6. franchising and the entrepreneur

Copyright ©2014 Pearson Education, Inc. publishing as Prentice Hall

Chapter 6 Franchising and the Entrepreneur

Part 1: Learning Objectives

1. Describe the three types of franchising: trade name, product distribution, and pure.

2. Explain the benefits and the drawbacks of buying a franchise.

3. Understand the laws covering franchise purchases.

4. Discuss the right way to buy a franchise.

5. Outline the major trends shaping franchising.

Part 2: Class InstructionIntroduction

The number of franchises has grown tremendously. The number of U.S. franchises has increased consistently since the 1970s, and the continued growth since the mid–1980s documents that franchises continues to play a significant role in the U.S. and world business economy.

Franchising is a business structure comprised of semi–independent business owners (referred to as the franchisees) that pay fees and royalties to a parent company (referred to as the franchiser) in return for the right to be identified with its trademark, to sell its products or services, and often to use its business format and system.

As presented in Figure 6.1: The Franchising Relationship on page 196, the connection between the franchiser and the franchisee is a unique and often a highly structured and defined business relationship regarding: Site selection Design Employees Products and services Prices Purchasing Advertising Quality control Support

Types of Franchises LO 1There are three types of franchising systems:

1. Tradename franchising2. Product distribution franchising

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3. Pure (or comprehensive or business format) franchising

One of the primary reasons for interest in a franchise system is that the franchisee is able to tap into the proven experience and guidance that the franchise offers.

The Benefits of Buying a Franchise LO 2-A

Benefits of franchising include: Management training and support Brand name appeal Standardized quality of goods and services National advertising programs Financial assistance – Refer to Figure 6.3: Franchisor Financial Assistance Proven products and business formats Centralized buying power Site selection and territorial protection Greater chance for success

These benefits have proven to have a positive impact on the success rate of franchises, beginning in the first year of operation, compared to nonfranchise ventures.

The Drawbacks of Buying a Franchise LO 2-BThere are some negative attributes of buying a franchise and those include:

Franchise fees and profit sharing Strict adherence to standardized operations Restrictions on purchasing Limited product line Unsatisfactory training programs Market saturation Less freedom

The 10 myths regarding franchising as described in Table 6.1: 10 Myths of Franchising include:

1. Franchises will be safer and will not fail2. Franchises will be economical3. Franchises will be more successful based on its size4. Franchises will be able to have improvement potential5. Franchises will be “all the same”6. Franchises will enable the owner to be removed from day–to–day management7. Franchises will be a business anyone can do

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8. Franchises will be the cheapest business option9. Franchises will be taking care of my business problems10. Franchises will be a business “I” can run things the way “I” want to

Franchising and the Law LO 3

In response to problems that occurred in the 1950s to the franchising boom and the associated franchisers who defrauded their franchisees, strict laws attempt to prevent such behavior.

Franchise Disclosure Document (FDD): In 2008, the FTC replaced the Uniform Franchise Offering Circular (UFOC) with the Franchise Disclosure Document (FDD). The FDD establishes full disclosure and guidelines for the franchising company. The FDD requires all franchisers to disclose detailed information to prospective franchisees before any offer or sale of a franchise. This document contains 23 major topics in its disclosure statement.

Trade Regulation Rule: Enacted by the Federal Trade Commission (FTC) requiring all franchisers to disclose detailed information on their operations at the first personal meeting or at least ten days before a franchise contract is signed, or before any money is paid. In this section, the twenty–three major topics required by the Trade Regulation Rule are discussed as well.

Red flags to detect dishonest franchisers occur when franchises:

Fail to provide sufficient documentation

Have marginally successful or no prototypes

Offer a poorly prepared operations manual

Promise future earning with no documentation

Demonstrate a franchise turnover or termination rates

Experience an unusual amount of litigation by franchisees

Discourage having your attorney review the contract

Have no written documentation

Exert a high degree of pressure

Claim to be exempt from federal disclosure laws

Promise high profits with minimal effort

Are reluctant to provide a list of referral franchisees

Respond with evasive, vague answers to your questions

Potential franchisees need to be aware and cautious when they see these signs. These issues may indicate that there are real concerns and, in the worst-case scenario, deception.

