Franchising 101 by Paul Connell, Peerless Franchises, LLC
Finding the best franchise opportunities for you can be the most rewarding and least risky way to start your own business. Here's what you need to know so you can decide if buying a franchise is right for you.
It's a very specific method or way of distributing goods and services through a variety of business models:
- In product franchises, a manufacturer grants a franchisee the right to sell its products, i.e. car dealerships and service stations.
- In name and process franchises, a franchisee is granted the rights to use a special process or recipe and to use the franchisor's name, such as Colonel Sanders' Kentucky Fried Chicken.
- In business format franchises, a franchisee is not only granted the right to use the name and sell the products or services of the franchise, but also the right and requirement to follow the total way of doing business developed by the franchise. Specifically, the franchise transfers all its operating systems, technical expertise, marketing systems, training systems, management methods and essentially all relevant information, to the new franchisee. The franchise also trains the new franchisee extensively up front and provides ongoing training and support throughout the life of the franchise agreement.
Business format franchising is the most successful method of distributing goods and services in economic history.
McDonald's epitomizes the power of franchising because it learned how to maximize the sales potential of a fast food outlet through systemization. McDonald's has an idiot-proof system for every aspect of their business – from how many seconds to perfectly cook French fries to the exact words employees use when addressing customers. McDonald's leaves nothing to chance or to employee discretion; there's a McDonald's way for everything and everything is done this way.
The core of McDonald's business format is the strict adherence to QSC: Quality, Service and Cleanliness. The McDonald's training program ensures that every franchisee implements their systems 100% of the time. Further, they developed a unique relationship with the franchisees, based on the fact that McDonald's owns the land and building for all the franchise units. McDonald's rents the business to the franchisee for a percentage of the gross sales of the unit.
The primary reason people buy a franchise is to minimize risk and enhance their chances of success. Here's why it does both.
- The top franchise opportunities offer minimal risk: Studies have proven that new (non-franchise) business startups have a much higher failure rate than starting a franchised business because the owners have to go through the learning curve of operating that specific type of business. Unfortunately, the market place is not very tolerant to new business owners. And if a new business fails, the owners often lose money, credit rating, and even their homes and business reputations. Unfortunately this happens to thousands of good people every year in the U.S. Unless you have considerable experience in the specific type business you're considering going into, odds are that you could fail within a short time.
- Business format franchising is as close as you'll come to a guarantee of success. Studies have shown that franchise business startups rarely fail. This is because the franchisor has already gone through the learning curve and developed the secrets of success for that specific business. When you buy a franchise with a strong model for growth and profits, you give yourself the best possible chance to succeed. This is mainly because you don't have to go it alone; franchises win when they support their franchise owners.
You can thoroughly research a franchise's performance before you make a commitment…unlike a new business startup (non-franchise), where you're always operating in the dark. The best franchise opportunities offer a wealth of information about the business, from how to compete against industry competitors to the best personality traits for the business. But the most important information comes from existing franchisees. When you ask them the following questions, you can "try on" the business to make sure it's a good fit for you.
- Do you feel you were properly trained?
- How long did it take before you reached break even?
- Have you felt supported every step of the way?
- What is your annual return on investment?
- How do you feel about the day-to-day duties of running the business?
- If you had it to do over, would you do it again?
Another important reason the best franchises work is because there are few restraints to growth. As a franchise system expands into hundreds of units, many positive things begin to happen. The name begins to become well known because people see it everywhere. Most people associate size with success. In addition, the large number of units enables the franchise to advertise heavily, which tends to increase sales for each franchisee. A synergy begins to be created in which success begets success. The franchise begins to squeeze out competition through its sheer size and buzz. The franchise can buy products in large quantity at significant discounts, which it passes on to the franchisees. This synergy keeps growing and growing.
The word franchise comes from old French meaning privilege or freedom. In the middle ages, a franchise was a privilege or a right in which the local sovereign or lord would grant the right to hold markets or fairs, to operate the local ferry or to hunt on his land. This concept extended to Kings granting a franchise for all manner of commercial activities such as building roads and the brewing of ale. In essence, the king was giving someone the right to a monopoly for a certain type of commercial activity. Over time, the regulations governing franchises became a part of European Common Law.
This franchising concept has evolved as the economies of the world have evolved. In the 1840's in Germany, certain major ale brewers granted franchises to certain taverns, giving those taverns the exclusive right to sell their ale. This was the beginning of the concept of franchising as we know it today.
Singer Stitches Together First Franchises
The first American franchise is reputed to be the Singer Sewing Center, developed by Isaac Singer in 1858. After Singer invented the sewing machine, he encountered two significant obstacles in bringing it to market. Consumers had to be taught how to use the new invention before they would buy, and Singer lacked the capital to manufacture his machine on a mass basis. Once Singer seized upon the idea of selling the rights to local business people to sell his machine and train users, his enterprise expanded rapidly. Fees for the license rights helped fund his manufacturing, and because each franchisee was self-financed, Singer was spared the expense of hiring each center's manager. Singer's franchise contracts were the forerunners of modern franchise agreements.
Business format franchising arrived after World War II with the return of the millions of US servicemen and women and the subsequent baby boom. There was an overwhelming need for all types of products and services, and franchising was the ideal business model for the rapid expansion of the hotel/motel and fast food industries.
During the explosion of the 60's and 70's, there were many abuses in franchising. A number of totally fraudulent franchise companies literally took peoples' money and ran, and a number of undercapitalized and poorly managed companies went bankrupt, leaving a trail of failed franchisees who had lost everything.
International Franchise Association Establishes Code of Ethics
It became clear that the franchise industry had to change in order to remain a viable business concept. On the industry side, The International Franchise Association (IFA) was created. It holds training in all aspects of franchising, which greatly enhances the professionalism of the industry. Members are required to adhere to the IFA's Code of Ethics. The IFA works closely with Congress and the Federal Trade Commission on improving how the industry relates to the franchisees.
On the government regulatory side, the Federal Trade Commission, in 1978, required that all franchisors submit to all potential franchisees a disclosure document called the Uniform Offering Circular (UFOC), before receiving monies. In July 2007, this document was renamed the Franchise Disclosure Document (FDD). The FDD provides detailed information on every franchise company, such as history, officers, litigation history, audited financial statements, the franchise agreement, which is the contract between the franchisor and franchisee, and a current list of franchises with owner information. The FDD's intent is to provide enough information so prospective franchisees can make informed decisions. The FTC doesn't actually review the FDD unless there's a complaint.
Some states, called registration states, have their own requirements that must be met before a franchisor is allowed to sell franchises in those states. In some cases, these requirements are more stringent than the FTC's. We'll help you check your state's requirements.
The growth of franchising is inevitable because it offers aspiring new business owners the best possible chance of succeeding with the least risk. Within a decade or less, franchising will comprise over 50% of the retail economy, will employ millions of people, and will enable hundreds of thousands to realize the American dream of successful business ownership.
As the U.S. and world economies grow and move toward free market economies, new franchise concepts will come on the scene and the solid, well-managed existing franchise companies will continue to grow.
Franchising is evolving; it's continually improving conceptually and in reality. There are greater opportunities for wealth creation among both franchisees and franchisors today then ever before. If you want to go into business for yourself, you should look closely at franchising as the vehicle to take you to where you want to be.
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