Difference between Franchising and Licensing - Research Paper Example

Difference between Franchising and Licensing Introduction The holder of a trade mark, copyright, or other kind of intellectual property may want to take advantage of the rights assigning to this property in a specific region or country through licensing an intermediary to use the property in the area given to him. This form of setup permits the owner to acquire the advantages from the utilization of his intellectual property yet, simultaneously, frees him of the need to furnish capital to finance the venture (Fried & Elango 68). Similarly, the commercial possibilities that could come with the utilization of the property will be shouldered by the one holding the license and not by the owner. The possibility of taking part in a licensing arrangement will be influenced, partly, by legal factors like royalty taxation, the effect of any relevant competition policies, if the contract between licensee and licensor could have an impact on competition in the area involved, and the degree to which intellectual property rights are safeguarded by the legal machinery of the country where the license will function (Welch, Benito, & Petersen 18). This research paper discusses the difference between licensing and franchising. Differentiating Licensing and Franchising A specific kind of licensing agreement is franchise. Within the franchising agreement, the ‘franchisor’ which has created a well-known, reputable brand image may permit a ‘franchisee’ or another individual to continue operating his/her business, but using the corporate identity and business structure of the franchisor (Kedia, Ackerman, & Justis 335). From the perspective of the general population, there will be no apparent differentiation between a business run by the franchisee and that run by the franchisor. Even though franchise ventures are normally related to popular names like Burger King, McDonald’s, and so on, franchise agreements are not confined only to consumer-based goods, and encompass the delivery of a huge range of products and/or services for the industry itself (Nayler 185). A franchise arrangement can confer advantages to both sides. Some of the benefits for the franchisor are as follows (Nayler 185): The franchisee will provide most, if not all, of the capital. The franchisee will invest his or her own skills and entrepreneurial flair in developing the business and promoting the brand; Most of the commercial risk will lie with the franchisee. A franchisee, in contrast, can (Nayler 185): start a business despite limited capital and experience; take advantage of the goodwill generated by a nationally or internationally known brand name or product; will obtain the benefits of the franchisor’s advertising and promotional activities without incurring the associated costs; rely on the franchisor’s business expertise in such areas as marketing and research. The franchise agreement, which will always be made and controlled by the one granting the franchise, will provide the franchisor wide-ranging power over how the owner of a franchise operates his/her business. Just like in numerous circumstances the franchisee will hold minor bargaining power; there is likelihood that the franchisor will take advantage of such power to demand unjust conditions to the franchisee (Sherman 12-13). As a result, legal rules of several nations aim to safeguard franchisees from the most adverse kinds of manipulation; in the United States, for instance, the courts are open to the possibility of applying the concepts of commercial fairness and honesty to abolish totally unjust conditions in a franchise arrangement. A code of ethics was developed by the International Franchise Association (IFA) (Sherman 13). Although not lawfully mandatory, it gives franchisors who agree with its terms minimum criteria of conduct to follow. The differentiation between franchising and licensing can create misunderstanding or confusion in any industry. However, the difference between these two has been clarified by CEO of MSS FitBiz Connection, Michael Scott Scudder (IDEA Health & Fitness Association 76): A general answer is that a license exists when the owner of a trademark, service mark or other intellectual property grants the right to use that trademark, service mark or other intellectual property for a particular purpose. All franchisees are licensees because all franchisors grant franchisees the right to use their trademarks or service marks to identify their businesses. Generally, the relationship of a licensee ends there. [In a licensing situation], the business… usually does not have the right to use systems of operation. In a franchise relationship, the franchisee usually gets all of the rights of a licensee, plus operational systems, training and marketing assistance. Thus, in essence, franchising is generally defined as a kind of licensing. In truth, the sole similarity between the two is that both of them require the handover of intellectual property rights. Even at this point, though, a license arrangement generally covers an array of intellectual property enclosed in patents, while franchising is normally restricted to trademarks. The holder of a license acquires only a small portion of the business design of the licensor: the franchisee gets an entire business bundle, which involves all the components the franchisee requires to do business effectively (IDEA Health & Fitness Association 76-77). The licensor, not like the franchisor, has restricted power over how the licensee operates. Licensees have a tendency to self-discriminating; franchisees are typically chosen by the franchisor. Franchisees are novice commercial ventures that assume the franchisor’s ‘image’ or ‘reputation’: licensees are often stable enterprises with their own image (Lafontaine & Kaufmann 108). The following are some of the major dissimilarities between international licensing and franchising (Sherman 17-20): licensing is considered as a low to zero-equity corporate type, while franchising can comprise significant equity share in the receiving country; licensing generally involves particular goods, while in franchising the franchisor transfers new components of the business system; in licensing there is a clear immediate relationship between those involved, while in franchising third parties can arise between the local parties and market players; in licensing competitor has restricted power over the licensees’ daily operations, while in franchising the competitor wields substantial power over the daily activities of the licensee. In licensing there are few common attributes between licensees and licensor, while in franchising there are well-known, stable series of commonly held entities; in licensing sizeable fee discussions occur, while in franchising there is fixed fee system; and, lastly, the income of licensors is derived from royalties, while franchisor gains from a combination of sale of goods, fees, and royalties (Sherman 18-20). Even though franchising and licensing provide less risky, inexpensive way of participating in foreign markets and significantly faster lead times, both are generally considered by scholars as of lower quality compared to foreign direct investment (FDI) and exporting, just to be considered when there are penal trade regulations or barriers on FDI. Specifically, with regard to licensing, the risk of attracting a competitor is always there (Nayler 82). Usually, franchising and licensing are believed to have obvious similarities, with ‘franchising’ being the correct term for services and licensing for products. Nevertheless, since the dissimilarities overshadow the commonalities, this is an incorrect idea, which can result in faulty interpretation. Licensing intellectual property grants licensee the power to use the right, specifically, create, utilize, bid to sell, or trade the licensed intellectual property good directly or goods acquired within the intellectual property system (Nayler 83). Presume firm A in the United States acquires new patent for its product and its commercialization has been quite prosperous in Asia and Europe. Inspired by its achievement, firm A now wants to launch the product to China and displays the product in an exposition. Firm B, in China, thinks the product could raise a huge amount of profit. After a series of discussions, the two firms enter a licensing agreement, with the American firm A as licensor and the Chinese firm B as licensee. Franchising is the same, yet gives a franchisee the power to utilize the intellectual property rights to operate a business where the terms of the franchiser should be valid. For instance, if Burger King’s franchises its ‘name’ to a franchisee in Brazil, in spite of the approval to offer local products under the name of Burger King, the franchisee should abide by practice rules as laid down by Burger King (Sherman 47). Hence, even though the food offered can be modified to take into consideration local cultural tastes, Burger King will specify how the outlet is supervised and the services and quality standards that should be complied with (Sherman 47). However, such theoretical perspective may fail to resolve the complexity of the distinction between licensing and franchising. Therefore, detailed and clear contrasts and comparison between the two are needed. Primarily, as regards business exercise, franchising and licensing are likely to have a different concern. Licensing tends to focus more on manufacturing. Besides this concern, established manufacturing companies may allow licensees to utilize their well-known brands for various products—for instance, Coca-Cola gives permission to the manufacturing of merchandise with the symbol on—or various enterprises in a subsidiary (Sherman 29). Franchising is more frequently performed in the service industry, to allow the utilization of managerial know-how and/or marks (Nayler 17). In addition, franchising and licensing diverge as to the degree of utilizing the holder’s marks. Licensing agreements have a tendency to permit manufacturing to occur with or in the absence of the owner’s mark, and certainly, quality is somewhat less important for the owner’s name when the mark is not utilized, even though it can have an effect on the sales returns (Thompson 212). However, it is important for the franchiser, since under franchising contracts, the franchisee is often obliged to utilize the licensor’s mark, and thus the service quality offered by the franchisee has an immediate importance to the franchiser’s repute (Lafontaine & Kaufmann 103). Licensing and franchising also differ in terms of the level of management control. The power of the licensor is likely to be restricted, because they are mostly focused on the royalty fees. It is the obligation of the licensee to regulate the firm and to raise revenue by successfully endorsing the product and making a substantial profit (Knight 10). The franchiser will conduct business under rigid owner regulation, once more to protect the name of the owner’s mark. There are also equally varying degrees of operational participation on the owner’s part. Participation will more likely be narrow in licensing, even though the licensor may be engaged in technical assistance at the operations’ of preliminary phase. Nevertheless, owner participation will keep on in franchising settings, because of the continuous requirement to keep an eye on the operation to ensure