Franchising – Definition, Types, Advantages and Disadvantages

Meaning and Definitions of Franchising

In a sense, franchising is very much similar to branching. Franchising is a system for selectively distributing goods or services through outlets owned by the retailer or dealer. Basically, a franchise is a patent or trademark license, entitling the holder to market particular products or services under a brand name or trademark according the different terms and conditions.

The origins of franchising as it is now defined can be clearly traced to one man: Isaac Singer. After the US Civil War in the 1860s, Singer had achieved the ability to mass-produce his famous sewing machines, but had no economically viable way of repairing and maintaining them across a country as geographically vast as the US. He began to license out servicing and repairs to local merchants around the country, who were later permitted to become regional salesmen for the machines too. Singer’s use of a contract for this arrangement introduced the earliest form of franchise agreements, and the first modern franchise system was born. Franchising grew rapidly during the Second World War, propelled by companies looking to expand quickly like soft drinks giants like Coca-Cola and Pepsi. By the mid-1960s some of the largest fast-food brands had become well-established international franchises, led by McDonald’s and KFC.

According to David D. Settz “A franchisee is a form of business ownership created by contract whereby a company grants a buyer the rights to engage in selling or distributing its product or services under a prescribed business format in exchange for royalties or shares or profits. The buyer is called the “franchisee” and the company that sells rights to its business concept is called the “franchiser”.

According to Beshel, franchising is an arrangement between legally independent entities which gives one party (franchisee) the right to market the products, services or trade name of the other party (franchisor) by paying fees for the rights.

David H. Holt has defined franchising as a ‘business system created by a contract between a parent company, called the franchiser and the acquiring business owner, called the franchisee, giving the acquiring owner the right to sell goods or services, to use certain products, names, or branded, or to manufacture certain brands”.

The International Franchise Association (IFA) of America has defined as “franchise operation is a contractual relationship between the franchiser and franchisee in which the franchiser offers or is obligated to maintain a continuing interest in the business of the franchisee in such areas as know how and training, wherein the franchisee operates under a common trade name, format and or procedure owned or controlled by the franchiser and in which the franchisee has or will make a substantial capital investment in his business from his own resources”.

Now, franchising can simply be defined as a form of contractual arrangement in which a retailer (Franchisee) enters into an agreement with a producer (Franchiser) to sell the producers goods or services for a specified fee or commission.

Franchising Types

Franchising arrangements are broadly classified into three types:

1. Product Franchising: This is the earliest type of franchising. Under this dealers were given the right to distribute goods for a manufacturer. For this right, the dealer pays a fee for the right to sell the trademarked goods of the producer. The Singer Corporation used product franchising perhaps for the first time during the 1800s to distribute its sewing machines. This practice subsequently became popular in the petroleum and automobile machines also.
2. Manufacturing Franchising: Under this agreement, the franchiser (manufacturer) gives the dealer (bottler) the exclusive right to produce and distribute the product in a particular area. This type of franchising is commonly used in the soft- drink industry.
3. Business-Format Franchising: This is recent type of franchising and is the most popular one at present. This is the type that most people today mean when they use the term franchising. In the United States, this form accounts for nearly three-fourth of all franchised outlets. Business-format wide range of services to the franchisee, including marketing, advertising, strategic planning, training, production of operations manuals and standards and quality-control guidance.

Advantages of Franchising

Franchising agreement is a symbolic one for the franchiser and the franchisee. Following are the advantages that franchising provides to the franchisee.

1. Franchising makes the task of getting started easier because the franchisee gets a business format already market tested and found to work. Hence buying a franchise is so far safer than trying to start a new business.
2. It reduces chances for failure. Here significant to mention is that less than 10 percent of all franchise fails. In dramatic contrast with this is the fact that two out of every five entrepreneurs who start on their own fail within three years and eight out of every ten fail within ten years.
3. A well established franchise brings with it the very important advantage of recognition. Many new businesses experience lean months or years after start up. Obviously, the longer the period the business must experience it, the greater the chances of failure. With the well tested franchise, this period of agency may reduce to only weeks or perhaps just days.
4. Franchising may increase the franchisee’s purchasing power also. Because, being part of a large and that too recognized organization means paying less for a variety of things such as supplies equipment, inventory, services, insurance and so on. It also can mean getting better service from suppliers because of the importance of the organization (franchise) of you is part franchisee).
5. One gets the benefit of the franchiser’s research and development in improving the product.
6. The franchisee has the protected or privileged rights to franchise within a given area.
7. The prospects of obtaining loan facilities from the bank are also improved.
8. The banking of a known trading name (franchiser) becomes quite helpful while negotiating for good sites with setting agents or building owners.

Disadvantages of Franchising

Franchising is not an unmixed blessing. There are some disadvantages as well associated with a franchise arrangement. The main ones are listed as follows:

1. Unlike entrepreneurs who start their own business, the franchisees find no room or scope for enjoying their creativity. They have to work as per the given format. One classic example of regimentation in franchising can be found in the Mc Donald’s restaurant organization. A Mc Donald’s franchise is given very little operational latitude, indeed the operations manual attends to such minor details as when to boil the bearings on the potato slicer. The purpose of these restrictions is not to frustrate the franchises, but to ensure that each outlet is run in a uniform correct manner.
2. A number of restrictions are also imposed upon the franchisees. Restrictions may relate to remain confined to product line or a particular geographical location only.
3. Franchisees usually do not have the right to sell their business to the highest bidder or to leave it to a member of their family without approval from the franchiser.
4. Though the franchisee can build up goodwill for his or her business by his or her efforts goodwill still remains the property of the franchiser.
5. The franchisee may become subject to fail with the failure of the franchiser, another disadvantage facing franchisees is that franchisers generally reserve the option to buy back an outlet upon termination of the contract. Many franchisees become vulnerable to this option. As such, they operate under the constant fear of non- renewal of the franchise agreements.

Then do these disadvantages mean that franchising is no longer desirable way to go small business? Certainly not franchising is a proven and complete business concept. In fact, what do they really mean is that the security that some people associate with franchising is an illusion? Hard work, realistic expectations, and very careful investigation are required if becoming a franchisee is to be a successful, satisfying experience. This underlines the need for evaluation of a franchising agreement.