Restaurant Franchising: Concepts, Regulations and Practices, Third Edition by Mahmood A. Khan

Concepts, Regulations, and Practices

Mahmood A. Khan, PhD

Revised and UpdatedThird

Edition

RESTAURANT FRANCHISING

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RESTAURANT FRANCHISINGConcepts, Regulations, and Practices

This book is the only up-to-date book of its kind that provides a complete and thorough introduction

to franchising, its pros and cons, and other important aspects. It is the only guide to franchising

written exclusively for foodservice professionals, and it will be an indispensable resource for anyone

wishing to break into one of today's most dynamic service industries.

Since the late 1800s when the idea was first conceived, the restaurant franchise has become a

worldwide phenomenon. Opportunities abound for restaurateurs and foodservice professionals with

the know-how to dive into and stay afloat in the growing, ever-changing sea of franchise operations.

With the help of vignettes and case histories, this completely updated new edition explains how to

do it right, from developing a winning franchise concept to demystifying the legal intricacies of

franchise agreements.

Topics include:

What is franchising

Franchising pros and cons

Selecting the franchise that fits your style and goals

Finding financial backing

Developing healthy franchisor/franchisee relationships

International franchising

Unconventional franchises

This practical first-hand information will be extremely useful to hospitality academicians and students

as well to franchisors and to entrepreneurs considering entering the world of franchising.

The newly revised 3rd edition is a classic book covering one of the most vibrant and vital

sectors of the US economy. . . . The book is an excellent introduction, much more than a

general academic treatment of the topic. . . . On behalf of the International Franchise

Association, we are grateful to Dr. Khan for revising and bringing out a new edition of this

classic book. It is a multi-purpose book, serving as classroom textbook, reference book, and

business guidebook. We are delighted to recommend it on the menu for anyone who wants

to learn more about this fascinating, fast-paced, and dynamic industry.

Steve Caldeira, CFE, President and CEO, International Franchise Association

ABOUT THE AUTHOR

Mahmood A. Khan, PhD, is a Professor in the Department of Hospitality and Tourism

Management, Pamplin College of Business at Virginia Techs National Capital Region campus. He

has served in teaching, research, and administrative positions for past 35 years, working at major

U.S. universities. Dr. Khan is the author of several books and has traveled extensively for teaching

and consulting on management issues and franchising. Dr. Khan has received many distinguished

awards for his work, and he has served in many important roles in several professional associations.

9 781926 895697

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ISBN: 978-1-926895-69-7




Edition


RESTA

URA

NT

FRA

NC

HIS

ING

Concepts

, Regula

tions, a

nd P

ractic

es

Khan












Topics include:

What is franchising

















ABOUT THE AUTHOR







9 781926 895697

00009

ISBN: 978-1-926895-69-7




Edition


RESTA

URA

NT

FRA

NC

HIS

ING

Concepts

, Regula

tions, a

nd P

ractic

es

Khan












Topics include:

What is franchising

















ABOUT THE AUTHOR







9 781926 895697

00009

ISBN: 978-1-926895-69-7




Edition


RESTA

URA

NT

FRA

NC

HIS

ING

Concepts

, Regula

tions, a

nd P

ractic

es

Khan












Topics include:

What is franchising

















ABOUT THE AUTHOR







9 781926 895697

00009

ISBN: 978-1-926895-69-7

www.appleacademicpress.com


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RESTAURANT FRANCHISINGCONCEPTS, REGULATIONS, AND PRACTICES

Third Edition, Revised and Updated


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CRC PressTaylor & Francis Group6000 Broken Sound Parkway NW, Suite 300Boca Raton, FL 33487-2742

Apple Academic Press, Inc3333 Mistwell CrescentOakville, ON L6L 0A2Canada

2015 by Apple Academic Press, Inc.Exclusive worldwide distribution by CRC Press an imprint of Taylor & Francis Group, an Informa business

No claim to original U.S. Government worksVersion Date: 20140924

International Standard Book Number-13: 978-1-4822-2349-1 (eBook - PDF)

This book contains information obtained from authentic and highly regarded sources. Reasonable efforts have been made to pub-lish reliable data and information, but the author and publisher cannot assume responsibility for the validity of all materials or the consequences of their use. The authors and publishers have attempted to trace the copyright holders of all material reproduced in this publication and apologize to copyright holders if permission to publish in this form has not been obtained. If any copyright material has not been acknowledged please write and let us know so we may rectify in any future reprint.

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To my family

Maryam, Samala, Safdar, Zaki, Layth, Feras, and Nufaylfor their affection, patience, and support

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ABOUT THE AUTHOR

Mahmood A. Khan, PhD, RD, FAND, FMPProfessor, Pamplin College of BusinessVirginia Techs Northern Virginia Center7054 Haycock Road, Falls Church, VA 22043-0362Phone (703) 538-8486 Fax (703) 538-8415E-mail: [email protected]

Dr. Mahmood A. Khan is the Professor in the department of Hospitality and Tourism Management, Pamplin College of Business at Virginia Techs National Capital Region campus. He has served in teaching, research, and administrative positions for past 40 years, working at major U.S. universi-ties. Dr. Khan is the author of seven books and has traveled extensively for teaching and consulting on management issues and franchising. He has been invited by national and international corporations to serve as a speaker, key-note speaker, and seminar presenter on different topics related to franchising and services management.

Dr. Khan has received Steven Fletcher Award for his outstanding con-tribution to hospitality education and research. He is also a recipient of the John Wiley & Sons Award for lifetime contribution to outstanding research and scholarship; the Donald K. Tressler Award for scholarship; and the Cesar Ritz Award for scholarly contribution. He received the Outstanding Doctoral Faculty Award from Pamplin College of Business.

He has served on the Board of Governors of the Educational Foundation of the International Franchise Association, on the Board of Directors of the Virginia Hospitality and Tourism Association, as a Trustee of the International College of Hospitality Management, and as a Trustee on the Foundation of the Hospitality Sales and Marketing Associations International Association. He is also a member of several professional associations, and is a Fellow of the Academy of Nutrition and Dietetics (FAND).

vii

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CONTENTS

List of Tables ............................................................................ xi

Foreword ................................................................................. xv

Preface .................................................................................... xvii

Acknowledgments .................................................................... xix

Chapter 1. Introduction to Franchising ............................. 1

Case Study: McDonalds: Menu Glocalization ......................... 27

Chapter 2. Impact of Hospitality Franchisingon the U.S. Economy .......................................................... 35

Case Study: Taco Bell: Beef Controversy .................................. 62

Chapter 3. Pros and Cons of Franchising .......................... 69

Case Study: Panera Bread: Customer Loyalty Programs ........... 90

Chapter 4. Franchising Agreements andLegal Documentation ........................................................ 95

Case Study: Quiznos: Franchisees and Legal Battles................ 144

Chapter 5. Franchise Application and FranchisePackage ............................................................................. 151

Case Study: Subway: Franchise Historical andOperational Aspects ............................................................... 176

