Chapter 15: Franchising
information about franchise opportunities. Every Thursday and Saturday, for
example, ads for franchise opportunities appear in special sections of The Wall
franchising. There is just no compelling reason to replicate the business in
additional locations. Similarly, a lawn and garden business in North Dakota,
that offers no source of income for its franchisees during the long winter
months, probably isn’t suitable for franchising. The exception would be if the
business is marketed as a seasonal business, and the franchisees had other
sources of income during the winter months.
15-9.
What are some of the issues an entrepreneur should consider when answering
the question, “Is franchising a good choice for me?”
MyLab Question.
15-10.
What are the costs involved in purchasing a business format franchise? Are
these costs similar across franchise systems, or do they vary widely? Which
costs are one-time costs and which costs continue indefinitely?
Answer: The following costs are typically associated with buying a business
unit franchise.
Initial franchise fee
Capital requirements
Continuing royalty payment
Advertising fee
Other fees
Costs vary widely across franchise systems (think of Burger King versus a new
franchise organization), with the exception of the continuing royalty payment.
Royalty fees are usually around 5 percent of gross income. The only one-time
costs are the initial franchise fee and the initial capital costs of getting the
franchise up and running (such as buying property and constructing a building).
The royalty payments continue indefinitely. Advertising and other fees are
typically assessed periodically, but theoretically can continue indefinitely.
15-11.
Typically, if an individual franchise unit is losing money, does it still have to
pay a monthly royalty to the franchisor? Explain your answer.
Answer: Yes. Franchisees pay royalties based on a percentage of gross rather
than net income. This means that even if they are losing money (i.e., negative
clientele, the success of an individual McDonald’s or an individual Panera
Bread still boils down to how effectively the franchisee runs that particular
outlet.
15-16.
What is the purpose of the Franchise Disclosure Document (FDD)? Are there
any regulations regarding when the FDD must be provided to a prospective
franchisee? If so, what are they?
Answer: The offer and sale of a franchise is regulated at the federal level.
According to the Federal Trade Commission (FTC) Rule 436, franchisors must
furnish potential franchisees with written disclosures that provide information
about the franchisor, the franchised business, and the franchise relationship.
These disclosures are made through a lengthy document referred to as the
Franchise Disclosure Document (FDD), which is accepted in all 50 states and
parts of Canada. The FDD must be supplied by the franchisor to the prospective
franchisee at least 10 business days before the franchise agreement can be
signed.
15-17.
What is the purpose of a franchise agreement?
Answer: The franchise agreement, or contract, is the document that
consummates the sale of the franchise. Although franchise agreements vary,
each agreement typically contains two sections: the purchase agreement and the
franchise or license agreement.
15-18.
What are some of the aspects of franchising that make it subject to ethical
abuses?
Answer: There are at least three aspects of franchising that make it subject to
ethical abuse. These are:
The get-rich-quick mentality
The false assumption that buying a franchise is a guarantee of business
success
Conflicts of interest between franchisors and franchisees
15-19.
For U.S. citizens, what are the main issues that should be considered before
buying a franchise in a foreign country?
Answer: For U.S. citizens, some of the main issues to consider before buying a
franchise in a foreign country are as follows:
Find out how much training and support you will receive from the
franchisor.
Evaluate currency restrictions.
15-20.
What are the main reasons that many U.S. franchise systems are expanding into
global markets? Do you think this expansion will continue to gain momentum
or decline over time?
Answer: There are several reasons that are motivating U.S. franchise systems to
expand into global markets:
The U.S. market for many franchised products is saturated.
The trend toward globalization is hastening the trend toward international
franchising.
Regional initiatives, such as NAFTA, are making it increasingly attractive
for U.S. firms to offer franchises for sale in foreign countries.
Challenge your students to find good examples of U.S. franchise systems that
are expanding overseas.
APPLICATION QUESTIONS
15-21.
A friend of yours heard her roommates talking about different kinds of
franchises. Before she could ask questions, they left for a team meeting to work
on a class project. Your friend knows that you are taking an entrepreneurship
course. She asks you: “What are the differences between a product and
trademark franchise and a business format franchise?” For a first-time
entrepreneur, she wonders, is there an advantage to one of these types of
franchise arrangements compared to the other one? If so, which one is more
advantageous for the first-time entrepreneur to pursue and why? What
responses would you provide to your friend?
