Most people would agree that Ray Kroc, founder of McDonalds restaurant chain, or Anita Roddick, Body Shop founder, were entrepreneurs. But is franchising entrepreneurship?
Ray Krocs and Anita Roddicks companies are the franchiser, the owner of the trade mark and system. What about the franchisees, those individuals who buy a franchise, operate the concept on a local basis and serve customers? Are they entrepreneurs?
The question involves more than linguistics. The central issue concerns the ability of the franchisee to create wealth. Clearly, there are no guarantees of wealth when a new venture is founded. Return and risk are key ingredients of the entrepreneurial process and therefore the possibility of failure looms in any business start-up. However, if the buyer of a franchise is simply purchasing employment then a franchise is no more than an alternative to an employment agency.
The franchise industry
Franchising is a key part of the US economy and is substantial in the UK and other western European countries. More than one-third of all retailing in the US, worth almost $750bn annually, is generated through franchised outlets while as much as 10 per cent of retailing in the UK is generated by franchises.
Franchising is generally divided into product franchises and business format franchises.
The product franchise is characterised by franchised dealers who concentrate on a companys product line and to some extent identify their business with that company. A car dealer selling one manufacturers models is an example.
In business format franchising the trademark and distribution rights are accompanied by information, provided by the franchiser to the franchisee, on production processes and delivery system. Business format franchising usually includes a marketing plan, documented and enforced procedures, process assistance, and business development and innovation. This article concentrates on business format franchising.
The belief that franchising is an entrepreneurial venture is supported by the phenomenon of multiple-outlet ownership by franchisees. Some individuals buy more than one outlet of any given franchise and even purchase different types of franchises. Thus they achieve growth and diversification.
One of the largest franchisers in the world is Allied Domecq, the UK conglomerate which takes in Dunkin Donuts, Baskin Robbins and Firkin Pubs. Bob Rosenberg, head of Allied Domecqs franchise operations, believes Allied Domecq franchising still has substantial growth potential, much of it in Europe. We can double our size in the US and the potential in Europe is exponential, he says.
Allied Domecq is not alone. Over 50 per cent of members of the International Franchise Association (an association formed by franchisers) have international departments and 93 per cent of those companies expect to increase international expansion. Research indicates that 22 per cent of franchisees own more than one outlet.
The Kwik Kopy group sees franchising and multiple store franchisees as a key element of the growth in entrepreneurship in Europe. The company argues that its franchise owners are with customers every day, focusing on their needs and sharing better ways to fill those needs with their franchisee colleagues. That is why franchising works. We are not interested in just growing, we want greater success.
Franchisees are becoming larger and more sophisticated. KFC (formerly Kentucky Fried Chicken) has granted franchise rights to a major Japanese group. In 1991 the European Community approved a block exemption to anti-trust regulations so that franchisers may now sell larger geographical territories, allowing franchisees to build several outlets.
Keeping the franchisee satisfied?
According to US franchise lawyer Eric Karp: The relationship is evolving. There is clearly an understanding that building equity is an important aspect of the franchise purchase decision. That means the productive franchisee-franchiser relationship is a long-term strategic link that builds wealth for both parties. When franchisees cant do better than a salary the relationship breaks down.
While the International Franchise Association proclaims a 95 per cent success rate for franchisees, recent research at Imperial College (Steve Spinelli and Sue Birley: An empirical analysis of conflict in the franchise system, Imperial College, London) indicates that almost 30 per cent of franchisees are dissatisfied.
Franchisee satisfaction appears more closely linked to the manner in which the relationship is conducted than to issues involving finance.
Most franchise contracts are long-term (5 to 20 years) and, generally, there should be a delineation of responsibilities between the franchiser and the franchisee based on competitive advantages. Those centralised functions that carry economies of scale, such as the acquisition of supply and the creation and purchase of advertising, are assigned to the franchiser.
On-site implementation, including real estate, hiring of employees and the local sales effort, is left to the franchisee.
It is not surprising that our research found most franchisees would like to see an improvement in the provision of some services. Figure 2 lists the key activities involved in the franchisee-franchiser relationship. It shows those that franchisees see as important and their assessment of how adequately they are provided. We used a 1 (clearly not important or clearly not adequate) to 5 (most important or completely adequate) scale.
But more important in our research was the identification of those service gaps that caused dissatisfaction in the relationship. Clearly, the bundle of marketing functions (national advertising, promoting new products and services, market information and analysis, and organising local advertising co-operatives) are the most sensitive issues for franchisees.
Good franchisers are good marketers in the view of franchisees. In general, however, franchisees have a clear tolerance zone of acceptable franchiser behaviour.
