Chapter 15: Franchising
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CHAPTER 15
FRANCHISING
LEARNING OBJECTIVES
1.
Explain franchising and how this form of business ownership works.
2.
Describe steps entrepreneurs can take to establish a franchise system.
3.
Become familiar with the advantages and disadvantages of establishing a franchise
system.
4.
Describe actions and issues associated with a decision to buy a franchise.
5.
Explain the steps an entrepreneur goes through to buy a franchise.
6.
Identify and explain the various legal aspects associated with the franchise
relationship.
7.
Discuss two additional issues—franchise ethics and international franchising—
entrepreneurs should think about when considering franchising.
CHAPTER OVERVIEW
This chapter focuses on franchising. The chapter begins by discussing what franchising is
and describes the steps entrepreneurs can take to establish a franchise system. The
distinction between a product and trademark franchise and a business format franchise is
explained. The different types of franchise agreements (e.g., individual franchise
agreement, area franchise agreement, master franchise agreement) are also explained and
discussed.
The middle portion of the chapter looks at franchising from both the franchisor and the
franchisee’s point of view. An emphasis is placed on when franchising represents an
appropriate growth strategy and the steps to franchising a business. An emphasis is also
placed on how an individual knows if franchising is a good choice for him or her. The
common misconceptions about franchising are also discussed.
The chapter ends by talking about the legal aspects of franchising and the future of
franchising in the United States and abroad. Also discussed are franchise ethics and
international franchising.
CHAPTER OUTLINE
I. What Is Franchising and How Does It Work?
A. What Is Franchising?
B. How Does Franchising Work?
II. Establishing a Franchise System
A. When to Franchise
B. Steps to Franchising a Business
Chapter 15: Franchising
C. Selecting and Developing Effective Franchisees
III. Advantages and Disadvantages of Establishing a Franchise System
IV. Buying a Franchise
A. Is Franchising Right for You?
B. The Cost of a Franchise
C. Finding a Franchise
D. Advantages and Disadvantages of Buying a Franchise
V. Steps in Purchasing a Franchise
A. Watch Out! Common Misconceptions about Franchising
VI. Legal Aspects of the Franchise Relationship
A. Federal Rules and Regulations
B. State Rules and Regulations
VII. More About Franchising
A. Franchise Ethics
CHAPTER NOTES
I. What Is Franchising and How Does It Work?
Franchising is a form of business organization in which a firm that already has a
successful product or service (franchisor) licenses its trademark and method of
doing business to other businesses (franchisees) in exchange for an initial
franchise fee and an ongoing royalty.
Some franchises are established firms; others are first-time enterprises that
entrepreneurs are launching.
A. What Is Franchising? The word franchise comes from an old dialect of French
1. Many of the most familiar franchises in the United States, including KFC
(1952), McDonald’s (1955), Burger King (1955), and H&R Block (1958),
started in the post–World War II era of the 1940s and 1950s.
B. How Does Franchising Work? There is nothing magical about franchising. It is a
1. There are two distinctly different types of franchise systems. A product and
trademark franchise is an arrangement under which the franchisor grants to
the franchisee the right to buy its products and use its trade name. This
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C. Selecting and Developing Effective Franchisees
1. Table 15.2 in the textbook contains a list of the qualities that franchisors look
for in prospective franchisees and the steps that franchisors can take to
1. First, early in the life of an organization, capital is typically scarce, and rapid
2. Second, a management concept called agency theory, which we discussed in
Chapter 13, argues that for organizations with multiple units (such as
1. The primary disadvantage of franchising is that an organization allows others
to profit from its trademark and business method.
C. Table 15.3 in the textbook lists the primary advantages and disadvantages of
franchising as a means of business expansion.
IV. Buying a Franchise
A. Is Franchising Right for You?
2. Answering the following questions will help determine whether franchising is
a good fit for people thinking about starting their own business.
a. Are you willing to take orders?
b. Are you willing to be part of a franchise “system” rather than be an
independent businessperson?
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c. How will you react if you make a suggestion to your franchisor and your
suggestion is rejected?
d. What are you looking for in a business?
e. How willing are you to put your money at risk?
1. The initial cost of a business format franchise varies, depending on the
2. Table 15.4 in the textbook shows the costs of buying into several franchise
organizations.
3. The following costs are typically associated with buying a business format
franchise:
a. Initial franchise fee
b. Capital requirements
C. Finding a Franchise
2. There are many periodicals, Web sites, and associations that provide
information about franchise opportunities. Every Thursday and Saturday, for
example, ads for franchise opportunities appear in special sections of The Wall
Street Journal. Similar ads appear every Wednesday in USA Today.
Magazines featuring franchise organizations include Inc. and Entrepreneur.
D. Advantages and Disadvantages of Buying a Franchise
1. There are two primary advantages to buying a franchise over other forms of
business ownership.
a. First, franchising provides an entrepreneur the ability to own a business
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2. The main disadvantage of buying a franchise is the cost involved.
