Franchising

While franchising provides franchisees with a proven system and the support of a much larger organization, the advantages to the franchisor are even more significant.

Definition of Franchising

In The U.S., the Federal Trade Commission and state regulatory agencies have developed a formal set of disclosure requirements and franchise-specific prohibitions that franchisors must follow in their relationships with their franchisees.

1. Trademark -- According to FTC Rule 436, "This element will be satisfied only when the franchisee is given the right to distribute goods and services which bear the franchisor's trademark, service mark, trade name, advertising, or other commercial symbol." Note that it is the right, not the obligation, which triggers the first element of the franchise definition.

2.Use of "significant control or assistance" -- FTC Rule 436 lists 18 specific criteria in the area of significant control or assistance, any one of which may trigger the second element of the definition. Some of these elements include site approval, site design or appearance requirements, specified hours of operation, accounting practices, personnel policies, required promotional campaigns, training programs, and the provision of a detailed operations manual.

3. Required Payment -- According to Rule 436, "The franchisee must be required to pay the franchisor (or an affiliate of the franchisor), as a condition of obtaining or commencing the franchise operation, a sum of at least $500 . . . within six months. . ." Required payments include franchise fees, royalties, or even from training fees, bookkeeping charges, payments for services, rent, or even from product sales (if they are sold above a bona fide wholesale price).

If you are contemplating a business relationship which involves all three of these criteria, you are contemplating a franchise - regardless of the label you choose to use for your business relationship.

As a franchise, you are required to provide prescribed disclosure documentation to prospective franchisees at the first face-to-face meeting during which the sale of a franchise is discussed. Failure to provide this documentation may result in fines of up to $10,000 per violation at the federal level. Moreover, in some states, the violation of franchise laws is actually a felony.

                                        Advantages Of Franchising

Capital - Since franchisees use their own capital, the franchisor has virtually no investment at the unit level. Franchising allows companies to leverage off the assets of franchisees.

Return on Investment - Because of this lower investment, ROI will be significantly higher.

Risk Reduction - With no capital invested in units, risk is reduced substantially.

Limited Contingent Liability - The franchisor will not be signing leases, taking on financing, etc., and will thus expand with limited contingent liability.

Speed of Growth - By leveraging off of the time and efforts of its franchisees, a franchisor can grow much faster without adding staff.

Reduced Role in Day-to-Day Operations - As a franchisor, your primary concern involves the franchisee's top line performance, reducing the scope of your involvement in day-to-day management.

Reduced Vicarious Liability - The liability for acts of employees (e.g., sexual harassment, EEOC violations, etc.) and for occurrences in the unit (e.g., slip-and-fall) accrues to the franchisee, not the franchisor, for the most part.

Highly Motivated Management - Franchising can provide a company with highly motivated management who will treat individual units as its own.

Quality Control - Franchisees generally keep their units in better operational shape than unit managers and, as a part of the community, are better able to promote these units locally.

Long-Term Management - The franchisor can invest in the long-term training of its franchisees, as they are unlikely to leave short-term.

Unit Performance - Units are generally better run, as is reflected in the fact that franchised stores generally outperform company-owned stores in terms of sales volume.

Lean Structure - Franchisors can grow the organization without adding significantly to overhead.

Brand Building - This ability to grow the organization without substantial additions to overhead will allow franchisors to grow their retail presence and their brand more quickly and effectively.

Advertising - Franchisees will often contribute to a common advertising and promotional fund. This fund will be used to promote the brand under the direction of the franchisor.

International - International expansion becomes easier, faster, and carries far less risk since a local partner becomes involved.

Moreover, it is important to note that franchising is not an exclusive strategy. Most franchisors use it in conjunction with company-owned growth to compound growth.

Criteria of Franchisability

While it is impossible to determine the franchisability of a business concept without a significant amount of analysis, We have identified a series of 12 predictive criteria that assess the readiness of a company for franchising and the likelihood that it will achieve success as a franchisor.

1. Credibility – To sell franchises, a company must first be credible in the eyes of its prospective franchisees. Credibility can be reflected in a number of ways: organization size, number of units, years in operation, look of the prototype unit, publicity, consumer awareness of the brand, and strength of management, to name the most prominent.

2. Differentiation – In addition to credibility, a franchise organization must be adequately differentiated from its franchised competitors. This can come in the form of a differentiated product or service, a reduced investment cost, a unique marketing strategy, or different target markets.

3. Transferability of knowledge – The next criteria of franchisability is the ability to teach a system to others. To franchise, a business must generally be able to thoroughly educate a prospective franchisee in a relatively short period of time. Generally speaking, if a business is so complex that it cannot be taught to a franchisee in three months, a company will have difficulty franchising. Some more complex franchisors offset this handicap by targeting only franchise prospects that are already "educated" in their field (e.g., a medical franchise targeting only doctors).

4. Adaptability – Next, measure how well a concept can be adapted from one market to the next. Some concepts (e.g., barbecue) do not adapt well over large geographic areas because of regional variations in consumer tastes or preferences. Others (e.g., medical practices) are constrained by varying state laws. Still other concepts work only because they are in a very unique location. And some work because of the unique abilities or talents of the individual behind the concept. Finally, some concepts are only successful based on years of perseverance and relationship building.

5. Refined and successful prototype operations – A refined prototype is necessary to demonstrate that the system is proven, and is generally instrumental in the training of franchisees. The prototype also acts as a testing ground for new products, new services, marketing techniques, merchandising, and operational efficiencies.

