Franchising

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Franchising

Franchising (from the French for free) is a method of doing business wherein a franchisor licenses trademarks and tried and proven methods of doing business to a franchisee in exchange for a recurring payment, and usually a percentage piece of gross sales or gross profits as well as the annual fees. Various tangibles and intangibles such as national or international advertising, training, and other support services are commonly made available by the entity licensing the 'chain store' or franchise outlet (commonly shortened to the one word: franchise), and may indeed be required by the franchisor, which generally requires audited books, and may subject the franchisee or the outlet to periodic and surprise spot checks. Failure of such tests typically involve non-renewal or cancellation of franchise rights.

According to Financial Times, if sales by US franchise businesses were translated into national product, they would qualify as the 7th largest economy in the world.

Overview

The term "franchising" is used to describe a wide variety of business systems which may or may not fall into the legal definition provided above. For example, a vending machine operator may receive a franchise for a particular kind of vending machine, including a trademark and a royalty, but no method of doing business.

The parties involved typically enter a franchise agreement, which binds the parties together through contractual provisions. This is an arrangement whereby someone with an idea for a business (the franchisor), sells to another person (the franchisee) the rights to use the business's name, sell a product, or provide a service to someone else . A franchise agreement will usually specify the given territory the franchisee retains exclusive control over (the area protection), as well as the extent to which the franchisee will be supported by the franchisor (e.g. training and marketing campaigns). Most franchisee agreements, however, do not provide the franchisee with area protection because of the disparity in bargaining power between franchisors and franchisees.

Advantages

As practiced in retailing, by using the business network concept, franchising offers franchisees the advantage of starting up a new business quickly based on a proven trademark and formula of doing business, as opposed to having to build a new business and brand from scratch (often in the face of aggressive competition from franchise operators).

As long as their brand and formula are carefully designed and properly executed, franchisors are able to expand their brand very rapidly across countries and continents, and can reap enormous profits in the process, while the franchisees do all the hard work of dealing with customers face-to-face. See customer service. Additionally, the franchisor is able to build a captive distribution network, with no or very little financial commitment.

For some consumers, having franchises offer a consistent product or service makes life easier. They know what to expect when entering a franchised establishment. See franchise validation.

Disadvantages

For franchisees, the main disadvantage of franchising is a loss of control. While they gain the use of a system, trademarks, assistance, training, and marketing, the franchisee is required to follow the system and get approval of changes with the franchisor.

In response to the soaring popularity of franchising, an increasing number of communities are taking steps to limit these chain businesses and reduce displacement of independent businesses through limits on "formula businesses." New Rules Website

Another problem is that the franchisor/franchisee relationship can easily give rise to litigation if either side is incompetent (or just not acting in good faith). For example, an incompetent franchisee can easily damage the public's goodwill towards the franchisor's brand by providing inferior goods and services, and an incompetent franchisor can destroy its franchisees by failing to promote the brand properly or by squeezing them too aggressively for profits.

Because litigation is expensive, the majority of franchisors have inserted mandatory arbitration clauses into their agreements with their franchisees. Since 1980, the U.S. Supreme Court has dealt with cases involving direct franchisor/franchisee conflicts at least four times, and three of those cases involved a franchisee who was resisting the franchisor's motion to compel arbitration. Two of the latter cases involved large, well-known restaurant chains (Burger King and Subway); the third involved Southland Corporation, the parent of 7-Eleven.

Legal aspects

In the United States, franchising falls under the jurisdiction of a number of state and federal laws. Franchisors are required by the Federal Trade Commission to have a Uniform Franchise Offering Circular "UFOC" to disclose potential franchisees about their purchase. This disclosure must take place 10 day prior to solicitation. Each state may require the UFOC to contain specific requirements. This means that many franchisors have a unique UFOC for each state or sometimes are able to include all state specific requirements into one document. FRANDATAFRANDATA Information for the Franchise World estimates that on average, 100 documents are distributed per franchisor per year. This represents 200,000 UFOCs distributed each year in the US alone. FRANDATA also estimates the cost of each UFOC to be near $100.PrivaSign: Complying with FTC Franchise Rule

Electronic UFOC:In October 1999, the Commission published for comment in the Federal Register a Notice of Proposed Rulemaking (“NPR”) in connection with the Franchise Rule, 16 C.F.R. (Code of Federal Regulations)Part 436. The NPR sought comment on a wide range of issues, including proposed instructions enabling franchisors to furnish disclosure documents electronically, including through the Internet. Among other things, the proposed instructions would:

Require prior consent by a prospective franchisee before a franchisor could comply with the Rule electronically;
Afford a prospective franchisee the right to obtain a paper disclosure document until the time of sale;
Require franchisors to provide a prospective franchisee with a paper summary document, which includes, among other things, the disclosure document’s table of contents, as well as an admonition to download or otherwise preserve the electronic disclosure document;
Specify the general format of an electronic disclosure document to ensure that it can be downloaded or otherwise preserved, that the disclosures are clear and conspicuous, and that the disclosures do not contain extraneous or distracting features (such as animation or pop-up screens); and
Permit the use of navigational tools to review a disclosure document, such as scroll bars, search features, and internal links.

Contrary to what might be expected, there is no federal registry of franchising or any federal filing requirements for information, rather, states are the primary collectors of data on franchising companies, and enforce laws and regulations regarding their spread.

In Russia, under ch. 54 of the Civil Code (passed 1996), franchise agreements are invalid unless written and registered, and franchisors cannot set standards or limits on the prices of the franchisee’s goods. Enforcement of laws and resolution of contractual disputes is a problem: Dunkin' Donuts chose to terminate its contract with Russian franchisees that were selling vodka and meat patties contrary to their contracts, rather than pursue legal remedies.

History

Franchising dates back to at least the 1850s. One early example resulted in the characteristic look of historic hotels (bars) in New South Wales, with franchising agreements between hotels and breweries. Early American examples include the telegraph system which was operated by various railroad companies but controlled by Western Union, and exclusive agreements between automobile manufacturers and operators of local dealerships.

Modern franchising came to prominence with the rise of franchise-based restaurants. This trend started initially in the 1930s with traditional sit-down restaurants like the early Howard Johnson's, and then exploded in 1950s with the development of fast food chains, of which McDonalds has been the most successful worldwide. Many retail sectors, particularly in the United States, are now dominated by franchising to the point where independently-run businesses are the exception rather than the rule.

References

External links

United States Federal Trade Commission - "Disclosure requirements and prohibitions concerning franchising and business opportunity ventures."
General Practice, Solo & Small Firm Division Magazine - "Franchise Law: A Critical Analysis of the Small Business Franchise Act of 1998."

Franchises | Distribution, retailing, and wholesaling | Marketing | Strategic Alliance