3. Table 15.6 contains a list of the advantages and disadvantages of buying a
franchise.
V. Steps in Purchasing a Franchise
Purchasing a franchise is a seven-step process, as illustrated in Figure 15.3 in the
textbook.
A. Watch Out! Common Misconceptions about Franchising
1. The following is a list of misconceptions that franchisees often have about
franchising:
a. Franchising is a safe investment.
b. A strong industry ensures franchise success.
c. A franchise is a “proven” business system.
VI. Legal Aspects of the Franchise Relationship
A. Federal Rules and Regulations
1. The offer and sale of a franchise is regulated at the federal level. According to
2. In most cases, the disclosures are made through a lengthy document referred
to as the Franchise Disclosure Document (FDD). The FDD contains 23
categories of information that give prospective franchisees a broad base of
information about the background and financial health of the franchisor.
Note: The Franchise Disclosure Document used to be called the Uniform
Franchise Disclosure Document.
3. The FDD requires the franchisor to attach a copy of the franchise agreement
and any other related contractual documents to the circular. The franchise
agreement, or contract, is the document that consummates the sale of the
franchise.
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B. State Rules and Regulations
1. In addition to the FTC disclosure requirements, 15 states have laws providing
2. In most of these states, a franchisor is required to file its FDD with a
designated state agency, making the FDD public record.
VII. More About Franchising
A. Franchise Ethics
2. There are certain features about franchising, however, that make it subject to
ethical abuse. An understanding of these features can help franchisors and
franchisees guard against making ethical mistakes. These features are as
follows:
B. International Franchising
1. International opportunities for franchising are becoming more prevalent as the
2. Foreign firms are also taking advantage of the trend toward globalization and
are offering franchises in the United States and other countries.
3. Steps to take before buying a franchise in a foreign country are listed in the
textbook.
C. The Future of Franchising
1. The future of franchising appears bright. Franchise opportunities represent a
larger and growing segment of the retail and service sectors of U.S. businesses
and are in some cases replacing more traditional forms of small business
ownership.
Chapter 15: Franchising
BOXED FEATURES: QUESTIONS FOR CRITICAL THINKING
What Went Wrong?
Down But Not Out: What Happened to Sbarro and Will It Make a Comeback?
1.
Why do you think Sbarro stuck with its strategy of operating out of food courts in
malls, even when it was evident that mall foot traffic was declining?
Answer: In retrospect it seems obvious that a mall-based chain was vulnerable to a
decline in mall traffic. Imagine in 2004 if somebody told Sbarro that, starting in a
year’s time, no new malls would be opened in the U.S.! 2004 was when Sbarro’s
hit its financial peak. When you have established a position as the go-to place in a
mall (as the case says, people shopped at JCPenney, Gap, and Waldenbooks at the
mall and then ate at Sbarro’s), it is hard to change your strategy.
2.
What are three things that food franchisors and their franchisees can learn from
Sbarro’s experience?
Answer: One thing that franchisors should learn is adaptation in its offerings. This
is extremely important in the food industry. The sight of greasy pizza, pre-made
and sitting for a while under hot lights was something that the market had pretty
much forsaken for fresher offerings. The second is adaptation in terms of format.
Fast food is a product where the decision largely rests on whether the outlet is
accessible. This means that food outlets should be where there is traffic. Mall
traffic was declining and this affected Sbarro adversely. Third, one has to adapt to
changing shopping behavior. Most Americans are comfortable with doing things
online. A food franchisor has to augment its offerings by integrating the web,
much like what Starbucks does in facilitating mobile payments that quicken the
delivery.
3.
Was Slate.com justified in calling Sbarro “America’s least essential restaurant?”
Answer: There is a strong case to be made for how Slate.com labeled Sbarro. It
was least essential because it was where people were not (malls) and it offered
something that people did not want (pre-cooked food).
4.
On a scale of 1 to 10 (10 is high), how likely is it that Sbarro will become a major
pizza franchise again? Explain your answer.
Answer: This is a good question for an individual or group assignment. Most
students will say that Sbarro’s time has passed, but some could argue that if they
pivot by locating in non-mall high traffic areas and offer fresh food, they have a
chance to succeed again.
Chapter 15: Franchising
Savvy Entrepreneurial Firm
Wahoo’s Fish Taco: A Moderate-Growth Yet Highly Successful Franchise Organization
1.
What are the advantages and disadvantages of Wahoo’s Fish Taco’s slow growth
philosophy of franchise expansion?
Answer: The advantage of Wahoo’s Fish Taco’s slow growth philosophy of
franchise expansion is that the company can deliberately and thoughtfully
incorporate everything it’s learned from its previous locations into its new
locations. It can also be selective in who it picks as franchisees and where its
franchise outlets are located, because it’s not moving at a rapid pace. The
disadvantage of slow growth is that the company may not be fully leveraging its
expertise and brand. It may be in effect “leaving money on the table” by not
expanding its concept faster to different geographic locations.
