Franchising

Chapter 12
New Venture Creation:
Entrepreneurship
for the 21st
Century. Stephen
Spinelli and Robert
J. Adams (2016)
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 Chapter Objectives

1. Explain franchising and how this form of business

ownership works.
2. Describe steps entrepreneurs can take to establish a
franchise system.
3. Become familiar with the advantages and
disadvantages of establishing a franchise system.
4. Describe actions and issues associated with the
decision to buy a franchise.

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 Chapter Objectives

5. Explain the steps an entrepreneur goes through to

buy a franchise.
6. Identify and explain the various legal aspects
associated with the franchise relationship.
7. Discuss two additional issues—franchise ethics and
international franchising—entrepreneurs should
think about when considering franchising.

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 What is Franchising?

• Franchising
– Franchising is a form of business organization in which a
firm that already has a successful product or service
(franchisor) licenses its trademark and method of doing
business to another business or individual (franchisee) in
exchange for a franchise fee and an ongoing royalty
payment.
– Some franchisors are established firms (like McDonald’s)
while others are first-time enterprises being launched by
entrepreneurs (like Uptown Cheapskate).

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 Two Types of Franchise Systems
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• Product and Trademark Franchise

– An arrangement under which the franchisor grants to the
franchisee the right to buy its products and use its trade
name.
– This approach typically connects a single manufacturer
with a network of dealers or distributors.
• For example, General Motors has established a network of dealers
that sell GM cars and use the GM trademark in their advertising
and promotions.
• Other examples of product and trademark franchisors include
agricultural machinery dealers, soft drink bottlers, and beer
distributorships.

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 Two Types of Franchise Systems
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• Business Format Franchise

– An arrangement under which the franchisor provides a
formula for doing business to the franchisee along with
training, advertising, and other forms of assistance.
– Fast-food restaurants, convenience stores, and motels are
well-known examples of business format franchises.
• Business format franchises are by far the most popular form of
franchising, particularly for entrepreneurial firms.

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 10 Industries In Which Business Format
Franchises Predominate

1. Automotive
2. Business Services
3. Commercial and Residential Services
4. Lodging
5. Personal Services
6. Quick Service Restaurants
7. Real Estate
8. Retail Food
9. Retail Products & Services
10. Table/Full-Service Restaurants

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Types of Franchise Agreements
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Individual Franchise Agreement

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Types of Franchise Agreements
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Area Franchise Agreement

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Types of Franchise Agreements
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Master Franchise Agreement

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 When to Franchise?
• When Is Franchising Most Appropriate?
– Franchising is most appropriate when a firm has a strong or
potentially strong trademark, a well-designed business
method, and a desire to grow.
– In some instances franchising is not appropriate.
• For example, franchising works for Burger King but would not work
for Walmart.
• Each individual Burger King store is relatively small and policies and
procedures can be written for almost any contingency.
• In contrast, Walmart stores are much larger, more expensive to build,
and more complex to run compared to Burger King. It would be
nearly impossible for Walmart to find enough franchisees with the
financial capital and expertise to run its more than 11,000 stores.

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Nine Steps in Setting Up a Franchise System

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 Qualities to Look for in
Prospective Franchisees

• Good work ethic.

• Ability to follow instructions.
• Ability to operate with minimal supervision.
• Team oriented.
• Experience in the industry in which the franchise competes.
• Adequate financial resources and good credit history.
• Ability to make suggestions without becoming confrontational
or upset if the suggestions are not adopted.
• Represents the franchisor in a positive manner.
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 Ways Franchisors Can Develop the
Potential of Their Franchisees

• Provide mentoring that supersedes routine training.

• Keep operating manuals up-to-date.
• Keep products, services, and business systems up to date.
• Solicit input from franchisees to reinforce their importance in
the larger system.
• Encourage franchisees to develop a franchise association.
• Maintain the franchise system’s integrity.

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Advantages and Disadvantages of Franchising
as a Method of Business Expansion
Advantages Disadvantages

• Rapid, low-cost market expansion. • Profit sharing.

• Income from franchise fees and • Loss of control.
royalties.
• Friction with franchisees.
• Franchisee motivation.
• Managing growth.
• Access to ideas and suggestions.
• Differences in required business skills.
• Cost savings.
• Legal expenses.
• Increased buying power.