6. Documented systems – All successful businesses have systems. But in order to be franchisable, these systems must be documented in a manner that communicates them effectively to franchisees. Generally speaking, a franchisor will need to document its policies, procedures, systems, forms, and business practices in a comprehensive and user-friendly operations manual and/or computer-based training module.

7. Affordability – Affordability merely reflects a prospective franchisee’s ability to pay for the franchise in question. This criterion is as much a reflection of the prospective franchisee as it is of the actual cost of opening a franchise. For example, a multi-million dollar hotel franchise is affordable to real estate developers, whereas a franchise with a $100,000 start-up cost that targets prospects with clerical experience might not be.

8. Return on Investment – This is the real acid test of franchisability. A franchised business must, of course, be profitable. But more than that, a franchised business must allow enough profit after a royalty for the franchisees to earn an adequate return on their investment of time and money. Profitability is always relative. It must be measured against investment to provide a meaningful number. In this way, the franchise investment can be measured against other investments of comparable risk that compete for the franchisee’s dollar. Typically, it should be expected that the franchisee achieves a ROI of at least 20 percent by the second to third year of operations. 

9. Market trends and conditions – While not an indicator of franchisability as much as a general indicator of the success of any business, these trends are key to long-term planning. Is the market growing or consolidating? How will that affect your business in the future? What impact will the Internet have? Will the franchisee’s products and services remain relevant in the years ahead? What are other franchised and non-franchised competitors doing? And how will the competitive environment affect your franchisee’s likelihood of long-term success.

10. Capital – While franchising is a low-cost means of expanding a business, it is not a "no cost" means of expansion. A franchisor needs the capital and resources to implement a franchise program. The resources required to initially implement a franchise program will vary depending on the scope of the expansion plan. If a company is looking to sell one or two franchised units, the necessary legal documentation may be completed at costs as low as $15,000. For franchisors targeting aggressive expansion, however, start-up costs can run $100,000 or more. And once the costs of printing, audits, marketing, and personnel are added to the mix, a franchisor may require a budget of $250,000 or more to reach its expansion goals.

11. Commitment to relationships – Successful franchisors focus on building long-term relationships with their franchisees that are mutually rewarding. Unfortunately, not all franchise organizations understand the link that exists between relationships and profits. Strong franchisee relationships enable the franchisor to sell franchises more effectively, introduce needed changes into the system more easily, and motivate franchisees and their managers to provide a consistent level of products and services to their customers.

12. Strength of management – Finally, the single most important aspect contributing to the success of any franchise program is the strength of its management. The iFranchise Group has found that the single most common contributor to the failure of start-up franchisors is understaffing or a lack of experience at the management level. Oftentimes, new franchisors will try to take everything on themselves. In addition to absorbing several new jobs for which the franchisor has little to no time, the franchisor needs to exhibit expertise in fields in which he or she may have little or no experience: franchise marketing, lead handling, franchise sales, ad fund management, training, and multi-unit operations management.

The Process of Franchising

The first step in franchising a business is to make the decision to franchise. That involves two key questions:

1. Is this business franchisable?
2. Is franchising the right strategy?

These questions can only be answered after evaluating your business and determining how franchising fits with your specific goals and objectives.

If the decision to franchise is made, a franchisor should develop a business plan outlining the company's growth and strategy for the next five years. A franchisor needs certain new capabilities and will need to be sure that these capabilities are seamlessly integrated into existing organizational functionality.

To ensure successful franchisees and maintain quality control, the franchisor will need to develop a state-of-the-art operations manual for its franchisees. This manual will serve as a sales tool demonstrating franchisor competence to new prospects, as a training guide for new franchisees, as a reference guide for established franchisees, as a "liability limiter" for the franchisor, and as a legally binding quality control device for the entire chain.

The franchisor should also develop training programs for use in conjunction with the operations manual. Computer-based tools and programs are highly effective, as are training videotapes, and can be used for the franchisee, for the franchisee's employees, and for corporate employees.

To be legally entitled to sell franchises, the franchisor will need to develop a franchise agreement and a Uniform Franchise Offering Circular, and will need to file with appropriate state authorities on a national basis (23 states have such requirements). The franchisor will also need to maintain ongoing compliance (keeping registrations in force while actively selling) and will need to be able to document compliance with state and federal law on an ongoing basis. These legal requirements are relatively easily met through the use of an attorney with substantial franchise experience.

Of course, the new company will also need to sell franchises. This will require a specific marketing plan designed to get the franchisor's message to the targeted franchise prospect.

Once the prospect has been identified, the franchisor will also require marketing tools to assist it in the sale of franchises. For aggressive sales campaigns, I would recommend the development of a mini-brochure (for use in direct mail campaigns and perhaps as a give-away at trade shows), a full-size franchise sales brochure, and a franchise sales videotape.

And of course, the franchisor will need to understand the nuances of the sales process and the legal constraints of franchise sales.

The tools necessary for franchising can be developed in approximately three months from the completion of the implementation plan, although state registrations may delay a company's ability to sell in certain states for another three to four months. Altogether, a new franchisor can anticipate that the franchise program should take between six months and a year to fully implement. The cost of a well-designed program varies substantially, depending on the strategy chosen and the desired speed of expansion.

Companies seriously considering franchising are well advised to seek the counsel of a knowledgeable franchise professional prior to initiating any franchise efforts.