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
distributors. For example, General Motors has established a network of dealers
that sell GM cars and use the GM trademark in their advertising and
promotions. 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. Most students will argue that the business format franchise
is the better choice for a first-time entrepreneur. It is much less expensive to
franchise, which is a franchise that helps homeowners and businesses restore
15-22.
Identify a franchise location near where you live and ask to talk to the owner.
Show the owner one of the two “You Be the VC” features at the end of the
chapter and ask the person whether he or she thinks the company will be
successful. Write a brief summary of the owner’s response.
Answer: This is a good question for an individual or a group assignment.
15-23.
Bill Watts has decided to buy a sub shop franchise called Super Subs. He lives
in Cedar Falls, Iowa, and will be the first Super Subs franchisee in the state.
Along with buying a Super Subs franchise, Bill would also like to purchase the
rights to offer and sell Super Subs franchises to other people in the Cedar Falls
area. What type of franchise agreement should Bill negotiate with Super Subs?
For Bill, what are the advantages and disadvantages of this type of
arrangement?
Answer: Bill should buy an area franchise agreement that gives him the right to
own and operate a specific number of Super Sub franchises in Cedar Falls,
Iowa. Sometimes area franchise agreements give the franchisee “exclusive”
rights to open franchise outlets within a certain geographic area and sometimes
they don’t. This is an issue that is typically part of the negotiations when an area
franchise agreement is sold. For the franchisee, the advantage of owning an area
franchise agreement is that he or she doesn’t have to negotiate multiple
individual franchise agreements. The disadvantage is that the franchisee
deepens his or her commitment to a single franchise system.
15-24.
A growing number of franchise organizations, including Wings Over, Great
Harvest Bread Company, and Beef O’ Brady’s, are allowing their franchisees to
tweak their menus and change the appearances of their facilities, to better
compete with local businesses. Do you think this is a good idea? What are the
advantages and disadvantages of this approach?
Answer: Most students will think this is a good idea. Although one of the staple
concepts of franchising is to provide customers a consistent experience, in most
cases allowing a few tweaks to accommodate local competitive conditions
makes sense. The advantage of this is that it enables the generation of good
ideas. The disadvantage of this is that it reduced consistency.
15-25.
Look at Table 15.4. If you were offered the opportunity to buy into any one of
the franchise organizations listed in Table 15.4, which one would it be? Explain
the rationale for your selection.
Answer: Students will vary in terms of their answers to this question.
15-26.
A friend of yours owns a carpet and installation business, which is a full-time
Chapter 15: Franchising
property that has been damaged by a flood or water leak. His thinking is that he
already has most of the equipment he needs to perform this type of service and
has an experienced crew. Is your friend a good candidate for a 1-800-Water-
Damage franchise? If not, what type of franchise could he buy that might be a
good fit with his current business?
Answer: Most students will say that the individual referred to in the question is
a good candidate for a 1-800-Water-Damage franchise. He has the equipment,
expertise, and crew to complete the work that’s required of a 1-800-Water-
Damage franchisee. The only downside is that if it isn’t his primary occupation,
he may not prioritize 1-800-Water-Damage’s jobs to the same degree that full–
time 1-800-Water-Damage franchisees do. This could be a problem, because
water damage is a problem that needs to be addressed quickly. Still, he
represents a good candidate for a 1-800-Water-Damage franchisee. An
increasing number of people just like the individual mentioned in the article are
becoming franchisees of companies like 1-800-Water-Damage to fill unused
time and to better leverage the value of the equipment and expertise they
already have.
15-27.
Suppose you became interested in opening a School of Rock franchise (see
Case 15.2 for more information about this company). You fly to Philadelphia
and visit the company’s headquarters. After learning more about the
opportunity, you tell the School of Rock representatives that you’re really
interested and would like to move forward. If School of Rock follows the
procedures it’s supposed to in negotiating with you as a prospective franchisee,
what should you expect from this point forward?
Answer: School of Rock should provide you a copy of their Franchise
Disclosure Document, and notify you that you have 14 business days to review
the document before you’re required to sign a franchise agreement. A copy of
the franchise agreement should also be supplied. During the 14 business days
you’re reviewing the documents, School of Rock should be open to any
inquiries you or your franchise attorney have about School of Rock in general
or the terms of the franchise agreement.
YOU BE THE VC 15.1
Company: iLoveKickboxing.com (www.iLoveKickboxing.com)
Business Idea: Create a workout studio franchise that allows patrons to strap on gloves
and punch and kick their way to a healthier, happier, and fitter life.