Chapter 6. Franchisee/Franchisor/Franchise Selection .... 185

Case Study: Chick fi l A: A Different Type of Franchise .............. 207

Chapter 7. Standard Franchisor Services .......................... 213

Case Study: Pizza Hut: Menu and Service Innovations ............. 235

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x Restaurant Franchising

Chapter 8. Financial Aspects of Franchising ..................... 239

Case Study: Sbarro: Financial Adjustments ............................. 264

Chapter 9. FranchisorFranchisee Relationships .............. 269

Case Study: Wendys: Logo & Tagline ..................................... 298

Chapter 10. Franchise Concept Developmentand Restaurant Design ..................................................... 303

Case Study: Dominos Pizza: History and Facts ........................ 337

Chapter 11. Site Selection and Real Estate ....................... 343

Case Study: Jollibee: Going International ............................... 365

Chapter 12. Nontraditional Franchises ............................. 369

Case Study: Starbucks: Nontraditional Locations ..................... 387

Chapter 13. Communications and Public Relations .......... 391

Case Study: Bennigans: Rebirth and Growth .......................... 416

Chapter 14. International Franchising .............................. 421

Case Study: ALBAIK: A Successful International Concept ......... 445

Chapter 15. Going International ...................................... 451

Case Study: Chilis: Domestic & International .......................... 481

Chapter 16. Marketing and Advertising: Managing Brand Equity ...................................................................... 485

Case Study: Restaurant Logos ................................................. 505

Chapter 17. e-Franchising ................................................ 509

Case Study: Popeyes: Franchise Development ......................... 536

References ............................................................................... 541

List of Abbreviations ................................................................. 555

Glossary................................................................................... 557

Index ....................................................................................... 579

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Table 2.1 Top 10 Chains 1973 ............................................... 42

Table 2.2 Top 10 Chains 2013 ............................................... 42

Table 2.3 Estimated Sales Per Unit for Top 100Restaurant Chains ................................................................. 50

Table 2.4 Growth in U.S. Franchise Units (Top 100) ................. 53

Table 2.5 Total Number of U.S. Units Company Ownedand Franchised (Top 100) ....................................................... 56

Table 3.1 Advantages of Franchising ...................................... 70

Table 3.2 Disadvantages of Franchising .................................. 71

Table 5.1 Firehouse Subs Application Process ........................ 160

Table 5.2 KFCs Franchisee Application Processand Timeline .......................................................................... 161

Table 6.1 Warning Signs of Less Credible Franchisors ............. 190

Table 6.2 Franchisee Self-Evaluation Checklist ........................ 196

Table 6.3 Franchisor Evaluation Checklist ............................... 197

Table 6.4 Franchise Restaurant Evaluation Checklist ............... 198

Table 6.5 Advice from U.S. Federal Trade Commissionto Prospective Franchisees ...................................................... 202

Table 6.6 Advice from U.S. Federal Trade Commission toProspective Franchisees: Questions to Ask about InitialAND Ongoing Costs Before Selecting a Franchise ................... 203

LIST OF TABLES

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Table 6.7 Advice from U.S. Federal Trade Commissionto Prospective Franchisees: Questions to Ask aboutTraining Provided by the Franchisor ........................................ 204

Table 6.8 Advice from U.S. Federal Trade Commission toProspective Franchisees: Questions to Ask aboutAdvertising Fund .................................................................... 204

Table 6.9 Advice from U.S. Federal Trade Commission toProspective Franchisees: Questions to Ask Current andFormer Franchisees Before Selecting a Franchise .................... 205

Table 7.1 Programs and Support Services Provided byYum! Corporation ................................................................... 229

Table 7.2 Response to a FAQ on Sonic Drive-In RestaurantWebsite .................................................................................. 231

Table 7.3 Summary of Training Programs Provided byDifferent Franchise Restaurants............................................... 231

Table 8.1 Different Types of Fees ............................................ 242

Table 8.2 Estimated Sales Projection ....................................... 245

Table 8.3 Financial Projections ............................................... 245

Table 8.4 Estimated Preopening Costs for a FranchiseRestaurant ............................................................................. 246

Table 8.5 An Example of Estimated Costs for Real Estate,Site Work, Building, and Equipment ........................................ 248

Table 8.6 An Example of Franchise Fees andRoyalty Payments .................................................................... 248

Table 9.1 Questions to Ask Prospective Franchisees ................ 272

Table 11.1 Checklist for Assessing the Site Qualitiesfor Franchise Restaurants ........................................................ 346

Table 11.2 Optimal Site Criteria for Yum! Restaurants............. 349

Table 11.3 Market and Site Analysis Form .............................. 350

Table 11.4 Optimal Site Criteria for Yum! Restaurants(Pizza Hut) ............................................................................. 355

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Table 11.5 Optimal Site Criteria for Yum! Restaurants(Taco Bell) .............................................................................. 355

Table 12.1 Points to Consider Before Getting IntoNontraditional Franchising ..................................................... 385

Table 13.1 Advantages of Use of Technology in HospitalityCommunications .................................................................... 406

Table 13.2 Actions and Communication During CrisisSituations ............................................................................... 411

Table 14.1 Requirements and Procedures by WendysCorporation for International Franchisees ............................... 441

Table 15.1 Top Five Growth Chains by Percentage Changein Worldwide System-Wide Foodservice Sales,2012 vs. 2011 ........................................................................... 454

Table 15.2 Top 5 Chains in ASIA-PACIFIC Region Rankedby Year-End Regional Units ..................................................... 455

Table 15.3 Top 5 Chains in EASTERN EUROPE RegionRanked by Year-End Regional Units ......................................... 455

Table 15.4 Top 5 Chains in LATIN AMERICA Region Rankedby Year-End Regional Units ..................................................... 456

Table 15.5 Top 5 Chains in MIDDLE EAST-AFRICA Region Ranked by Year-End Regional Units ......................................... 457

Table 15.6 Top 5 Chains in WESTERN EUROPE RegionRanked by Year-End Regional Units ......................................... 457

Table 15.7 Top 5 Chains in UNITED STATESCANADARegion Ranked by Year-End Regional Units ............................. 458

Table 15.8 Checklist/Score Sheet for Assessing PoliticalFactors ................................................................................... 470

Table 15.9 Checklist/Score Sheet for AssessingSociocultural Factors .............................................................. 472

Table 15.10 Checklist/Score Sheet for AssessingFranchising-Related Factors .................................................... 473

Table 15.11 Quick Checklist Showing Factors That AreEssential for Franchising in a Country ..................................... 474

List of Tables xiii

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xiv Restaurant Franchising

Table 16.1 7Ps Model with Examples Pertainingto Restaurants ........................................................................ 487

Table 16.2 Advantages of Strong Franchise Brands ................. 501

Table 17.1 Assessing Technology-Related Readinessand Use by Franchisor ............................................................ 530

Table 17.2 Assessment and Points to Consider inDeveloping a Website ............................................................. 532

Table 17.3 Examples of Use of Technology byRestaurant Franchises ............................................................ 533

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The newly revised 3rd edition of Restaurant Franchising is a classic vol-ume covering one of the most vibrant and vital sectors of the U.S. econ-omy. Nearly 190,000 franchise restaurants provide more than 4.1 million jobs and more than $266.4 billion in economic outputamounting to one-quarter of all establishments, one-half of all jobs, and one-third of the total economic output of the franchising industry. The franchising sector of the restaurant industry accounts for nearly 40 percent of total restaurant industry sales of $660 billion, 30 percent of the more than 13 million restaurant industry jobs, and nearly 20 percent of all restaurant establishments. Hundreds of well-known, iconic brands, and new emerging concepts serve tens of millions of customers day in and day out, at home and abroad, in every imaginable for-matkiosk, drive-through, take-out, sit-down, self-serve, full menu, food trucks, and home delivery, while maintaining the quality, consistency, and convenience that their customers have come to expect.