What to look for
The franchise method of growth is predicated on the assumption that value has been developed through the careful operation, testing and documentation of a commercially viable idea. The essence of franchisee due diligence is to verify the franchises ability to create wealth through a business format which can be transferred for local execution.
Prospective franchisees must answer two questions.
Is risk sufficiently mitigated by the trademark value, operating system, economies of scale and support process of the franchiser to justify sharing equity with it (via the payment of an up-front franchise fee and on-going royalties)?
Is personality and management style amenable to sharing decision-making responsibilities in the business with the franchiser and other franchisees?
In other words does the franchisee fee and the present value of the royalties equal the increased net income from the value of the franchiser trademark? Or how many more hamburgers will I sell with a golden arch in front of my restaurant (and the systems and advertising that support the arch) than I would going it alone?
(It appears that franchisees tend to be so consumed with start up, survival and growth in the initial years of operation that building equity is only obliquely regarded as important. But, around the seventh year of operation, their piece of the value of the brand seems to take on greater importance. If the franchisee does not internalise the value of the franchise by then there is a dramatic increase in dissatisfaction.)
A new franchisee should be assured the franchiser has the income stream and/or is capitalised sufficiently to provide the support services needed to transfer its knowledge base to the franchisee.
The list of franchiser-provided services in Figure 2 is an appropriate starting point.
Is there sufficient quantity and quality of resources, applied to the specific support area, to fulfill the franchiser obligations?
The chronology of store development indicates the critical path of service support. Starting with an intimate understanding of the primary target customer, is there a specifically documented guideline for acquiring (through lease or purchase) a location that makes the customer reachable? Are there blueprints or fitting-out plans to guide construction?
While a facility is being built the business format must be taught to the franchisee. Therefore, a training mechanism must be in place, and the methods of training and the level of sophistication of franchisers varies dramatically.
This is an extremely important issue. Once the franchisee is trained, what about staff? Employee turnover in an existing operation may not necessarily correspond to the scheduled training programmes of the franchiser (if they are offered), and the franchisee often becomes the trainer for his or her staff. How well he is trained for this task not only affects profitability but the quality of life.
Most entrepreneurs work long hours. But poor training schemes may result in a franchisee spending inordinate amounts of time and effort in operations and little time managing the growth of the franchise.
The international dimension
A common problem with franchising in Europe is that a trademarked system is imported from the US with little attention to the small, but significant, differences in customer demand and the detail of how the business format will address that demand. Therefore, understanding the amount and sophistication of franchiser support services takes on even greater importance when a franchise is brought in from another country.
Malls in the US versus high street in Europe is a distinction that dramatically affects franchise success. Again, our research has shown that delivery by the franchiser to the franchisees of the bundle of marketing services required to grow a venture is essential for a successful franchise relationship.
Part of the thinking behind the importance of the marketing services is a thorough understanding of the franchises target customer. Not understanding who the customer is may, for instance, lead to an outlet being placed in the wrong location. It is often difficult or impossible to relocate a business without significant financial hardship. Franchisees businesses can be trapped in a bad real estate deal.
The importance of information
One of the significant advantages of a franchise is the abundance of information available to help complete due diligence. In the US there are numerous federal and state laws regulating franchising, including a disclosure document called a Uniform Franchise Offering Circular.
There are no similar disclosure requirements in Europe but European buyers of US franchises should read the Uniform Franchise Offering Circular, which includes franchiser-audited financial statements, a list of US franchisees and current franchise litigation. In addition, visits to franchise outlets and interviews with franchisees provide a wealth of information.
Technical issues of support and logistics are easily discovered. More important is the way in which the franchise relationship is managed.
Our research clearly indicates that the advantages of franchising, including economies of scale in purchasing, supply and marketing, result from rapid growth and the overall size of the franchiser. Buying power increases and competitive advantages in cost are manifest. However, size can be a double-edged sword.
Franchisees see themselves as partners with the franchiser in a strategic relationship. Partners require communication to develop decision-making synergy and co-ordination to properly execute plans. When communication and co-ordination result in a co-operative attack on the marketplace franchisees are overwhelming satisfied.
An investigation of a franchise must include an understanding of the communication processes. Often the conduit from the franchiser to the franchisee is a field representative of the franchiser.
As for wealth creation our research indicates that many franchisees are making money. The average franchisee in our study at Imperial College had a profit of around 40,000. However, it is important to recognise that the average does not necessarily describe any individual franchisee and that returns cover a wide spectrum. n
Stephen Spinelli is assistant professor of entrepreneurship at Babson College, Wellesley, Massachusetts. His research interests include franchising, multiple outlet operations, retailing and new venture creation. He is a former franchisee of Jiffy Lube in the US, developing 47 stores in eight years, a founding shareholder of Jiffy Lube International, and founder, chairman and Ceo of American Oil Change Corporation.