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326
You Be the VC Scorecard
iLoveKickboxing.com
(www.iLoveKickboxing.com)
Item
Score/Comments
Strength of New-Venture
Team
1 2 3 4 5
Michael Parella founded iLoveKickboxing in 2009. He
comes with a fitness background. He has built a team of
professionals consisting of people well-versed in various
business functions. The 12-member executive staff seem
quite capable of managing the company’s growth.
Strength of the Opportunity
1 2 3 4 5
We believe the opportunity is moderately strong.
Kickboxing has obvious benefits – as a fitness method,
as a way to relieve stress, and as a way to develop self-
defense skills. All this is accomplished in a communal
setting. However, kickboxing is one of several fitness
options and so it has to compete will all these options.
Strength of the Industry
1 2 3 4 5
The personal fitness market is a $28 billion market that
is growing as more people realize the benefits of
exercise. About 25 million Americans use fitness centers
at least once a month. The industry is fragmented and
consists of several distinct segments, of which
kickboxing is one.
Strength of Business Model
1 2 3 4 5
The business model is sound. It does not cost a lot of
money to be a franchisee ($120,000 to $312,000) and
the 7 percent royalty fee (base plus ad) appears
reasonable. There is minimal investment in the facility
which makes it an attractive franchise. While the value
proposition is sound, at the end of the day, kickboxing is
one of many options.
Average Score
3.0/5.0
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327
YOU BE THE VC 15.2
Company: IceBorn (www.ice-born.com)
Business Idea: Develop a 24-hour-a-day, convenient, on-demand ice vending destination
offering fresh, clean ice at a competitive price.
You Be the VC Scorecard
IceBorn
(www.ice-born.com)
Item
Score/Comments
Strength of New-Venture
Team
1 2 3 4 5
IceBorn is led by CEO Jeff Chiarugi. Chiarugi has more
than 30 years of experience in sales, manufacturing, and
executive management. IceBorn and its parent company,
IHA Holdings, were acquired in 2014 by Ulysses
Management, a New York–based investment firm.
Ulysses Management has substantial experience in
providing management and operations oversight for its
portfolio companies.
Strength of the Opportunity
1 2 3 4 5
We believe the opportunity is strong. Almost everyone
purchases packaged ice (at least occasionally), and ice is
a consumable commodity, which means that it must be
continually repurchased. The way IceBorn dispenses ice
is also very appealing. It’s easy to sell the story that it’s
safer and fresher to buy IceBorn ice than ice from a
traditional ice machine, a grocery store, or a gas station.
The fact that ice is a $4 billion industry is attractive.
IceBorn currently has only a small sliver of the
packaged ice market which provides it substantial upside
potential.
Strength of the Industry
1 2 3 4 5
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328
The bagged ice industry is a $4 billion industry and is
growing. Ice vending represents only 4 percent of that
market, giving IceBorn substantial upside potential.
IceBorn is well positioned to capitalize on industry
growth as a result of its strong brand and its proprietary
method of dispensing ice. We also like the fact that the
company has five patents on its ice vending technology,
which means that no one will be able to dispense ice in
the exact manner that IceBorn does. Packaged ice is not
a sexy industry, but it is a consumable product that
nearly everyone uses.
Strength of Business Model
1 2 3 4 5
The business model is sound. IceBorn offers three
different types of vending models, from the 6,000 pound
bin capacity ICEBORN House to the smaller ICEBORN
Express (which looks like a traditional vending
machine). The entry point for the ICEBORN express is
$19,000, putting it within the reach of a large number of
potential franchisees. ICEBORN units require minimal
maintenance, meaning that people with jobs can
purchase an ICEBORN franchise and manage the
franchise in their spare time. We like the fact that the
company is targeting veterans. Franchisees have a low
COGS and high margins because the major input is
water. The company offers franchisees access to
financing, which expands the number of potential
franchisees.
Average Score
4.5/5.0
Decision: We would fund this firm. It has strong management, is in a growing industry,
and has a solid business model. We also like the fact that the company is targeting
veterans. The “story” the company has to sell is also very appealing. Almost everyone
has had a bad experience purchasing packaged ice from a grocery store or gas station.
The fact that IceBorn’s ice is made on demand, and the first person to touch the ice is the
customer, is an attractive idea to sell. Ice is obviously a consumable, which means that
the franchisees will have repeat customers. The low price point of becoming a franchisee
suggests that IceBorn has the potential to grow quickly.
Chapter 15: Franchising
CASES
Case 15.1
Quiznos: Will It Regain a Leadership Position in the Sandwich and Sub Shop Franchise
Industry?