The fi rst edition of Dr. Khans book, published in 1991, broke new ground, giving both educators and entrepreneurs a comprehensive, insightful guidebook into the many facets of the restaurant franchising industry. The book is an excellent introduction to prospective franchisees (those consider-ing buying an existing franchise) and to prospective franchisors (those con-sidering using the franchise method to grow and expand their business). The book covers many topics, including the pros and cons of franchising, concept development, choosing the right franchise, fi nding fi nancial backing, under-standing franchise legal agreements, federal and state franchise regulations, selecting the right franchisees, developing healthy franchisor/franchisee rela-tionships, international franchising, and nontraditional franchises. Excellent examples and case studies are included in the book that make this book much more than a general, academic treatment of the subject.

FOREWORD

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xvi Restaurant Franchising

On behalf of the International Franchise Association, we are grateful to Dr. Khan for revising and bringing out a new edition of this classic book on the subject of restaurant franchising. It is a multi-purpose book, serv-ing as classroom textbook, reference book, and business guidebook. We are delighted to recommend it on the menu for anyone who wants to learn more about this fascinating, fast-paced, and dynamic industry.

Steve Caldeira, CFE

President & CEO, International Franchise AssociationWashington DC, USA

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With technological advancements, the world is ever becoming a smaller place. This provides a conducive environment for the development of franchises, and especially so in the restaurant business. A pioneering effort was made to bring out in the fi rst edition of a book titled Restaurant Fran-chising in 1991, followed by a second edition in 1999. Things have drasti-cally changed since then; hence this book is a completely updated version. Five new chapters have been added to highlight new research and informa-tion available in the area of franchising. This edition is designed the to meet the needs of the industry as well as academia. Several tables, illustrations, and photos are added to supplement the information.

This edition covers all aspects of restaurant franchisingfrom defi ni-tions, to pros and cons, and to the legal documents needed for franchising. It goes into the concepts, practice, management, and legal aspects of franchis-ing. Selecting a franchise, franchisee, and franchisor is discussed in detail, thus making this book valuable to prospective franchisees, current franchi-sees, and franchisors, as well as to the customer. Franchising demands a symbiotic relationship between the franchisor and franchisee, and steps to develop this mutually benefi cial relationship are described. There are several tables, which describe steps to be taken at different phases of management of franchised restaurants. Examples are provided as and when necessary.

Several domestic and international restaurant franchises are described, giving selected information. It should be noted that some information is selected from available websites to explain certain points. Since most of the information can be secured from websites of individual restaurant franchises, and since web addresses change often, those references are not included. However, it is strongly urged for the readers to seek more information related to individual franchises if needed.

PREFACE

xvii

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xviii Restaurant Franchising

This book is suitable for classroom use, and an instructors manual to accompany Restaurant Franchising: Concepts, Regulations, and Practicesis available as a teaching resource for instructors. A template of possible syllabus is provided to fi t one semester within an academic calendar. Each chapters contents are highlighted starting with the chapters objectives. Objectives are designed so that after reading and studying each chapter, the student should be able to complete specifi c knowledge components. Key teaching elements and points are listed for each chapter, with special empha-sis on defi nitions and terminology. References or other sources for additional information are also provided. At the end of each chapter within this book, there is a case study, for which discussion questions are listed. Possible top-ics for class assignments and fi eld studies are suggested in the instructors manual. In addition, at least 20 PowerPoint slides are provided for each chap-ter. Overall this manual is designed to provide teaching aids that will help in making lectures a more productive, interactive, and interesting learning experience for students.

It is the intent of the author to make this edition as useful as possible to franchisors, franchisees, prospective franchisors, corporations, and inter-ested individuals. Every effort was made to collect, update, and add informa-tion to make this book a valuable source for readers. The fi nal presentation of this manuscript would not have been possible without the assistance of several individuals and corporations. It is impossible to acknowledge every-one, but sincere thanks go to everyone who contributed to make this publi-cation possible.

The author wishes to thank all those who helped in reviewing, copyedit-ing and publishing this manuscript. Special thanks are due to Ashish Kumar, President, and Sandra Jones Sickels, Vice President, Apple Academic Press, Inc., for their constant support and advice.

Finally, th e author sincerely hopes that this book will prove to be a tool for professional success and development of franchises. It will be great to hear back from successful entrepreneurs.


Professor, Department of Hospitality and Tourism Management,Pamplin College of Business,

Virginia Polytechnic Institute and State University (Virginia Tech),Falls Church, Virginia

email: [email protected]

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The author would like to acknowledge all those who have supported him and contributed to this edition of the book, without whom it would have been impossible to present such information on this multidisciplinary topic. Special thanks are due to following individuals and corporations who pro-vided intellectual support or resources to strengthen the topics discussed in this book.

Ihsan AbuGhazalah, Chairman, ALBAIK & AQUAT Food Industries

Rami AbuGhazalah, CEO, ALBAIK Food Services

Mark Beck, Account Executive, Coltrin & Associates, New York, representing Popeyes Louisiana Kitchen

Chris Brandon, Public Relations, Dominos Pizza

Michael Bullington, Archivist, McDonalds Corporation

Mandy Burns, Marketing and Public Relations, Panera, LLC

Todd Burns, Vice President, Franchise Operations, Panera, LLC

Steve Caldeira, President and CEO, International Franchise Association

Alexxis Cardenas, Taco Bell Public Affairs & Engagement Team

Scott Carman, Director, Public Relations, Choice Hotels International

Patrick Doyle, President and CEO, Dominos Pizza

Don Fertman, Chief Development Offi cer, Subway Restaurants

Eric Gallender, Senior Intellectual Property Counsel,McDonalds Corporation

Alison Goldberg, Public Relations Specialist, Subway FranchiseWorld Headquarters, LLC

Craig Hoffman, Senior Manager, External Communications, IHOP

ACKNOWLEDGMENTS

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xx Restaurant Franchising

Steve Joyce, President & CEO, Choice Hotels International

Kris Kaffenbarger, Senior Vice President, Business Development, Wendys International, Inc.

Al Litchenburg, Chief Development Offi cer, Pizza Hut

Sarah Lockyer, Editor-in-Chief, Nations Restaurant News, A Penton Restaurant Group publication

Kitty Munger, Director, Communications, Wendys International, Inc.

