The Franchise Business
Introduction
Franchise businesses are everywhere and growing. It is difficult to
drive down a street in a commercial part of a city without seeing a
number of franchise businesses. For many individuals, they provide an
enticing opportunity to own and operate their own business. For the
franchisor, selling a franchise provides an opportunity to
expand the reach of the franchise system without being concerned with
the day-to-day operations of the individual franchised business.
These systems can be a wonderful opportunity for both parties and at the
same time they can represent risks for both parties. Therefore, it is
important for the parties to make an informed decision before
entering into a franchise relationship and that an appropriate franchise
agreement be in place.
Nature of the Franchise Relationship
Very generally, a franchise is a busIness where one party, the
franchisor, establishes the branding and the manner by which the
franchised business is to operate and the other party, the franchisee,
becomes responsible for the day-to-day operations of the franchised
business. In exchange for being permitted to own and operate the
franchised business, the franchisee will make periodic payments to the
franchisor and comply with the franchisor's specific operating
requirements. Usually, for any given franchise system, there will be
one franchisor and many franchisees. As well, there is no reason a franchisor cannot own and operate one or more franchises.
It is through the consistent use of the franchise branding and the
consistency in the offering of the products and services by all
franchisees that significant goodwill in the marketplace will be
developed. This goodwill increases the value for both the franchisor
and the franchisees.
Types of Franchise Businesses
Businesses that have been franchised come in all shapes and sizes. They
include:
- Fast food restaurants
- Full service sit-down restaurants
- Automotive services
- Automotive dealerships
- Employment and staffing
- Cleaning
- Coffee vendors
- Moving and storage
- Real estate brokerages
- Retail sales
- Fitness
- Health and beauty
- Security services
- Hotels
- Financial services
- Pest control
- Printing
- Education
- Dry cleaning
- Lawncare
- Weight control
- Dating and introductions
Benefits of the Franchise Relationship
A franchise system enables the system owner to concentrate on developing
and expanding the franchise system while not having the responsibility
for the day-to-day operations of the franchise outlets. Each franchise
outlet is typically owned and operated independently by a third party,
the franchisee. This structure permits the system to grow significantly
faster than it could otherwise.
From the franchisee's point-of-view, the franchisee is able to own and
operate a business that may already have significant goodwill in the
marketplace. As well, the franchisee is able to participate in a system
that has already been proven to be successful. This removes a
significant amount of the risk associated with starting up a business.
As another benefit to the franchisee, the franchisor typically provides
a significant amount of guidance to the franchisee in the day-to-day
operations of the franchised business. Since the franchisor has already
figured out what works and what does not work, the franchisee will not
have to repeat the same mistakes that the franchisor has already made.
From the consumer's standpoint, a franchise system represents a known
offering of goods and services. This
reduces the risk to the consumer of an unsatisfactory experience. As an
example, a consumer knows exactly what they will be getting when they
order a Big Mac at a McDonalds, even though the customer may never have
been at the particular McDonalds location. They will also have comfort
in other matters such as the standards of cleanliness and safety that
are maintained by McDonalds.
Risks of the Franchise Relationship
Of course, franchises have their risks. From the franchisor's
point-of-view one of the most significant risks arises due to the loss
of direct control over the manner in which the franchised business is
operated. A single bad experience at a franchise outlet may result in a
consumer not returning to any other franchise outlet in the future.
For the franchisee, there are also a number of risks and obligations.
Most notable is the ongoing payments to the franchisor just for the
right to operate the franchised business. These payments would not have to be
paid if the franchisee started the business independently of the franchise
system. However, these fees often represents the additional value to
the franchisee due to brand recognition and the existing goodwill in the marketplace
as well as the reduced risk through being able to own and operate a
proven business model.
As well, another risk or limitation to the franchisee is that the
franchised business must be operated within the strict requirements set
by the franchisor. This may limit the modifications the franchisee may
make to the product and service offering. This lack of control over the
business may be a source of frustration for the franchisee as they may
not be able to pursue available opportunities. However, most
franchisors do provide for some flexibility as they recognise that
market conditions may differ from location to location. For example,
McDonalds offers the Ebi Filet-O in Japan, which is basically a burger
made from shrimp meat.
By signing a franchise agreement, the franchisee is making a long-term
commitment to operate the franchised business. If the franchised
business is not profitable for any number of reasons, the franchisee
could suffer substantial losses over an extended period of time. This
potentially is a significant risk.
Franchise Agreements
The primary means of binding the franchisee and the franchisor in the
franchise relationship is the franchise agreement. The franchise
agreement contains the rights and obligations of the parties. Some of
these agreements can be quite extensive.
Most franchisors will insist that the parties use their form of
franchise agreement. Not surprisingly, the provisions in a franchise
agreement typically favour the franchisor. However, as with all
agreements, they are open to negotiation. However, many franchisors
resist having their forms of agreements changed. The modifications to
the franchise agreement that are acceptable to the parties is a matter
of negotiation between the parties.
Often, the franchisee will be investing considerable time, effort and
money in developing and running their franchised business. As well, the
franchisee will likely be exposed to significant risk in the event the
business does not work out. Therefore, it is important that an
appropriate franchise agreement be in place.
From the franchisor's perspective, the franchise agreement needs to
contain provisions that will protect the franchisor in the event the
franchisee is not complying with all of the requirements of the franchise system. These
requirements are there to ensure that the standards for services and
products are maintained and that there is consistency between franchise
outlets. Many franchise systems are extremely valuable and a single
franchisee can create a significant amount of damage in a short period
of time. Therefore, it is important that the franchise agreement
properly protects the franchisor's interests.
While the terms of the franchise agreement generally favour the
franchisor, a franchisee should take comfort that those terms will also
apply to all other franchisees. Therefore, in the event another
franchisee fails to operate in accordance with the requirements of the
franchise system, the franchisor would have the ability to keep the
franchisee in line. That, in turn, will serve to protect the value of
the businesses of all franchisees. Think of the damage to the franchise
system of a fast food restaurant if it become widely publicised that a
single franchise outlet had a number of rats living within the premises.
Summary
Franchise legislation has been put in place in some provinces to protect
the interests of franchisees. Primary among the protection provided is
the requirement of the franchisor to deliver a franchise disclosure document to
the potential franchisee. The intention is that the franchise disclosure document
will help the potential franchisee make an informed decision before
purchasing the franchised business and investing a significance amount
of time, effort and money.
The franchise relationship can be a fairly complex relationship due to
the amount of control that a franchisor needs over the franchisee. This
complexity is then reflected in the franchise agreement, making these
agreements long and complex. The franchise agreement will typically
address the various rights and obligation of the parties and allocate
the various risks between the parties. The parties need to spend
adequate time considering these risks and weighing the appropriateness
of the various provisions contained in the franchise agreement.
A franchise can be rewarding for both the franchisee and the franchisor.
For the franchisor, through enlisting a franchisee to run the franchised
business, the franchisor gets to expand the franchise system while at
the same time having someone who is passionate about the business look
after the day-to-day operations. For the franchisee, they get to own
and operate a business that has been proven to be successful and to
participate in the related financial rewards.