The Right Way to Buy a Franchise LO 4

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The steps to consider buying a franchise are:

1. Evaluate yourself

2. Research your market

3. Consider your franchise options

4. Get a copy of the franchiser’s FDD

5. Talk to existing franchisees

6. Ask the franchiser some tough questions

7. Make your choice

Factors that make a franchise appealing include an association with:

A unique concept

The potential profitability

The benefits of a registered trademark

A proven business system

Training programs

Its affordability

The relationships with other franchisees:

Trends Shaping Franchising LO 5

Franchising has experienced three major growth waves since its beginning with fast–food activity in the 1970s, service businesses in the 1980s, and low–cost franchises that focus on specific market niches. Today, franchisees are better educated, are more sophisticated, have more business acumen, and are more financially secure than those of the past. Other trends include:

International opportunities: Franchising is becoming a major U.S. export industry. About 52 percent of U.S. franchisers have outlets in other countries.

Smaller, nontraditional locations: Due to high costs of building full–scale locations, franchises are putting scaled–down outlets directly in the path of customers in places such as college campuses, grocery stores, gas stations, theaters, and airports.

Conversion franchising: Owners of independent businesses become franchisees to gain the advantage of name recognition.

Multiple–unit franchising: A franchisee opens more than one unit in a broad territory within a specific time period. “Franchisers are finding it’s far more efficient in the long run to have one well–trained franchisee operate a number of units than to train many franchisees.”

Area Development and Master franchising: A franchisee is given the right to create a semi–independent organization in a particular territory to recruit, sell,

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and support other franchisees. Under area development the franchisee earns the exclusive right to open multiple units in a specific territory within a specified time. A master franchise is a method that gives a franchisee the right to create a semi-independent organization in a particular territory to recruit, sell, and support other franchises.

Cobranding: Franchisers team up with other franchisers selling complementary products or services by combining two or more franchises under one roof.

Conclusion

Franchising is a significant force in the U.S. and world economy. The franchise experience offers entrepreneurs, regardless of their experience or background, the ability to own and operate their own business with guidance and support increasing the chance for success.

Part 3: Chapter ExercisesYou Be the Consultant: “Would You Buy This Franchise?” Page 203-204

1. What are the advantages and the disadvantages of purchasing an outlet from a small franchise system such as the ones described here?

The advantages of buying an outlet from a small franchise system include:

Tailored management and training support

Flexibility regarding of goods and services

Customized advertising programs

Unique products and business formats

The novelty of the concept

The potential for future growth with a smaller but more unique concept

The potential disadvantages of buying a from a small franchise system:

Undeveloped training programs

The limited and scale of the management and training support.

Potentially limited brand name appeal

The lack of a national advertising program

Limited or no financial assistance

Limited product line

Unproven track record compared to franchise systems with a larger base of outlets

2. Suppose that one of your friends is considering purchasing one of the franchises described here and asks your opinion. What advice would you offer him or her?

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Expect students to offer this type of advice to their friend:

Determine how many of franchisees exist.

Locate and contact other franchisees:

Find out how long have they been in business.

Have them describe their experience with the franchise including training, support, and financial obligations of any kind.

Inquire if the franchise has met their expectations.

Ask how long it took to reach break–even.

If they are willing, ask them for gross revenue and profit figures.

Ask them if they would do it again.

Request a copy of the FDD and review the document in detail.

Enlist the involvement of an attorney with experience in dealing with franchises if necessary.

Encourage your friend to answer this question: Will this franchise enable you to accomplish your business and personal goals?

If your friend continues to have interest, he or she can then can contact the franchise representative and ask direct questions to gain a clear picture of what to expect. This information may provide the perspective necessary to avoid overlooking the franchise “red flags” that may be signaling disaster.

You Be the Consultant: “Russia: A Rising Star for Franchisors” Page 220-221

1. What steps should U.S-based franchisors take when establishing outlets in foreign countries?

U.S-based franchisors should consider the following when establishing outlets in foreign countries:

Research the potential market, its size and potential acceptance of the franchise concept

Inventory the business climate for U.S. business operating within the foreign country

Assess the state of the current and anticipated economic and financial environment

Gain information about government restriction on a national, regional and local bases

Assess tax implications

Examine logistical issues, such as shipping and delivery options

Explore hiring processes and anticipated costs

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Perform a complete financial analysis