John Reynolds, President, International Franchise Association Educational Foundation

Megan Saint-John, Communications Coordinator, Chilis Grill & Bar

Julia Stewart, CEO, IHOP

Doug Terfehr, Director, Public Relations, Pizza Hut

Phai Yingprasert, Media Center Coordinator, McDonalds Corporation

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1CHAPTER 1

INTRODUCTION TO FRANCHISING

Without franchising, Wendys could never have expanded so rapidly. From the beginning weve looked at our franchisees as important partners. Theres no I in Wendys. WE are Wendys. Our franchisees commitment and their support means a great deal to me. Their hard work and dedication have created countless opportunities for others to achieve their dreams of success.

Dave Thomas, Founder, Wendys

Franchisingthe most dynamic business arrangementhas become the dominant force in the distribution of goods and services in the United States as well as in many other countries. National and international experts believe that franchising has become the primary method of doing business worldwide. Paradoxically, in spite of its popularity and distinct impact on

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2 Restaurant Franchising

the economy, franchising still remains a relatively obscure concept. Some view it as an industry in itself, while others associate it with a particular type of business, such as fast food restaurants. Much of the confusion stems from franchising being an umbrella term that covers a wide variety of busi-ness arrangements and activities. It is not restricted to a particular type of business, rather it is a method that is applicable to a variety of business deal-ings. In fact, its strength lies in its adaptability to an ever-expanding array of industries, markets, products, and services. In addition to being responsive to economic development and consumer demands, it is fl exible enough for the distribution of goods and services as conditions demand. This is one of the primary reasons why franchising is commonly referred to as a method or channel for distributing goods and services.

Franchising means a granting of right; an exemption or freedom from servitude.

DEFINITION OF FRANCHISING

The term franchise has its origin in the French word meaning free from servitude. Roughly translated that would mean that a businessman is free to run his own business. It is used as a noun as well as a verb. Strictly from the business point of view, a franchise is a right or privilege granted to an individual or a group.

Franchising is a form of business arrangement which originated from France in the 18th century. The term franchising in French also means a granting of right or an exemption. Strictly from the business point of view, a franchise is a right or privilege granted to an individual or a group. Fran-chises may be granted by government or private bodies. From the point of view of economics, a franchise is a right granted to operate a business under the general regulation of one who grants its. Simply defi ned, a franchise is a legal agreement in which an owner (franchisor) agrees to grant rights or priv-ileges (license) to someone else (franchisee) to sell the product(s) or services under specifi c conditions. This method of doing business is referred to as franchising and, like marketing or distributing a product or service, may be adopted and used in a wide variety of industries and businesses.

Franchising is also defi ned as a continuing relationship in which a fran-chisor provides a licensed privilege to the franchisee to do business and offers


Introduction to Franchising 3

assistance in organizing, training, merchandising, marketing and managing. Franchising is a form of business by which the owner (franchisor) of a product, service or method obtains distribution through affi liated dealers (franchisees).

Since there are certain rights that pass from one party to another, there are legal aspects that should also be considered in any defi nition of franchising. From a legal standpoint, according to a report by the U.S. Congress House Committee on Small Business (1991), franchising is essentially a contrac-tual method for marketing and distributing goods and services of a company (franchisor) through a dedicated or restricted network of distributors (fran-chisees). Under the terms of this legal franchise contract, a franchisor grants the right and license to franchisees to market a product or service or both, using the trademark and/or the business system developed by the franchisor. The contract imposes obligation on both parties. The franchisor must provide the product, proven marketing support, and training. The franchisee brings fi nancing, management skills, and a determination to own and operate a suc-cessful business. Franchising happens when someone develops a business model and sells the rights to another entrepreneur, a franchisee; the company selling the rights is the franchisor. The franchisee usually gets the rights to the business model for a specifi c time period and in a specifi c geographic area (Spinelli, Jr., Rosenberg & Birley, 2004). In the best arrangement every-one wins: the franchisor expands its number of outlets and gains additional income; the franchisee has a business of his or her own.

According to Tarbutton (1986), a generally accepted defi nition for the term franchise is a long-term, continuing business relationship wherein for a consideration, the franchisor grants to the franchisee a licensed right, subject to agreed-upon requirements and restrictions, to conduct business using the trade and/or service marks of the franchisor and also provides to the franchisee advice and assistance in organizing, merchandising, and managing the business conducted pursuant to the licenses.

Justis and Judd (1989) defi ne franchising as a business opportunity by which the owner (producer or distributor) of a service or a trade-marked product grants exclusive rights to an individual for the local distribution and/or sale of the service or product, and in return receives a payment or royalty and conformance to quality standards. Although similar to the above defi -nitions, this one takes into account the conformity to quality standards by a franchisee. Franchising is also defi ned as a contractual business arrange-ment in which a fi rm grants an individual or companies the rights to con-duct business in a prescribed manner within a specifi ed territory during an



agreed time period in return for royalty contributions or other fee payments (Justis and Judd, 2004). Franchising was viewed previously as a small busi-ness alternative to fully independent business ownership, within the broader context of the individuals drive toward self-employment (Kaufmann, 1999). In terms of legal contracts, franchising can also be defi ned as the network of a contract-giving fi rm (franchisor) with (in principle) independent contract takers (franchisees). The grant of rights to use labels, names, trademarks, production procedures, prescriptions, etc., of the franchisor against payment by the franchisee can be regarded as constitutive features of franchising. The payment generally consists of a lump-sum fee to be paid when entering the system as well as royalties based on gross sales (Hempelmann, 2006). Com-pared to nonfranchised businesses, franchising is inelastic and is diffi cult to change. The entire system is locked into legal and business boundaries, with several vested ownerships that makes it diffi cult to maneuver.

Franchising is a method of doing business.

Franchising, particularly in the area of services, has two unique features; fi rst, franchising typically occurs in businesses where there is a notable ser-vice component that must be performed near customers. The result is that service-providing outlets must be replicated and dispersed geographically. Secondly franchise contracts typically refl ect a unique allocation of respon-sibilities, decision rights, and profi ts between a centralized principal (the franchisor) and decentralized agents (franchisees) (Combs, Michael, and Castrogiovanni, (2004). The franchisor sets and enforces chain-wide stan-dards for performance, selects franchisees, approves outlet locations, man-ages brand image, and coordinates activities (Caves and Murphy, 1976). The franchisors revenue comes primarily from franchise fees and royalty pay-ments tied to franchisee sales. Franchisees establish local outlets, set oper-ational policies such as price, hours, and staffi ng, and manage day-to-day operations in exchange for profi ts after royalties and other expenses. Viewed from the perspective of entrepreneurship, franchising is a vehicle for entering business ownership (Shane and Hoy, 1996). From the perspective of market-ing, franchising is often considered as a distribution channel (Kaufmann and Rangan, 1990). From the fi nance point of view it is a capital structure issue (Norton, 1995). From the perspective of economics, franchising is a leading venue for understanding the structure of contracts (Lafontaine, 1992). From the perspective of strategic management, franchising is an important organi-zational form (Combs and Ketchen, 1999).



Although it has been suggested that franchisees are little more than employees (Rubin, 1978), a more encompassing view is that it represents a method of controlled self-employment (Felstead, 1991). This dyadic relation-ship affords franchisees many benefi ts, which may be broadly categorized as marketing, fi nancial, and operational advantages derived from economies of large-scale operation (Hing, 1995).

