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Lesson 1- Franchising Basics

Ms. Kisses Dayle R. Manio, MBA (c)
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What is Franchising?
Franchising is a system used by a company (franchisor) that grants others (franchisee) the right
and license (franchise) to market a product or service under the franchisor’s name, trademarks,
service marks, know-how and methods of doing business. It is a system for distributing products or
services through independent resellers.it is a format of mutual dependence which allows both the
franchisor and the franchisee realize profit and benefits.

Mutually beneficial

Franchise agreements are generally beneficial for both parties. Agreements such as these are
common business practice around the world. Some of the most well-known brands used franchising
To take their business global.

Key terms in Franchising

Franchisor-franchisor owns the overarching company, trademarks, and products, but gives the
right to the franchisee to run the franchise location, in return for an agreed-upon fee.
Franchisee- One who purchases a franchise. The franchisee then runs that location of the
purchased business. He or she is responsible for certain decisions, but many other decisions
(such as the look, name, and products) are already determined by the franchisor and must be
kept the same by the franchisee. The franchisee will pay the franchisor under the terms of the
agreement, usually either a flat fee or a percentage of the revenues or profits, from the sales
transacted at that location.
Royalty- The periodic charge that the owner of a franchised business needs to pay to remain
part of the franchise system that provides branding, advertising and administrative support. The
royalty fee for a franchise is typically some percent of either the overall or net sales of the
business and the payment is required each week, month or quarter.
 Franchise royalty are additional fees that are paid to the franchisor on a continuous basis over
and above the initial start up costs.

The fee is based on a percentage of the franchisees income and constitutes regular monthly
earnings for the franchisor.

What do royalties cover?

• On-going training
• Updates to operating manuals
• On-going advertising and promotions
• Sales to your business of goods or services directly to your franchisor.
• The franchisors on-going consultations to help you run your business.

Franchise consultant is a professional who specializes in helping you find the right franchise
fit. He or she will help you identify your goals – what do you really want to achieve through
business ownership? – and narrow down the list of businesses that fit those goals. They know
the questions to ask, how to help you find financing, the information you’ll need to collect and
many other nuances in the complex world of entrepreneurship.

Franchise agreement is, essentially, an agreement between two parties that allows one party
to use the brand, product or production process of the other party. In return, the brand owner
charges franchising fees or royalties. Franchising typically occurs when a company has a
successful business model that would suit heavy expansion, but the company does not have
the capital necessary to support said expansion. Instead, the company licenses local
businesses to carry its brand, product or service in return for fees and royalties.

Types of Franchises
• Business format

A business franchise is the most common type of franchise. The franchisor grants the franchisee the
full use of an established business, including its name and any related trademarks. The Franchisee
is allowed to run the business independently but is due to pay an agreed upon amount in royalties
or franchising fees. With this type of franchising, the franchisee typically enjoys a lot of support from
the franchisor and also has the option, or is legally obliged to, buy his supplies from the franchisor.
A business format is generally characterised by a lot of support with almost no independence.
McDonald’s is a classic example of a business franchise. There is little autonomy among the retail
outlets and the individual owners have no control over the products on offer.

• Product format

A product franchise is a type of franchising agreement where the manufacturer allows retailers to
sell products and use names and trademarks. This is most common for Franchisors that don’t have
any direct retail locations but instead sell their products through either supermarkets or third party
retail stores. Within this type of franchising arrangement, the manufacturer retains a lot of control
over the distribution process. In trade for fees or a purchase of a minimum amount of products, the
retailer is allowed to sell the manufacturer’s products and use his name and related trademarks. A
product format franchise is almost always based on a dealer-supplier relationship. A good example
would be the car tire industry. Car tire manufacturers franchise the right use their brand name and
trademarks to car dealerships. The dealerships than uses these rights to market and sell the tires.

• Manufacturing format

A manufacturing franchise allows the franchisee to assume the responsibility of producing the
Franchisor’s good or service, in addition to the use of its name and trademarks. I a business or
product format, the franchisees are not allowed to actually produce the good or service that they are
selling. With a manufacturing format, however, the production process is integral to the franchise
agreement. Take Coca-Cola for example. As part of their franchise agreements, they supply their
syrup concentrate to bottling companies, who then use this syrup to manufacture the actual cola.
After that, they bottle and package the product and sell it on to retailers. Of the three formats, the
manufacturing format offers the most independence.
Advantages and Disadvantages of Franchising

Advantages of Franchising

• The brand is already established

You are starting off using an already existing brand, with all the perks that come with it. Your
products/services will already have the customer loyalty and brand recognition associated with the
franchise brand.

• The business model has a proven track record

When starting up a business, your business model is likely to require a lot of revision and adjustment
as you become more familiar with your market. When you decide to get into franchising, you’ll most
likely adopt the business model that is common throughout the other outlets. This saves you the
trouble of setting up a business model from scratch since the standardised business model already
has a proven track record.
 • Training programs

As part of the franchise, your employees can benefit from training programs provided by the
franchisor. This will allow you to get your staff on point a lot faster than usual. If you plan to actively
manage the business yourself, you can most likely also benefit from the management training
programs that the franchisor offers.

• Ongoing support

You don’t have to do it alone! Whenever you run into issues, you have a strong support structure to
fall back on. The franchisor has likely been in business for a while and therefore has corresponding
support and failsafe systems in place, in case anything goes wrong.