Conduct a risk analysis2. Describe the opportunities and the challenges franchisors face when entering

emerging markets such as Russia. The opportunities franchisers may realize in a country such as Russia include:

An attractive long–term growth strategy for the franchise that leverages the unique skills and resources of local franchisees

Product innovation through feedback and experience The establishment of a world–wide brand

Challenges that franchise organizations may face include uncertainties in these areas:

Cultural understanding and acceptance Financial volatility and uncertainty Hiring and training new owners in the proven franchise system Addressing logistical and supply chain barriers Appreciating the role the government plays in the business environment

3. Use the Web as a resource to develop a list of at least five suggestions that will help new franchisors looking to establish outlets in RussiaStudents’ responses will vary and may include the following factors:

Thoroughly research the culture relating to your franchise concept. Analyze the role the Russian government may play in your franchise

future—product import and purchase restrictions, tax obligations, property ownership limitations and other factors.

Identify potential “benchmark” businesses established in the Russian market that may offer insight regarding their entry strategy and success to date.

Conduct a comprehensive market analysis of the local market. Conduct market research based on your product offering. Research all attributes of the proposed site(s). Conduct a logistic supply chain analysis for accessing and transporting

goods and physical resources. Assess the availability, requirements and costs of the required labor

resources. Establish the role that exchange rates may play in the financial arena of

the venture. Prepare a comprehensive business plan addressing all issues this new

market will present and with realistic timeframes.

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Identify adaptation and contingency options if things do not go according to the plan.

Part 4: Chapter Discussion Questions1. What is franchising? (LO 1)

Franchising involves semi–independent business owners (franchisees) that pay fees and royalties to a parent company (franchiser) in return for the right to sell its products or services and often to use its brand, logo, business format and system.

2. Describe the three types of franchising and give an example of each. (LO 1)

The three types of franchising with examples are:

1. Trade name franchising: The franchisee purchases the right to use the franchisor’s trade name without distributing particular product under the franchisor’s name. Examples include True–Value Hardware and Western Auto.

2. Product distribution franchising: Involves a franchiser licensing a franchisee to sell specific products under the franchiser’s brand name and trademark through a selective, limited distribution network. Examples include Exxon, Chevrolet, and Pepsi Cola.

3. Pure franchising: Involves providing the franchisee with a complete business format. Examples include Burger King, H&R Block and Hampton Hotels.

3. Discuss the advantages and the limitations of franchising for the franchisee. (LO 2)

The benefits of buying a franchise include: Management training and support – Franchisers provide training programs for

franchisees in an attempt to reduce failures due to incompetent management. Brand name appeal – Franchisee has the ability to identify his business with a

widely recognized product or service, giving the firm immediate drawing power.

Standardized quality of goods and services – Since the quality of the product or service sold determines the franchiser’s reputation, he maintains uniform quality standards.

National advertising programs – Franchisers design mass advertising programs that accomplish more than the franchisees could achieve individually.

Financial assistance – Entrepreneurs may be able to purchase franchises for less money requirements than what it costs to start businesses from scratch, and some franchisers offer financial help.

Proven products and business formats – Franchisees can depend on an established product and business system.

Territorial protection – Franchisees are guaranteed territorial protection in some cases; they have the right to exclusive distribution of the product/service

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in this territory. Greater chance for success – The failure rate for franchisees is substantially

lower than that of independent businesses.

The drawbacks of buying a franchise include: Franchise fees and profit sharing – Franchisees are required to pay initial

franchise fees plus a share of gross receipts throughout the life of the franchise arrangement.

Strict adherence to standardized operations – The franchisee may be restricted in his freedom to make decisions about business operations.

Restrictions on purchasing – Franchisees frequently are required to purchase goods or services from approved vendors.

Limited product line – Franchise agreements normally require franchisees to sell only approved products and services from the outlet.

Unsatisfactory training programs – Some franchisers do not deliver all they promise in a “franchisee training program.”

Market saturation – Some franchisers do not offer franchisees territorial protection and the market becomes oversaturated.

Less freedom – When a franchisee signs a contract, he is agreeing to sell the franchiser’s product or service following its prescribed formula. In essence, there is a lack of independence.

