasks and detailed instructions
to which allow for the technical and commercial viability of the franchise system.
Alberto (2016) notes that this element will allow the franchisee to “benefit from an
immediate competitive advantage.” The more detailed and complete the system, the
higher price the franchisor can justify a franchisee to purchase the system.

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However, before the sale and implementation of the operating system typical to the
franchise, a successful prototype will need to be tried and tested with adjustments
made to the system before wide spread implementation. Testing of the prototype will
require the refinement of the business concept and the product or service offering, the
operating system which will be licensed to franchisees as well as logistical and
purchasing networks and operations needed to supply materials to franchisees. DLA
Piper US LLP (2003) recommends piloting the system in multiple locations and
markets for a sufficient amount of time to become aware of issues that may potentially
impact the franchise in the future and find and test solutions to these issues. DLA
Piper US LLP (2003) promotes the benefits of testing the system will allow the
franchisor the opportunity to test and refine:

(1) designs, layouts, décor and signage;

(2) products and services;
(3) customer reactions and satisfaction;
(4) equipment and fixtures;
(5) training methods;
(6) advertising and marketing;
(7) job descriptions;
(8) number of employees needed at different times;
(9) required skill levels;
(10) wage levels and benefits; and
(11) other operating characteristics and costs.

Additional to the trademarks and operating system bestowed to a franchisee, the

operations manual is the single most important document to the success of the
franchise. Its co tents are essential to understanding and fulfilling the successful
day-to-day operations of the business. The success of the franchise system hinges on
the franchisees ability to understand and implement the tasks as described in the
manual. The manual contains the literature of the system as published by the
franchisor. Following the franchise system as described in the manual benefits both
the franchisee an the franchisor, however, deviation from the manual may result in
discipline fro the franchisor. DLA Piper US LLP (2003) has identified the following
critical elements that are typically included in the manual:

• proven business format;

• standardized method of operation;
• national advertising;
• franchise name recognition;
• franchisee training and networking opportunity;
• standardized fixtures and equipment;
• professional site location assistance;
• centralized buying power; and,
• rules and quality control standards.

Boroian, D. D and Callaway, L. P. (2008) explains the link regarding franchises. An

individual or single-unit franchise is one that is offered to a single individual for one
physical location or territory in which to own and operate the franchise. A multi-unit
franchise however is a specific territory granted to the franchisee in which they are
required to operate a specific number of franchise outlets. The multi-brand franchise
as described by Boroian, D. D and Callaway, L. P. (2008) goes on to explain, is a
strategic consolidation of multiple brand under one location. This gives the franchisee

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opportunity to diversify their product or service offer yet the location remains managed
by a single unit operator.

3.6 Advantages and disadvantages of the franchise system

It has become evident that a successful franchise system can be a profitable route to
business expansion while reducing risk for both franchisors and franchisees.
Nevertheless, while toting the benefits of the system, there are also drawbacks that
will be discussed in regards to both franchise operators and owners. As discussed,
franchising is a viable option for people to run their own business, while maintaining
an element of autonomy and simultaneously taking advantage of an integrate
corporate network. The franchisee benefits from their buy in to a proven business
system and associated logistics and the franchisor benefits from externally financed
business expansion and brand growth. They are also, to a certain degree, sheltered
from the failure of a particular unit, as pointed out by DLA Piper US LLP (2003).

While the franchisor is invested in the success of a franchisee unit, the more sales the
franchisee makes, the more the franchisor makes in royalties, there is a point at which
franchise unit growth has the potential to impact the revenue of both franchisees and
franchisors.

As the graph depicted in Figure 1, there is a certain number of sales at which point the
volume of sales require the franchisee to outlay additional costs resources to support
the growth. In this regard, franchisors take advantage of royalties of franchisee sales,
but the franchisor does works at a loss due to the outlay for additional resources to
support additional sales.

Figure 1: Relationship between profit and turnover in a franchise system.

Source: Cocuzza, Alberto (2016): International franchising in the fashion industry.
Master Thesis. The Libera Università Internazionale degli Studi Sociali, Rome, Italy

In this situation, the interests of both parties becomes conflicting. This highlights the
importance of the franchise system and its ability to support franchise unit growth
without hindering the revenue capacities of the franchisee.

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 3.6.1 Advantages for franchisors

For the franchisor, the obvious benefit to a franchised business system is company
expansion funded by franchisees and also without loss of company shares and
interests if the funds were raised through taking the business public. There is no
interest pay back as with traditional loans, and the franchisor transfers rent or property
taxes to the franchisee. Unit investment and operating expenses are transferred to the
franchisee which enable to franchisor to focus on the expansion of their business and
franchise strategy.

