franchise

A McDonald's franchise.

Franchising is the practice of using another firm's successful business model. The word 'franchise' is of anglo-French derivation - from franc - meaning free, and is used both as a noun and as a (transitive) verb.^[1] For the franchisor, the franchise is an alternative to building 'chain stores' to distribute goods and avoid the need for investments and liability for a chain. The franchisor's success depends on the success of the franchisees. The franchisee is said to have a greater incentive than a direct employee because he or she has a direct stake in the business.

Thirty three countries, including the United States, China, and Australia, have laws that explicitly regulate franchising, with the majority of all other countries having laws which have a direct or indirect impact on franchising ^[2].

Overview

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Businesses for which franchising work best have one or several of the following characteristics^{[citation needed]}:

• A good track record of profitability
• Ease of duplication
• Detailed systems, processes and procedures
• A unique or unusual concept
• Broad geographic appeal
• Relative ease of operation
• Relatively inexpensive operation.

As practiced in retailing, franchising offers franchisees the advantage of starting up business quickly based on a proven trademark, and immediate access to the tooling and infrastructure, as opposed to having to develop them.

The following U.S. listing tabulates^[3] the early 2010 ranking of major franchises along with the number of sub-franchisees (or partners) from data available for 2004.^[4] As can be seen from the names of the franchises, the USA is a leader in franchising, a position it has held since the 1930s when it used the approach for fast-food restaurants, food inns and, slightly later, motels at the time of the Great Depression. As of 2005, there were 909,253 established franchised businesses, generating $880.9 billion of output and accounting for 8.1 percent of all private, non-farm jobs. This amounts to 11 million jobs, and 4.4 percent of all private sector output^[5].

1. Subway (sandwiches and salads) | startup costs $84,300 – $258,300 (22,000 partners worldwide in 2004).

2. McDonald's | startup costs in 2010, $995,900 – $1,842,700 (37,300 partners in 2010)

3. 7-Eleven Inc. (convenience stores) |startup costs in 2010 $40,500- 775,300, (28,200 partners in 2004)

4. Hampton Inns & Suites (midprice hotels) |startup costs in 2010 $3,716,000 – $15,148,800

5. Great Clips (hair salons) | startup costs in 2010 $109,000 - $203,000

6. H&R Block (tax preparation and now e-filing) | startup costs $26,427 - $84,094 (11,200 partners in 2004)

7. Dunkin Donuts | startup costs in 2010 $537,750 - $1,765,300

8. Jani-King (commercial cleaning) | startup costs $11,400 - $35,050, (11,000 partners worldwide in 2004)

9. Servpro (insurance and disaster restoration and cleaning) | startup costs in 2010 $102,250 - $161,150

10. MiniMarkets (convenience store and gas station) | startup costs in 2010 $1,835,823 - $7,615,065

Mid-sized franchises like restaurants, gasoline stations and trucking stations involve substantial investment and require all the attention of a businessman.

There are also large franchises like hotels, spas, hospitals, etc. which are discussed further under technological alliances.

Two important payments are made to a franchisor: (a) a royalty for the trademark and (b) reimbursement for the training and advisory services given to the franchisee. These two fees may be combined in a single 'management' fee. A fee for "disclosure" is separate and is always a "front-end fee".

A franchise usually lasts for a fixed time period (broken down into shorter periods, which each require renewal), and serves a specific territory or geographical area surrounding its location. One franchisee may manage several such locations. Agreements typically last from five to thirty years, with premature cancellations or terminations of most contracts bearing serious consequences for franchisees. A franchise is merely a temporary business investment involving renting or leasing an opportunity, not the purchase of a business for the purpose of ownership. It is classified as a wasting asset due to the finite term of the license.

A franchise can be exclusive, non-exclusive or 'sole and exclusive'.

This section requires expansion.

Although franchisor revenues and profit may be listed in a franchise disclosure document (FDD), no laws require an estimate of franchisee profitability, which depends on how intensively the franchisee 'works' the franchise. Therefore, franchisor fees are typically based on 'gross revenue from sales' and not on profits realized. See Remuneration.