4. Why might an independent entrepreneur be dissatisfied with a franchising arrangement? (LO 2)

Franchisees surrender a degree of autonomy and creativity when signing a franchise agreement. Many entrepreneurs feel stifled by the controls imposed on them by franchisers, and they resist them. In many cases, the franchisee becomes an “employee” or a “junior partner” of the larger franchise. In some situation, the franchise system may impose decisions that increase franchise revenues, but have a negative impact on the profit potential for the individual franchisee.

5. Fran Lubbs, who after a five-year stint left the corporate office of Goddard School, an early education franchise, to become a franchisee, says, “Follow the system. It’s one of the reasons you bought the franchise. Don’t try to change it, break it, or fix it.” Do you agree with her? Explain. (LO 2)

Expect student to agree with the perspective Lubbs offers for well-established franchise systems. Franchises with an established history are proven systems based on previous business experience. They have been modified and apply best practices based on extensive experience and performance. Modifying the business process may introduce risk and uncertainty.

Students may debate that smaller franchises with a limited history may not offer this type of legacy track record. The attributes of a less mature franchise may benefit from modifications and improvements.

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6. What kinds of clues should tip off a prospective franchisee that he/she is dealing with a disreputable franchiser? (LO 3 and 4)The following clues should tip off a prospective franchisee that he is dealing with a disreputable franchiser:

Claims that the franchise contract is a standard one that “you don’t need to read.”

A franchiser who fails to give you a copy of the required disclosure document at your first face–to–face meeting.

A marginally successful prototype store or no prototype at all. A poorly prepared operations manual outlining the franchise system or no

manual at all. Oral promises of future earnings without written documentation. A high franchisee turnover rate or a high termination rate. Attempts to discourage you from allowing an attorney to evaluate the

agreement. No written documentation to support claims and promises. A high–pressure sale with the implication to sign now or lose the opportunity. Claiming to be exempt from federal laws requiring complete disclosure of

franchise details. “Get–rich–quick schemes”; promises of huge profits with only minimum effort. Reluctance to provide a list of present franchisees for you to interview. Evasive, vague answers to your questions about the franchise and its operations.

7. What steps should a potential franchisee take before investing in a franchise? (LO 4)The following steps will help you make the right choice:

1. Evaluate yourself: An entrepreneur should first know his own traits, goals, experience, likes, dislikes, risk–orientation, and other characteristics.

2. Research your market: Get to know the market and the area you plan to serve.3. Consider your franchise options: Read trade journals such as Franchise

Opportunities Guide, published by the International Franchise Association. Many magazines such as Entrepreneur, Inc., and Success offer information about franchising.

4. Obtain a copy of franchiser’s FDD: This document summarizes the details that will govern the franchise agreement. It outlines exactly the rights and obligations of the franchisee.

5. Talk to existing franchisees: One of the best ways to evaluate the reputation of a franchiser.

6. Ask the franchiser the tough questions: Gather as much information regarding the franchise beforehand.

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8. Two franchising experts recently debated the issue of whether new college graduate should consider franchising as a pathway to entrepreneurship. (The text elaborates on these two positions.) Which view do you think is correct? (LO 2 and 4)

Expect students to select one position and defend it. The Kushell position supports the fact that entrepreneurs are younger and better informed than ever before.

Pro College Students: Many of these young entrepreneurs are technically proficient, are energetic, have an intimate understanding of their peer market, and may be highly creative in identifying market needs and solutions. This group also brings a fresh viewpoint and an ability to see beyond obstacles.

Con College Student: One of the most significant challenges college students face is due to their inexperience. The learning curve can introduce uncertainty and risk. In addition, their youth may not be taken seriously when working with older business people and engaging in business transactions. Securing financing may prove to be an example of these types of challenges.

9. What is the FTC’s Trade Regulation Rule? Outline the protection the Trade Regulation Rule gives all prospective franchisees. (LO 3)

The Trade Regulation Rule requires all franchisers to disclose detailed information on their operations at the first personal meeting or at least ten days before the franchise contract is signed, or before any money is paid. Its purpose is to help potential franchisees investigate the franchise deal and to introduce consistency into the franchiser’s disclosure statements. It does not verify the accuracy of the data, thus no protection is provided. This information may serve as a starting point for investigation.

10. Describe the current trends in franchising. (LO 5)

Current trends in franchising include:

International opportunities: Franchising is becoming a major U.S. export industry. About 52 percent of U.S. franchisers have outlets in other countries.

