Franchising: Meaning, Types, Advantages and Limitations, Franchising in India

Franchising is based on a marketing concept which can be adopted by an organization as a strategy for business expansion. Where implemented, a franchisor licenses some or all of its know-how, procedures, intellectual property, use of its business model, brand, and rights to sell its branded products and services to a franchisee. In return the franchisee pays certain fees and agrees to comply with certain obligations, typically set out in a franchise agreement.

The word “franchise” is of Anglo-French derivation from franc, meaning free and is used both as a noun and as a (transitive) verb. For the franchisor, use of a franchise system is an alternative business growth strategy, compared to expansion through corporate owned outlets or “chain stores”. Adopting a franchise system business growth strategy for the sale and distribution of goods and services minimizes the franchisor’s capital investment and liability risk.

Franchising is not an equal partnership, especially due to the legal advantages the franchisor has over the franchisee. But under specific circumstances like transparency, favourable legal conditions, financial means and proper market research, franchising can be a vehicle of success for both franchisor and franchisee.

Thirty-six countries have laws that explicitly regulate franchising, with the majority of all other countries having laws which have a direct or indirect effect on franchising. Franchising is also used as a foreign market entry mode.

Fees and Contract arrangement

Three important payments are made to a franchisor:

(a) A royalty for the trademark

(b) Reimbursement for the training and advisory services given to the franchisee

(c) A percentage of the individual business unit’s sales. These three fees may be combined in a single ‘management’ fee.

A fee for “disclosure” is separate and is always a “front-end fee”.

A franchise usually lasts for a fixed time period (broken down into shorter periods, which each require renewal), and serves a specific territory or geographical area surrounding its location. One franchisee may manage several such locations. Agreements typically last from five to thirty years, with premature cancellations or terminations of most contracts bearing serious consequences for franchisees. A franchise is merely a temporary business investment involving renting or leasing an opportunity, not the purchase of a business for the purpose of ownership. It is classified as a wasting asset due to the finite term of the license.

Types:

Manufacturing Franchising:

Under this arrangement, the franchisor (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.

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. Product franchising was used, perhaps for the first time, by the Singer Corporation during the 1800s to distribute its sewing machines. This practice subsequently became popular in the petroleum and automobile industries also.

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 franchising is an arrangement under which the franchisor offers a wide range of services to the franchisee, including marketing, advertising, strategic planning, training, production of operations manuals and standards and quality control guidance.

Franchising in India

1. Trade-name Franchising:

When franchisee purchases the right to use the franchisor’s trade name without actually distributing the specific trade mark products exclusively using the name of the franchisor, this is called ‘trade-name franchising.’

2. Product Distribution Franchising:

Such franchising involves a system in which a franchisor gives license to the franchisee to sell the specific products under the trademark and brand name of the franchisor. This type of franchising is commonly used to market automobiles (such as Chevrolet), soft-drinks (such as Coca-Cola) and appliances. It is worth mentioning that these two types of franchising give franchisees some sort of franchisor’s identity.

3. Pure Franchising:

When franchisor sells the complete business format and system of his/her product to the franchisee, it is called ‘pure franchising.’ In other words, this type of franchising provides the franchisee with a complete business format including license for a trade name, the product or service to be marketed, the physical plant, methods of operation, a marketing strategy plan, a quality control process, and so on. Such type of franchising is common among fast-food restaurants (such as McDonalds) hotels, educational institutions (such as Delhi Public School, (DPS), and many others.

Franchising is an old concept in use for long time in the business world. Some trace out the history of franchising dating back to the mid-nineteenth century when Isaac Singer decided to improve the distribution of his sewing machines, i.e., ‘Singer.’ Nowadays, franchising has become a common business format especially in the businesses with a good track record of profitability and businesses which are easily duplicated.

Advantages:

Franchising arrangement is a symbiotic one for the franchisor and the franchisee, nonetheless franchising is particularly beneficial for the franchisee.

Following are, for example, the distinct advantages that franchising provides to the franchisee:

(i) 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 business.

(ii) It reduces chances for failure. Here, what is significant to mention is that fewer than 10 per cent of all franchise fail. 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.

(iii) 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 agony may reduce to only weeks, or perhaps just days.

(iv) Franchising may increase the franchisee’s purchasing power also. Because, being part of a large and that too proprietor 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 organisation (franchisor) of you (franchisee) is part.

(v) One gets the benefit of the franchisor’s research and development in improving the product.

(vi) The franchisee has the protected or privileged rights to franchise within a given area.

(vii) As compared with other forms of new business, the prospects of obtaining loan facilities from the banks and financial institutions in case of franchising are also improved.

Disadvantages:

In-spite of above benefits, franchising is not an unmixed blessing. There are some disadvantages as well associated with a franchise arrangement.

(i) Unlike entrepreneurs who start their own business, the franchisees find no room or scope for enjoying their creativity especially in case of ‘pure franchising.’ They have to work as per the business-format given by the franchisor. One classic example of regimentation in franchising can be found in the McDonald’s restaurant business-format.

A McDonald’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 franchisees, but to ensure that each outlet is rim in a uniform, correct manner.

(ii) 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.

(iii) Franchisees usually do not have the right to sell their businesses to the highest bidder or to leave it to a member of their family without approval from the franchisor.

(iv) Though the franchisee can build up goodwill for his or her business by his or her efforts, goodwill still remains the property of the franchisor.

(v) The franchisee may become subject to fail with the failure of the franchisor.

(vi) Another disadvantage franchisees face is that franchisors 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 arrangement. Then, a question arises is that do these disadvantages mean that franchising is no longer a desirable way to go into small business? Certainly not. Franchising is a proven and complete business concept world-wide.

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 and satisfying experience. This underlines the need for a perspicacious evaluation of a franchising arrangement. This is discussed subsequently.