Various tangibles and intangibles such as national or international advertising, training and other support services are commonly made available by the franchisor.

Franchise brokers help franchisors find appropriate franchisees. There are also main 'master franchisors' who obtain the rights to sub-franchise in a territory.

According to the International Franchise Association approximately 4% of all businesses in the United States are franchisee-worked.

It should be recognized^{[citation needed]} that franchising is one of the only means available to access venture investment capital without the need to give up control of the operation of the chain and build a distribution system for servicing it. After the brand and formula are carefully designed and properly executed, franchisors are able to sell franchises and expand rapidly across countries and continents using the capital and resources of their franchisees while reducing their own risk.

Franchisor rules imposed by the franchising authority are usually very strict in the USA and most other countries need to study them carefully to protect small or start-up franchisee in their own countries.^{[citation needed]} Besides the trademark, there are proprietary service marks which may be copyrighted, and corresponding regulations.

Obligations of the parties

Each party to a franchise has several interests to protect. The franchisor is involved in securing protection for the trademark, controlling the business concept and securing know-how. The franchisee is obligated to carry out the services for which the trademark has been made prominent or famous. There is a great deal of standardization required. The place of service has to bear the franchisor's signs, logos and trademark in a prominent place. The uniforms worn by the staff of the franchisee have to be of a particular design and colour. The service has to be in accordance with the pattern followed by the franchisor in the successful franchise operations. Thus, franchisees are not in full control of the business, as they would be in retailing.

A service can be successful if equipment and supplies are purchased at a fair price from the franchisor or sources recommended by the franchisor. A coffee brew, for example, can be readily identified by the trademark if its raw materials come from a particular supplier. If the franchisor requires purchase from his stores, it may come under anti-trust legislation or equivalent laws of other countries.[1] So too the purchase of uniforms of personnel, signs, etc., as well as the franchise sites, if they are owned or controlled by the franchisor.

The franchisee must carefully negotiate the license. He and the franchisor must develop a marketing or business plan. The fees must be fully disclosed and there should not be any hidden fees. The start-up costs and working capital must be known before the license is granted. There must be assurance that additional licensees will not crowd the "territory" if the franchise is worked according to plan. The franchisee must be seen as an independent merchant. He must be protected by the franchisor from any trademark infringement by third parties. A franchise attorney is required to assist the franchisee during negotiations.^[6]

Often the training period - the costs of which are in great part covered by the initial fee - is too short in cases where it is necessary to operate complicated equipment, and the franchisee has to learn on his own from instruction manuals. The training period must be adequate, but in low-cost franchises it may be considered expensive. Many frachisors have set up corporate universities to train staff online. This is in addition to providing literature, sales documents and email access.

Also, franchise agreements carry no guarantees or warranties and the franchisee has little or no recourse to legal intervention in the event of a dispute.^[7] Franchise contracts tend to be unilateral contracts in favor of the franchisor, who is generally protected from lawsuits from their franchisees because of the non-negotiable contracts that require franchisees to acknowledge, in effect, that they are buying the franchise knowing that there is risk, and that they have not been promised success or profits by the franchisor. Contracts are renewable at the sole option of the franchisor. Most franchisors require franchisees to sign agreements that mandate where and under what law any dispute would be litigated.

Regulations

Australia

In Australia, franchising is regulated by the "Franchising Code of Conduct", a mandatory code of conduct concluded under the Trade Practices Act 1974.

This code requires franchisors to produce a disclosure document which must be given to a prospective franchisee at least 14 days before the franchise agreement is entered into.

The code also regulates the content of franchise agreements, for example in relation to marketing funds, a cooling-off period, termination, and the resolution of disputes by mediation.