DISCUSSION QUESTIONS
15-32.
To what degree do you think Quiznos’ brand has been permanently damaged by
its missteps? Is Quiznos doing everything it can to repair its brand? What, if
anything, would you do differently to revive Quiznos’ brand if you were the
company’s CEO?
Answer: There is no doubt that the Quiznos brand name no longer has the same
cachet as in the past. It is hard to say if it is permanently damaged because the
company is trying to make a comeback. But the company is now far behind
both Subway and Jimmy John’s in terms of number of outlets, which means it
has a lot of catching up to do. The franchisee issues and leadership changes do
not really affect how consumers perceive the brand. Inconsistent positioning
and advertising do matter, though.
15-33.
Why do you think Quiznos established the policies that caused so much angst
among its franchisees?
Answer: It is very likely that the company wanted to grow rapidly and thought
the way to do it was sell a lot of franchises quickly and also profit from selling
them ingredients. Corporate Quiznos wanted to grow and therefore came up
with these policies.
15-34.
At one time, Quiznos’ major source of competitive advantage was the fact that
it toasted its subs. What was the inherent danger in promoting toasted subs as
the franchise chain’s primary source of competitive advantage?
Answer: The problem with touting its toasted subs was that toasting is an easy
to imitate activity. When others saw that the market responded to Quiznos’
toasted sub, it was easy for, say, Subway to install ovens in their stores and take
away Quiznos’ advantage.
15-35.
Of the four factors that caused Quiznos to lose market share, including identity
crises, being at odds with franchisees, inconsistent advertising, and leadership
changes, which factor do you think was the most damaging? Explain your
answer.
company’s very poor relationship with its franchisees that was more serious. A
franchise-based business is strong only when it has a robust franchisee network.
They are the ones who operate locally and implement the overall strategy. The
parent Quiznos did not treat their franchisees well, which weakened the
company’s network and that ultimately resulted in deteriorating performance.
15-36.
To what degree do you think Quiznos will be able to re-establish itself as a
leader in the sandwich and sub shop franchise industry?
Answer: This is similar to the first question for this case, which talked about the
value of the Quiznos brand. Quiznos’ revival depends upon whether the
company can articulate a clear message to the market and maintain good
relationships with their franchisees. Although they are far behind the leader,
Subway, they can at least be a viable company if they correctly implement their
strategy.
Case 15.2
School of Rock: Filling a Gap in Music Education and Growing via Franchising
DISCUSSION QUESTIONS
15-37.
What types of characteristics do you anticipate School of Rock looks for in
franchisees?
Answer: Most students will say that School of Rock will principally look for
franchisees that (1) have good music instruction skills, (2) enjoy and are good
at working with kids in School of Rock’s target market, and (3) have a network
in the music industry. The reason having a network is important is that it will
enable the franchisee to recruit qualified instructors to staff the franchise.
15-38.
Look at Table 15.2. Of the ways mentioned in this table for franchisors to
develop franchisees, which ones are the most important for School of Rock to
emphasize to support its franchisees?
Answer: Although most students will say all methods of support are important,
the ones that jump out for School of Rock franchisees are: (1) keep operating
manuals up-to-date; (2) keep product, services, and business systems up-to–
date; and (3) maintain the franchise system’s integrity. The instruction and
creative side of the business will come from the franchisee. The best way the
franchisor can help School of Rock franchisees is to assist them with the
business side of the operation.
15-39.
If you were to consider buying a School of Rock franchise, what issues would
concern you the most about your ability to be successful as a franchisee for this
Chapter 15: Franchising
Answer: The answer to this question is similar to the answer to question 1. A
School of Rock franchisee would need to be good at music instruction and
enjoy working with young people. He or she would also need a strong network
in the music industry. The network would be important to recruit instructors for
the local franchise.
15-40.
Over the next 10 years, what do you think lies ahead for School of Rock? What
are some things that could go “right” for the firm and some things that could go
“wrong” as the firm continues selling franchise locations as a means of growth?
Answer: Most students will say that School of Rock has a bright future. The
things that could go right include (1) the continual development of a strong
brand, (2) satisfied students and parents who will tell others about the service,
and (3) continued interest in music, which will motivate students to enroll in
School of Rock programs. The things that could go wrong include: (1)
franchisees that fail, which tarnishes the organization’s brand; (2) dissatisfied
students and parents, which will create negative buzz about the organization;
and (3) a sour economy, which would limit the ability of students and parents to
pay for School of Rock programs.