Franchise News June 2007

TO FRANCHISE OR NOT TO FRANCHISE?

Franchise is a word bandied around a lot today and automatically conjures up images of McDonalds, Wendys, Michele’s Patiserre, Dominoes; Pizza Hut etc. But what is it as a concept really? The International Franchise Association defines franchising as a “continuing relationship in which the franchisor provides a licensed privilege to do business, plus assistance in organising training, merchandising and management in return for a consideration from the franchisee”.

Although the word ‘franchising’ can describe various modes of conducting business, the most common is ‘business format franchising’. Others include:

Manufacturer-Retailer – Where the retailer as franchisee sells the franchisor's product directly to the public. (eg. New motor vehicle dealerships).

Manufacturer-Wholesaler – Where the franchisee under license manufactures and distributes the franchisor's product (eg. Soft drink bottling arrangements).

Wholesaler-Retailer – Where the retailer as franchisee purchases products for retail sale from a franchisor wholesaler (frequently a cooperative of the franchisee retailers who have formed a wholesaling company through which they are contractually obliged to purchase. (eg. Hardware and automotive product stores).

Retailer-Retailer – Where the franchisor markets a service, or a product, under a common name and standardised system, through a network of franchisees. This is the classic business format franchise.

Business Format Franchising

The characterisation of the business format franchising system includes standardisation, consistency and uniformity. It requires a unique relationship between the franchisor (the owner of the system) and the franchisee (the owner of the outlet) and has commonly been referred to as a ‘commercial marriage’.

Business format franchising however, is the fastest growing type of franchising and is evident in every sector of economy in Australia from McDonalds to Jim’s Lawn Mowing. This system has more outlets, employees and opportunities for growth than product and tradename franchises.

The concept for success is to provide small business with the tools of big business. This is represented through the franchisor providing the product, service, trademark together with the business concept (from marketing strategy and plan, operation standards, systems and formats to training quality control) yet also maintaining ongoing assistance guidance and supervision.

The prospects of success of the venture is increased for both parties. The franchisor can expand its market share without spending its own capital. The franchisee benefits from the goodwill of an established business system.

Don’t be fooled however into believing this commercial marriage is anything less than a proper legal relationship, with the full obligations and responsibilities of both franchisor and franchisee outlined in a franchise agreement. All contracts vary in length and terms and conditions and generally are drafted to favour the business being franchised.

Advantages of a franchise system.

The Australian Franchise Council succinctly sets out the advantages and disadvantages of a franchise system as follows:

The Franchisor provides detailed training.

The Franchisee has the incentive of owning their own business with the additional benefit of continuing assistance from the Franchisor.

The Franchisee benefits from operating under the name and reputation (brand image) of the Franchisor, which is already well established in the mind and eye of the public.

The Franchisee will usually need less capital than they would if they were setting up a business independently because the Franchisor, through their pilot operations and buying power, will have eliminated unnecessary expense.

The Franchisor provides the advice and/or help in identifying suitable trading locations or operating territories for the Franchisee.

The Franchisor helps the Franchisee obtain occupation rights to the trading location, comply with planning (zoning) laws, prepare plans for layouts, shop fitting and refurbishment, and provide general assistance in calculating the correct level and mix of stock for the opening launch of the business.

The Franchisor trains the Franchisee (and very often, the Franchisee's staff as well) in all areas of the business such as; manufacture, preparation, accounting, business controls, marketing, promotion and merchandising.

The Franchisor may negotiate better rates of finance, or more favourable conditions, for Franchisees with financial institutions.

The Franchisee receives the benefit on a national scale (if appropriate) of the Franchisors advertising and promotional activities at a lower cost than if they were to attempt such marketing themselves.

The Franchisee taps into the bulk purchasing power and negotiating capacity made available by the Franchisor by reason of the size of the franchised network.

The Franchisee can call on the specialised and highly-skilled knowledge and experience of the Franchisor's head office organisation, while remaining self-employed in their business.

The support and benefits provided by a Franchise system greatly reduce a Franchisee's business risks.

The Franchisee has the services of the field operational staff of the Franchisor who are there to assist with any problems which may arise from time to time in the course of business.

The Franchisee has access to use of the Franchisor's patents, trade marks, copyrights, trade secrets, and any secret processes or formulae.

The Franchisee has the benefit of the Franchisor's continuous research and development programs, which are designed to improve the business and keep it up-to-date and competitive.

The Franchisor provides a knowledge base developed from their own experience, as well as that of all the Franchisees in the system, which would otherwise be impossible for a non-franchised business to access.

Defined territories of operation within the Franchise can help protect the Franchisee from competition.

A Franchisee can always speak to their Franchisor or a fellow Franchisee to discuss their business challenges or problems - something a non-franchised business can almost never do.

Disadvantages of the franchise system

Inevitably, the relationship between the franchisor and franchisee must involve the imposition of controls. These controls will regulate the quality of the service or products to be provided or sold by the franchisee to the consumer.

Franchisees must accept that in return for the advantages enjoyed by them, by virtue of their association with the franchisor and all the other franchisees, control of quality and standards is essential.

Each bad franchisee has an adverse effect, not only on his own business, but indirectly on the whole of the franchised chain and as such, all other franchisees. The franchisor, will, therefore, impose standards and demand that they are maintained.

This is not to say that the franchisee will not be able to make any contribution, or to impose their own personality on their business. Most franchisors do encourage their franchisees to make contributions to the development of the business.

The franchisee will have to pay the franchisor for the services provided and for the use of the system, i.e. the initial franchise fee and continuing franchise fees.

The prospective franchisee may find it difficult to assess the quality of the franchisor. This factor must be weighed very carefully by the potential franchisee for it can affect the franchisee in two ways.

Firstly, the franchisor's offer of a business-format package may not amount to what it appears to be on the surface.
Secondly, the franchisor may be unable to maintain the continuing services which the franchisee is likely to need in order to sustain their business.

The franchise contract will contain some restrictions against the sale or transfer of the franchised business.

Franchisees may need to be realistic about the expected level of involvement of the franchisor and find themselves becoming too dependent upon the franchisor and fail to produce the personal drive which the system provides.

The franchisor's policies may affect the franchisee's profitability. For example, the franchisor may wish to see a higher turnover from which he gets his continuing franchise fee, while the franchisee may be more concerned with increasing his profitability, which does not always necessarily follow from increased turnover.

The franchisor may make mistakes in their policies. They may arrive at decisions, relating to innovations in the business, which turn out to be unsuccessful and detrimental to the franchisee.

The good name of the franchised business and its brand image may become less reputable for reasons beyond their own control.

CONCLUSION

As outlined in this document there are various types of franchise arrangements that you may consider entering into. We have taken the time to consider the most basic model which is the business format franchising and discussed it in some length. We have also outlined the pros and cons for entering into a franchising relationship.

Whether you wish to franchise your business or are thinking of entering into a franchise yourself, then please do not hesitate to contact Annette Fontana of Forum Law who can give you detailed legal advice in relation to your specific