Franchise Business Model: Business Success–Rate is Over 90% vs. Independent Business–Rate is About 25%…

“There are many different types of franchises. Many people associate only fast food businesses with franchising. In fact, there are over 120 different types of franchise businesses available today, including automotive, cleaning & maintenance, health & fitness, financial services, and pet-related franchises, just to name a few”. ~Don Daszkowski

Franchising is the practice of using another firm’s successful business model. The word ‘franchise’ is of anglo-French derivation – from franc– meaning free, and is used both as a noun and as a verb. An individual who purchases and runs franchise is called “franchisee.” The franchisee purchases a franchise from the “franchisor.” The franchisee must follow certain rules and guidelines already established by the franchisor, and in most cases the franchisee must pay an ongoing franchise royalty fee, as well as an up-front, one-time franchise fee to the franchisor.

Franchising has become one of the most popular ways of doing business in today’s marketplace. In the United States, the Federal Trade Commission has oversight of franchising, rather than the US Securities and Exchange Commission. The FTC administrates oversight via the FTC Franchise Rule.  There is no federal registry of franchises or any federal filing requirements for information. States are the primary collectors of data on franchising companies, and enforce laws and regulations regarding their presence and their spread in their jurisdictions.

In 2007, the Census Bureau surveyed 4.3 million businesses that have paid employees, and its forms included questions about franchising for the first time. The results, which were released in September 2010, show that franchises account for 10.5 percent of all businesses and support 7.9 million workers in a work force of 59 million. Franchising sales account for nearly $1.3 trillion of $7.7 trillion in total sales.

The numbers came as no surprise to the International Franchise Association (IFA) inWashington,D.C., says spokeswoman Alisa Harrison, because they closely match information gathered by accounting firm Pricewaterhouse-Coopers for the IFA’s annual Economic Impact of Franchising reports. The U.S. Commerce Department estimates that 95% of franchises succeed; only 25-35% of independent businesses succeed. Why the difference? Since a franchise is usually a duplicate of an already successful business, it should succeed.

The term franchising can describe some very different business arrangements. It is important to understand exactly what you’re being offered. The franchisee owns the outlet it runs. But the franchisor keeps control over how products are marketed and sold and how their business idea is used. Different types of sales relationships are also sometimes referred to as franchises, for example: Distributorship & Dealership, Agency, Licensee.

The main distinguishing feature of a franchise is its structure–in other words, the rights that the franchisor allows a franchisee to have regarding the franchisor’s products or services. However, a secondary classification of franchise types does exist; it’s based on the type of franchise ownership. The following is an overview of the types of franchise structures and ownership classifications. Franchise structures:

  • Product Franchises: Manufacturer grants a franchisee the authority to distribute goods by the manufacturer and allows the owner to use the name and trademark.
  • Business Format Franchising: Company provides a franchisee with a proven method for operating a business using the name and trademark of the company.
  • Manufacturing Franchise: Right to manufacture a product and sell using the franchisor’s name and trademark.

There a four types of franchising opportunities available with varying levels of qualification requirements.

  • Single Franchise: Franchisee is awarded the exclusive rights to operate a single unit franchise in a specified geographic area.
  • Multi Unit Franchise: Franchisee owns and operates multiple unit operations.
  • Area Development Franchising: The franchisee will own an exclusive territory and will agree to a development schedule for the number of units they must open and operate.
  • Master Franchising: Franchisee has the exclusive franchise rights to a geographic area and acts as business partner for the franchise company in his specific territory or region
  • Absentee Investor: Own a franchise business and not be directly involved in its day-to-day management.

All franchises require a Franchise Disclosure Document (FDD). The Federal Trade Commission (FTC) requires that the owner of a franchise business furnish a FDD to a franchisee at least 14 days before finalizing the deal or signing the contract. As required by the FTC, each FDD will include; license and permit requirements, the business backgrounds of the owner or management team, a list of other current or former franchises, any bankruptcy or litigation history the franchise has been subject to, all franchise fees, and all trademark or copyright information.

