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Franchising Yesterday, today and tomorrow

Written by : Michel Gagnon
Franchising is about a lot more than restaurants. More than 30 industry segments are franchised in Canada, from specialty retail and cleaning services to business training and fitness centres. There are more than 1,000 franchise systems operating in this country, accounting for nearly 76,000 franchised outlets. Franchise sales represent $100 billion a year and the fastest growing demographic of franchise buyers is women. While initially developed for businesses servicing consumers, franchising is now entrenched in business-to-business (B-to-B) industries as well.

Obviously, Canadian franchising is alive and growing. However, franchising is not just a North American phenomenon. Canada and the U.S. combined represent less than 22 per cent of the global franchise industry, which contains more than 17,500 franchise systems and 1.2 million franchisees. In some countries, including Australia and South Africa, a large percentage of systems are homegrown. Franchising has become a truly international business format, employing 13 million people and exceeding $1.4 trillion US in global sales each year.

Despite its success, even franchising has its limits. Concepts totally dependent on the originator's skills or personality cannot be franchised. For example, a celebrated chef or successful lawyer could pass along his techniques through a procedural manual but cannot do the same for innate talent. Franchising is also a poor fit for manufacturing or primary industries, due in part to their high levels of capitalization.

How we got here

The beginning of franchising traces back several centuries. During the Middle Ages, members of the royal court and other nobles granted rights to hold markets and operate other business services in exchange for a royalty. ("Royalty' derives from "royal tithe.') One of the advantages this royalty bought was protection. It's therefore appropriate that "franchise' originally meant "free,' since it was only with the protection of the local lord that business people in this era could feel free to conduct their affairs.

The years that followed saw great expansion and creativity in the business world. The first murmurs of brand awareness appeared in 19th-century England and Germany, where pub owners became exclusive distributors for particular breweries. As the breweries maintained no regular control over the pubs, they were able to act as entrepreneurs selling someone else's distinctive product.

True franchising appeared not long after. In 1850, American inventor Isaac M. Singer found himself too poor to manufacture his innovative sewing machines. He also struggled because people refused to buy his machines without being trained to use them—a service retailers couldn't or wouldn't provide. Singer solved both his problems by charging licensing fees to other businessmen, who then owned the rights to sell and repair his machines in certain areas. His scheme provided money for the machines' production and also forced licensees to teach people how to use them. Singer opened his first franchise in 1851 with great success, expanding manufacturing to Canada in 1873.

The idea caught on. In the 20th century, new technologies drove franchising into many industries. Among the first were gas stations, which franchised to keep pace with Henry Ford's franchised Model T dealerships. The middle decades were even more explosive, as the postwar "baby boom' created great demand for products of all kinds. Between 1950 and 1960, the number of franchised companies grew from about 100 to 900 in the United States alone.

Perhaps the most well-known franchise of all was born when a milkshake mixer salesman named Ray Kroc came across the McDonald brothers' San Bernardino, Calif., hamburger stand in 1954. The pair bought his mixers in large numbers thanks to their high-volume, low-cost production system. Kroc saw the franchise possibilities, became their licensing agent and started recruiting franchisees. He bought the brothers out in 1961.

Franchising today

At its core, franchising can be defined as one party—the franchisor—providing services to another party—the franchisee—who in turn sells the franchisor's products to a consumer. The franchisor and franchisee share in the profit, with the former usually getting his or her share from a royalty on the sale. The franchisee realizes his or her share from the sale itself, less the royalty, cost of sales and operating expenses. It would not be practical for the franchisor to get royalties on the franchisee's profits, since this would require a closer partnership than either typically wants. For example, the franchisor would need to approve all the franchisee's expenses, since those expenses would affect the royalties.

Many franchises are "turnkey' businesses, whereby the franchisor handles almost everything in order to provide the franchisee with a unit ready to operate. The franchisor wants to expand his or her system to increase market share and profits, but there is a limit to how much capital can be invested and how well control can be maintained as the network of units grows. Franchising solves these problems because it combines the franchisor's experience with the franchisee's capital and desire to succeed. Even though the system is owned by the franchisor who created it, the franchisee contributes to its operation in vital ways.

The franchisor's experience advantage

Typically, the originator of a business concept operates it for a few years, either alone or with partners, before trying to franchise it. In that time, he or she will have modified and adapted the concept, often by trial and error. To franchise effectively, the potential franchisor must meet three conditions:

  1. Profitability

  2. The business concept has proven it can make money and provide a decent return on investment (ROI) once all expenses, royalties, etc., have been factored in.

  3. Replicability

  4. The concept can be reproduced from one unit to the next by someone with sufficient training/materials but no prior experience.

  5. Added value
The concept requires franchisor input to maintain its success. The franchisor's brand recognition and marketing strategy allows the business to be promoted efficiently and effectively to the customer.

Once these conditions have been met, the potential franchisor begins assembling the tools every franchise system requires to function:

  • Product sourcing allows the franchisor to determine where, how and in what amounts the raw material needed to make the product will reach the franchisee;

  • Operating manuals tell the franchisee how to make and market the products, how to service the client, how to maintain the standards of the franchise, etc.;

  • Standardized store design, logos, furniture, etc., allow the customer to easily recognize any outlet as part of the franchise system.

  • The franchisee's capital and desire

    The typical franchisee is (or has been) a company employee and may have limited knowledge of business, at least in the franchisor's industry. It therefore makes sense to start a business with a proven system, through which the inexperienced franchisee receives assistance with site-selection/construction, banking, marketing, store operation, product knowledge and more. However, no amount of help will be enough if the franchisee lacks the necessary capital to start.

    The franchisee must also dream of being an entrepreneur while still being willing to follow a system. Just as there are company owners who would make bad franchisors, there are certainly talented people who make poor franchisees. Franchising is about working as a team and following a set of time-tested guidelines. Yes, the contribution of franchisees is crucial (they provide some of a franchisor's best ideas), but in order for the system to work, rules must be adhered to. Franchisees also face problems when they view the franchise system as a free ride to success. Owning any business demands hard work, long hours, self-confidence and a strong work ethic. People unable to provide these things should remain employees.

    Variations in the franchise model

    Due to the importance of having the owner on-site, some franchisors will refuse to grant anyone a second outlet. Nevertheless, many franchisees are no longer limited to the basic format of "one franchisee, one store.' Here are some of the more popular ways a franchisee's role can be expanded:

    Multi-store ownership

    Some concepts lend themselves well to multiple locations within an area. Franchisees with more management skills (and more capital) may therefore be encouraged to run more than one franchised unit.

    Area development

    Area developers are franchisees who take on the additional role of recruiting new franchisees within their regions. The franchisor will often ask them to assist with some support functions for the franchisees in the area, even for those the area developer didn't scout. While this is more work, area developers also enjoy added revenue.

    Master franchising

    Master franchisees act on the franchisor's behalf in a large geographic area (in many cases, an entire country). The master franchisee signs franchise agreements with the franchisees he or she has recruited and supplies most of their support functions. In most cases, the master franchisee will still be the owner of at least one franchise unit.

    As franchisors are fond of saying, a franchise lets you be in business "for yourself' but not "by yourself.' The advantages of a known brand and experienced support continue to draw thousands of new entrepreneurs to the franchise life every year. As a result, franchising has evolved into a complex and diverse business model. With a little capital and a lot of drive, you too can be part of this worldwide phenomenon.

    Michel Gagnon is president of Davier Consultants Inc., a franchise consulting firm based in Montreal.

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