Investing the resources to expand the franchise and aid franchisees obtain sales is a
strategy that can benefit both parties immensely. Unlike company owned and
operated outlets, the franchisee works together with the franchisor to understand,
operate and manage the franchise unit without adding additional staff and overheads
to the payroll. As Seid, M. (2009) points out, franchising is valuable tool to aid market
penetration and increase franchise business through the following means:

 Increased brand recognition as locations open

 Enables penetration of smaller markets
 Accelerates market dominance over local competitors
 Improves location availability from landlords
 As system expands value of brand, at the franchisor and franchisee level
increases

An additional benefit of implementing a growth strategy through franchising is the

financial impact that may occur through a failed store location. As DLA Piper US LLP
(2003) explains “ a failing franchisee has a lesser financial impact than a failing
company-owned outlet” as it is able to shelter itself from fluctuations and outlet failures.
This is due to the fee revenue received from a franchisee is considerably less than
fluctuations in profits from a company owned unit. Revenue is generated through
franchising fees, development fees, ongoing royalties, reduced costs through buying
power and fees charged fro marketing and advertising activities. Additional savings
are made through inventory and management control systems implemented in the
system designed to reduce costs.

The franchisor outsources the success of the franchise unit to the franchisee. With the
owner/manager having a direct interest in the success of the unit, they are more likely
to show a heightened interest in the units profitability and performance. The
franchisee usually has a long-term view of the management of their unit and are more
likely motivated to work longer hours and provide quicker response to local conditions
than if the company were to manage each unit of their business. And while the
day-to-day operations are left to the unit owner/manager, the franchisor still benefits
from the control they have over the brand, the product or servicing and the promise it
makes to the consumers.

3.6.2 Disadvantages for franchisors

Yet despite the advantages that come from offering a franchising system to aid
business expansion, there are still many drawbacks faced by the franchisor. The first
obvious disadvantage is cost. It is expensive to develop and implement a franchise
system. As highlighted by Seid, M. (2009) they are likely to include costs to create the
franchise, consulting, legal and accounting fees, the cost associated with registering

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the franchise in the location of operation, staff and enterprise costs and the costs
associated with recruiting franchisees into the system.

The second point is the profitability of each franchise unit. Franchisors only take a
small royalty fee from the sales generated by each franchise unit as opposed to the
revenue generated if the unit was owned and operated by the company. And wile the
franchisor receives an initial lump sum for the purchase of the franchise unit and
additional royalties from the franchisees operation, there is little possibility to change
the fee structure after the deal has been signed.

As mentioned previously, the franchisor benefits from owning and having ultimate
control of the franchise system, however there exists the possibility of a franchisee to
operate outside the guidelines set forth in the operations manual and cause public
backlash that could ultimately ruin the reputation of the franchise. It is therefore
necessary to maintain a good working relationship and ensure the quality standards
and expectations of the franchise are made clear and the franchisee is aware of the
consequences of not following the franchise system.

One drawback of the franchisor/franchisee relationship is that it often involves a large

investment in time. Roles can become highly politicized and an overbearing franchisor
will quickly diminish the independence of the unit manager. As Seid, M. (2009) notes,
the long term contractual arrangements can become difficult or expensive to terminate
should the franchisee display a substandard performance. Another risk faced by the
franchisor is the potential for competition from the franchisee. Franchisees have the
potential to copy and exploit the franchise system and replicate the business format
under another name. While this may be hard to prove during litigation process, it
highlights the importance of maintaining good relationships with unit franchisees.

3.6.3 Advantages for franchisees

For the budding entrepreneur, owning a franchise allows one to go into business for
yourself, with the support and benefits the franchise network has to offer. Unlike
independent entrepreneurs, the franchisee has a wealth of experience and knowledge
available to access when establishing their business.

Unlike independent businesses, a franchisor can take immediate advantage of the

franchise brands reputation. As Alberto (2016) highlights “A franchise provides an
established product or service which may already enjoy widespread brand-name
recognition. This gives the franchisee the benefits of a pre-sold customer base which
would ordinarily takes years to establish.” This simple fact allows the franchisor to
begin turning a profit before in a shorter period of time than if they were to find and
build their own customer database.

The franchisee advantages from the network in having the franchisor compensate the
necessary skills required to run a business. Franchisors will provide new franchisees
with training and compensate skill set that take independent entrepreneurs years to
develop. According to Alberto (2016) “The best franchises assist the franchisee in all
the aspects of the management by offering optimal solutions.” With optimized trade
agreements, training and management training, the franchisor is on their way to
earning a reasonable profit margin.

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For the franchisor, the franchise system is the ultimate ‘plug and play’ business. After
purchasing the rights to operate the franchise, a franchisor benefits from reduced
business start up and resource costs through economies of scale available to the
franchise network, access to a tried and tested business operating system, access to
the franchisors brand and reputation, support, training and assistance with marketing
activities. As franchise operators have little flexibility in pricing structures and
promotional offers, much of the marketing material is provided to the franchisee.

3.6.4 Disadvantages for franchisees

Although a franchise system allows the franchisee the ability to own, operate and
subsequently reduce the time required to turn a business profit, there are still a few
disadvantages of buying into the system.

Seid, M. (2009) identifies the loss of independence as one of the main disadvantages
of entering into a franchise system. Franchisors dictate, through the franchise
agreement, how the daily operations of the business should be conducted. A
franchisee has limited opportunities to influence price structures, limited selection of
franchise location and have little influence over the franchise system, although
feedback and input is welcome from the franchisor in order to improve their system.