The importance of ongoing franchisor support and a proven concept in minimizing potential risk has been reported (Baron and Schmidt, 1991; Hunt, 1977; Withane, 1991) as one of the primary reason for selecting franchising. Other reasons include the role of an established name, lower development costs and operational independence (Mendelsohn, 1999; Peterson and Dant, 1990). A franchise system is not only an economic system but also a social system in which the franchisor and franchisees have a close working rela-tionship (Strutton, Pelton, and Lumpkin, 1995). Accordingly, the fundamental behavioral dimensions of power/dependence, communications, and confl ict that characterize a social system (Stern and Reve, 1980) are also characteris-tics of a franchise system.

The U.S. Department of Commerce defi nes franchising as a method of doing business by which a franchisee is granted the right to engage in offering, selling, or distributing goods or services under a marketing format which is designed by the franchisor. The franchisor permits the franchisee to use the franchisors trademark, name and advertising.

The International Franchise Association, the major franchising trade asso-ciation, defi nes franchising as a continuing relationship in which the franchi-sor provides a licensed privilege to do business, plus assistance in organizing, training, merchandising, and management in return for a consideration from the franchisee. In a widely circulated publication brochure entitled Investi-gate before Investing, the association offers a further defi nition of franchising based on a prototype franchise disclosure law: a contract or agreement either expressed or implied, whether oral or written, between two or more persons by which (a) a franchisee is granted the right to engage in the business of offering, selling or distributing goods or services under a marketing plan or system prescribed in substantial part by a franchisor; and (b) the operation of the franchisees business pursuant to such plan or system is substantially associated with the franchisors trademark, service mark, trade name, logo-type, advertising or other commercial symbol designating the franchisor or its affi liate. In short, franchising is a business method and relationship.



In addition to mutual benefi ts provided to franchisors and franchisees, franchising provides economic benefi ts to a region by providing employ-ment, tax revenues, economic multiplier effect, and other related community benefi ts. It also promotes expertise, skills, and expertise among available human resources within the region. Since franchising is closely linked with entrepreneurship, it also helps in bringing forth entrepreneurial and manage-rial capabilities within the labor force.

BASIC CONCEPTS AND DEFINITIONSOF FRANCHISING

According to the Federal Trade Commission (2007) the following terms defi ne various legal aspects pertaining to franchising:

Franchise means any continuing commercial relationship or arrangement, whatever it may be called, in which the terms of the offer or contract specify, or the franchise seller promises or represents, orally or in writing, that:

1. The franchisee will obtain the right to operate a business that is identifi ed or associated with the franchisors trademark, or to offer, sell, or distrib-ute goods, services, or commodities that are identifi ed or associated with the franchisors trademark;

2. The franchisor will exert or has authority to exert a signifi cant degree of control over the franchisees method of operation, or provide signifi cant assistance in the franchisees method of operation; and

3. As a condition of obtaining or commencing operation of the franchise, the franchisee makes a required payment or commits to make a required payment to the franchisor or its affi liate.

Franchisee means any person who is granted a franchise.

Franchisor means any person who grants a franchise and participates in the franchise relationship. Unless otherwise stated, it includes subfranchisors. For purposes of this defi nition, a subfranchisor means a person who functions as a franchisor by engaging in both presale activities and postsale performance.

Franchise seller means a person that offers for sale, sells, or arranges for the sale of a franchise. It includes the franchisor and the franchisors employ-ees, representatives, agents, subfranchisors, and third-party brokers who are



involved in franchise sales activities. It does not include existing franchisees who sell only their own outlet and who are otherwise not engaged in fran-chise sales on behalf of the franchisor.

Parent means an entity that controls another entity directly or indirectly through one or more subsidiaries.

Person means any individual, group, association, limited or general partner-ship, corporation, or any other entity.

Leased department means an arrangement whereby a retailer licenses or other-wise permits a seller to conduct business from the retailers location where the seller purchases no goods, services, or commodities directly or indirectly from the retailer, a person the retailer requires the seller to do business with, or a retailer-affi liate if the retailer advises the seller to do business with the affi liate.

Plain English means the organization of information and language usage understandable by a person unfamiliar with the franchise business. It incor-porates short sentences; defi nite, concrete, everyday language; active voice; and tabular presentation of information, where possible. It avoids legal jar-gon, highly technical business terms, and multiple negatives.

Predecessor means a person from whom the franchisor acquired, directly or indirectly, the major portion of the franchisors assets.

Principal business address means the street address of a persons home offi ce in the United States. A principal business address cannot be a post offi ce box or private mail drop.

Prospective franchisee means any person (including any agent, representa-tive, or employee) who approaches or is approached by a franchise seller to discuss the possible establishment of a franchise relationship.

Required payment means all consideration that the franchisee must pay to the franchisor or an affi liate, either by contract or by practical necessity, as a condition of obtaining or commencing operation of the franchise. A required payment does not include payments for the purchase of reasonable amounts of inventory at bona fi de wholesale prices for resale or lease.

Sale of a franchise includes an agreement whereby a person obtains a fran-chise from a franchise seller for value by purchase, license, or otherwise.



It does not include extending or renewing an existing franchise agreement where there has been no interruption in the franchisees operation of the business, unless the new agreement contains terms and conditions that differ materially from the original agreement. It also does not include the transfer of a franchise by an existing franchisee where the franchisor has had no signifi -cant involvement with the prospective transferee. A franchisors approval or disapproval of a transfer alone is not deemed to be signifi cant involvement.

Signature means a persons affi rmative step to authenticate his or her identity. It includes a persons handwritten signature, as well as a per-sons use of security codes, passwords, electronic signatures, and similar devices to authenticate his or her identity.

Trademark includes trademarks, service marks, names, logos, and other commercial symbols.

Written or in writing means any document or information in printed form or in any form capable of being preserved in tangible form and read. It includes typeset, word-processed, or handwritten documents; information sent via email; or information posted on the Internet. It does not include mere oral statements.

The above legal defi nitions include certain terms that are used in the legal franchising documents and agreements. In summary it can be stated as follows:

n Franchising is a method of distributing goods and/or services.

n A franchise is a right or privilege granted to an individual or a group.

n A franchise is a legal agreement business two parties.

n The owner who agrees to grant rights or privileges is referred to as the franchisor.

n The individual or group to whom the rights or privileges are granted by the franchisor is called the franchisee.

n The system under which franchisor and franchisee operate is known as franchising.

The above defi nitions are crucial in understanding the concept of franchis-ing. A franchise should not be confused with a subsidiary or branch operation



of a business. A business may have several solely owned subsidiary branches of the original operation that are not franchises. For example, Sears has branch stores that cannot be considered as franchises. The use of trademark alone does not constitute a franchise. There are multi-unit operations and groups of restaurants owned by an individual or corporation that have the same trade-mark but are not franchises. For example, Red Lobster restaurants are a part of a national chain; individual restaurants are not franchises. What constitutes a franchise is the legal agreement between a franchisor and a franchisee for the conduct of specifi c business. Further, a franchise-granting corporation may itself be a wholly owned subsidiary of another corporation. A good exam-ple is Pizza Hut, which is a subsidiary of Tricon Global Restaurants, which also owns Taco Bell Corporation and KFC. Thus Pizza Hut is a component of a large conglomerate. Components of conglomerates are not considered franchises, although some of them may individually be franchise-granting corporations. Another way of categorizing the different types of franchised and nonfranchised unit is (a) fully franchised restaurant, where all units are franchised such as in Baskin-Robbins; (b) dual distribution units, where some units are franchised and some are company owned, such as McDonalds; and (c) wholly owned chains, where all units are owned by a corporation, such as Red Lobster restaurants, which are also referred to as nonfranchised units.

