What is a Franchise?
Franchising is a business model that combines the best aspects of sole proprietorship and corporate America. It can be described as a “hybrid” model that fills the gap between working for somebody else (whether a large corporation or a small business) and working for yourself.
Franchising is not an industry in itself. Rather, it’s a way of doing business that can be applied in almost any sector. Franchising has two main forms. In product/trade name franchising, a franchisor owns the right to a name or trademark and sells or licenses the right to use that name or trademark. Business format franchising, the form discussed here, involves a more complex relationship in which the franchisor provides franchisees with a full range of services and support. Franchisees sign an agreement to conduct operations in conformity with specific rules laid out by the franchisor.
Franchising is not an industry in itself. Rather, it’s a way of doing business that can be applied in any sector.
According to the International Franchise Association, “Franchising is a method of distributing products or services. At least two levels of people are involved in a franchise system: 1) the franchisor, who lends his trademark or trade name and a business system; and 2) the franchisee, who pays a royalty and often an initial fee for the right to do business under the franchisor’s name and system.”
Franchising is a team effort. In order for any franchisor to succeed, the vast majority of its franchisees (ideally, all) must operate profitable individual franchise units over the long term. A brand’s success depends on an ongoing partnership between franchisor and franchisee. One of the most common sayings in franchising is: “Franchising means working for yourself, but not by yourself.”
What qualities make a franchise?
According to the American Bar Association, there are three main elements that define a franchise under both federal and state franchise laws. Whether or not a business chooses to call itself a franchise, it legally qualifies as a franchise if it meets these qualifications.
3 Main Elements: Trademark, Payment, Marketing
1. Significant Affiliation with a Trademark
In order to qualify as a franchise, the business must have a strong association with a trademark provided by the franchisor. Or, in the case of a new franchise, the business must create a trademark for their company. Not to mention, before the franchisor can give out a trademark license, their mark must be registered. This process can be lengthy and complicated but must be completed before the trademark is used. Once a franchisee purchases a franchise, they gain the right to use and sell products bearing the trademark name.
2. Payment of a Fee
The payment of a fee is a key part of the qualifications of a franchise. This fee does not have to be a franchise fee in order to fulfill this requirement. This may be an ongoing royalty payment, training fees, or fees associated with site assistance. Simply, the fee must contribute to the right to operate the business.
It is relevant to note, however, that the FTC’s Franchise Rule does not count payments less than $500 that are completed within the first six months of operation. Therefore, any payments less than $500 do not serve to qualify a business as a franchise, despite that the payment may contribute to the business owner’s right to operate the business.
3. Marketing Plan or Community of Interest
The third element that a business must satisfy in order to qualify as a franchise is a developed marketing plan. Or, in other words, does the licensor (or franchisor) give the business owner marketing tools or a training manual? Furthermore, does the licensor provide marketing or promotional materials? If these elements are in place, then the business location qualifies as a franchise.
In some states, this standard is slightly different. Rather than a marketing plan, these states prioritize the business’ community of interest. If the business has a community or customer base that they plan to attract, they qualify as a franchise.
What are the different franchise models?
In recent years, the franchise model has caught on as an attractive business opportunity for wealthier individuals and investors, often purchasing many units at once. These multi-unit owners, area developers, or area representatives (some of whom also recruit new franchisees and support them within their territory) are part of a growing trend in franchising, accounting for about 50 percent of all franchised units in the U.S. today.
“Multi-brand” franchisees are also on the rise. These franchisees operate different brands under a single organization, creating efficiencies, economies of scale, and market penetration to increase sales and profitability. The primary reasons successful franchisees seek additional brands are:1) they have “built out” their territory for their current brand, and/or 2) they are seeking a new, complementary brand to smooth out the ups and downs of business or seasonal cycles. Franchisors, too, combine several different brands under one roof, frequently offering discounts to current franchisees who take on a second (or third) brand.
“Co-branding,” in which a franchisee operates two brands from the same location, is another recent trend. Co-branding saves on real estate or leasing costs, allowing more profit per square foot and often balancing out day parts (breakfast, lunch, dinner). An increasing number of franchisors now offer several different brands, and often provide incentives to franchisees to co-brand.