Smaller, nontraditional locations: Due to high costs of building full–scale locations, franchises are putting scaled–down outlets directly in the path of customers in places such as college campuses, grocery stores, gas stations, theaters, and airports.

Conversion franchising: Owners of independent businesses become franchisees to gain the advantage of name recognition.

Multiple–unit franchising: A franchisee opens more than one unit in a broad territory within a specific time period. “Franchisers are finding it’s far more efficient in the long run to have one well–trained franchisee operate a number of units than to train many franchisees.”

Area Development and Master franchising: A franchisee is given the right to create a semi–independent organization in a particular territory to recruit, sell, and support other franchisees. Under area development the franchisee earns the

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exclusive right to open multiple units in a specific territory within a specified time. A master franchise is a method that gives a franchisee the right to create a semi-independent organization in a particular territory to recruit, sell, and support other franchises.

Cobranding: Franchisers team up with other franchisers selling complementary products or services by combining two or more franchises under one roof.

11. One franchisee says, “Franchising is helpful because it gives you somebody [the franchiser] to get you going, nurture you, and shove you along a little. But, the franchiser won’t make you successful. That depends on what you bring to the business, how hard you are prepared to work, and how committed you are to finding the right franchise for you.” Do you agree? Explain. (LO 4)

It is true that franchising allows a franchisee to begin with a given structure, and establishes rules and guidelines for the business. While these “givens” do help, they will not make the franchisee successful. The franchisee must contribute to the business. Characteristics such as enthusiasm and commitment are not a part in the plan “given” to the franchisee by the franchiser. These things must come from within the franchisee and be communicated throughout the organization in order for it to be successful.

12. Robyn Vescovi, a former financial executive who recently became a Tasti D-Lite franchisee, offers the following advice to first-time franchisees:

Do your homework: (The text elaborates on these four points positions.)

Research the brand.

Know the team behind this brand and understand their vision for that product/business.

Know yourself and your limits.

Be involved!

Do you agree? Explain. What other advice can you offer first-time franchisees? (LO 4)Expect students to state their position regarding the “homework” that Vescovi recommends. The following consideration may be a part of their position to support Vescovi’s perspective.

Understand what you are buying into: Does the brand have value to the market you plan to serve and is this a brand you can support and sell?

Know the people behind the brand: Are these people you can work with and become a part of the team that pursues a common vision?

Evaluate yourself: Have you assessed your own traits, goals, experience, likes, dislikes, risk–orientation, and other characteristics. Do they match those of the franchise?

Commit: This experience will become a significant part of your life and you need to invest in the franchise any many ways – time, money and energy. .

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Part 6: Online Videos and PodcastsThese online videos may enhance class discussion and provide additional insight for the chapter topics.

Buying A Business or A Franchise 2:06 minuteshttp://www.youtube.com/watch?v=90fIl2TbpLc

Fast Foods Gone Global – Brazil Hearts McDonald’s 2:46 minuteshttp://www.travelchannel.com/video/brazil-hearts-mcdonalds

Fast Foods Gone Global – India’s Take on KFC 1:16 minuteshttp://www.travelchannel.com/video/indias-take-on-kfc

Fast Foods Gone Global – Keeping Subway Kosher 1:28 minuteshttp://www.travelchannel.com/video/keeping-subway-kosher

Fast Foods Gone Global – Local and Global in London 2:06 minuteshttp://www.travelchannel.com/video/local-and-global-in-london

Fast Foods Gone Global – What’s Hot in Chile 2:11 minuteshttp://www.travelchannel.com/video/whats-hot-in-chile

Inside the McDonald’s Empire 37:07 minuteshttp://video.cnbc.com/gallery/?video=1409843942

Links to additional online resources are available on the companion Web site at www.pearsonhighered.com/scarborough.

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http://www.pearsonhighered.com/scarborough

http://video.cnbc.com/gallery/?video=1409843942

http://www.travelchannel.com/video/whats-hot-in-chile

http://www.travelchannel.com/video/local-and-global-in-london

http://www.travelchannel.com/video/keeping-subway-kosher

http://www.travelchannel.com/video/indias-take-on-kfc

http://www.travelchannel.com/video/brazil-hearts-mcdonalds

http://www.youtube.com/watch?v=90fIl2TbpLc

6. franchising and the entrepreneur

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