Abstract
Franchising is gaining popularity as an important tool for international expansion. It benefits both the parties involved in franchising. The purpose of the paper is to highlight the importance of franchising and understand the factors that affect franchising decision of businesses. While a franchisor uses this tool as a method of distribution and international expansion, a franchisee uses it to reduce business risk. The factors affecting franchising decision differ for a franchisor and a franchisee. The franchisor looks at its decision of franchising with a more global angle through analysis of the global market and legal scenario, a franchisee has a local approach to make an investment decision.
Keywords: Franchising, franchisee, franchisor, allocation, rights, expansion, international
Franchising
Franchising is a tool of business expansion for companies having a profitable business model and strong brand equity in the market. According to Beshel (2001), 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. A franchisor is the party that owns the business model and the trademark. A franchisee is the party that gets the rights to market the franchisor’s trademark products, services or trade name. McDonalds is a classic example of an international franchisee business operating worldwide.
Mumdžiev (2009) states that according to the US Department of Commerce business format franchising accounts for more than 40% of United States’ retailing industry. With increasing focus on liberalisation and removal of entry barriers by nations, international franchising is gaining popularity. The purpose of the paper is to highlight the importance of franchising and understand the factors that affect franchising decision of businesses.
The paper is divided into four parts. The first part highlights the importance of franchising for the franchisor and franchisee. The second part mentions the types of franchising formats. The third part discusses the factors that affect franchising decision of a franchisor and a franchisee. The fourth part concludes the paper.
Importance of Franchising
Franchising is an important business decision for both the parties in franchising. Following section discusses the importance of franchising in detail.
Importance of Franchising for Franchisor
Selden, Gipson and Parker (2008) state the importance of franchising for business entities. They mention the role of franchising as a mode of distribution of goods and services, a method of business expansion and a catalyst to achieve other organisational goals, like vertical integration.
Mode of Distribution
Distribution is one of the basic reasons for having franchisees. It serves as a mode of distribution for an organisation’s products or services. The extent of involvement of the franchisor in the distribution of its goods depends on the type of franchise format used.
Method of Business Expansion
Business expansion is another important reason for using the franchising tool. While distribution is one of the primary activities of an organisation, expansion is a larger and long term goal. Expanding the scale of operation requires huge capital expenditure. Expenditure is even higher for expanding to unchartered territories. Companies see franchisees as a source of capital. Also, they are locally present and have a deeper understanding of the socio-economic patterns of the region. The companies can also take advantage of the local goodwill of the franchisee. Hence, franchising is a very effective tool for overseas expansion without huge capital investments.
Catalyst for Other Business Goals
Sometimes, franchising is also used as a catalyst to achieve other organisational goals. Vertical integration is one such goal. A manufacturer of a technologically advanced product requires having a great presence in the retailing of its product. But, getting into the entire retailing process requires huge capital and burdensome managerial responsibilities. By franchising the retailing part of the business and vertical integration, companies can improve their overall effectiveness.
Importance of Franchising for Franchisee
Franchising is a very effective model of business for an entrepreneur. Firstly, franchising reduces business risk as the product or service offering and its system of delivery is already proven. Secondly, franchisee benefits from the extensive brand recognition and customer awareness. Building a brand and customer awareness in a costly and long term activity. Thirdly, the entrepreneur gets constant support from the corporate in a number of ways. He gets regular training, national marketing support and constant monitoring of quality standards. The constant monitoring helps the franchisee in getting regular feedback and improvising. It is like owning the business, but running it under the guidance of an expert. While an entrepreneur gets independence in this model, he or she is not adversely affected by the nuances of a start-up entity. In some cases, the franchisor also provides financial support to the entrepreneurs, depending on the latter’s capabilities.
Types of Franchise Formats
Typically, there are four franchising formats usually followed by organisations as a method of distribution of goods and services. According to Selden, Gipson and Parker (2008), these four franchise formats are business format franchises for products, business format franchises for services, product franchises and affiliation franchises. The following section briefly discusses each of these franchise formats.
Business Format Franchises for Products
Business format franchise, for products, is a franchise format in which the franchisor first develops a successful business concept for a prescribed product and a strong brand. The franchisor trains the franchisee and dictates the system of operationalization of the business concept. The franchisor does not manufacture the products in this model.
Business Format Franchises for Services
This format is very similar to business format franchise for products. The only difference is that the franchisor trains and dictates the franchisee on a prescribed marketable service, rather than product.
Product Franchises
Product franchise is an arrangement wherein the franchisor manufactures and distributes the products through franchisees. The franchisee usually serves as a dealer for selling the franchisor’s products in this case.
Factors Affecting a Franchising Decision
As discussed so far, franchising is an important part of business expansion strategy, especially for overseas expansion. However, it is not easy for a company to make a franchising decision given its complexity and direct impact on the business. It is a key decision for both, the franchisee and the franchisor. However, factors that affecting franchising decision for a franchisor will be different from the factors that affect a franchisee’s investment decision. The following section discusses the decision points for both the parties.
Factors Affecting a Franchising Decision for a Franchisor
The major factors that affect franchising decision for a franchisor are expectations of organisation’s shareholders, potential markets, franchise format, ownership type, franchisee selection, legal considerations and allocation of rights.
Expectations of Organisation’s Shareholders
Managing the expectations of organisation’s shareholders is a key consideration in any business decision of a corporate. Hence, it is imperative that franchisors ensure profitability of the model, protection of its core competencies and prevention of brand dilution in the new market.
Potential Markets
Potential markets are those that have demand for the product and where the company’s product can be sold profitably. For profitable selling, the product should be either unique, cost competitive and acceptable in the new market. The identified location should be such that the goods can be transported with ease and cost-effectiveness. The franchisor needs to consider the socio-economic and political situation of the country as well. A country with very high illiteracy and poverty rates, lack of proper infrastructure and political unrest can never be a good investment location.
