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'Franchising' - a golden opportunity to enter the business arena

by T. M. Jayasekera , Management Specialist

Every one of us may not be able to be an entrepreneur who is willing to take risk and use his creativity or an entrepreneur who uses his creativity with the assistance and opportunity provided by an organisation for risk taking, as some people are more cautious and simply want more assurance of success. For them there is a vastly different strategy for starting and operating a business; i.e. the opportunity of franchising.

The personality called for franchising is not necessarily that of a risk taker or an innovator. Franchising is not an industry but a method of distributing or operating a business to provide a product or service or both to achieve maximum impact with a minimum amount of investment.

Entrepreneurship and franchising go hand in hand as they are actually two major complimentary processes in the business arena. Entrepreneurship develop ideas and build a winning product that they offer to share through a franchise agreement, which is nothing more than an agreement where by someone with a good idea of business (identified as a Franchiser) sells the right to another (known as Franchisee) to use the business name and manufacture or sell a product or do both to others (known as Franchise) in a given territory within the same country or in another country.

Entrepreneurship has become so important to economic development that economists now list entrepreneurship as a factor of production along with land, labour, capital, and information. In fact many feel that a country can prosper if it has little land and other resources but has many willing entrepreneurs. That is why there is franchise fever in the world today. Franchise too has become equally important, as it is a strategy for entrepreneurship.

The franchise fever in the world

The potential in franchising is very impressive as many of us will not easily fall in to the category of entrepreneur or entrepreneur. There are over 500,000 franchised outlets in United States selling over $700,000 billion worth of goods and services and the growth in this area was so heavy that 50% of all the retail sales in USA fell in to this category in the 1990s. In America one out of every three retailers operating a franchise and this was one of the secrets of rapid large-scale development of self-employment in America.

Today, franchising has penetrated every aspect of American and global business life by offering products and services that are reliable, convenient and cost effective. According to Richard Ashman, Chairman of the International Franchise Association which is head quartered in Washington, franchising is like an octopus and it takes up any business in the world. That is why he went on to make the following quote - "You name any business and there is a good chance that someone out there is franchising it."

When a firm in one country (the Franchiser) authorises a firm in another country (the Franchisee) to utilise its brand names, logos and operating techniques in return for a payment known at royalty International Franchising will result. Probably the best-known franchise in the world is McDonald's. However much smaller franchises also exist. For example Dome Coffees in an Australian, Perth-based company that turned a simple morning cup of coffee in to an international franchise where Dome is franchising its knowledge of how to create a pleasant, up market coffee shop.

The company currently has about eight franchises in Singapore, ten in Malaysia, four in Philippines and three in the United Arab Emirates. They even are in the process of extending this to the countries such as India Sri Lanka, Bangladesh and Nepal. The good thing about franchising is that it is contagious and if given a start by others it will create its own momentum.

Franchise fever in Asia

Even though we in Sri Lanka have not experienced it so much, Franchising is experiencing a rapid growth in the Asia-Pacific region too. Today, it is nearly impossible to drive down the streets of major Asian capitals without seeing a McDonald's, Kentucky Friend Chicken, Pizza Hut, Star Bucks or a Hard Rock Cafe. Today Asian entrepreneurs are regionalising proven brands and business processes from the west at a rapid pace.

More established entrepreneurs obtain master franchises for the entire region and sub licence their rights to others. Some even have gone a step further and had become joint venture partners in global franchises.

Asian entrepreneurs are also setting up their own franchise systems in addition to seeking franchises from the west. Beyond food related franchises (food industry has the highest growth in Asia) they are moving in to new areas like education in the form of computer schools, hotels, cleaning services, and many other newer forms of franchises.

According to the law of nature everything has two sides and franchising too is bound by the rules of the nature's game. Franchising has both the success and failures as well, but failures of franchising have been very much lower than that of other business ventures. As the growth of franchising in the recent past has been so high there had been situations where weaker franchises have also entered the field, but the situation is not that bad yet. According to the statistics available more than one third of typical franchises do well another third break even and only the rest are in the red or not making money. What actually is meant by franchising

In recent years international firms mostly the American firms have gone overseas with a new kind of licensing which was termed as franchising. Franchising permits the franchise to sell products or services under a highly publicised brand name and a well proven set of procedures with a carefully developed and controlled marketing strategy at a fee, which is called royalty. The Franchiser provides the franchise with trademarks operating systems and well-known product reputations as well as continuous support services such as advertising, training, reservation services in hotel operations and quality assurance programmes. Franchising allows franchiser more control over the franchisee than in the case of licenser-Licensee relationship.

