Why might an existing non-franchised business choose to become a franchisor - Essay Example

Why might an existing non-franchised business choose to become a franchisor? Why Firms Franchise There are many reasons a non-franchised business may opt to franchise. First, franchising has become a major model of operation for many organisations, and remains a dominant feature of modern economies [Com03]. The model is gaining popularity in a diverse range of industries. Thus, it appears that franchising has a bright future [Bar11] in spite of the several challenges in the franchisor-franchisee relationship. Secondly, franchising enables a firm to expand and grow with limited funds while retaining control over operations. This is one of the most cited motivations for franchising. The motive is consistent with the resource allocation theory that stipulates that organisational units are most productive when tightly controlled [Ash88], although the new resource-based view of the theory advocates value creation by combining local (or franchisee) and central (or franchisor) advantages [Com03]. The motive was a major driver of franchising among American auto manufacturers in the 1900s [Com03]. The auto manufacturers lacked funds to open dealerships across the country. Their workaround to the problem was to create chains of franchises across the US. The franchisees invested in stocks of vehicles and premises. In return, they enjoyed exclusive marketing territories. Although a business may want franchise in order to use other people’s funds to grow, some scholars have cast doubt over the cherished notion that the ability to expand without investing their money and retain control over operations is one of the main reasons firms franchise. Franchisee financial constraints are a major cause of poor relations between the franchisor and franchise and a threat to the survival of both [Dad09]. If this argument is true then it defeats the logic of the franchisor seeking to expand using the franchisee’s capital. A number of reasons explain the occurrence of such a situation. First, some franchisees may falsify their financial position in order to meet the stringent requirements of the franchisor. Such falsification of information, coupled with lack of due diligence on the part of the franchisor creates a situation where the franchisee starts the franchise with inadequate capital. Shortly afterward, the franchisee becomes unable to provide the product they set out to provide. Even in the absence of documented cases of this nature, the risk of such a scenario is real. The implication is that a business that is desirous of adopting a franchise model as a means of achieving growthmust do due diligence to ensure that the would-be franchisee has adequate capital to provide the goods or services they are seeking to provide. A business may also franchise because of the ease of entry associated with the model. This motivation especially applies to international franchising by large organisations [Rub78]. These organisations use franchising to gain entry into new markets outside their home country. The rationale behind international franchising is that the franchisee, being a native of the host country, is more familiar with the prevailing business environment. In addition, many countries have tougher market entry conditions for foreign firms relative to local ones. Unfortunately, ease of entry has been the subject of abuse by some franchisors. This was especially the case in the 1960s and 1970s. During this period, there arose the so-called “quick buck” franchisors – franchisors who lured unsuspecting franchisees with promises of quick and high returns on their investment [Wri12]. Most of these “franchisors” were either fraudulent or, if genuine, they sold more units than they could effectively manage and support. Others lacked the necessary experience required to run successful franchise systems. Today, there are a number of franchise associations that support franchising businesses and the support may motivate a non-franchised business to franchise. These associations first emerged as state and self-regulation efforts in response to the problems that bedevilled the global franchise industry in the 1960s and 70s. They have since evolved into efficient support frameworks besides exercising oversight over the industry. The first franchise association to be established was the European Franchise Association in 1972 followed by the British Franchise Association (BFA) in 1977. Then in 1978, theUS Franchise Industry Chapter of the Federal Trade Commission was established. The Commission had been established much earlier in 1914 under the Federal Trade Commission Act to ensure consumer protection and eliminate unfair business practices such as coercive monopoly[Fed11]. These bodies have since streamlined the franchise industry, even though they have had their fair share of negative publicity. For instance, in 1986, La Mama collapsed a month after it received full membership from BFA. Then, in 1993, a number of large franchises such as Prontac went into