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 Buying a Franchise
From the Franchisee’s Point of View
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• Buying a Franchise
– Purchasing a franchise is an important business decision
involving a substantial financial commitment.
– Potential franchise owners should strive to be as well
informed as possible before purchasing a franchise and
should be aware that it is often legally and financially
difficult to exit a franchise relationship.

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 Buying a Franchise
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Answering the following questions will help

determine if franchising is right for you

• Are you willing to take orders? Franchises are typically

very particular about how outlets operate.
• Are you willing to be part of a franchise “system” rather
than be an independent businessperson?
• How will you react if you make a suggestion to your
franchisor and your suggestion is rejected?
• What are you looking for in a business? How hard do you
want to work?
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 Buying a Franchise
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Answering the following questions will help

determine if franchising is right for you

• How willing are you to put your money at risk? How will
you feel if your business is operating at a net loss but you
will have to pay royalties on your gross income?

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The Costs Involved With Buying a Franchise
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• Initial Franchise Fee

– The initial fee varies depending on the franchisor.
• Capital Requirements
– The costs vary but may include the cost of buying real estate,
the cost of putting up a building, the purchase of inventory,
and the cost of obtaining a business license.
• Continuing Royalty Payment
– Is usually around 5% of monthly gross income.

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The Costs Involved With Buying a Franchise
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• Advertising Fees
– Franchisees are often required to pay into a national or
regional advertising fund.
• Other Fees
– Other fees may be charged for various activities, including:
• Training additional staff.
• Providing management expertise when needed.
• Providing computer assistance.
• Providing a host of other items or support services.

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The Costs Involved With Buying a Franchise
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 Advantages and Disadvantages of
Buying a Franchise
Advantages Disadvantages

• A proven product or service within • Cost of the franchise.

an established market. • Restrictions on creativity.
• An established trademark or • Duration and nature of the commitment.
business system.
• Risk of fraud, misunderstandings, or
• Franchisor’s training, technical
lack of franchisor commitment.
expertise, and managerial expertise.
• Problems of termination or transfer.
• An established marketing network.
• Poor performance on the part of other
• Franchisor ongoing support.
franchisees.
• Availability of financing.
• Potential for failure.
• Potential for business growth.

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Seven Steps in Purchasing a Franchise

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 Watch Out! Common Misconceptions
About Franchising

• Franchising is a safe investment.

• A strong industry ensures franchise success.
• A franchise is a “proven” business system.
• There is no need to hire a franchise attorney or an accountant.
• The best systems grow rapidly and it is best to be part of a rapid-growth
system.
• I can operate my franchise outlet for less than the franchisor predicts.
• The franchisor is a nice person—he’ll help me out if I need it.

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Legal Aspects of the Franchise Relationship

• Federal Rules and Regulations

– The offer and sale of a franchise are regulated at the federal
level.
• According to Federal Trade Commission (FTC) rule 436,
franchisors must furnish potential franchisees with written
disclosures that provide information about the franchisor, the
franchised business, and the franchise relationship.
• In most cases, the disclosures are made through a lengthy document
referred to as the Franchisor Disclosure Document (FDD).
• The FDD contains 23 categories of information that give a
prospective franchisee a broad base of information about the
background and financial health of the franchisor.

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 More About Franchising
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• Franchise Ethics
– The majority of franchisors and franchisees are highly
ethical.
– There are certain features of franchising, however, that
make it subject to ethical abuse. These features are as
follows:
• The get-rich-quick mentality.
• The false assumption that buying a franchise is a guarantee of
business success.
• Conflicts of interest between franchisors and franchisees.

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 More About Franchising
2 of 2

• International Franchising
– International opportunities for franchising are becoming
more prevalent for the following two reasons:
• The markets for certain franchised products in the U.S. have
become saturated (i.e., fast food).
• The trend toward globalization continues.
– Steps to take before buying a franchise overseas:
• Consider the value of the franchisor’s name in the foreign country.
• Get a good lawyer.
• Determine whether the product or service is saleable in the foreign
country.
• Find out how much training and support you will receive from the
franchisor.

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