quality, and to determine if it conforms to the corporate rules of the franchiser (Sherman 59). Business growth can be limited in various ways for licensing and franchising. The growth of a licensee or a licensor can be limited based on the form of licensing contract between them. The contract may specify that the licensor is prohibited from advertising its product directly in the market of the licensee. On the contrary, franchising operations have less constraint on those involved; specifically, franchisers have liberty to grant as numerous franchising licenses as they want in a country (Fried & Elango 69). In other words, franchising enables faster expansion than licensing. Moreover, the duration of agreements can vary. The length of a licensing contract can be brief, and will at any rate be limited to the duration of the appropriate patent. It can be lengthy if the licensing agreement includes the main organization and its subsidiary. Nevertheless, a franchising agreement may continue for an indefinite period, and will perhaps be determined by how long the franchisee can continue with the franchise (Fried & Elango 69). Theoretically, at least, these agreements may continue indeterminately. Ultimately, quality is valued varyingly by franchising and licensing. For the licensor, the quality assurance should be strict if the licensee is offering intellectual property products to the licensor, because they have to take into consideration the products’ marketability or commercial viability in the home country (Sherman 83). Nevertheless, quality control could become not much of an issue in case the licensor is disconnected from the sector of product sales. With regard to franchising, quality control is important to sustain the high repute of the intellectual property holder and has immediate impact on service profit (Baron & Schmidt 15). A business tourist may check in at the Ritz Hotel in Paris, be delighted by its good service and consider the hotel favorably. On a different vacation to an American city, she recalls this previous experience, and chooses to check in at the same hotel once more. Sadly, this time, the she was disappointed with the service, making her uncertain whether to support the chain on forthcoming vacations. Although quality control is performed in all franchising agreements, sustaining quality measures can be difficult. Furthermore, the practice of adjusting products and/or services to satisfy local preferences may threaten standards (Nayler 63). In spite of the dissimilarities, licensing and franchising have several similarities as well. The costs can be less for licensors and franchisers, because they allow the utilization of their intellectual property rights and minor financial effort is needed (Sherman 216). The returns rely on the contracts—concerning franchising charges and royalties—between the two sides. Franchisers and licensors also have same obligations with regard to risk—to safeguard their intellectual property from being infringed by their associates or intermediaries. This is specifically the case concerning safeguarding managerial abilities and knowledge, because they are not limited by the length of the Intellectual Property Policy (IPP) (Sherman 217). Important steps have to be made, for instance to approve an independent and particular agreement specifying how to deal with any infringements, as well as penalty conditions. One more commonality between franchising and licensing involves how political limitations are addressed. Countries have a tendency to employ political mechanisms to persuade or dissuade foreign ventures, especially in technologically oriented business sectors (Sherman 105). Licensing and franchising could permit intellectual property holders to avoid such barriers, since the primary operational agent is a local firm. Dodging political limitations reduces the owners’ vulnerability to political threats. Yet, for both modes, sending of income to home countries can be limited if government restricts the sum that can be transferred overseas (Welch et al. 92). Countries have a tendency to promote spending of local income to reinforce the domestic economy. This is clearly a concern that prospective franchisers or licensors have to consider at the preparation phase. Moreover, both franchising and licensing tend to help domestic competition. Licensees have a tendency to improve their abilities by utilizing the intellectual property of the licensor, placing them in a greater position to launch an appealing product and/or service to the market, which may also push competitors to launch derivative alternatives into the same market. Furthermore, licensees, guided by their familiarity of the market, may become a competitor of the licensor and contend with them in the global market once the licensing contract ends. Similarly, franchising would also encourage concerned entities to create additional franchising outlets, heightening the presence of competitors and the level of competition. Franchising Even though it is known that numerous attributes of franchising could have a useful effect on society by enhancing economic productivity, there is worry that several features of the franchising agreement may function as barriers to trade. Some of the specific franchising aspects explored in studies are requirement contracts, in which the franchisee is obliged to buy some items from the franchisor; exclusive transactions, in which the franchisee can solely make deals with the franchisor; exclusive territories, in which a single franchisee can conduct business in a given territory; and resale price maintenance, in which the franchisor determines the price the franchisee can demand (Fried & Elango 70). Besides investigating