Franchising is the most rapidly growing path to entrepreneurship in the world today. Currently one out of every 12 business in USA is franchised. According to the statistics available a new franchise business opens every eight minutes in the USA, and franchising employs more than eight million people in USA alone.

McDonald's has approximately 10,000 restaurants franchised in over 100 countries. Other types of franchisers are hotels such as Hilton Business services such as Muzak and Manpower Soft Drinks such as Coca Cola Home Maintenance such as service master and automotive products such as Midas and many others.

Definition of franchising

According to Dr. Richard L. Daft of the Owen School of Management of the Vanderbilt University who authored the Book Management, "Franchising is an arrangement by which the owner of a product or service allows others to purchase the right to manufacture or distribute the product or service with the help of the owner."

Major components of franchising

A. (What) - It is about giving a licence to do a business

B. (To whom) - To a trader, distributor or a manufacturer

C. (Why) - To enable them to sell a product or service or

D. (What for) - To manufacture or sell a product or do both

E. (Where) - In a particular area within or outside the country of origin

F. (For How Long) - For a stated period

G. (Value) - For a stated price known as Royalty

The working arrangement of franchising

The holder of the licence (Franchisee) usually pays the granter of the licence (Franchiser) a royalty on sales, often with a lump sum as an advance against royalties.

Franchiser may also supply the franchise with a brand identity as well as finance and technical expertise. Franchises are common in fast food business, petrol stations and travel agents etc. What really happens in franchising is that the franchisee invests his or her money and owns the business but does not have to develop a new product. Create a new company or test the market. Franchisee typically pays a flat fee plus a percentage of gross sales.

Types of franchises that exist today

The franchises that exist today in the world include -

Fast Food Outlets

Restaurants

Coffee Shops

Hotels

Video Shops

Retail Shops

Record and CD Parlours

Weight loss clinics

Pet sitting services

Sports outfits

Photography centres

Bakeries

Janitorial services

Maintenance services

Auto repair shops

Real Estate offices and

Numerous other types of businesses

How large is this field

According to published data, in Automotive services, and retial and business there are more than 2,000 such units and in lodging and bakery goods there are more than 3,000 units and in automotive services and fast food there are over 5,000 such businesses in America alone. In other areas such as retail, maintenance, printing and computer related services there are over 1,000 such units exist in America as at present. The size of these businesses vary from US $ 75,000 to US $ 250,000 and over. The world scenario is very much larger than this.

Costs involved in setting up

Start up costs are generally small as it may not require any large investment as they will be carrying out only part of the work done by the franchiser. In USA it is generally in the range of US $ 5,000 and some of the franchising arrangements in Sri Lanka has started with small investments too.

There are larger ones where starting up costs are very high and one such situation is starting up a franchise with McDonald's or Econolodge that will require around US $ 500,000. It is also to be noted that a franchisee may be able to set up a franchise without any set up cost if the franchiser agrees to bear the expenses of setting it up for the franchisee. There had been instances where large-scale retial shop owners who had decided to give their retial shops in different localities to others on franchise. By this the franchiser wants the commitment and involvement of the franchisee to run the business more effectively as it has been operated on remote control basis earlier.

The owners of business operations which are scattered in different parts of the country but managed from a central headquarters could easily have a better control over their operation without much headache provided the right selection of the franchisee is made by them.

What are the advantages of franchising

The powerful advantages of a franchise are that management help is provided by the franchisee or the owner - e.g. Large multi-nationals such as Burgher King or McDonald's does not want their franchisees to fail as it will ultimately reflect on them.

Growth experienced in franchising throughout the world could not have been accomplished by accident. This indicates that there are many advantages in franchising, which can be categorized in to following major areas.

1. Management assistance

The franchisee has a much greater chance of succeeding in business because he or she has an established product, receive help choosing a location and receive assistance in promotion as well as in all phases of operation. This is similar to having a consultant to your operation whenever you need them. In addition you can share experiences with a whole network of peers who will be having similar problems and issues.

