The Franchise Business Model

Franchising is one of the most ubiquitous business models used in today’s commercial sphere.

The Franchise Business Economic Outlook for 2015, published by the International Franchise Association Educational Foundation, reports that in January 2015, a total of 781,794 small U.S. businesses are franchises. Statista, a statistics portal, estimates that the economic output from these small businesses will generate $889 billion.

With such a foreseeable impact on U.S. businesses and the nation’s economy, some people may be asking: “Exactly what is the franchise business model?”

Definitions

Franchises are systems of business that sell permission to use a company’s products or services. The selling company is referred to as the franchisor or parent company. The buyer is called the franchisee.

This distribution method allows the parent company to disseminate its products or services throughout the country through a series of independently owned outlets. The franchisees pay an upfront sum called the initial franchise fee and continue paying a portion of the profits, usually ranging from four to eight per cent, called royalties.

Process

Franchising is essentially a step-by-step business blueprint. Once the purchase has been finalized, the franchisee has the obligation to run the business, secure inventory and use the methods and procedures proscribed by the franchisor.

Quality of service and products is determined by the parent company, and must be maintained by the franchisee. Periodic financial statements and other forms are sent to the franchisor, as agreed on the contract.

Parent companies periodically send representatives to the locations to inspect the premises, financial statements, and operating procedures. Some franchisors also provide the location, but usually the franchisee is required to secure a pre-approved site. Franchisors also support their franchisees with programs such as initial and ongoing training, national advertising, and telephone or on-site representatives who can advise on day-to-day operations.

History

The concept of franchising has its roots in the Middle Ages. Lords of large tracts of land would sell privileges to local peasants to use the land for specified purposes, such as holding festivals or hunting.

Here in the U.S., Benjamin Franklin established a rudimentary form of franchising when he went into partnerships for a string of printing shops that could be found throughout the colonies, and a few in Jamaica, Canada, and even as far as Great Britain. Similarly, I. M. Singer distributed his sewing machines by selling territorial contracts, and Martha Matilda Harper sold over 500 franchises for her hair salon later in the 1880s.

Disclosure document

The Franchise Disclosure Document required by the Federal Trade Commission could be said to encapsulate the business model. It is a legal requirement for this document to be sent to the potential franchisee within 10 business days before purchasing, and it has 23 sections.

It protects both the seller and the purchaser, by detailing specific information with the aim of alleviating any misconceptions or implied agreements.

The first four sections describe the parent company, its background, principal owners’ business histories, business affiliates, any bankruptcy history, present litigation, and ethics. The following six sections explain royalties, fees, and all financial arrangements, such as advertising fees. They also include service and source of product restrictions.

Sections 12, 13 and 14 stipulate territory restrictions, trademarks, copyrights, patents, and any proprietary information, such as a secret recipe or any particular process. Sections 15 -17 delineate the franchisee’s obligations. These include restrictions on specific products that may be sold, and processes for transferring the business to another party, disputing procedures, and termination.

In most documents the franchisee must comply with the stipulation that he or she will participate in the actual operation of the business. Section 18 is an agreement concerning the use of any public figures that represent the company. Section 19, on the other hand, describes earning potential, which includes costs, earnings, and factors that may affect financial performance in the future.

The parent company then provides a list of the franchisor active and previous franchisees. Section 21 will be the franchisor’s financial statements, and the next entry denotes contracts that finalize the sale. This section will include the Franchise Agreement.

The last segment of the document is the receipt that must be signed by the franchisee to acknowledge that the document has been received. The length of the franchise contracts increase with the franchisor experience. These contracts can be as short as five years, with the average length being 10 years, although some do last as long as 20 years.

Periodically, the agreements must be renewed. At that time, obligations and terms can be renegotiated. Issues may include the franchisee getting current on any payment obligations, resigning the same conditions as the previous contract, and the payment of renewal fees.

Today, the franchise model continues to offer a pre-planned business to anyone willing to put in the time, effort, and money. It’s just a matter of finding the one that will be the right fit!

Darren Jamieson is the Technical Director of Engage Web and writes for Minuteman Press on franchising in the U.S. and throughout Canada, Australia and his native United Kingdom. He has extensive knowledge of the franchise industry, and of running a business, having helped many franchise clients through Engage Web.