what disadvantages franchising could inflict to society in general, researchers are also interested in how much the franchisor may take advantage of the agreement to the franchisee’s disadvantage. Although the franchisee supplies the capital or resources for the franchising outlet, the franchisor has the authority to make decisions over numerous aspects highly critical to the success of the outlet (Sherman 113). Research carried out in the topic sees franchising as a type of organization for the purpose of maximizing profit. The most contested issue in franchising studies is the reason a company decides to enter a franchising agreement instead of expanding by means of creating units. Studies have placed emphasis on two conflicting theoretical perspectives—agency and resource scarcity (Fried & Elango 70). A life cycle framework of franchising was introduced by Oxenfeldt and Kelly (1969), where in a new company with scarce resources becomes a franchisor so as to acquire the resources of the franchisee for the purpose of expansion. Afterward, as it gains adequate resources, the franchisor will eventually take possession of the bigger entities from franchisees. This perspective is called ‘resource scarcity’. Several researchers, like Fried and Elango (1997) provided preliminary substantiation for this assumption. He discovered a cumulative pattern towards subsidiaries in the industry of fast-food service. He also discovered that bigger and more established outlets are expected to become subsidiaries. Further support was given by other researchers, who reported that the number of outlets held by franchisors steadily rose over a decade. Nayler (2006) discovered that company possession is less prone to take place when units need substantial resources or when the franchisor is going through major progress, thus substantiating the idea that resource limitations push action towards franchising. The essence of capital for companies in the initial phases of development is also demonstrated by new franchisors demanding greater payment than earlier franchisors. Yet, the model of resource scarcity does not give explanation of the reason franchising is exercised by numerous enterprises who apparently have total access to capital markets. Based on the model of well-functioning capital markets, numerous scholars embrace another point of view rooted in organizational economics, especially agency model (Kedie et al. 336). They claim that the franchisor is capable of decreasing risk through putting the whole system as investment and thus has a more reduced capital cost than the franchisee’s, making resources more accessible to the franchisor than the franchisee. Rather than capital constraints, the presence of franchising is clarified by agency model, which argues that agents (e.g. managers) will have a tendency to avoid their obligation to the principal (e.g. firm) because their salary is permanent (Kedia et al. 336-337). Consequently, high costs of monitoring or supervision will be sustained by the company to guarantee that its managers behave in the best interest of the company. Thus, units owned by franchisees are expected to outperform those owned by companies because the agreement between the franchisee (agent) and the franchisor (principal) is intended to maintain the strong alignment of their financial interests (Fried &Elango 70). Several studies provide explanation of the reason franchising takes place. Martin (1988) investigated franchising within the industry context and discovered that capital requirements, monitoring costs, market competition, and the necessity to stay within the minimum efficient scale were purposes of franchising. Carney and Gedajlovic (1991) tried to combine the agency theory and resource scarcity model. Derived from an investigation of franchising trends in Quebec, they created a franchising life cycle’s path model that unites the two theories. The same results were obtained by Lafontaine (1992). According to her, franchising is widespread when there are motivation dilemmas, but companies also exercise franchising to develop or expand more rapidly, though the limitations that franchising should surpass might not constantly be financially oriented. Thompson (1994) claims that managerial skills could be a more inadequate resource than capital for a developing firm. Investigations with no sound theoretical perspective emphasize a wider vision than either the agency model or resource scarcity theory. Baron and Schmidt (1991) interviewed people about the reason they entered a franchising structure as a franchisee. They discovered that franchisees desired to manage their businesses autonomously but thought that the accessibility of support or backup assistance, an established reputation and brand identity, and lower possibilities of failure made the activity of franchising appealing. Likewise, Knight (1986) reported that the advantages of an established brand identity, the faster business growth, and greater job satisfaction and autonomy were the main purposes of franchising. Eagerness to try and a passion to thrive were believed to be the most essential aspects of a flourishing franchisee. In short, it seems that both resource scarcity and agency models provide a certain extent of clarification as to the reason companies enter franchising. A current research by Arthur Andersen and associates reported that one-third of American franchisors had businesses abroad. Among the companies that do not have businesses abroad at present, fifty percent revealed plans to conduct business abroad in the foreseeable future (Fried & Elango 70). Although franchisors who are more established and/or have more units have a greater tendency to operate globally, all