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Is Franchising Right for Your Industry?

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Today franchising occurs in more than 80 different industries. This chapter will help you determine if franchising is right for your business by considering multiple factors.
This chapter is from the book

Today franchising occurs in more than 80 different industries. Included among them are automobile repair, automobile sales, book selling, building materials, business services, camera sales, car washes, carpet sales, check cashing, computer training, credit agencies, data processing, dentistry, drug stores, dry cleaning, e-commerce, employment agencies, fast food, formal wear rental, gas stations, greeting cards, grocery sales, hair care, hardware, home remodeling, insurance, lawn care, lumber and building, maid services, music sales, oil lubrication, optical care, photo processing, photocopying, real estate, restaurants, telephone networks, tax preparation, tire sales, security systems, swimming pool sales, travel agencies, and weight loss centers.

While the list of industries in which franchising takes place is impressive—and with franchising spread over 80 industries, the breadth of this organizational form is quite large—franchising is far from a universally applicable way of doing business. Franchising does not occur in literally hundreds of industries. Moreover, franchising is highly concentrated in just a few industries. One study from the International Franchise Association reports that 18 percent of all franchise systems are found in fast food and 11 percent are found in general retail. Other data sources provide similar results. Table 1.1 summarizes the percentages of franchisors for the most popular industries for franchising as reported in the Sourcebook of Franchise Opportunities.

Table 1.1 The Top Ten Industries for Franchising in Percentage of Franchisors

Industry

Percent of Franchisors

Percent of Franchised Units

Fast food

15.2

26.8

Restaurants

7.0

3.8

Automotive products

6.2

5.5

Maintenance and cleaning

5.4

8.2

Building and remodeling

4.9

1.5

Specialty retail

3.8

1.5

Specialty food

3.8

2.0

Health and fitness

3.3

3.5

Child development

3.2

0.7

Lodging

3.1

5.9



Source: Adapted from data contained in R. Bond's Bond's Franchise Guide, 15th Annual Edition (Oakland, CA: Sourcebook Publications, 2004). 14–15.


Other evidence shows that franchisors perform much better in certain industries than in others. Franchisors now account for the majority of sales in tax preparation, printing and copying, and specialty food retailing, and close to half of all sales in restaurants and lodging. This suggests that these industries are particularly good ones for franchising. Several research studies also demonstrate the favorability of certain industries for franchising. In a report to the Office of Advocacy of the U.S. Small Business Administration, I showed that new food franchisors have a higher 12-year survival rate than retail or service franchisors. Similarly, FRANDATA Corporation, a franchise consulting firm, examined franchisor bankruptcies from 1983 to 1993 and found that 17.4 percent of lodging franchisors had gone bankrupt, as compared to only 12.5 percent of restaurants and less than 5 percent of business franchisors.

The somewhat limited range of industries in which franchising operates, combined with the concentration of franchising in a handful of industries and the evidence of better franchisor performance in some industries than in others, suggests that an important issue for you, as a potential franchisor, is to determine whether franchising is appropriate for the industry in which you operate. This chapter identifies nine characteristics that make franchising appropriate for an industry:

  • Production and distribution occur in limited geographic markets.

  • Physical locations are helpful to serving customers.

  • Local market knowledge is important to performance.

  • Local management discretion is beneficial.

  • Brand name reputation is a valuable competitive advantage.

  • The level of standardization and codification of the process of creating and delivering the product or service is high.

  • The operation is labor intensive.

  • Outlets are not terribly costly or risky to establish.

  • The effort of outlet operators is hard to measure relative to their performance.

  • Before discussing the characteristics that make some industries more appropriate for franchising than others, however, the chapter first defines franchising and gives a short history of how it evolved and became a part of the business landscape.

What Is Franchising?

In casual terms, a franchise is a particular legal form of organization in which the development of a business concept and its execution are undertaken by two different legal entities. Of course, franchising is a legal arrangement, and the Federal Trade Commission, the U.S. government agency responsible for regulating franchising, provides a legal definition of this arrangement. According to the Federal Trade Commission Rule 436.2, paragraph 6160:

"The term 'franchise' means any commercial relationship... whereby a person offers, sells or distributes to any person...goods, commodities, or services which are: (1) identified by a trademark service mark, trade name, advertising or other commercial symbol...or (2) directly or indirectly required or advised to meet the quality standards prescribed by another person where the franchisee operates under a name using the trademark, service mark, trade name, advertising, or other commercial symbol."

The broad category of franchising is made up of two different business models: product franchising and business format franchising. Product franchising is an arrangement in which one party, a franchisor, develops a trade name and licenses it to another party, a franchisee. The product franchisee contracts for the use of the name to deliver products or services to end customers for a certain time period at a certain location. Examples of companies that engage in product franchising are Coca-Cola®, Goodyear Tires, and John Deere.

Business format franchising is an arrangement in which one party, a franchisor, develops a brand name and an operating system for a business, and licenses them to another party, a franchisee. The franchisee contracts for the use of the name and the operating system to deliver products or services to end customers for a certain time period and at a certain location. Examples of companies that engage in business format franchising are General Nutrition Centers®, Jiffy Lube®, MAACO®, McDonald's, Subway®, Uniglobe® Travel, and Wendy's®.

The major difference between product franchising and business format franchising is that product franchisors do not offer an operating system to franchisees, and business format franchisors do. Because product franchisors do not license an operating system to franchisees, they do not seek uniformity in the operations of their franchisees. Another difference between the two types of franchisors is that product franchisors tend to seek compensation from sales of products to franchisees who resell them to retail customers, whereas business format franchisors tend to make money from royalties on gross sales to retail customers. However, this latter difference tends to be blurred because a significant minority of business format franchisors makes at least some profits from the sale of inputs to their franchisees.

As will be explained in more detail later, franchising is most common in industries in which companies need to operate a large number of outlets across a wide variety of geographic locations. This means that franchising is very common among the chain organizations that dot the business landscape. But not all chains need to be franchised. As was mentioned in the "Introduction," Starbucks manages an enormous retail coffee chain without franchising a single outlet.

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