In summary, under the terms of the franchise contract, a franchisor grants the right and license to a franchisee to market a product or service, or both, using the trademark and/or the business system developed by the franchisor. Franchising works because of ownership attention. The fran-chisors motivation to use franchising as a means of retailing lies in the attention that the franchisee as a semi-independent owner directs toward the business (Dahlstrom and Nygaard, 1994). In other words, franchising alleviates franchisors need to monitor their outlet managers because fran-chisees are the residual claimants on the profi ts of their outlets (Norton, 1988a; Fama and Jensen, 1983).

The entire process of franchising starts with a concept, which may be based on an idea, name, process, product, or format. The franchisor grants a license to another party to use this concept. The franchisor normally charges a fee for this arrangement, which is called a franchise fee. In particular, fran-chising offers a method of extending capital (Oxenfeldt and Kelly, 1968), labor (Norton, 1988b), and managerial limitations on future venture growth, while maximizing the joint utility of network partners (principal and agents), thus ensuring ongoing operational effi ciency (Bergen, Dutta, and Walker, 1992).



FRANCHISING: A SYMBIOTIC RELATIONSHIP

A review of service franchises reveals the existence of a symbiotic and mutually benefi cial relationship between the franchisor and the franchisee. If properly executed, franchising is a winwinwin situation. There are signifi -cant advantages to franchisor, franchisee, and the consumer. For an entrepre-neur, a small business, or a growing company with a potentially successful product, a service process, or plan, franchising provides a cost-effective and systematic strategy for marketing and rapid expansion with a minimum of direct involvement and fi nancial investment. For a prospective franchisee, it represents an opportunity to own and operate a business involving a proven concept, product, or business format with a minimum of fi nancial risk. For potential consumers, franchising provides a way to receive goods and services in a reliable and predictable manner.

For the franchisee, the most signifi cant characteristic of a franchise rela-tionship is the minimizing of the risk of starting a new business. A franchi-see also benefi ts from consumer recognition of the franchisors trademark and service mark. Costly operating and marketing mistakes can be avoided because franchisors provide advertising, training, continuous supervision, and assistance. On the other hand, a franchisee is not as independent as a nonfranchised businessperson because of his or her contractual depen-dence on the franchisor for promotion, advertisement, training, technical support, maintenance of quality standards, and overall assistance in opera-tional matters. This loss of independence is often the cause of friction and confl ict. Other franchisorfranchisee relationship problems can be traced to the franchisees yielding of some options and controls. The franchisor exercises a certain degree of control over the actions of the franchisees, primarily for the maintenance of quality and performance standards. The degree of control varies from one franchise to another and is based on the type of business.

DIFFERENCE BETWEEN SERVICE FRANCHISESAND RETAIL CHAINS

The importance of services franchising is increasing tremendously, and there are distinct differences between retail chains and service franchises. Some of the basic differences stems from the quality attributes of services, which include (1) intangibility of services; (2) simultaneous production and consumption; (3) perishability; and (4) heterogeneity.



The process of franchising starts with a concept, which may bebased on an idea, name, process, product, or format.

Intangibility

Services are intangible and cannot be touched, felt, or tasted. This is one of the major differences between service franchises and retail franchises. For example, the concept of providing service with a smile is not easy to made tangible since the service vary based on the customer expectation and ser-vice provider. This intangibility poses major challenges for services chains. It is diffi cult for the customers to evaluate services before they buy them or after they use them. For instance, when buying vacation packages from travel agencies or using a hairstyle outlet, it is impossible for assessing what services will be provided prior to purchasing them. In order to reduce this intangibility, services try their best to provide as much tangible evidence as possible. This comes in the form of service and satisfaction guarantees, employee uniforms, menu boards, advertisement and promotion, slogans, logos, and many other such evidences, which provide tangible evidence of the expected services.

Simultaneous Production and Consumption

Services are provided mostly at the franchise unit or by the franchisees at a customer location, thereby forming a direct link between the producer and consumer of services. For example, the customer is present at the premises in a restaurant or sleeping under the same roof in a hotel. Thus services are generally created and delivered as the customer is consuming it.

These simultaneous production and consumption makes services dif-ferent than products since the customer is present, involved, may witness services being produced and maybe involved in its production process. For example, a customer using a buffet service in a restaurant is physically pres-ent, sees what is being served, is involved in service is and may have direct contact with the service provider. Customer choices also are infl uenced by those who are with the customer, such as friends, family, person in front of him in line, etc. This imposes a lot of variability and expectations in services demanded by each customer. Franchisors in the services industry have there-fore the responsibility of building service component in the franchise concept as well as providing a fi ne-tuned training program to provide that service.



Perishability

Services are perishable since they cannot be saved, stored, resold, or inventoried. Once the night is over and the room is not sold in a hotel, the opportunity is lost forever. Similarly, when a fl ight takes off and the seats are not sold, then they cannot be resold. Also there is a capacity constraint since there are fi xed number of seats in a restaurant or seats on a plane. There are also peaks and valleys in the service timings and customer demands. If a bus pulls in front of the restaurant, all guests have to be served promptly; if not, the business is lost. This calls for different management arrangements and pricing structures to provide business at various time periods. For instance, hotels have varying rates during peak travel and convention times.

Heterogeneity

Services are performed, produced, and served by people (employees) to people (customers). People have different levels of performance and serving capabilities, which are affected by numerous psychological, social, econom-ical, and other factors. For instance a waiter at a restaurant may be stressed out or not in a good mood and that will affect the service. If a guest is in a bad mood, the expectation level and satisfaction is affected. Combined with per-ishability of services this poses a major problem for service franchises. For example, if a hairstylist messes up hair or a waitress drops coffee on a guest, the impact can be very negative for the services and service providers. Also since franchises are linked, it has an impact on the entire franchise system. Thus providing quality service is always a challenge for service franchisees.

The franchisors will have to spend time and effort selecting, training, managing, motivating, and controlling their services providers: franchisees, managers of company-owned units, and to a lesser extent the employees of all the units. Contrary to a product whose quality can be controlled by the franchi-sor before marketing it through the franchisees, the services can be controlled only at the moment they are offered to the fi nal consumers (Perrigot, 2006).

TYPES OF FRANCHISE ARRANGEMENTS

A variety of business arrangements may exist within a franchise system. All of these arrangements can be classifi ed into two major groups: products and trade name franchising and business-format franchising.