receivership. BFA responded by introducing annual audits of its members [Dad12]. Benefits of Franchising There are many benefits associated with becoming a franchised business. One benefit is the reduced “people risk” of setting up a business [BFA10]. By “people risk” is meant the difficulty of finding suitable franchisees. This point will be illustrated by an example. Traditionally, a person is either employed by and works for a firm or starts their firm. Franchising can be seen as a middle ground between the two, especially if the franchisee is a former employee of the franchisor. An example is David Shaw, a franchisee of MacDonald’s. Prior to becoming a franchisee, David Shaw, who is a graduate of Lancaster University, worked for MacDonald's from 1982 to 2001. He served as the Northern Regional Manager between 1993 and 2001. Then he became a franchisee in 2002. Today, Shaw owns ten MacDonald restaurants, six of which are located in Warrington and the remaining four in Bolton. Together, the ten have an annual turnover of £20 million and employ more than 850 staff. Franchises rarely develop in this manner, but where they do,the chances of success increase tenfold. Another benefit that accrues to the franchisor is the steady flow of income from the franchisee in the form of royalties[Ali05]. Besides royalties, franchisors also charge a management fee. This is the price the franchisee pays for receiving the "great idea", an established brand (this is true where the franchisee trades under the same name as the franchisor), a tested and proven business model and managerial support. However, before a franchisor can start to enjoy a steady flow of royalties, they must allow the franchisee a grace period during which the franchisor trains the franchisee in basics of running the franchise. Unfortunately, many franchisors allow a very short grace period. MacDonald's is an exception. The organisation allows a grace period and offers training for up to twelve months. Indeed, the long grace period is one of the factors that motivated David Shaw to become a franchisee of MacDonald’s. MacDonald’s dedicated support partly explains the corporation’s success. Today the Corporation runs the largest chain of fast food restaurants – 35,000 of them spread across more than 100 countries. The number includes outlets that the Corporation owns directly, franchises and affiliates. Together, the outlets serve an estimated 70 million customers a day [Mac132]. Increased brand recognition is another benefit that accrues to the franchisor [Com03]. However, this is only the case where the franchise agreement allows the franchisee to trade under the same name as the franchisor. A number of franchise organisations such as KFC and MacDonald’s operate this way. In instances where the franchisee trades under the franchisor’s name, the former pays a marketing fee in addition to the regular royalties. In the case of MacDonald’s, the Corporation owns or leases the premises that house the franchise and the franchisee pays rent to the Corporation. Many observers have seen the latter practice of the Corporation as designed to “milk” the most money out of the franchisee. However, the debate is beyond the scope of this paper. Still, some franchise organisations opt to run franchises under different brands. An example is the UK-based The Bardon Group that runs four franchise brands: Recognition Express, The Zip Yard, Computer Explorers and KallKwik. Finally, franchising enables the franchising organisation to grow using the franchisees’ money thereby freeing the former from the financial risk associated with business growth; the franchisee bears the all the financial risk associated with starting the franchise [Ali05]. However, the franchisor has the duty of helping the franchisee reduce the risk of business failure, notably through training and support. Usually, franchisors retain "field support" staff who act as liaison between the franchisor and franchisees on such matters as supplies, communicating and marketing. The liaison efforts are geared towards ensuring that the franchise system put in place is adhered to. Training and support are a major benefit to the franchisee because it ensures that they are not "on their own" in trying to make the business succeed [BFA10]. Research has shown that 80% of franchises that receive comprehensive training and support succeed. However, research has also shown that the older the franchise grows, the less support it needs and so the less the franchisee contacts support staff [BFA10]. Theoretical and Empirical Academic Studies Over the last four decades, franchising has received considerable research attention from the academic community. This section discusses some theoretical and empirical scholarly investigations into the subject. The first scholarly article to be examined is one on the agency theory and how it relates to franchising. Manna et al start from the point that the relationship between the franchisor and the franchisee can be seen from the viewpoints of two theories: the agency theory and the