Much of what prospective franchisees are seeking to buy in a franchise brand is peace of mind. They want to know, with as much certainty as possible, that if: 1) the franchise opportunity is presented accurately and realistically by the franchisor; 2) they take the time to perform “due diligence” by speaking with current franchisees, reading the Franchise Disclosure Document (FDD) carefully with the aid of an experienced franchise attorney; 3) after comparing the brand and sector under consideration with the competition (franchised or not); then 4) their chances of making money and building a successful business are better than if they started a business from scratch.
Yet for many aspiring entrepreneurs looking at the franchise business model for the first time – especially those coming from a corporate background – the business proposition can seem ludicrous: “Why should I pay tens of thousands of dollars before I even start, and then 8 or 10 percent off the top every month for 10 or 15 years?”
For those who investigate further, the answer is clear: they can make more money faster through franchising than on their own and they realize the potential for a greater long-term return on their investment as well. Franchise fees range from a few thousand dollars to tens of thousands, depending on the concept, while royalties generally run 5 to 8 percent and the marketing/advertising fund an additional 1 to 3 percent.
Legally, franchisees do not “own” the franchise they “buy.” They are granted, or awarded, a license that gives them the right to operate and manage their franchise business. However, franchisees do own the assets of their company, and as long as they adhere to the franchise agreement have specific rights under state and federal law. Franchisees can form franchisee associations that can participate in corporate decision-making if the franchisor is amenable, or band together to oppose decisions they see as detrimental to their operation and the brand in general.
How did franchising begin? History of Franchising.
Today, the word franchising conjures images of restaurant or fitness locations. But actually, franchising far predates the business model we know today.
If we look to the “Online Etymology Dictionary,” we can trace the origin of Franchise (Noun) – c.1300 franchise, “a special right or privilege (by grant of a sovereign or government);” also “national sovereignty; nobility of character, generosity; the king’s authority; the collective rights claimed by a people or town or religious institution,” also used of the state of Adam and Eve before the Fall, from Old French franchise “freedom, exemption; right, privilege.”
The origins of franchising as a business practice can be traced back to 200 B.C.
Most associate the origins of franchising with Albert Singer, who created the Singer sewing machine. Others point to Martha Matilda Harper as the source of franchising due to her creation of the Harper Method Shop franchise system. Yet, the origins of franchising as a business practice trace much farther back. In fact, franchising can be traced back to 200 B.C, in a Chinese retail shop owned by Lo Kass. Let’s look at a brief history timeline to see the history of Franchising.
In Franchising: The How-to Book by Lloyd Tarbutton, the author suggests the first chain store concept was started by Lo Kass in 200 B.C. China. According to Tarbutton, Kass even operated several retail units within the country, selling various goods. Although there is little information regarding early forms of franchising, many have pointed to ancient China as the home origin of this business model.
The Middle Ages
In the Middle Ages, manorial courts largely ruled the law. In this system, lords exercised jurisdiction over tenants, making franchise-like agreements with tax collectors. The tax collectors retained a portion of their collections in return for physically collecting tax dollars. These collections were made in the name of the Lords who governed the land. In a sense, this can be seen as the beginning of the franchisee/franchisor relationship.
The Colonial Period
During the Colonial period, landowners authorized individuals to run markets and perform business activities, such as run local ferries for a certain fee. European monarchs would allow individuals to expand colonies and operate those lands under the protection of the Crown in exchange for taxes and royalties.
The 19th Century
In the mid-1800’s the first american franchise was established by Albert Singer, producing the Singer sewing machine, still a popular brand today. Singer was highly regarded for his licensing arrangements. The franchisor set up specific geographical locations for business owners and charged an upfront licensing fee for the right to sell his sewing machines.
The 20th Century
In the 1950’s and 60’s, franchising as a marketing strategy started to take off. This is especially prevalent in the fast food chains. With the expansion of interstate highways, fast food chains, such as McDonald’s and Kentucky Fried Chicken, began expanding into two of the most successful Franchises today.