The franchisor will most likely require the franchisee to buy certain types of insurance for the franchise as well, which also must be listed in the FDD. Franchise contracts tend to be unilateral contracts in favor of the franchisor; they are generally protected from lawsuits from their franchisee because of the non-negotiable nature of the contracts requiring franchisees to acknowledge, in effect, that they are buying the franchise knowing that there is risk, and that they have not been promised success or profits by the franchisor…. Business franchising is a global business:

  • Europe: Franchising has grown rapidly in Europe in recent years, but the industry is largely unregulated.
  • Brazil: Brazil has about 1,013 franchises with more than 62,500 outlets, making it one of the largest countries in the world in terms of number of units. Around 11 percent of this total are foreign-based franchisors.
  • China: China has the most franchises in the world but the scale of their operations is relatively small. Each system in China has an average of 43 outlets, compared to more than 540 in the United States. Together, there are 2600 brands in some 200,000 retail markets.
  • India: India is in its infancy with franchising. However, it’s one of the biggest potential franchising markets because of its large middle-class of 300 million who are not reticent on spending and because the population is entrepreneurial in character.

In the article “Small Business or Franchise – The Pros and Cons” by Don Daszkowski writes: There are two main options for becoming a business owner: Start your own business from scratch, or invest into an existing franchise system. There are pros and cons to both business models:

  • Starting a Business from Scratch-Pros: Control & creativity; Profitability; Less initial startup expense.
  • Starting a Business from Scratch-Cons: More time & effort; Competition; Higher Failure Rates.
  • Buying a Franchise-Pros: Brand Awareness; Established system & support; Less competition.
  • Buying a Franchise- Cons: Fees; Possibility of poor franchise choice; Less freedom in decision-making.

“Don’t assume a franchise is an easy, risk-free option – you’ll be running your own business with all the responsibility and hard work that running a business entails. Use professional advisers and make sure they’re franchise specialists. Negotiate your agreement and don’t think you have to accept the first set of terms put in front of you.”

In the article “Should You Franchise Your Business?” by Lindenmayer writes: Companies decide to begin franchising for one of three reasons: lack of money, people, or time. The primary barrier to expansion that today’s entrepreneur faces is lack of capital. And franchising allows companies to expand without the risk of debt or the cost of equity. Since franchisees provide the initial investment at the unit level, franchising allows for expansion with minimal capital investment on the part of the franchisor.

In addition, since it’s the franchisee, and not the franchisor, who signs the lease and commits to various service contracts, franchising allows for expansion with virtually no contingent liability, thus greatly reducing a franchisor’s risk….But, “Is Your Business Franchisable?” Franchising is a relatively flexible format, and just about any type of business can be franchised, provided it meets some basic characteristics: Credible; Unique; Teachable; Adequate ROI… 

If your business meets these criteria, then it may be a good candidate for franchising. Properly structured, franchising can allow small companies to more effectively compete with much larger competitors. It can also allow larger companies to gain the advantages of highly motivated unit management while reducing overhead.

As such, franchising is an option that more and more companies should explore… Franchising is being employed by more businesses and more types of businesses than ever before. Today, almost any product/service can be distributed through franchising.  Franchising commands a staggering 43% of the nation’s total retail sales and service dollars. 

According to the Small-Business Association, 41 percent of the nation’s small businesses are unable to secure adequate financing.  Independent small-business owners must cope on their own, while many franchisees will continue to receive help from their franchisors, through direct loan programs or a waiver of royalties and other fees. Franchisors are also helping their franchisees increase sales with new marketing programs and by providing them with new products and/or services to offer their customers.

A creed of the franchising world says: “Never be a pioneer; it doesn’t pay. Let the other man do the pioneering; and then after he has shown what can be done, do it bigger and more quickly. But let the other man take the time and risk to show you how to do it.” However, on the flip-side: The ‘U.S. Small Business Administration (SBA)’s Office of Inspector General’s Inspection and Evaluation Division’ published a report comparing the failure rate of the SBA’s non-franchise loans to the SBA’s franchise loans.

The SBA’s findings:  “Despite the popular view that franchisees are much more successful than non-franchisees, SBA’s experience with defaulted loans does not support this.”

“You can have the best business model in the world, but if you sell it to the wrong kind of person it’s not going to work,”