resource-based perspective [Man06]. The concept of strategic management dictates that the management of a firm makes decisions on what the firm should do and what it should not do, especially in the light of limited resources. Strategic decision-making entails making trade-offs, an important aspect of franchising. From the point of view of the franchisor, it would be more desirable to have total control of the organisation in all the markets it serves. However, given the limitation of financial resources, the organisation may opt to forego part of its control in order to expand using the franchisee's capital. In return, the franchisee receives training and support from the franchisor. This article lays a sound theoretical foundation for franchising. The resource-based view of franchising, among other assumptions, assumes the tendency towards the acquisition of former franchises [Cas11]. As the franchise matures, it becomes easier for it to acquire the resources it requires to grow, a situation that gives the franchisor the motivation to buy it back. The idea underlying this assumption is that franchisors prefer to own all the units that trade under their name and, if the organisation had the capacity, run them as wholly owned chains. This has been the tendency of a number of organisations including KFC, Avis and MacDonald’s. The tendency towards vertical integration challenges the rather narrow view that practitioners and academics have had of business format franchising, also dubbed the MacDonald’s approach to franchising. That view was that businesses franchise in order to overcome financial constraints and was informed by the agency approach. However, the resource-based view proposes that franchising is only a part of the larger growth strategy of an organisation. The dominant theories that explain the franchising phenomenon – notably the agency and resource-based theories – tend to imply that firms that choose to grow through franchising possess a number of advantages over those that opt to grow by their means[Ali05]. Franchisors can keep agency problems to a minimum and enjoy access to cheaper capital, managerial expertise and better knowledge of local markets. Based on these advantages, one may hypothesise that a franchised orgnisation reports better financial performance than those that are not franchised. A study involving 41 American franchising firms validated this hypothesis to some extent[Ali05]. The study revealed that during the ten-year period between 1993 and 2002, franchising US public restaurants have created more value relative to their non-franchising competitors. However, the study had a number of limitations. First, all the firms involved in the study were mature with at least ten years of experience and were publicly traded. For these firms, the advantages of franchising are not as critical as in the case of new firms. For instance, unlike new firms, many of the studied firms had easy access to capital. Secondly, the scope of the study was narrow: US public restaurants. The results would have given a better picture had the study covered other American industries and more countries. Related Topics Related to the topic of why firms franchise and the benefits they derive from franchising are the topics of why an entrepreneur may opt for franchise as opposed to starting their independent business, the advantages they enjoy as a franchisee and the benefits that accrue to the consumers. Starting one's business entails many risks; key among them the risk of failure. Studies have demonstrated that as many as nine out of every ten new businesses fail in their first six months [BFA10]. For the few that survive the first six months, even fewer get to celebrate their fifth birthday. The most cited reason for failure is not the lack of capital, but the lack of managerial skills [Com03]. Therefore, from the franchisee point of view, franchising reduces the risk of failure through the training and support they receive from the franchisor. As research has shown, the older a franchise grows, the less support the franchisee needs. However, for the first few months to year, that support can make the difference between success and failure. Indeed, research has also shown that the initial franchisor support significantly increases chances of success. Besides support, the franchisee enjoys working with an established business model rather than starting from scratch. For the consumer, the main advantage of franchising is that they get to enjoy standardised product offering as the franchisor controls quality across all the franchises. References Com03: , (Combs, 2003), Bar11: , (Baringer & Ireland, 2011), Ash88: , (Ashar & Shapiro, 1988), Dad09: , (Dada, et al., 2009), Rub78: , (Rubin, 1978), Wri12: , (Wright & Grace, 2012), Fed11: , (Federal Trade Commission (FTC), 2011), Dad12: , (Dada, et al., 2012), BFA10: , (BFA, 2010), Ali05: , (Aliouche & Schlentrich, 2005), Mac132: , (MacDonald's Corporation, 2013), Ali05: , (Aliouche &Schlentrich, 2005), Man06: , (Manna, et al., 2006), Cas11: , (Castro, et al., 2011), Read More