Product and Trade Name Franchising

Product and trade name franchising began primarily as an independent sales relationship between supplier and dealer in which the dealer acquired some of the suppliers identity. The dealer (franchisee) identifi es with the supplier (franchisor) through the product line and, to some extent, with its trade name or trademark. Franchisees are granted the rights to distribute a franchisors products or services within a specifi ed territory or at a specifi c location, generally with the use of the manufacturers identifying name or trademark. This type of franchising can be considered as a distribution chan-nel for products manufactured by the franchisor. The franchisee becomes the selected distributor of the franchisors products after securing the license. Examples of product and trade name franchising include automobile deal-erships, gasoline service stations, soft-drink bottlers, and farm equipment dealers. This type of franchising dominates the distribution fi eld since the franchisee has assigned territory for distributing franchisors products. There is considerable competition and, to a certain extent, saturation among fran-chises within this category. The benefi t to the franchisors using this type of franchising is that they can penetrate into a market that they are not familiar with or that they do not have resources to enter. This type of franchising was previously referred to as selective franchising; in fact, for a long period of time franchising was treated as a method of distribution.

Two types of franchising are product and trade name and business-format franchising.

Business-Format Franchising

Business format franchising is defi ned as the granting of a license for a predetermined fi nancial return by a franchising company (franchisor) to its franchisees, entitling them to make use of a complete business package, including training, support and the corporate name, thus enabling them to operate their own businesses to exactly the same standards and format as the other units in the franchised chain (Grant, 1985). It involves a complete business format rather than a single product or trademark. Although product franchising (e.g., automobiles, gasoline) is the largest franchising segment, business format franchising (e.g., McDonalds, Holiday Inn) is the segment that most clearly represents franchising and also shows its relationship to



entrepreneurship. It is characterized by an ongoing business relationship between franchisor and franchisee. Compared to the product and trade name franchising, business format franchising may not have any product manu-factured by the franchisor. However, they serve as a supplier of ingredients, equipment, technical know-how, fi nished products, and all affi liated services. In addition the franchisor provides training, advertisement, promotion, and business process guidance. The franchisor also provides the trademark, trade dress, and other copyrighted information for use by the franchisees. In the restaurant business sometimes the distinction between product and trade name franchising and business-format franchising can get be blurred. For example a coffee shop may give license to a manufacturer to produce the product, which in turn is bought by the franchisee for use in their restau-rant. Some of these products such as Taco Bell sauce may also be available through other outlets.

Business-format franchising includes not only the product, service, and trademark but also the entire business concept itself: a marketing strategy and plan, operating manuals and standards, quality control, group purchas-ing power, research and development, and a continuous process of training, assistance, and guidance. The franchisee is required to comply with the fran-chisors guidelines pertaining to all aspects of the business, including operat-ing procedures, the quality of the products and/or services, and the physical appearance of the business facility. A two-way channel of communication is maintained.

Examples of business-format franchising include restaurants (all types); hotels; motels; and campgrounds; recreation, entertainment, and travel; auto-motive products and services; business aids and services; construction, home improvements, maintenance, and cleaning services; convenience stores; laundry and dry cleaning; educational products and services; rental services (auto and truck); rental services (equipment); nonfood retailing; and food retailing (nonconvenience). Business-format franchising is responsible for much of the franchising in the United States and internationally since 1950. It has shown rapid growth and continues to offer numerous opportunities for individuals seeking to own a business. Business format franchising has also been mentioned as an easier method for women and minorities to enter self-employment (Hunt, 1977).

Differences between the two types of franchising sometimes appear blurred, particularly among nonrestaurant franchises. Where alternative



business arrangements, such as distributorships and licensed agencies, are concerned, it becomes hard to place franchises in one group or the other. In some cases, it is a question as to whether to classify them as a franchise or not. In case of any doubt the FTCs franchise rules and regulations should be referred to. All states incorporate criteria similar to the FTCs franchise rule, although their defi nitions may differ, particularly with regard to the threshold amount paid to acquire a franchise. Thus regardless of what a business arrangement is called, how it is advertised or sold, or even whether it has a formal written contract or agreement, the contractual relationship between parties in the business arrangement governs whether or not it is a franchise.

The dynamic nature and the rapid development of franchising will cer-tainly change the nature and shape of future classifi cation of franchising arrangements and will lead to the introduction of new business terminology. New and creative methods of business arrangements are being introduced to keep pace with the growth of franchising. Some increasingly common terms are dual-concept/multiple-concept franchising, master franchising,and cobranded franchising.

Dual-concept/multiple-concept franchising as the name indicates refers to the arrangement in which two or more concepts function simultaneously at one location. For example, some gas stations are teaming up with restaurants or baked goods franchises and providing both types of goods and services at one location. Also, the presence of KFC, Taco Bell, and Pizza Hut at one location is an example of multiple concepts working collaboratively. Simi-larly some brand hotels are including different brand franchise restaurants within their premises. This type of arrangement lends itself to effective cost sharing and increase in sales by providing additional goods and services or different brand choices to customers. Customers stopping at a gas station may fi nd it convenient to buy from a franchised restaurant or doughnut shop located at the same premises. At times these are also referred to as cobrand-ing or dual branding when two brands are involved.

From a different angle, two types of multi-unit franchising have been identifi ed as area development franchising and sequential multi-unit fran-chising (Kaufmann and Dant, 1996). In area development franchising, the franchisee enters a contractual obligation to open a certain number of outlets in a specifi ed period of time. In turn the franchisee pays for having devel-opment rights. The developer may own one or more developed units. After



termination of the development agreement, each developed outlet signs a separate franchise agreement and starts operating as a traditional franchise. Franchisors can also buy some or all of the developed units. Since it is a huge task of development, the franchisees should have enough investment and managerial capabilities. The principle behind this type of franchising is that it leads to rapid development by someone who is very well acquainted with the area and has suffi cient construction experience. The franchisor does not have to monitor the development or get involved in the tedious process of getting approvals and construction. This could be very risky for the franchi-sors if the developer cannot perform due to fi nancial or other related reasons. In sequential multi-unit franchising, the franchisor grants the franchisee the right to open additional outlets, with each subsequent unit typically being governed by a separate franchise contract.

The master franchising or subfranchising program is designed to provide growth of a franchise in areas or locations where the original franchisor may not have easy access or a franchisor may not want to get involved. In this pro-gram, an individual is trained to be a franchisor and, upon completion of a set training, is referred to as a master franchisee. A master franchisee is respon-sible for selling a franchise and for assisting the new franchisee with the total franchise package, including the site selection, equipment purchase, and personnel training. The master franchisor is also responsible for maintaining the quality of products and/or services in the assigned region on an ongoing basis. The master franchisee assumes all functions of the original franchisor and acts as sole representative in the region. This type of arrangement works effi ciently in international markets, where the original franchisor may not have easy access because of political, social, or cultural reasons. The master franchisee can own units as well as grant franchises in the area assigned by the franchisor. This way a minifranchisor is helped in developing an area and the master franchisee can develop by using the fi nancial resources col-lected by subfranchising. The master franchisee can collect initial franchise fees, royalty, and other associated fees. In return the master franchisee has to provide training, support services, monitor standards, and maintain controls as required by the original franchisor. There are shared responsibilities by which the local aspects are taken care of by the master franchisee and overall research and development by the franchisor. A portion of the fees and royalty collected by the master franchisee has to be paid to the franchisor. As far as agreements are concerned, there is one agreement between the franchisor and the master franchisee and another agreement between master franchisee and subfranchisees. However, the franchisor retains the rights over brand name



and other business practices. This type of arrangement works well mainly in international areas and where the reach of the franchisor is diffi cult. There is a risk of loss of control by the franchisor and depending on how strong the master franchisee is from the business point of view. Overall the franchisor has the liability in case there are legal problems or bankruptcy of the master franchisee. In order to avoid giving all rights of franchising to a master fran-chisee, sometimes franchisors enter into contract under area representation. In this case there are limited rights given by a franchisor.