Franchise Format
The franchise format differs with type of industry and type of goods sold. While an affiliation format may be relevant for a real estate business, it cannot be relevant for a fast food chain like McDonalds. Similarly, dealership business is best suited for product franchise formats.
Franchise Ownership
Mobilising capital is one of the reasons for corporates to get into a franchising model. Hence, it is better for a franchisor to have the franchisee own the franchise. The other benefits for the corporate are relief from managerial responsibilities and leverage on the franchisee’s local knowledge. While the royalty earned will motivate the franchisor to maintain quality standards in a franchise, the human and capital investments will motivate the franchisee to efficiently operate the business.
Franchisee Selection
The franchisor should ensure that the franchisee’s structure is legally permissible for franchising; the franchisee is financially sound to undertaking the responsibility and the franchisee is capable of running the business smoothly. The franchisor will also need to take care of any legal permission required in appointing a franchisee.
Legal Considerations
Laws affect the scale of franchising business in any country. LaFranchi explains this with an example of Mexico. He states that before formulation of the Industrial Property Law in 1991, Mexico was a difficult market to get into because of its many restrictions and limitations. It has, now, become a potential franchising market. Hence, different countries have different regulations that pose different requirements for franchising and impact it differently. Also, there are different contractual structures available for franchising. Therefore, it is imperative for a corporate to take due counselling from experienced advocates before charting into the franchising territory.
Allocation of Rights
According to Mumdžiev (2009), allocation of rights is an important determinant in franchising and factors affecting franchisor’s modal choice. Higher decision rights are allocated to the franchisee in highly uncertain environment, in markets with greater difference in socio-cultural conditions and higher geographical distance between the two markets.
Factors Affecting a Franchising Decision for a Franchisee
The major factors that affect franchising decision for a franchisor are industry selection, company selection, location, ownership type, legal considerations and permissions, transportation.
Industry Selection
Franchisee should conduct an analysis to identify the ideal industries for investment. The opportunities available, level of competition, investment requirement, future demand and government’s interest in the industry are some of the key variables for industry selection.
Company Selection
Once the industry has been identified, selecting the right company becomes the second challenging task. Analysing the financial strength of a company, in terms of its profitability and growth, is essential for making an investment decision. The royalty and fees charged by the franchisor is also to be taken into account. If the fee is too high, the franchise business may become unviable for the franchisee.
Location
A location that is hub of economic activities, has unmet demand for the franchisor’s products or services, has good infrastructure facilities and is politically stable is the ideal location. It is also important that the location is convenient for the franchisee to travel. Availability of cheap labour and rent is also essential in identifying an ideal location for franchising.
Location
It is in the interest of the franchisee to own the company and pay fees to the franchisor for marketing rights. In this way, the franchisee gets to own the business with higher chances of success because the business strategy is already tried and tested elsewhere. Ownership provides independence to the franchisee to run the business. However, the franchisee needs to insure that franchisor takes interest in training, maintaining quality standards and providing other support in running the business. This can be insured by paying sales based royalty and requesting the franchisor for part investment.
Franchising is government by a set of regulations that need to be considered when making an investment decision. Firstly, franchising requires a lot of documents and disclosures from the entrepreneur. It may be a daunting task to read and comprehend these documents. Secondly, only specified legal structures can be converted into a franchisee. Lastly, franchising requires a lot of permissions and approvals from the franchisor and other concerned regulatory bodies. It is, thus, recommended that a franchisee hires a well-informed lawyer to take care of these issues.
Transportation costs can have huge impact on the viability of a business. Transportation costs are very high for imported goods. Sometimes there is a trade-off between buying cheaper products and reducing transportation cost. If there is a huge price difference between domestic and international market, importing and bearing the transportation cost makes sense. However, if the industry is very competitive, looking for local vendors is a better proposition.
Franchising is an important strategic business tool for international expansion. It is most common in retailing and service industry. The model is gaining popularity with increasing focus on liberalisation and removal of entry barriers. Franchising is advantageous for both the parties in franchising. A franchisor uses this tool as a method of distribution of goods or services, international expansion and meeting other goals. A franchisee gets to market a strong brand with high customer awareness. It reduces business risk by using proven products or services.
Factors affecting franchising decision differ for a franchisor and a franchisee. The franchisor looks at its decision of franchising with a more global angle. It analyses global economic scenario and chooses a location with immense business opportunities and political stability. It takes into consideration the regulations of different countries before making a location choice. On the other hand, a franchisee has a local approach to make an investment decision. It analyses the best performing industries in the country, or may be in his state. It, then, picks up the best franchising proposition available to him in the given setting. Hence, the choices vary between the franchising parties and may even be conflicting at times.
References
Beshel, Barbara (2001). An Introduction to Franchising. Retrieved from http://www.franchise.org/uploadedFiles/Franchise_Industry/Resources/Education_Foundation/Intro%20to%20Franchising%20Student%20Guide.pdf
LaFranchi, Jane Woods. International Franchising: Legal Structures and Issues. Retrieved from http://www.strasburger.com/calendar/articles/intl/jwl_intl01.pdf
Mumdžiev, Nada (2009). Allocation of Decision Rights in International Franchise Firms. Retrieved from http://emnet.univie.ac.at/uploads/media/Zizic_01.pdf
Selden, Andrew C., Gipson and Parker (2008). An Introduction to Franchising. Retrieved from http://www.positivelyminnesota.com/Data_Publications/Publications/All_Other_DEED_Publications/Small_Business_Assistance_Office_Publications/An_Introduction_to_Franchising.pdf
