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Franchising

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author/source: Geoff Caesar

20190621

What is Franchising?

The British Franchising Association defines franchising this way:

The term ‘franchising’ has been used to describe many different forms of business relationships, including licensing, distributor agreements and agency arrangements. In its most familiar sense, the term ‘franchise’ has arisen from the development of what is called ‘business format franchising’. Business format franchising is the granting of a license by one person (the franchisor) to another (the franchisee), which entitles the franchisee to trade as their own businesses under the brand of the franchisor, following a proven business model. The franchisee also receives a package, comprising all the elements necessary to establish a previously untrained person in the business and to run it with continual assistance on a predetermined basis (including a predetermined agreement length, with renewal options).

A franchise will usually have the following key elements:

  • The franchisor allows the franchisee to use a name which is associated with the franchisor.
  • The franchisor exercises continuing quality control over the franchisee.
  • The franchisor provides assistance to the franchisee.
  • The franchisee periodically has to make payments to the franchisor.

”First generation” franchises

Commercial marketing agreements resembling modern franchise agreements first began to be used on a regular basis in the car industry and the brewing industry. The brewing industry developed tied house agreements between brewers and pub landlords. The car industry developed dealerships between vehicle manufacturers and dealers. These supply dealership arrangements are sometimes referred to as “first generation” franchises because they lacked the two essential elements of modern “second generation” or “business format” franchises.

”Second generation” or “business format” franchises

The two essential elements of “second generation” franchises are:

  1. The franchisee operates its business under the franchisor’s trade name or trade mark so that to the outside world the franchisee is the franchisor.
  2. The franchisor must be able to exert substantial influence and control on the way that the franchisee operates its business.

It is this latter aspect that attracted many potential franchisors to franchising. In the petrol industry, for instance, both Shell and Texaco introduced (with various degrees of success) franchising to replace their previous retailing operations, under which a loose licence was granted to independent operators. The licence arrangements gave the operators a broad discretion as to how they ran their business, and have now become unpopular as a result of the increased importance of “quality” and the need to safeguard brands. Large companies must be able to control the way in which their retailers sell their goods or provide their services.

The growth of franchising

The Natwest BFA 2018 annual survey reports the following key findings:

  • The total contribution of franchising to the UK economy is reckoned to be in excess of £17 billion, up over £2 billion since the previous stats in 2015. Furthermore, there has been a significant increase in the estimated overall number of people working in franchising, with over 700,000 people employed in the sector, with a little over half in full-time employment.
  • While around 70% of franchisees are male, the indications are that around 65% of those employed within franchise units are female. Furthermore, more females are becoming franchisees, with a 20% jump since the 2015 report.
  • More under 30s are also getting into franchising by becoming franchise business owners, with 18% of all franchisees now under 30. Of the new franchisees under 30, 52% are female, with 37% of all new franchisees in the last 2 years being female.
  • There are an estimated 48,600 franchised units in the UK, the highest number ever and nearly two times more than 25 years ago, with the number of franchisees reckoned to be around 20,000. That’s because around a third of franchisees own and run multiple units.
  • One in three franchisors also have international operations.
  • Of those who do not currently operate internationally, 4% have a definite business plan to do so, and a further 30% are considering it an as option.
  • The biggest growth areas for franchising remain personal services and hotel and catering, although store retailing also shows some growth, despite a challenging environment for retail.
  • Franchisees claimed profitability remains high at 93%, and over two-thirds of franchised units that have been running for five years or more report being either quite or highly profitable. 
  • 60% of franchised units turn over more than £250,000.
  • Failure rates for franchises remain very low, with fewer than 1% per year closing due to commercial failure.

Franchising Pros and Cons

There are a number of advantages and disadvantages to getting involved in franchising, whether as a franchisor or franchisee.

Franchising: advantages and disadvantages: franchisor

Advantages

  • Franchising offers the opportunity to secure distribution for products or services faster than would be the case if the franchisor had to train up its own employees and develop its own internal marketing, sales and distribution organisation.
  • The use of a franchisee’s capital will facilitate the expansion of a network more quickly than would be the case if the franchisor had to find the funds itself.
  • Many companies involved in the supply of goods or services seek to motivate their employees by linking their remuneration to sales. Franchising takes this one step further by linking the franchisee’s financial well-being to the success of the franchisor’s business.
  • A franchisor, with its increased purchasing power and possibly also reduced overheads, may be able to increase the profitability of small units.
  • There is some evidence to show that franchisors may be more likely to thrive in a recession than non-franchised businesses.

Disadvantages

  • The major disadvantage for franchisors is loss of control. While the franchise agreement will impose substantial restrictions on franchisees, it is important to remember that franchisees will be independent third parties who will be seeking to maximise their profits, sometimes at the expense of the franchisor.
  • Part of the franchisor’s profit element is used in supporting an additional entity, the franchisee, in the distribution chain.
  • In involving third parties in their business, franchisors will, inevitably, have to divulge substantial know-how and information concerning their business. The franchise agreement will contain restrictions on the franchisee’s ability to make use of this information for his own purposes, but such provisions are often difficult to monitor and enforce.
  • The skills required to control franchisees and provide the back-up are different from those involved in operating a business through employees.

Franchising: advantages and disadvantages: franchisee

Advantages

  • Research suggests that as many as 50% of franchisees would not otherwise become self-employed were it not for the franchise format.
  • Franchisees do not have to have general business or management skills, or specialised knowledge in the proposed business activity.
  • By taking advantage of the franchisor’s name and reputation the lead time in making a business successful may be reduced. This reduces the franchisee’s working capital requirements.
  • Finance may be more readily available to franchisees than those setting up in business on their own account. 
  • The risks of business failure are substantially reduced.
  • The franchisee is able to make use of the franchisor’s purchasing power and there may be other benefits relating to the size of the franchisor’s operation.
  • National advertising is undertaken by the franchisor for the benefit of the franchisee.
  • Assistance and training is given throughout the term of the franchise.

Disadvantages

  • A franchisee is subject to substantial control from the franchisor. 
  • A franchisee will have to pay royalties and/or a mark up on the goods or services which he receives from the franchisor or his nominated supplier.
  • There may be restrictions on the franchisee’s ability to sell the franchised business or to pass it on to a relative.
  • The franchisee’s operation will be directly affected by the actions or insolvency of the franchisor.

The legal landscape

In the UK the legal landscape for franchising is relatively lightweight although there are a wide range of other legal issues to consider, as with any business model, more details of which can be found across our website. 

If you are looking to establish a franchise as franchisor, be aware that the British Franchise Association requires its members to comply with the European Code of Ethics for Franchising. As such the franchisor is required to:

  • Have operated a pilot operation before launching the franchise.
  • Be the owner of all relevant brand names and trade marks.
  • Provide initial and continuing training 

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