What is franchising?

Jason Gehrke | Director Fran C hise a dvisory Centre

About the Author

Jason has more than30 years’ experience in the franchise sector and is the founder of the Franchise Advisory Centre, a leading provider of education in franchising best practice.

He is a former director on the boards of two franchise brands, and a past chairman of the World Franchise Council. He is a regular contributor to franchise magazines, and publishes Franchise News, Australia’s leading email news bulletin on franchising trends and issues. For details about upcoming franchise education events presented by Jason go to www.franchiseadvice.com.au

Copyright © Jason Gehrke, 2022.

Asyou read these words, you are surrounded by franchising. It is highly likely that today you have bought (or will buy) a product or a service from a franchised business.

As you read these words, you are surrounded by franchising. It is highly likely that today you have bought (or will buy) a product or a service from a franchised business.

Franchising touches our lives so frequently in so many ways that we often fail to see the wood for the trees. We live in homes bought from or rented by franchised businesses. We maintain these homes with the help of franchised lawnmowing services, gardeners, handymen, pest controllers, and so on. We furnish these homes with furniture from franchised retailers, clothe ourselves in goods from franchised businesses, and entertain ourselves with the latest gadgets, games and videos from franchised stores.

We drive cars bought from franchised dealerships (or made by auto franchisors). These are also maintained by franchised repair specialists. We buy fuel from franchised fuel retailers, pick up last minute supplies from franchised convenience retailers, and buy food from franchised eateries.

Franchising is everywhere and we interact with it constantly without even realising how it works. It surrounds us in almost everything we do, buy or consume. It exists in almost every business sector and industry around the world, and yet it is commonly misunderstood by the very people who rely on it to provide them with the goods and services they need to live.

Franchising in Australia is big business. According to the Franchise Council of Australia, the sector generates $172 billion in revenue each year through more than 94,000 outlets across approximately 1,300 brands, and which employs more than 565,000 people in total.

To understand franchising is to understand one of the most dynamic forms of business in operation today. As a concept, franchising is remarkably simple, but in execution, it can be incredibly complex.

This article looks at some common perceptions of franchising and highlights what franchising is, as well as what it is not.

What is a franchise? – Definition

In simple terms, a franchise is a conditional grant. A franchisor offers a grant to use its brands and business systems to the recipient of the grant (the franchisee). The grant is conditional upon the franchisee meeting certain standards to maintain the integrity of the brands and business systems. The grant is usually limited by time and can be withdrawn if the conditions under which it has been provided are not met by the franchisee.

The table below outlines some common perceptions of franchising held within and outside the franchise sector.

Fr ANC h ISING IS…

Fr ANC h ISING IS NOt…

a way to get into business without reinventing the wheel just fast food small business that can take on big business a license to print money a method of growing a business not suited to everyone or every business a business unlike any other not for the unprepared a structured and regulated business partnership an interdependent relationship these perceptions vary according to the perspective of the beholder (eg. franchisee or franchisor). each are considered in more detail below:

Franchising is a way to get into business without reinventing the wheel

This view is commonly held by most potential franchisees, who are drawn to franchising as a way of starting out in business but with the guidance and support of a larger organisation to fall back on. The oft-repeated cliché is that franchising offers a way to be in business for yourself, but not by yourself.

Starting a new business is a daunting challenge and there are no guarantees of success. For new, non-franchised businesses, almost every step of the way breaks new ground for the business owner who can often be overwhelmed by the sheer complexity of the task they have undertaken. As a result of their lack of business experience, independents can easily overlook critical details which may be essential to the success of their business. Most commonly, these include mistakes in estimating the capital required to set up the business, the working capital needed to support the business in its growth phase, as well as the product or service mix, marketing, supply chain management, site selection and many other factors.

In a franchise, the franchisee pays to access the experience of the franchisor and to access the cumulative expertise the franchisor has developed across the spectrum of business operations through the establishment of its own outlets, as well as those of all the current and former franchisees in the group.

Franchising is small business that can take on big business

A key disadvantage of independent small business compared to a franchise is the lack of strength behind the brand. The brands of franchise networks grow stronger as the networks grow larger. The marketing clout of the brand becomes more and more substantial. The collective purchasing requirements of the group provide a substantial lever to negotiate better prices, quality or terms with suppliers not otherwise available to independent operators.

Franchisees are able to call on the resources available in the centrally co-ordinated head office of the franchisor to access advice, expertise and experience not available to stand-alone independents. Not only does this give franchisees and franchise groups greater economic force compared to independent small businesses, but it also helps franchised networks take on corporate chains in the same market place. Franchise groups can match corporate chains for marketing clout and buying power, but press their advantage further due to the profit motive of each franchise owner at individual store or territory level – a motive generally lacking among salaried corporate branch managers.

The ownership of a franchised outlet provides the operator with not only a profit incentive, and an opportunity for capital gain, but a greater level of focus on customer service and greater sense of achievement in building a business asset compared to that of a branch manager.