2. Personal ownership

Whatever the case may be the franchise operation is still yours and you will enjoy much freedom, incentives and profit enjoyed by any sole proprietor. You are still your own boss, although you may have to follow some rules, regulations and procedures than you would with your own private operation but it is definitely would benefit you in many ways.

3. Nationally recognised name

It is one thing to open a new ice cream or clothing or burgher shop. It is quite another to open a new signer shop or for that matter a shop having international recognition such as McDonald's, Burgher King or a Pizza Hut shop, as with an established franchise one can get instant recognition and support from a product group with established customers from around the world.

4. Financial advice and assistance

Sourcing of funds and arranging financing is one of the major problems experienced by a small business. Franchises normally get a valuable advice and assistance in these areas and periodic advice from people with expertise in these areas, which would not have been dreamt by a small businessman. Some franchisers will even provide some sort of direct financing to potential franchisees.

Very simply, the advantages a franchisee will get could then be summarised as -

* Receiving a national recognised and established reputation of a brand

* Receiving help to find a suitable location,

* Proven record of success of the original manufacturer

* Training in all phases of operation

* Receiving free advertising and other forms of promotional assistance

* A proven management system and management assistance

* Periodic management counselling by the franchiser

* Tested methods of inventory and operations management

* Financial assistance and * Problem solving assistance

So as to stimulate the demand for the product or service which they hope to market. One has also to consider the fact that above all the listed advantages you have business of your own.

What are the disadvantages of franchising?

Like with any other form of a business, franchising has potential disadvantages too. Otherwise it will appear to be too good to be true. Some disadvantages that are associated with franchising are, viz -

1. Large set up costs

Most franchises will demand a fee to just obtain the rights to the franchise, which may be a large component for the franchisee in setting up his or her business. Franchises can be sometimes be very expensive and the high start up costs are followed with monthly payments to the franchiser that can run from 2 - 15% of the sales revenue.

2. Shared profit The franchiser may demand a share of profit or percentage commission based on sales which is generally referred to as royalty.

3. Management regulation Management assistance has a way of becoming managerial orders directives and limitations. Franchisees may sometimes feel over burdened by the company's rules and regulations and lose the spirit and incentive of being their own boss with their own business.

4. Coattail effects

Even if your franchise is profitable, the failure of the majority of the other franchises may cause the franchiser to decide to close up the franchise operation and you could be forced to go out of business even though your particular franchise is making profits. This is what is generally referred to as coattail effect.

5. Competition from fellow franchisees The actions of other franchisees will have an impact on your future growth and level of profitability. Remember franchising is a team effort. if you play with a bad team the chances are that you may lose badly.

6. Lack of control

Lack of control that occurs when franchisers want every business managed in exactly the same way. In some cases franchisers require that franchise owners use certain contractors or suppliers, which may cost more than others would.

Drawbacks of franchising in the eyes of franchisee can be summarised as

High initial franchise fee in the form of Royalty

* Additional fees that may be charged for special advise

* A monthly percentage of gross sales may go to the franchiser

* Possible competition from other nearby franchises

* No freedom to select decor or other design features

* Little freedom to determine management procedures

* Many rules and regulations to follow and

* Other drawbacks specific to a country or a specific to a product or a service Essential factors to be considered in buying a franchise

We saw above that there are advantages as well as disadvantages in operating a franchise. Nonetheless it is an excellent way to enter a business as an owner or as a manager and make a good salary and profit. In order to become a successful businessman one should be careful of the following situations.

* Be careful of franchises that grow too fast as there is a possibility of overgrowth, hence check the financial strength of the company before getting involved.

* Watch out for scans - those who usually show off more than what they really are and disappear with investors money. They can be easily identified. They are the ones who suddenly come out from nowhere, come up with over-flashy ads, too nice office environments, hard to believe proposals and over persuade people to invest in what ever they do. Be overly careful of those scams as they are fakes and not the right types of franchisers to get involved in.

There are many things people should know with regard to franchising. A checklist provided in the Franchise opportunities Handbook provide some useful guidance in evaluating the condition of a franchise.