2.
Spend some time looking at Wahoo’s Fish Taco’s Web site, focusing particularly
on its menu and its store layout. Do you think the business is well positioned or
poorly positioned to take advantage of current trends in the types of restaurants
that are doing well and in light of today’s food preferences? Explain your answer.
Answer: This is a good question for an individual or group assignment. In regard
to Wahoo’s menu, most students will say Wahoo’s is well positioned to take
advantage of the trend for healthier eating, given its emphasis on fish, chicken,
salads, and vegetable dishes. It even has a tofu offering. It’s more difficult to
discern whether the company configures its stores in a manner that is consistent
with current trends. Photos of exterior and interior shots of their stores, which can
be accessed via Google Images, protray their stores as very modern and hip.
3.
To what degree do you think Wahoo’s Fish Taco has been too conservative in its
expansion?
Answer: This is a good thought question because there is not a single correct
answer. On the one hand, Wahoo’s has benefited from its measured pace of
growth, as discussed in the answer to Question 1. On the other hand, it’s clear that
Wahoo’s may be “leaving money on the table” if it has more qualified franchisees
than it’s willing to accommodate.
4.
Spend some time studying the cost of becoming a Wahoo’s Fish Tacho franchisee
compared to similar franchise organizations. Is the cost of acquiring and owning a
Wahoo’s Fish Taco franchise on the high end, in the middle, or on the low end
compared to its closest competitors? To what degree do you believe your answer
has affected Wahoo’s pace of growth?
Answer: Wahoo’s is on par with similar restaurant franchises. It’s initial
Chapter 15: Franchising
an initial investment of $594,000–$795,000, has a $30,000 franchise fee, and
charges a 5 percent royalty. Some nationally branded restaurant chains have even
higher fees. Taco Bell, for example, requires a $1 million to $2 million total
investment, has a $45,000 franchise fee, and charges a 5.5 percent royalty. Based
on these numbers, it’s hard to argue that the costs of becoming a Wahoo’s
franchisee has affected the company’s pace of growth, either positively or
negatively.
Partnering for Success
Franchises Partner with Nonprofits to Give Back
1.
Identify an ideal nonprofit for a fitness center franchise that caters to college
students to partner with. Describe the rationale for your selection. You can pick a
nonprofit that is local to your area or a nonprofit that has a national presence.
Answer: Students should be encouraged to think of ideas on their own. One
possibility could be the Boys and Girls Club of America where the fitness center
could encourage both its employees and customers (college students) to volunteer
to be mentors or coaches. A second example would be Junior Achievement, to go
into classrooms and teach impressionable young minds.
2.
If you worked for a home improvement or home repair franchise organization, to
what degree would it enhance your commitment to the organization if they
allowed you to donate a certain number of hours to a nonprofit such as Habitat for
Humanity “on the clock”?
Answer: This is a question that asks students to share their feelings about doing
volunteer work on the clock. This is a good question for a classroom discussion.
3.
Do some Internet research and identify a partnership between a franchise
organization and a nonprofit that is not mentioned in this feature. Describe the
purpose of the partnership and how the franchise organization and the nonprofit
both benefit.
Answer: This is a good question for an individual or a group assignment.
4.
Brainstorm a fourth potential rule-of-thumb that would facilitate a successful
franchise organization/nonprofit partnership.
Answer: This is a good question for a classroom assignment.
15-1.
What is franchising?
Answer: Franchising is a form of business organization in which a firm that
already has a successful product or service (franchisor) licenses its trademark
and method of doing business to other businesses (franchisees) in exchange for
an initial franchisee fee and an ongoing royalty.
15-2.
How does franchising differ from other forms of business ownership?
MyLab Question.
15-3.
What are the differences between a product and trademark franchise and a
business format franchise? Provide at least two examples of both types of
franchise arrangements.
Answer: A product and trademark franchise is an arrangement under which the
franchisor grants to the franchisee the right to buy its products and use its trade
name. This approach typically connects a single manufacturer with a network of
dealers or distributors. Examples of this type of arrangement are automobile
dealerships and soft drink franchises. In a business format franchise, the
franchisor provides a formula for doing business to the franchisee along with
training, advertising, and other forms of assistance. Examples include fast-food
restaurants and hotels.
15-4.
What are the differences among an individual franchise agreement, an area
franchise agreement, and a master franchise agreement?
Answer: An individual franchise agreement involves the sale of a single
franchise for a specific location. An area franchise agreement allows a
franchisee to own and operate a specific number of outlets in a particular
geographic area. A master franchise agreement is similar to an area franchise
agreement, with one major difference. A master franchise, in addition to having
the right to open and operate a specific number of locations in a particular area,
also has the right to offer and sell the franchise to other people in its area.
15-5.
Why is it important for a franchisor to develop detailed and thorough operating
manuals?
Answer: So the franchisees can quickly learn the business methods and systems
and procedures of the franchisor.