Franchising is a method of growing a business

Franchising offers budding franchisors with an idea or an existing business the opportunity to grow into a household name. (At least, that’s the hype.)

Franchising is a method of growth suited to existing businesses that are both profitable and sustainable, and which have owners and management teams committed to the long term enhancement of the brand. Ideas can’t be franchised – only businesses. So any idea must be converted into a viable business before franchising can even be considered.

Once a business is determined to be viable, growing it to the next level might involve an assessment of a number of options, including franchising. If an assessment of the available growth options determines that franchising is the most effective way to grow, a long process of planning, documentation and business process review must be undertaken before the first franchise can ever be granted. After all, if franchising was easy, every business would do it.

Start-up franchisors need to confirm that their original operation is not a fluke one-off by replicating it in several other company-owned operations before franchising. These additional outlets help test the business model and over time serve as the nucleus of the franchise network if they are later converted to become the first franchise outlets.

Franchising is a business unlike any other

Franchising is the Place in the famous four P’s of marketing (Price, Product, Place and Promotion). Marketers recognise that Place (also referred to as distribution) is a key benefit of franchising where a cohesive distribution channel enables individuallyowned and operated businesses in different states or countries to provide consistent services and products. Franchising provides the common thread that binds these businesses together.

In this regard, franchising is unique – the franchisees are individually owned, but act as a collective whole for the best interests of the brand.

Furthermore, franchisees pay for the right to join a franchise group, and are accepted only if they meet specific selection criteria (which of course will vary from one group to another).

And because the franchisees share a common brand and operating systems within a group, the franchisor has the dual role of supporting and encouraging franchisees to maximise performance, while at the same time maintaining system and brand integrity. This can mean that franchisees who are not operating in accordance with the rules of the system (or more specifically, the conditions of the franchise granted), may be required to improve or risk the termination of their franchise.

These factors combine to make franchising a truly unique method of business. As such, both franchisors and franchisees must appreciate from the outset the finer detail of the relationship that binds them together.

Franchising is a structured and regulated business partnership

The entire basis of the relationship between a franchisee and franchisor is outlined in four key documents. These are the Franchising Code of Conduct, the Disclosure Document, the Franchise Agreement, and the Franchise Operations Manual.

The Franchising Code of Conduct is the national set of regulations that govern the franchise sector. The Code applies equally to all franchises in Australia, regardless of size and age and determine the environment in which franchising operates. There are protections under the Code for franchisees, and every potential franchisee should read the Code prior to seeking their ideal franchise. Some of these protections include mandatory disclosure of information by franchisors, waiting periods before and coolingoff periods after signing franchise agreements, and dispute resolution procedures.

The Disclosure Document contains key information about the franchise offer, the franchisor and the network to help a potential franchisee make a reasonably informed decision. A Disclosure Document template in the Code identifies the type of information to be provided, irrespective of the size or age of the franchise system.

The Franchise Agreement is the contract that binds the franchisee and franchisor together in a business relationship. Agreements span an initial term which is five years on average in Australia but can be shorter or longer depending on the system, and may be extended for an optional term usually of the same length.

A franchise agreement is a very broad contract that includes provision for almost everything that might occur during the life of the franchise, as well as a number of provisions that will continue to exist after the franchise has ended (eg confidentiality). It can be likened to the ultimate pre-nuptual contract – an agreement that shapes the commercial marriage between franchisor and franchisee which follows. It is vital that franchisees read these agreements (and get professional advice) before signing so that they are fully aware of the terms and conditions up front.

Finally, the Franchise Operations Manual determines how the franchisee must operate their business. It outlines the systems and procedures and “how to” information for a franchisee to run their business. It is inevitably linked to the franchise agreement, so that a failure to comply with the procedures in the operations manual may result in a contravention of the franchise agreement and possible termination of the franchise.

These three documents combined determine the structure of the unique relationship between franchisor and franchisee. This relationship is a business partnership, but not an equal partnership because the franchisor must always retain control of the brand for the good of the network as a whole.

Franchising is an interdependent relationship

The relationship between franchisee and franchisor is unique. On the one hand, the franchisor provides the brand, business know-how, guidance and support to the franchisee. On the other hand, the franchisee provides the front line customer service and implementation that makes the brand real to its customers. This makes franchising interdependent – the franchisee needs the franchisor and in turn the franchisor needs the franchisee.

Franchisors often choose franchising as a method of growth because their own experience operating corporate outlets indicates that customer service levels, and therefore customer satisfaction and repeat patronage are higher in outlets which are operated by a local owner. Franchisees choose to join franchise networks to align themselves to the brand, marketing, buying power and support provided by the franchisor. The relationship is mutually dependent – both parties need each other in order to survive and flourish.

But for all things that franchising is, there are a number of things that franchising is not.

