Franchise is a commercial concession by which a company or person grants to retailer the right of selling its products or services in a specified area. The owner of a product (known as franchisor) permits another business firm (called franchisee) to sell the product in exchange of royalty payments.
Franchise is the right or privilege to use an established business system. According to the International Franchising Association, a franchise is “a continuing relationship in which franchisor provides licensed privilege to do business plus assistance in organising, training, merchandising and management in return for consideration from franchisee.”
Thus, franchise is a system under which the owner of a product or service grants the franchisee the exclusive right to distribute the product or service in a specific geographical area on specified terms and conditions.
The owner of the product or service which grants the right to distribute is known as the franchisor. The person or firm which acquires the right or franchise is called the franchisee.
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Franchise is found in several types of business. Consumer items such as cosmetics, readymade garments, television sets, V.C.R., music system, computers, machinery and equipment, automobiles, servicing of consumer durables, computer training, real estate are some of the examples where franchise is popular.
Wimpy, Nirulas, Essex farms, Snowhite Drycleaners, etc., are notable examples of franchise in India.
The franchisor receives either a fixed sum or periodical royalties for allowing use of trade mark and providing training. The franchisee pays for a reliable and proven business.
He gets professional advice and national sales promotion support from the franchisor. Generally, all franchised outlets of a product or service have identical trade mark, standard symbols, standardised products and uniform business policies. The franchisee has to raise his own finances.
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Types
Franchise arrangements may be of the following types:
1. Product and trade name franchise:
In this arrangement the franchisee acquires the right to use the product and trade name of the franchisor.
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2. Exclusive dealership:
Under this system, a manufacturer signs an exclusive agency contract with a distributor. The distributor gets exclusive right to sell the product within a specified geographical area.
The distributor agrees to certain conditions of the manufacturer, e.g., adequate stock, prices to be charged, the services to be provided, etc. Exclusive dealership is popular in automobiles.
3. Conversion franchising:
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Herein an established businessman gets affiliated with a franchisor. The two share the benefits of franchising relationship.
4. Combination franchising:
In this arrangement two franchisees share a location and management.
5. Formal franchising:
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This is a fully integrated and continuous relationship between franchisor and franchisee. The relationship covers total operations of the franchise including product or service, trade mark quality control, strategy, etc. A fast food restaurant such as McDonald is an example of such franchise.
Merits
The main advantages of franchise are as follows:
1. Availability of established brands:
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The franchisee acquires the right to use the popular brand name or trade mark of the franchisor. Association with an established name provides a ready market. Franchise gives a quick and easy start in business.
2. Standardised goods and services:
Reputation of the franchisor depends largely on the quality of products and services supplied by the franchisee. The franchisor takes steps to ensure that products and services in all the franchised outlets are uniform. He provides the raw materials and keeps close control on the quality of goods.
3. Advertising support:
The franchisor carries on advertising. The franchisee gets the benefit of such advertising and the reputation or goodwill of the franchisor.
4. Financial assistance:
Franchisor offers a wide range of financial assistance to the franchisee in the form of short term credit, lower down payment, flexible repayment terms, etc. Financial assistance if available for plant and equipment, accounts receivable, etc.
5. Managerial training:
Franchisors provide technical and managerial training to franchisees and their staff. Prior to opening a franchise, counselling and training is provided in professional and profitable operation of business.
Such training is provided in inventory management, accounting, sales promotion, advertising, etc. Assistance is also available in site selection, marketing research, in addition to ongoing business assistance.
6. Established business methods:
The franchisee can capitalize on the accumulated knowledge, experience and skill of the franchisor. He has not to build business from scratch. The franchisee buys a business that has proved its success and can, therefore, avoid many of the pitfalls faced by small business owners.
7. Economies of scale:
Due to group or cooperative purchasing, costs of products are reduced. Mass buying provides economies of scale.
8. Uniform control system:
All franchising outlets are subject to uniform control system. Standardised inventory control enables the franchisor to have more accurate information about merchandise available and needed. Standardised reporting procedures are also helpful.
9. Higher success rate:
On an average, franchises survive better than other business startups. The success rate of franchises is higher than that of independently owned businesses.
Therefore, franchises are more attractive to middle-aged people who are less willing to make the full risk of starting their own business. Potential income can be higher than independent small business.
10. Benefits to franchisor:
Franchise enables the franchisor to enter a new business territory at a low cost. It is a relatively quick way to raise cash and expand business operations. Owner operators (franchisees) are highly motivated.
Franchises can be used as outlets for goods and services manufactured or supplied by the franchisor. This provides economies of scale in manufacturing and purchases. The franchisor can exercise control over products, services and processes.
Demerits
Franchise system suffers from the following disadvantages:
1. Fees and royalties:
Costs of a franchise include license fee and fees for initial processing of application. It is payable when franchise agreement is signed and is not refundable.
Other costs include down payment on equipment, decoration of the outlet, office furniture, publicity on opening, etc. The franchisee has to bear travel and living expenses while undergoing training. In addition, he has to pay royalty on continuing basis.
2. Lack of freedom:
The franchisee does not have the freedom to run the business like an independent owner. He has to conform to the controls exercised by the franchisor to ensure quality and uniformity of standards of product or service.
Quality standards and specifications for all items used in franchise are established. The freedom of purchasing is also restricted.
3. Limited product line:
The franchisor controls the products or services sold at the franchisee’s outlet. The franchisee cannot introduce other products except those permitted by the franchisor.
4. Restriction on sale of franchise:
Sale, transfer or assignment of ownership interest requires the franchisor’s approval. Even when the sale is approved, the new franchisee is required to conform to the terms and conditions of the franchise.
5. Disadvantages to the franchisor:
The franchisor cannot treat or control the franchisees like his employees. Franchisees tend to become quite vocal and demanding if they feel they are not getting a fair treatment or do not see benefits in the franchise network.
Extensive communications are necessary and costs of visiting the franchisees at distant places can be high. The franchisor has to bear expenses of administration, training, advertising, legal services, supervision, etc.