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This chapter explained that 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: the franchisor, which provides the trade name, and the franchisee, which delivers the product or service under that name. The broad category of franchising is composed of product franchising, which does not involve the provision of an operating system to franchisees along with trade name, and business format franchising, which does.

Most business historians date the beginning of franchising to the Middle Ages, when feudal lords initiated the practice of selling to others the rights to collect taxes and operate markets on their behalf. In the United States, the earliest business use of franchising dates to 1851, when Isaac Singer began his sewing machine company. However, franchising did not enter widespread use in the United States until the turn of the twentieth century, when auto manufacturers began to use this business model with their dealerships. The most dramatic growth in franchising occurred in the 1950s and 1960s, when many of the current large franchise chains were established.

The first rule of successful franchising is to make sure that your industry is appropriate for franchising. Some industries are simply better than others for the creation of franchise chains. Almost 56 percent of franchisors are concentrated in the top ten industries for franchising: fast food, restaurants, automotive products, maintenance and cleaning, building and remodeling, specialty retail, specialty food, health and fitness, child development, and lodging. In some industries, such as tax preparation, printing and copying, and specialty food retailing, franchisors now account for the majority of all firms.

Researchers have identified nine industry characteristics that make franchising appropriate: 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; and the effort of outlet operators is hard to measure relative to their performance.

Franchising makes more sense in industries in which providing customers with a product or service requires small-scale production and distribution in a wide variety of different geographic locations, particularly where some aspect of production—such as creating the brand name or sourcing supply—is subject to economies of scale. Franchising also works better in industries in which customers are served from a fixed geographic location than when they are not.

Because local production is a necessary component for franchising to work well in an industry, franchising tends to be more useful in industries in which local knowledge and local managerial discretion are important to business success. At the same time, however, franchising requires an industry in which the creation and delivery of products or services can be standardized, codified, and easily learned.

Franchising is more effective in industries in which brand name development is important than in ones in which brand names are not a source of competitive advantage. It also works better in labor-intensive industries than in capital-intensive ones. Franchising does not work well in industries in which outlets are costly or risky to operate. Finally, franchising works better in industries in which performance can be measured more easily than effort, than it does in industries in which the inverse is true.

Now that you understand rule number one of franchising, making sure that your industry is appropriate for franchising, we now turn to rule number two, understanding the advantages of franchising. This is the subject of the next chapter.

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