Franchising is not just fast food

Franchising encompasses most categories of businesses in the retail and service sectors. It exists also in wholesaling and manufacturing sectors, and permeates almost all aspects of economic activity. Commonly however, franchising is perceived as concentrated on just fast food.

This perception might arise from the prevalence of fast food brands in the economic landscape, their high-profile locations and broad market appeal, as well as their massive marketing budgets.

The overwhelming majority of franchise brands and outlets however, are in the services sector, ranging from lawnmowing to telecommunications and beyond. These brands provide a variety of business models and capital entry points which in most instances are considerably lower than the cost of investing in a fast food franchise.

Franchising is not a license to print money

A misconception that has developed around franchising over the years is that it is somehow a license to print money for either the franchisor or franchisee. No such businesses exist, or if they do, they don’t happen overnight. Franchisees and franchisors can both enjoy good profits, but first must be prepared to put in the hard work and effort required to build the business to the point that it can be profitable.

Some potential franchisees think that a franchise is a sure-fire iron-clad guarantee of success, and that all they need to do is to open the doors and be flooded by the avalanche of money coming in. Nothing could be further from the truth. While the franchisee’s investment in the brand and franchisor’s knowledge and experience substantially increases their chances of market recognition and uptake, the operation of the business right down to the delivery of customer service is the responsibility of the franchisee. Any single or compound failings by the franchisee to properly execute the business model provided by the franchisor could substantially delay profitability, or worse still, sink the business altogether.

Aspiring potential franchisors are also mistaken if they think that franchising is a license to print money, and that to be extremely profitable all that is required is to sell franchises. The reality is that the time, effort and cost of preparing a business to be franchised is considerable, and often outweighs the financial rewards of franchising for the first few years. As a result, potential franchisors must have deep pockets to commence with, or be prepared to maintain company-owned operations to generate the income necessary to pay for their franchise preparations.

Franchising is not suited to everyone or every business

Not everyone is suited to be a franchisee, and not every business is suited to franchising. Successful franchisees will generally be self-motivated, highly-disciplined individuals who conducted extensive due diligence prior to joining the franchise and who understand how to work most effectively within the parameters of the franchise system. Franchising is not suited to potential franchisees who do not work well with others, who are unable to work within guidelines, who are not disciplined or motivated, and who come to franchising with unrealistic expectations about support or profitability.

Similarly, potential franchisors with unprofitable and unsustainable businesses are not suited to franchising. In some instances even profitable and sustainable businesses may not be suited to franchising if the organisational culture and leadership are not geared towards long-term growth and a continual process of improvement.

Franchising is not suited to the unprepared

The principle of preparation applies equally to both franchisors and franchisees. Businesses that mistakenly believe that franchising is simple greatly underestimate the work involved in preparing a business for franchising.

For example, documenting the business procedures into an operations manual is a considerable undertaking that forces each process to be reviewed and draws heavily from the personal knowledge and experience of the business owners or its key personnel. This requires an investment of time that alone can take many weeks or months to complete. Shortcuts taken by a franchisor at this stage will place a greater burden on the system later if the operations manuals or training systems are incomplete, causing franchisees to place greater demands on support resources after commencement.

Likewise for franchisees, preparation is everything. Potential franchisees are recommended to spend at least one hour in research and due diligence for every $1,000 to be invested in a franchise. This time should be spent reviewing the franchise documentation provided by the franchisor, using professional advisors, undertaking professional development, contacting current and former franchisees, and spending time working in and familiarising themselves with the franchise business.

Summary

Franchising means many things to many people. Franchising surrounds us in our daily lives and exists at all levels in the provision of goods and services. It is a strong economic force in the Australian business environment and continues to grow.

Franchising can provide the well-prepared with opportunities to grow their businesses, and opportunities for potential franchisees to go into business for themselves with the support of a strong brand and more experienced business partner.

Franchising can provide small businesses with the same competitive advantages to compete equally with big businesses, but deliver improved performance at outlet level due to the profit incentive and ownership of the local operator.

Franchising is a unique business relationship where the franchisor and franchisee come to depend on each other. The relationship is documented in the form of a highly-detailed legal contract (the franchise agreement) and shaped by the national regulations that govern the franchise sector in Australia (the Franchising Code of Conduct). Information about the franchise offer is contained in the disclosure document and the knowledge of how to operate the business is provided by the franchisor through training and ongoing support, as well as through its operations manuals.

Common misconceptions about franchising include a perception that it only exists in the fast food sector, and that it will provide unrealistically quick and substantial profits.

Franchising is not suited to everyone and both potential franchisors and potential franchisees must do considerable homework before committing themselves to franchising. The more preparation done beforehand, including extensive reading and research, professional development, and the use of qualified and experienced advisors will bolster their chances of long-term success.

J A son Gehrke | Director

Franchise Advisory Centre

www.franchiseadvice.com.au