Franchising is a contractual arrangement in which a parent company, the franchiser, allows an individual or firm, the franchisee, to operate a certain type of business under an established name, according to specific rules. The terms "franchise store" and "franchise" are interchangeable. According to the International Franchise Association, franchising takes one of two basic forms, either product/service distribution or business format.
Product/Service Distribution Form
The product/service distribution form of franchising encompasses two distinct types of arrangements, manufacturer sponsored retail systems and manufacturer sponsored wholesale systems. Manufacturer sponsored retail systems are prominent in the automobile and gas station industries. For example, Ford licenses dealers to use the Ford logo and sell its cars subject to various sales and service conditions.
Manufacturer sponsored wholesale systems often appear in the beverage industry. For instance, Coca-Cola licenses a wholesaler that purchases raw ingredients from Coca-Cola, and then carbonates, bottles, promotes and distributes Coca-Cola products to local stores and restaurants.
Business Format Form
The business format form of franchising includes two different arrangements, service sponsored retail franchise systems and service sponsored franchise systems. Service sponsored retail franchises are common in the restaurant, hotel and car rental industries. They are provided by firms that have designed a unique approach for performing a service.
Service sponsored franchise systems exist when individuals or firms are licensed to dispense a service under a trade name and specific guidelines. This occurs frequently in the staffing and tax preparation industries.
Although the two systems seem very similar, the difference is in the existence of a tangible product. Both hotel room rental and tax preparation are services, but when renting a hotel room, the room is physically occupied for a short period of time.
Franchiser & Franchisee Duties
The franchiser is responsible for assisting the franchisee in selecting an appropriate location, setting up the facility, initiating national advertising campaigns, and training personnel. In the business format form of franchising, the franchiser also provides step-by-step procedures for handling major aspects of business operation.
The franchisee is responsible for helping to preserve the brand and protecting their investment along with the investments of the other franchisees. The franchisee must pay a onetime franchise fee and annual royalties, and adhere to agreed upon product and service standards.
The franchisee can start a business with limited capital and benefit from the business experience of others. If any problems arise, the franchisee can receive guidance and advice from the franchiser. Nationally advertised franchises, such as McDonald's and Burger King, are guaranteed customers as soon as they open. Additionally, franchisees often receive materials to use in local advertising to benefit from the national promotional campaigns.
The franchiser gains additional outlets without incurring construction and operational costs, freeing up the franchiser's cash flow to expand production and advertising. The franchise agreement also ensures the franchise stores are operated according to its own standards.
A major drawback for a franchisee is the control exerted by the franchiser. The franchiser often dictates employee uniforms, facility layout, signage and other details of business operation. Plus, franchisees have to pay to use the franchiser's trade name and logo. Franchisees often must work extremely long hours, as they are responsible for the success of the business. Also, because annual fees are based on a percentage of sales, some franchisees may pay more than others for the same services.