How to evaluate a franchise

To evaluate a franchise following checklist would be useful

1. Get your lawyer to approve the franchise contract after carefully studying it paragraph by paragraph.

2. Check whether the franchise gives you an exclusive territory for the length of the franchise.

3. What are the costs of termination of a contract and under what conditions you can terminate the contract.

4. Can you get compensated for the goodwill in case you decide to sell off the franchise.

5. Will there be protection for your investment if the franchiser decides to sell the company.

6. The number of years of operation of the franchiser's business.

7. Check whether the franchiser has got a reputation for honesty and fair dealing among the other franchisees and in the community as well.

8. Check the financial position of the franchiser and if possible ask for a disclosure statement.

9. Check what you are going to receive from the franchiser by way of management assistance, training, capital, credit, assistance for finding a good location and other important things.

10. Check whether the franchiser has evaluated the possibility of running a franchise operation so as to provide profit to both you and him.

11. Check the market by studying it to determine whether the product or service which you propose to sell under the franchise has a market in the territory proposed at prices you will have to charge.

12. What is the condition of the population in the territory under consideration - whether it will remain static or will it increase or decrease in the next five years.

13. What are the prospects of an increase in demand of the product or service you are going to handle in the years to come.

14. What will be level of competition existing and what will be the level in future for the product you are going to sell.

15. The level of capital investment needed to start up the franchise and how long will it take to pay back.

16. Check whether the industry appeal to you and whether you are prepared to spend a sizeable portion of you life with the franchise.

17. Finally it is better to ask the question from you as to whether you and your family are prepared to give up some independence of action to secure advantages offered by the franchise.

What should entrepreneurs do

Entrepreneurs who are considering buying a franchise should investigate the company thoroughly. The prospective franchisee is legally entitled to a copy of franchiser disclosure statements, which include information on several topics including;

* Litigation

* Bankruptcy history

* Identities of directors and

* Identities of executive officers,

* Financial information,

* Identification of any products the franchisee is required to buy and

* From whom the purchase must be made.

The entrepreneur should also talk with as many franchise owners as possible since they are among best sources of information about how the company really operates. According to what is indicated by Thomas Love in his book "The Perfect Franchise" and by Robert Maynard in his Book "Choosing a Franchise", when considering buying a franchise people should ask some questions about himself, about the franchise, and should be concerned about the following before sign on the dotted line for accepting the franchise.

What the entrepreneur (potential franchisee) should consider The potential franchiser should ask himself the following questions and get himself satisfied before entering into a franchise -

A. Will I enjoy day-to-day work of this business

B. Do my background experience and goals make this a good choice for me

C. Am I willing to work within the rules and guidelines established by the franchiser

If you are not answering in the affirmative to the questions listed above, it is better not to go ahead in buying a franchise.

What the franchisee should know about the franchiser before starting up the operation

The potential franchisee should try and get answers to the following questions before considering setting up the franchise

D. What assistance does the company provide in terms of the following:

i. Selection of Location

ii. Set up costs

iii. Securing credit

iv. Day to Day technical assistance

v. Marketing

vi. Ongoing training and development

E. How long does it take the typical franchise owner to start making a profit

F. How many franchises changed ownership within the past year and why Last things to do before signing the agreement

Following will indicate the last bits of things that one should consider before the franchiser puts his signature to the contract

G. Do I understand the risks associated with this business and am I willing to assume them

H. Have I had an adviser review the disclosure documents and franchise agreements

I. Do I really understand the terms of the contract What should we do

Even though many countries in Asia have adopted several forms of licensing in a larger way and there appears to be a Franchising fever in Asia, we in Sri Lanka have not used this mode very much. The fever may not have come to Sri Lanka yet, even though only a few appears to have got it.

The major reason for this lies in our limited exposure to international business, the poor attitude towards entrepreneurship and the established mindset of our youth in looking for public sector administrative type of work as the highest priority.

It is also true that our countrymen did not have that much of opportunity to expand their businesses as the markets in Sri Lanka are relatively small to attract International franchises and also that we Sri Lankans are not used to "thinking out of the box".

There are few international franchises such as McDonald's Kentucky, Pizza Hut Domino's, Singer, some Hotels and some others. But overall our Businessmen have not used this mode of licensing very much in Sri Lanka.

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