On the other hand, the franchisor may become overly dependent on the franchisor,
have unrealistic expectations in regards to the operation of the franchise and may be
obligated to uphold the franchise agreement with little opportunity to step out of the
system without occurring financial obligations.

Franchisors work hard to maintaining the image of their brand and the consistency of
their product or service. As such, they are very strict on maintaining the consistency of
their system with penalties for franchisees who fail to fulfil their obligations.

4. Discussion

The use of the franchising system can aid business in rapid expansion with little
expenditure on financed capital. The offering of a systemised, profitable business
model to budding business owners provides franchisors with capital to expand their
business operations while franchisees benefit from a joining a network of successful
business operators that are interested in the success of their business.

The sale of a franchise is essentially the entering of a business relationship between

the franchisee and franchisor. The franchisee is granted permission to take advantage
of a franchisors trademarks including brand, operating system and business
reputation to begin generating revenue for their franchise unit operation.

While franchising has seen an explosion in popularity and refinement since

McDonald’s used the strategy to expand their business interest both in the United
Sates and further abroad, the first recorded use dates back to the mid 1800’s. It has in
some form existed many hundreds or thousands of years previously when land
owners would grant food producers the right to cultivate the land in exchange for a fee
for the the right to do so. In present day business operations, the use of franchising
spans many industries and is a popular method at increasing brand visibility and
value.

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For the franchisee, the opportunity to own franchise presents a shortcut to business
operations that could otherwise take years to develop. The purchasing of the system
also grants access to networking and training opportunities offered by the franchisor
that are vital to understanding the business and undertaking the tasks vital to
day-to-day business operations.

In exchange for the franchise business system, the franchisor is granted another
location of business operation, funded by the budding business operator without the
hassle of negotiating a lease, hiring and training staff and responding to local market
situations. They get to retain their business operations and make a royalty fee while
focusing energy into training franchisees and scouting new markets in which to
operate.

As for the reason a company would consider franchising is because it provides many
benefits for business expansion without having to source financing and worry about
loan repayments. It also frees up human resources which can be used to train and
recruit new franchise operators into the system.

With restaurants and food service outlets currently popularize the franchise system,
there are still may other industries in which the franchise system is in use to expand
business interests.

However, as populations grow older and demographics change, so to the service they
require. As the population becomes older, there will become an increasing need to
provide health and care services to cater for the needs of the population. This can
include nursing and aged care facilities, in home and assisted living services and
health services that help improve peoples life quality as their bodies begin to slow
down.

A growing population concerned for their health and that of the planet will require more
transparent in regards to supply chain issues and food cultivation. A younger
generation of consumer has more information available to them in regards to product
origins and are prioritizing healthy alternatives in regards to food consumption.

Other services that will require development include postage and delivery services to
support the take up of online shopping and changes in consumer habits.

Many other industries have seen success with the franchise system as a rapid
expansion strategy/ Not only limited to restaurant and food services, franchising has
successfully been implemented in retail settings, lodging and motels, home
maintenance services, automotive services, professional service sector, B to B
services, children's services, energy providers and health and fitness sector.
The multitude of sectors in which franchises have been successfully implemented
indicates that budding business owners with a particular skill set, or who wish to enter
a particular business industry can take advantage of the franchise system in regards
to owning and operating a business.

However, with many the many parts involved in establishing and operating a franchise,
it should be the aim of both franchisors and franchisee to understand the key terms
and elements as to better understand the system. Obviously there will bee elements
more suitable in particular industries as opposed to others an it is encouraged that
franchisees familiarize themselves with these before entering a franchise agreement.

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And while there exists advantages and disadvantages it is the priority of both
franchisors and franchisees to maintain a healthy working relationship in order to see
business success for both entities. There is a balance between profit maximization
and franchisor input and the franchise system should be prototyped, tested and
refined in order to provide both parties the greatest chance at achieving commercial
success.

5. Conclusion

The franchise agreement is a business system in which parties come together for the
mutual benefit of business operation. For the franchisor, the development and
licensing of franchises can aid an affordable business expansion strategy, add value
to the brand name and image and encourage entrepreneur to join the in the network.

For the franchisee, entering into the franchise agreement can provide business people
from different sectors with varying skill sets the opportunity to become business
owners without the struggle of starting a business from scratch. Their success in the
system is integral to the franchisors success and therefore training and support are
offered to ensure the success of the franchise operation.

With a little understanding of what is involved in the franchising system how it can be
implemented in the aid of business development and why it it is such a powerful
system, we can begin to promote the benefit of the systems to both business owners
and entrepenures. And although the purchasing of a franchise is not a guarantee, the
likelihood of business success is greater for the entrepreneur due to the knowledge
and support the franchisors networks has to offer. For an entrepreneur who wishes to
be in business for themselves, buying into a franchise system short cuts the time they
would otherwise need to develop their business, find customers and begin to generate
cash flow.

Despite fast food services dominating the franchise landscape, most businesses that
follow some type of process are able to be franchised. With the change in
demographics, consumer needs and expectations, there exists the possibility to
develop a systemised approach to catering for peoples needs that can be replicated
many times over for the benefit of the franchisor and upcoming franchisees..

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