Franchising
Franchising involves the franchisor company providing a license for its business model to other firms. This enables them to use the franchisor's intellectual properties (such as logos, trademarks, and patents) and corporate goodwill to start their own business. The two main parties involved in a franchise business are the franchisor and the franchisee. Initially, the franchisee must pay a franchise fee to the franchisor. Subsequently, on a regular basis, preferably every month, a royalty fee must be paid, usually calculated as a percentage of the sales proceeds. Additionally, the franchisee pays advertisement fees periodically to promote national and international awareness.
A major advantage of a franchise business is its lucrative nature, often generating a faster return on investment. It provides an instant business setup with tested and readily available support systems, including business expertise, management support, marketing and operational assistance, and the use of an established brand name. As these support facilities reduce the risks usually associated with establishing a new business, franchising not only simplifies the startup process but also increases the likelihood of achieving a break-even point more quickly. The products also benefit from instant recognition, which aids client acquisition.
However, running a franchise business is not without challenges. It is essential to conduct a feasibility study before selecting a franchise due to the substantial capital investment involved. Exhaustive analysis and preliminary market research are crucial to gauge the viability of a particular project. Prospective franchisees should obtain general information about the franchisor through the company brochure or CD by submitting a request form. Acquiring the Franchise Disclosure Document (FDD) is vital, as it safeguards individuals from making decisions based on unsupported information. Furthermore, state-specific regulations to protect franchisees' interests should be understood, and a neighborhood survey should be conducted to assess consumer preferences, brand strength, product acceptability, and competitor presence.
One rationale behind the franchising setup is the presence of capital market imperfections. Franchising allows the franchisor to raise capital at a lower cost, providing a cheap source of capital. However, franchisors are in an advantageous position compared to franchisees due to income from royalty and input fees. Therefore, franchisees wary of risks should seek a risk premium from the franchisor. According to the market power concept, the dominance and control that franchisors exert over franchisees negate any replacement theory that might diminish the franchisor's market power value. Franchisee owners bear the residual risk since their income depends largely on revenue inflows and operational payments.
Other factors impacting franchising include the location of the franchise outlet relative to the franchisor. The farther the franchisee outlet, the higher the costs incurred in dispersing functions. Firm size is another consideration; larger businesses may find franchise contracts less advantageous, as specialization and separating investment from management can increase profits.
Protecting the franchisor's brand name capital is crucial. The quality of products used by local franchisee outlets significantly affects the franchisor's brand name. A franchisor investing in a reputable local franchisee, who pays a substantial franchise fee, ensures that the brand name capital is maintained, as the franchisee will be diligent due to their substantial investment.
Another advantage of franchising is that the expansion costs of a business are shared with the franchisee, making it a desirable proposition. Employing specialized managers for franchise operations can minimize expansion costs, as they are better equipped to handle the franchising business's operations and functions.
References
Hg.org - Legal Resources. (2017). Franchising Law.
Klein, B., & Leffler, K. (1981). The Role of Market Forces in Assuring Contractual Performance. Journal of Political Economy, 89(4), 615-641.
Obringer, L. (2001). What is Franchising? - How Franchising Works. HowStuffWorks. Retrieved 7 October 2015.
Prescott, E., & Visscher, M. (1980). Organizational Capital. Journal of Political Economy, 88, 446-61.
Rubin, P. (1978). The Theory of the Firm and the Structure of the Franchise Contract. The Journal of Law and Economics, 21(1), 223-233.