Another term, conversion franchise, is sometimes used to describe a situation where an owner of an existing business decides to become a fran-chisee by associating with a franchisor. For example, a restaurant owner may decide to convert his or her existing business into a nationally recognized franchise. The franchisor benefi ts by gaining an established clientele and a tested business site, while the franchisee benefi ts by recognition and franchi-sors assistance. Conversion franchising can prove fi nancially benefi cial for both parties. In essence, the franchisor gains the expertise of an experienced established business in exchange for services such as training, marketing, advertising, and research and development. Many franchisors started grow-ing their distribution channels with dealers or licensees who would like to convert their business. The reason why a supplier or licensor would like to convert to a franchise is to derive more revenue in the form of initial fees and royalties as well as to increase advertising and brand awareness (Duvall, 2012). The advantage of conversion franchising is that the franchisor is able to expand business without going through considerably large start-up costs and time. In return the franchisees gain immediate brand name recognition and support services from the franchisor. Also, the franchisee will have a better chance to compete compared to when operating as an independent business.

Management franchises or quasi franchise relationships refers to a relationship where franchisor provides management of a facility owned by the franchisee. Franchisees avail of the management techniques as well as the brand name of the franchisor. The entire management and operation is han-dled by the franchisor, making the franchisee in essence a passive investor. Many hotel companies such as Marriott have this type of franchise relation-ship. The franchisor in this case provides identity, the reservation system, and development. In lieu of management services provided, franchisees pay roy-alty fees. Some hotels practically run the whole operation even with their own managers and employees, thus making franchisees a passive observer.



This method may be costly for the franchisees; however, if a strong brand name is involved, they benefi t by a proven management system.

The different forms of franchising releases franchisors from the burden of expansion related to administration, fi nancial resources, controls, and franchise system maintenance. Also it helps in developing franchisees in areas where the franchisor is not familiar with local bureaucracy and political issues. On the other hand it provides opportunities for franchisors to devote time to research and development of the franchise system. Ideally, it is a winwin situation if properly executed. As expected, with the size of the franchisor, the impacts varies. Stronger franchisors have more bargaining power and can implement more rigid requirements for prospective franchisees. They often have a long list of prospective franchisees and prefer giving franchises to the existing successful franchisees. Considering the power that established franchisors have, a prospective franchisee has better chance of getting a franchise from a start-up franchisor than an established successful franchisor. Also, many large franchise networks are owned by established multioutlet operators, which are independent corporations. This further restricts the chances of a prospective independent small franchisee. Conversely, going with an established strong franchisor ensures to an extent well-established training program, sound oper-ational procedures, effective distribution system for supplies and equipment, marketing and advertising help, and eventual surety of success.

HISTORY AND DEVELOPMENT

Franchising in principle, if not in its current form, has existed for many centuries. In early ages, kings and rulers granted the right to certain individu-als to collect taxes. In the Roman Republic, offi cials referred to as publicaniwere responsible for collecting taxes, a portion of which they withheld as compensation. In the medieval period, churches granted individuals privi-leges to conduct business enterprises within their jurisdiction. In England, many companies received charters of incorporation from the crown.

The rapid development of franchising started in the late 1800s, coin-ciding with the Industrial Revolution. Changes became evident in the way business was conducted, and innovative distribution methods were sought. All these industrial and business changes, coupled with the mass movement of populations to cities and suburbs, led to the development of franchising. Individual enterprises found it profi table to expand into larger franchises, particularly in real estate, hardware, auto repair, and other retail businesses.



The fi rst formal form of franchising in consumer goods fi rms was in the year 1851, when Isaac Singer accepted fees from independent salesmen to acquire territorial rights to sell his recently invented sewing machine. Singer Sewing Machines had experienced diffi culty in marketing the innovative new product; there was a need for representatives to go out and educate con-sumers regarding its versatility. Because Singer did not have the capital to hire such a large workforce, agents working on commission were the most logical choice. Franchising gained much broader recognition with the mar-keting efforts planned by the automobile industry. General Motors Corpora-tion sold its fi rst franchise in 1898, after which franchising became common throughout the automobile and gasoline industries.

Franchising in the Early 1900s

The success of franchising in the auto and petroleum industries opened the door for its use in other types of retail businesses. Basic principles of franchising were introduced into retail marketing with events such as the development of the Ben Franklin general merchandise store in 1920 and the emergence of national A&W walk-up root beer stands in 1925. Also in 1925, Howard Johnson offered three fl avors of ice cream in a drugstore in Mas-sachusetts. This ice cream business was expanded through franchising to a group of restaurants on the East Coast. The fi rst Howard Johnson Restaurant appeared on a turnpike in 1940, and the fi rst Howard Johnson Motor Lodge opened in the year 1954. Baskin-Robbins opened its fi rst ice cream stores in 1940. Thus major growth in franchising was witnessed after World War II. As the economy developed and the population grew after war, businesses includ-ing franchising, grew rapidly. The soft drink industry began franchising by giving proprietary syrup or concentrate to bottlers. The franchisor provided marketing and other support services. Independent wholesalers and retailers also got involved in franchising, when seeing the advantages of franchising.

It was in 1930s that the foodservice industry got involved with franchis-ing. The fi rst recorded case of franchising is when Howard Johnson estab-lished its fi rst franchise. They had two ice cream businesses and a restaurant but did not have enough capital to open additional restaurants. Johnson agreed to help his former classmate open a restaurant and sell ice cream sup-plies as a Howard Johnsons franchise. When this fi rst franchise was success-ful, more franchises were granted. Since many of the franchisees did not have any experience, they benefi ted from the franchisors expertise and guidance and the franchisor benefi ted by supplying ice cream. This idea was found to



be of mutual benefi t to both parties resulting in over 100 Howard Johnsons restaurants by 1940.

Franchising in the 1950s

The decade of the 1950s was a boom period for franchising. Major fac-tors for this growth were an expanding postwar economy and rapid devel-opment of the interstate highway system, which encouraged the growth of restaurants, gasoline stations, and other franchises. The development of high-ways has greatly contributed to the growth of franchising in the United States. The resulting highway franchises often entail large increases in the value of adjoining land developments (Engel, Fischer, and Galetovic, 2005).

Many well-known restaurant franchises started during this time. Colonel Harlan Sanders initiated his fi rst Kentucky Fried Chicken franchise in 1950 and built a chain of more than 600 restaurants during the decade. The greatest suc-cess story in restaurant franchising is often credited to the salesman Ray Kroc, who sold Multimixers to a small hamburger stand in San B

Documents

Restaurant Franchising: Concepts, Regulations and Practices, Third Edition by Mahmood A. Khan