sizes and forms of franchisors want to become global franchisors. As an organizational form, franchising is becoming increasingly popular in numerous countries. Franchising has become widespread globally in two phases. First, it expanded to countries defined by an advanced retail service industry and increased per capita income; afterwards to countries defined by larger diversity in political structures, income, and culture (Fried & Elango 70). Such worldwide growth of franchising has been the focus of some studies, even though they are mostly not based on theories. Hackett (1976) reported that the main reason why franchisors expand to other countries was an objective to exploit profitable and competitive markets and to create a brand identity. Numerous franchising companies successfully entered foreign markets without modification in their marketing policy and gained the same extent of productivity as in their home countries. Global franchising also provides a strategic alternative for countries that do not enter into franchising agreements locally. Ayal and Izraeli (1990) argue that for technologically advanced products, a global market growth by means of franchising could confer numerous benefits, such as greater value bestowed upon the product because of the services offered by the franchising practice alongside scale benefits of franchising. Other researchers reported that global franchising creates prospects for companies to build up business operations in countries where per capita income or population is not enough for a large-scale expansion attempt (Fried & Elango 71). Some researchers discovered that governmental and legal bureaucracy were the main impediments to global access by franchising companies. On the contrary, some researchers discovered that the huge U.S. market, the absence of global managerial skills, and scarce financial capital were the justifications of franchisors that chose to stay local. The significance of beliefs in making such choices is shown by Kedia and colleagues (1995), who reported that companies whose managers are positively inclined toward globalization are prone to seek global opportunities. Studies have also examined techniques for global franchising. For instance, some researchers proposed governmental contracts, direct investment, licensing, joint venture, or master franchising as potential entry tactics for franchises planning to take part in the East Asian market (Sherman 120). Therefore, it could be assumed that global expansion will be sought by U.S. franchisors more aggressively in the near future as their local markets progress. Global franchising may also create prospects for companies who are not customarily franchisors. The main hindrances to global franchising are the absence of legal restrictions and managerial skills. Franchising also has to develop and sustain a minimum size so as to afford transaction costs from global operations (Nayler 97). Franchising as an organizational sort is becoming ever more popular in numerous countries across the globe. Licensing A license is, basically, authorization to carry out something the licensor has the power to otherwise forbid. Licensing, within the arena of intellectual property, is defined as “a grant by the owner of the property, to another (the licensee) of this right to use the licensed rights free of suit by the property owner, pursuant to certain terms and conditions and subject to certain limitations” (Poltorak & Lerner 1). The degree of the rights given in a license could range from a sheer approval to utilize the licensed property in some restricted way to everything but possession of the property. There are some interesting aspects about licensing (Poltorak & Lerner 2): In the United States, royalties from patent licensing have increased from $15 billion in 1990 to more than $110 billion in 2000. Licensing experts believe that a well-managed IP portfolio should yield 1 percent of a firm’s revenues and 5 percent of its net profits. At the same time, however, a recent survey found that two-thirds of U.S. companies own IP that is neither used internally nor licensed to others. Investors value a dollar of royalty income four to five times as highly as a dollar of operating earnings. Intellectual property was deemed an important factor driving mergers and acquisitions by 51 percent of surveyed business executives. Obviously, it is somewhat profitable to engage in intellectual property licensing. More importantly, the process of this form of licensing is currently very popular and recognized as to be anticipated by directors, shareholders, and market experts—and those who determine the compensation and benefit packages of executives (Poltorak & Lerner 2). In fact, nowadays it is the inability to license which is viewed to be notable—and intolerable. There are a number of reasons to license intellectual property or one’s company. The most widely cited is related to monetary resources. Licensing generates revenue. Majority of licenses carry royalties, either through irregular payments derived from sales—a running royalty license—or a lump sum (Sherman 54). Several licenses carry no royalties but are, basically, giving and taking of rights between owners of intellectual property, or also referred to as ‘cross license’ (Poltorak & Lerner 2). If, though, one take into consideration the cost savings gained by getting a license within another’s property with no fee of a cash royalty, a cross license could be thought to raise credited earnings (Welch et al. 71). Besides the sheer creation of royalty earnings, licensing could be used as a means of admission into new product or geographic markets. A property holder may give a license permitting the entry of