By Andrew J. Sherman
Over the last five decades, franchising has emerged as a leading intellectual properly leveraging strategy
for a variety of product and service companies at various stages of development. Recent International
Franchise Association (“IFA”) statistics demonstrate that retail sales from franchised outlets comprise
nearly 50 percent of all retail sales in the United States, estimated at over nearly one trillion dollars and
employing over ten million people in 2002. Notwithstanding these impressive figures, franchising as a
method of marketing and distributing products and services is really only appropriate for certain kinds of
companies. Despite the favorable media attention that franchising has received over the past few years as a method of business growth, it is not for everyone. There are a host of legal and business prerequisites that must be satisfied before any company can seriously consider franchising as an alternative for rapid expansion.
Many companies prematurely select franchising as a growth alternative and then haphazardly assemble and launch the program. Other companies are urged to franchise by unqualified consultants or advisors who may be more interested in professional fees that in the long?term success of the franchising program. And still others move too quickly in the development of their franchising program without devoting the time and resources to the development of and effective and viable business and economic model. This has caused financial distress and failure at both the franchisor and franchisee level and usually results in litigation. Current and future members of the franchising community have a duty to take a responsible view toward the creation and development of their franchising programs.
Reasons for Franchising
There are a wide variety of reasons cited by successful franchisors as to why franchising has been selected as a method of growth and distribution. Through franchising, they are able to:
- 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
In the typical franchising relationship, the franchisee shares the risk of expanding the market share of the franchisor by committing its capital and resources to the development of satellite locations modeled after the proprietary business format of the franchisor. The risk of business failure of the franchisor is further reduced by the improvement in competitive position, reduced vulnerability to cyclical fluctuations, the existence of a captive market for the franchisor’s proprietary products and services (due to the network of franchisees), and the reduced administrative and overhead costs enjoyed by a franchisor.
Strategic Prerequisites to Launching a Franchising Program
Typically, the most important strategic prerequisites for the success of any business format franchise system is the operation and management of a successful prototype and a business and financial model which makes sense for both franchisor and franchisee. This prototype location is where virtually all operating problems are to be resolved, recipes and new products tested, equipment and design decisions made, management and marketing techniques tested, a trade identity and goodwill established, and financial viability proven. The franchisor is in theory offering a tried and tested package to a franchisee, and the contents of that package must be clearly identified prior to sale. It is irresponsible and potentially in violation of the law to ask someone to part with their life savings to invest in a system which is not ready for replication. The financial aspects of the business model should be analyzed and tested to ensure that both parties can do well and are fairly rewarded for their efforts.
The concept of a system or prescribed business format that is operated according to a uniform and consistent trade identity and image is at the heart of a successful franchising program. Therefore, a prospective franchisor must be able to reduce all aspects of running the business to be franchised into an operations and training manual for use by franchisees in the day?to?day operation of their business. These systems must be adequately and clearly communicated in the initial and ongoing training program. If a company offers services that are highly personalized or a product that is difficult to reproduce, then franchising may not be the most viable alternative for growth because of the difficulty in replicating these systems or products in the operator’s manual or in the training program. Similarly, if all the “kinks” in the system have not yet been worked out, it is probably premature to consider franchising.
There are a number of other important business and strategic factors that must be considered before franchising. First, franchising should not be viewed as a solution to undercapitalization or as a “get rich quick” scheme. While it is true that franchising is less capital?intensive than is construction of additional company?owned sites, the initial start?up costs for legal, accounting, and consulting fees can be extensive. Second, franchisors must view franchising as the establishment of a series of long?term relationship and the ongoing success of the company as a franchisor will depend on the harmony of these relationships. A field support staff must be built to provide ongoing services to the existing franchisees, as well as to maintain quality control and uniformity throughout the system. New products and services must be developed so that the franchisee can continue to compete with others in its local market. Innovative sales and marketing strategies must be continually developed to attract new customers and retain existing patrons of the franchised outlet. If the franchisor expects the franchisee to continue to make its royalty payment on gross sales each week, then an array of valuable support services must be provided on an ongoing basis to meet the franchisee’s changing needs.
ABOUT THE AUTHOR
Andrew J. Sherman is a Partner in the Washington, D.C. office of Dickstein Shapiro LLP, with over 350 attorneys nationwide. Mr. Sherman is a recognized international authority on the legal and strategic issues affecting business growth, with a focus on the protection and leveraging of intellectual property. Mr. Sherman is an Adjunct Professor in the Masters of Business Administration (MBA) program at the University of Maryland and Georgetown University where he teaches courses on business growth, capital formation and entrepreneurship. Mr. Sherman has been General Counsel to YEO since 1987. Mr. Sherman is also the founder of Grow Fast Grow Right, an education and training company for executives of middle market companies (www.growfastgrowright.com). Mr. Sherman is the author of fourteen (14) books on the legal and strategic aspects of business growth and capital formation. His most recently published books include Mergers and Acquisitions: A Strategic and Financial Guide for Buyers and Sellers published by AMACOM in March of 1998 and the second edition was published in November of 2005, The Complete Guide to Running and Growing A Business, published by Random House in November of 1997, Parting Company, published by Kiplinger’s in May of 1999, Raising Capital, published by Kiplinger`s in Spring of 2000 and Raising Capital (2nd Edition), published by AMACOM in February of 2005 and Fast Track Business Growth, published by Kiplinger`s in January of 2002. Mr. Sherman can be reached at 202-420-5000 or e-mail ShermanA "at " dicksteinshapiro.com.
READY TO GROW THROUGH FRANCHISING?