• Marketing Assistance

You will benefit from every promotion that the franchisor is running on their brands. You don’t have
spent any time or money on designing and creating brands and marketing materials. In most cases,
you can instead just order them from the franchisor. This type of value exchange helps the franchisor
in keeping its brand consistent across all outlets. Imagine if each outlet would create his own
marketing materials, it would be very messy and the effect of the overarching brand would be diluted.

Disadvantages of franchising

• High startup costs

Next, to the regular costs of starting a business, you are also going to have to pay an initial franchising
fee to become part of the franchise. Additionally, depending on your contract, you will most likely be
paying royalties or a percentage of your revenue to the franchisor, as long as the franchise
agreement lasts.

• Profits aren’t guaranteed

Starting a business is always a risky venture. Becoming part of a franchise does not mean that you
will share in the profits of the entire company. The brand company might be making a large profit but
that does not apply to you. Your business operates independently and you are therefore responsible
for running your own profitable business.

• Limited independence

No matter how you look at it, becoming part of a franchise means limiting your independence.
Whereas with a regular start up, you can decide what you want to sell, how you want to position your
brand, etc. As part of a franchise, you no longer have that freedom. You are legally required to
conform to the franchises range of products/services and branding strategy. The Franchisor can also
prescribe rules that you have to follow in order for you to use their brand. For example, rules about
employee training, management policies and quality standards. This doesn’t necessarily have to be
a bad thing, put it limits your choices.
 • Conflict of Interest

Usually, the franchisor is supporting your effort to make your franchise business a success. But if
this is not legally established in your franchise agreement, you might run into trouble.

for example, the franchisor has a model franchising agreement which states that royalty payments
are due regardless of whether the business was profitable or not. This can actually encourage the
franchisor to just open as many franchise outlets as possible, regardless of the profitability of the
businesses, because the royalties are due anyway. Similarly, if you don’t have an agreement about
territory in your franchise agreement, the franchisor might open another outlet in the same street as
you. Even though you’re carrying the same brand, you are actually competing because you don’t
share the same profit structure. Pay attention to details when signing a franchise agreement, the
small print can have a long-lasting effect on your business.

Franchising, chains and licensing

Chain- is a group of identical businesses that use the same logo, products, marketing, etc. (just
like a franchise) where each individual location is owned by the parent. This means that a location
can have a store manager who runs day-to-day operations, but that person does not own the
business. With a franchise, as we know, each location is owned by the individual.

Licensed store has slightly more subtle differences. It is very similar to a franchise in that the brand
owner (licensor) gives permission to the individual (licensee – are you sensing a theme here?) for
the brand to be used and products to be sold, but the structure and fees associated differ widely.
Typically, the licensor has little to no operational control of the licensee, and the licensee receives
significantly less training from the brand. Additionally, there is typically no one-time fee upfront, like
with a franchise. Instead, an ongoing licensing fee is typically assessed.

Reasons for franchising

Obtain operating efficiencies and economies of scale.

Increase market share and build brand equity.
Use the power of franchising as a system to get and keep more and more customers—building
customer loyalty.
Achieve more rapid market penetration at a lower capital cost.
Reach the targeted consumer more effectively through cooperative advertising and promotion.
Sell products and services to a dedicated distributor network.
Replace the need for internal personnel with motivated owner/operators.
Shift the primary responsibility for site selection, employee training and personnel management,
local advertising, and other administrative concerns to the franchisee, licensee, or joint venture
partner with the guidance or assistance of the franchisor.
Distribution in different type of franchise

1. From manufacturer to retailer- this type of a franchise is a very flat structure in this
particular type of franchising the manufacturer directly gives a franchise to a particular end
buyer.
the best example of this type of franchise is car manufacturers you observe Honda
Yamaha Audi BMW all of these brands have frequent franchisees which are directly
appointed by the franchisor that is the parent brand. in this format, the franchise store
which sells the product of a parent brand is known as a direct franchise. this direct
franchise has all the authority from the franchisor to sell the product to the end
customer. many a time and exclusive agreement is formed between the franchise and the
franchisor so that the franchise cannot sell any other brand from the airport.

2. From manufacturer to wholesaler- this type of a franchise is very commonly observed in

the food market, the apparel industry and the technology industry. In this type of franchise,
the franchisor actually shares all the recipes ofMaking the food item and the wholesaler is
responsible for both the production as well as the sales of the product the wholesaler only
has to give The trademark fees to the franchisor.

in the technology industry it is observed that a for manufacturer cannot replicate the
production in a different region then he will frequently appoint the wholesaler and share all
the trade secret to the wholesaler and will enter an agreement as a franchisor the
wholesaler will be responsible for the production and distribution of the technical products
but I will at all times be paying the fees for the franchisor for the use of trademark.

3. From franchisors to service provider- Do you again very similar to the business level
franchising which described above. and this format the franchisor who is The trademark
holder Looks for the franchise which can get customers for the franchisor. this franchise
is generally service providers.

Example – Trademark holder wants to sell his products on Amazon. Trademark holder
Can either sell the product directly on Amazon for you can appoint a service franchise who
keeps his Trademark product in stock and then sells it on all different E-Commerce
portals. the only thing that the franchise is doing is keeping the stock and selling the
product forward where is all the marketing and brand building activities are done by the
franchisor itself
Besides the above example of e-commerce, there are many offline businesses as well as
McDonald’s pizza hut KFC etcetera which observe this type of franchise model.