a licensee into a geographic market not included in the licensor’s business. The licensee shoulders every risk related to this kind of new enterprise and gives a royalty for the right (Schlicher 39). The licensor gets the royalty and monitors the licensee. If the attempts of the licensee are effective, the licensor could gain access of the market too. If, though, the attempts of the licensee fail, the licensor has gained an important knowledge without expense to itself (Schlicher 39-40). Quite paradoxically, licensing could, in some situations, also work to boost the market status of the licensor. Numerous companies will decline to buy a product accessible only from one provider, thus putting themselves at the hands of suppliers. For instance, these companies will require that a patentee give licenses to others. In addition, licensees could work to offer diversity and scale of alternative in a market where a monopoly is capable of providing merely a narrow product variety (Schlicher 42). Likewise, they could create enhancements or additional products and/or services, every one of which work to enhance the appeal of the core, licensed good. Licensing also has the consequence of reinforcing the licensed products. In relation to patents, another advantage arises. The acknowledgment, by others, of the legitimacy of rights of patent, as shown by the existence of licensees giving royalties, is judged by the courts to be favorable. The larger the number of licenses that are given, the greater the licensed patents come to be (Welch et al. 88). By expanding the accessibility of a patented product, licensing could result in the integration of the product into an industry criterion. The repercussions of this integration for prospective royalty earnings must be freely evident to all (Sherman 63). Ultimately, licensing of a breakthrough product may lessen the responsibilities of those tasked with implementation of the antitrust laws. Discussion and Conclusion As discussed above, there is substantial misunderstanding about the difference between franchising and licensing, and in truth it is at times tricky to differentiate these two commercialization modes. For the purposes of this paper, the distinction, especially in relation to business system franchising, rests in the level of control—in business system franchising the franchisee is significantly controlled, particularly as regards marketing promotion and strategy, while in licensing, this depends more on the licensee. Franchisees are portion of an entire system and should work in it and are controlled by it, while licensees have a tendency to be in control of the numerous conditions or terms of the operation: usually licensing occurs in a current enterprise which establishes numerous of the parameters to the utilization of the licensed product. However, licensing, as a sort of overseas operation, has been progressing toward franchising, with licensing offers largely becoming more comprehensive, involving more potent marketing elements. Moreover, licensing can imply a business agreement where a business ‘associate’ is given license to a name. This might be a situation where an organization has built a brand and would like to license out the name. There should not be a business format related to such licensed rights, just the brand name. Franchising, on the other hand, is a mixture of the trademarks, brand, or name together with the business format. Since franchise agreements involve both the business format and the name, the franchisor keeps the capacity to regulate the business and quality of products and/or services provided by the franchisees that enter the system. There are a number of rationales for licensing or franchising, but the major rationale is control. The expansion of a franchise enables the franchisor to regulate the quality of the services or operations of the franchisee. This permits the franchise structure to regulate how and when the name is utilized for commercial purposes. Franchisors possess the power to terminate the business of franchisees that are not embodying the name in a practice that is proper and dignified. Nevertheless, before suggesting a franchise, a business should regularize its distribution, marketing, operations, and internal systems. A business should also accomplish comprehensive legal paperwork and create franchising contracts prior to becoming a franchisor. Franchisees undergo a long and intensive selection mechanism. Franchising normally is costlier and lengthier than licensing. All owners of a thriving business is, at times, faced with the decision to put more investment and expand, or be contented with their success and remain insignificant. The innate risk and capital needed to expand a new business generally encourages numerous businesspeople to choose the second one. Nevertheless, licensing and franchising are two mechanisms by which owners can quickly expand their enterprises while transferring a large portion of the risks and costs to an intermediary or a third party. Works Cited Ayal, I. & D. Izraeli. “International Market Expansion for New High Tech Products through Franchising,” Journal of High Technology Management 1.2(1990): 167-179. Print. Baron, S. & R.A. Schmidt. “Operational Aspects of Retail Franchisees,” International Journal of Retail and Distribution Management 19.2(1991): 13-19. Print. Carney, M. & E. Gedajlovic. “Theoretical Integration in Franchise Systems: Agency Theory and Resource Explanations,” Strategic Management Journal 12(1991): 607-629. Print. Fried, Vance & B. Elango. “Franchising Research: A Literature Review and Synthesis,” Journal of Small Business Management 35.3(1997): 68+ Print. 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