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Franchising as a strategy

A successful franchise arrangement is a win-win relationship for both the franchisor and franchisee

Charles Schofield

Franchising is a good strategy for businesses entering new territories. For the business owner, it limits the costs related to starting a new business. For local entrepreneurs, it prov-ides the chance to run their own business using an already established business model.

There is a clear win-win relationship for both parties in a successful franchise arran-gement. The franchisor obtains business from a new territory with limited capital outlay and reduced risk. The franchisee assumes much of the business risks and initial costs, but enjoys the added incentive of reaping the profits if things go well.

As the business grows, the incentive continues for both parties to do all they can to ensure the success of the other. The franchisor has strong incentives to provide ongoing training and support to the franchised business. If successful, the new franchised business will return profits to both parties. The franchisor will also want to maintain involvement in the franchised business to ensure ongoing quality control and so protect its brand reputation for the benefit of the rest of its franchise network. The franchisor will seek to maintain quality control through standardisation and consistency. The franchisee will also benefit from the training and support provided by the franchisor and may also benefit from the shared experience of the franchise network.

Entering into a franchise is the start of a long-term relationship, which, if implemented successfully, will provide ongoing benefits to both parties. Like any long-term business relationship, there has to be give and take on both sides and flexibility to deal with new challenges arising over time.

Documenting the relationship
The key constitutional document in any franchise arrangement is the agreement between the parties. This is the bedrock document that should set out the parties' commitments to one another and the means for resolving any issues between them.

Franchise agreements, as is the case with the relationship built around them, should not be one-sided. If either party feels that they are not getting a fair deal from the arrangement, then it will undermine the relationship and, over time, affect the rewards both parties receive from the franchise. A recent study has shown that the following four requirements are important for the long-term stability of a franchise:

* The franchisee must consider that it is getting value from the franchisor's contribution to the business

* Both parties need adequate financial returns from the relationship

* There must be flexibility in administration of the franchise system, and

* The franchisor needs to resolve disputes in a quick and fair manner.

These factors should be taken into account in the franchise agreement. For example, it is important that the agreement specifies dispute resolution mechanisms that allow disputes to be dealt with in a quick and fair manner. The agreement should specify dispute resolution methods that will seek to avoid expensive or protracted arbitrations or court proceedings. The parties may, for example, agree on a system of escalating issues within their organisations and for those issues which cannot be resolved by mutual agreement, appointing an independent expert to make a binding determination.
The agreement also needs to be sufficiently flexible, so that the parties have room to modify their approach to certain matters as the need arises. This can be achieved in some instances by stating principles as to how issues will be dealt with, rather than hard and fast rules that specify outcomes.

Key terms

There are key terms which one can expect to find in every franchise agreement. Those include the following:

1. An exclusive right
Generally the franchisee will be granted an exclusive right to operate the franchise business. This will usually be confined to an agreed territory or premises and last for a specified period of time. This is critical for the franchisee. They will need to outlay the capital required to get the business started and increase sales to a level where the franchise is profitable. Without an exclusive right, there is a risk that the franchisor or another franchisee it has appointed, can open a competing store and leverage off the business built at the cost of the franchisee. The franchisee, therefore, needs exclusive rights to give it a fair chance of earning back its initial outlay as well as reasonable profit.

2. Franchise fees, royalties etc
Often, the franchisor will require the payment of an upfront fee for establishing the franchise. Ongoing payments may also need to be made to the franchisor. Most often these take the form of royalty payments for the use of the franchisor's trademarks and brand, services fees for training, exclusive product supply arrangements and an ongoing share of sales revenues.

3. Franchisor provided support
The franchise agreement should contain speci-fic obligations on the franchisor to provide support. This may include training services, use of the franchisor's trade names, brand and other intellectual property, the provision of standard signage and packaging. When retail businesses are franchised, it may typically also include the supply of premises or layout designs.

4. Franchisor controls
There will be terms of the agreement which impose quality standards on the franchisee. These may relate to the use of trademarks, trading hours, appearance of premises, or specifications for services or products it supplies. The usual mechanism to implement this cont-rol is by way of an operating manual supplied by the franchisor, which the franchisee is bound to comply with. This will often be a detailed document, which can be updated by the franchisor from time to time as the need arises.

5. Exits
All franchise agreements will have very specific grounds under which the agreement can be terminated. In some agreements there may be option to sell the business or have the franchisor buy it back. A good franchise agreement will not only have details of circumstances in which the parties may exit from the agreement, but also how that exit will occur.

In conclusion, although there are standard terms that will be found in almost all franchise agreements, it is important that the parties approach the relationship in the spirit of mutual co-operation. The agreement can reflect this by being balanced in approach and being careful to avoid rigid rules or unwieldy processes which will, over the long term, erode the relationship which is key to the success of a franchise.