Historical development

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The emergence of the modern concept of franchising occurred in the US just after the Civil War with the activities of the Singer Sewing Machine Company (Goncalves and Duarte, 1994). However, it was not until the beginning of the 20th century that this method of business development gained wider acceptance. The automobile industry and the soft drinks industry were the first to adopt the so-called product and trademark franchising. By the 1930s the petroleum industry was franchising gasoline/petrol service stations. The real expansion of franchising took place in the 1950s, with the appearance of business format franchising. This type of franchising is also known as second generation franchising, and is characterized by an ongoing relationship between the franchisor and the franchisee. This includes the product or service, trademark, as well as the entire business concept - a marketing strategy and plan, operating manuals and standards, quality control and a continuing process of assistance and guidance.

Business format franchising continued to grow and develop throughout the 1950s and 1960s, but it was not until the early 1970s that these successful domestic chains began to apply their franchising concepts internationally. Initially the expansion took place in markets which were most accessible or had good, market potential, low cultural distance and the existence of a developed, service sector. Thus, Canada became a prime target for international expansion, followed by the UK and Australia. Development of franchising in Japan was facilitated by the use of a master franchise agreement. This reduced the need for direct involvement in the development of operations in what was, especially for Americans, a very unique culture. A master franchise usually has responsibility for more than one outlet and is commonly totally responsible for the development of the franchised business (through other franchisees) in an area. By 1988 Canada, the UK, Australia and Japan accounted for 70% of the total US international franchised outlets.

Franchising business models

'Franchising' is used to describe a number of business models, the most commonly identified of which is business format franchising. However, there are other models which are also dependent on franchise relationships. These include:

1. Manufacturer-retailer - where the retailer as franchisee sells the franchisor's product directly to the public, (for example new motor vehicle dealerships).

2. Manufacturer-wholesaler - where the franchisee under licence manufactures and distributes the franchisor's product (for example soft drink bottling arrangements).

3. Wholesaler-retailer - where the retailer as franchisee purchases products for retail sale from a franchisor wholesaler (frequently a co-operative of the franchisee retailers who have formed a wholesaling company through which they are contractually obliged to purchase, for example hardware and automotive product stores).

4. Retailer-retailer - where the franchisor markets a service or a produce under a common name and standardized system through a network of franchisees, that is, the classic business format franchise.

The first two categories above are often referred to as product and trade name franchises. These include arrangements in which franchisees are granted the right to distribute a manufacturer's product within a specified territory or at a specific location, generally with the use of the manufacturer's identifying name or trademark, in exchange for fees or royalties.

The business format franchise, however, differs from product and trade name franchises through the use of a format, or a comprehensive system for the conduct of the business, including such elements as business planning, management system, location, appearance and image, and quality of goods. Standardization, consistency and uniformity across all aspects are hallmarks of the business format franchise.

Under a business format franchise the franchisees operate the franchise in a standard way under a common trademarked name. The kinds of businesses operating under such a system can include fast food restaurants, courier services, cleaning services, employment or estate agents, kitchen or bathroom installers. The options, in ascending order of initial investment, are:

■ Job franchise - usually a one-person self-employed business that the franchisee runs from their own home, such as local deliveries, drain clearance, car repairs.

■ Business franchise - generally involves a larger investment in business premises and equipment, employing and training staff, such as fast food restaurants, quick print outlets and card shops

■ Investment franchise - here the franchisee is working for a return on their relatively large investment, such as in a hotel or major retail franchise.

With a business format franchise, the franchisees will be operating as satellite enterprises of an already proven larger business under its established trade name. The satellites sell its products or services along specified lines.

The franchisor can expect from the franchisees:

■ An initial fee to purchase the business system. The fee should also cover initial training and support

■ A continuing management service fee, typically 5-10% of their sales turnover.

The franchisee gains:

■ The use of an established trade name

■ Prime rights within a particular area

■ Support and advice from head office covering central marketing, promotion and administrative back-up

■ Continuous market research leading to further development of the product or service concerned.

Why businesses franchise

Companies can expand in a number of ways and full ownership of new outlets is perhaps the most obvious way forward. However, having fully assessed the costs and risks of expansion, some organizations decide to follow the franchising route; why? Combs and Castrogiovanni (1994) suggest three reasons why franchising is used. These are resource scarcity, agency theory and risk spreading.

Resource scarcity means that a company needs access to management talent or other knowledge not available to them, and at the same time may not have a large amount of money to invest in the expansion. Agency theory is about the way in which those people who manage the outlet are motivated and monitored. Since franchisees have considerable financial investments at stake, and since they receive profits from the outlet then they are more motivated than managers of firm-owned units to work hard to make the franchise profitable. Risk spreading, compensating for the decisions surrounding any expansion, is accomplished through franchising. The investment risk is lowered through franchising compared with joint ventures, which can involve large capital investments and legal complications. Franchising creates sales and brand recognition at a much lower cost. In international expansion the political risk and the overall risk of failure are primarily borne by the franchisee.

Dant (1995) identifies seven reasons why successful, growth orientated businesses may well take the franchising route to expansion:

■ Access to capital

■ Access to management talent

■ Access to local market knowledge

■ Economies of production

■ Economies of promotion

■ Economies of co-ordination

* In-built disincentives to agent-shirking (lack of responsibility taken by staff).

The time scale required by franchising is seen as faster than self-owned expansion, which will often require more monitoring. The process of establishing a chain of franchises increases the knowledge of the franchisor, and the time required for each new outlet is reduced as expertise increases. With experience the franchisor develops sensitivity to site selection, store layout, procurement and operating policies appropriate to particular environmental settings.

Box 11.2 provides an introduction to the 'sales pitch' from Allied Domecq for three of its brands, two of which are internationally famous as Dunkin' Donuts and Baskin Robbins.

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