The federal government is currently considering recommended changes to the Code of Conduct. These are contained in the report, "Opportunity not Opportunism: Improving conduct in Australian Franchising" tabled by a Parliamentary inquiry into franchising on 4 December 2008.^[8]

Some experts have warned that any pressure to increase the regulation of the franchising sector could make it a less attractive means of doing business.^[9]

New Zealand

New Zealand is served by around 423 franchise systems operating 450 brands, giving it the highest proportion of franchises per capita in the world. Despite (or because of) the recession, the total number of franchised units increased by 5.3% from 2009 to 2010.^[10] There is no separate law covering franchises, so they are covered by normal commercial law. This functions very well in New Zealand and includes law as it applies to contracts, restrictive trade practices, intellectual property and the law of misleading or deceptive conduct.^[11]

The Franchise Association of New Zealand introduced a self-regulatory Code of Practice for its members in 1996. This contains many provisions similar to those of the Australian Franchising Code of Practice legislation, although it should be noted that only around a third of all franchises are members of the association and therefore bound by the code.^[12]

A case of fraud in 2007 perpetrated by a former master franchisee of the country’s largest franchise system^[13] led to a review of the need for franchise law by the Ministry of Economic Development.^[14] The New Zealand Government decided there was no case for franchise-specific legislation at this time.^[15] This decision was criticised by the Opposition,^[16] which had initiated the review when in power, and the review process was questioned by a leading academic.^[17] The Franchise Association originally supported the positive regulation of the franchise sector^[18] but its eventual submission to the review was in favour of the status quo – self-regulation.^[19]

Brazil

In 2008, there were about 1,013 franchises^[20] with more than 62,500 outlets, making it one of the largest countries in the world in terms of number of units. Around 11 percent of this total are foreign-based franchisors.

The Brazilian Franchise Law (Law No. 8955 of December 15, 1994) defines the franchise as a system in which the franchisor licenses the franchisee, for a payment, the right to use a trademark/patent along with the right to distribute products or services on an exclusive or semi-exclusive basis. The provision of a "Franchise Offer Circular" or disclosure document is mandatory before execution of agreement and is valid for all of the Brazilian territory. Failure to disclose voids the agreement, which leads to refunds and serious payments for damages. The Franchise Law does not distinguish between Brazilian and foreign franchisors. The National Institute of Industrial Property (INPI) is the registering authority. Indispensable documents are a Statement of Delivery (of disclosure documentation) and a Certification of Recording (INPI). The latter is necessary for payments. All sums amounts may not be convertible into foreign currency. Certification may also mean compliance with Brazil's antitrust legislation.

Parties to international franchising may decide to adopt the English language for the document, as long as the Brazilian party knows English fluently and expressly acknowledges that fact, to avoid translation. The Registration accomplishes three things:

* It make the agreement effective against third parties

* It permits the remittance of payments

* It qualifies the franchisee for tax deductions.

Page reference in franchising in this country: Guide of Franchising - Guia do Franchising (http://www.guiadofranchising.com.br)

China

China has the most franchises in the world but the scale of their operations is relatively small. Each system in China has an average of 43 outlets, compared to more than 540 in the United States. Together, there are 2600 brands in some 200,000 retail markets. KFC was the most significant foreign entry in 1987 and is widespread ^[21] Many franchises are in fact joint-ventures, as at their forming the franchise law was not explicit. For example, McDonalds is a joint venture. Pizza Hut, TGIF, Wal-mart, Starbucks followed a little later. But total franchising is only 3% of retail trade, which seeks foreign franchise growth.

The year 2005 saw the birth of an updated franchise law,^[21] "Measures for the Administration of Commercial Franchise".^[22] Previous legislation (1997) made no specific inclusion of foreign investors. Today the franchise law is much clearer by virtue of the 2007 law,^[23] a revision of the 2005 law.

The laws are applicable if there are transactions involving a trademark combined with payments with many obligations on the franchisor. The law comprises 42 articles and 8 chapters.

Among the franchisor obligations are:

• The FIE (foreign-invested enterprise) franchisor must be registered by the regulator
• The franchisor (or its subsidiary) must have operated at least operated two company-owned franchises in China (revised to "anywhere")for more than 12 months ("the two-store, one-year” rule)
• The franchisor must disclosure any information requested by the franchisee
• Cross-border franchising, with some caveats, is possible (2007 law).

The franchisor must meet a list of requirements for registration, among which are:

• The standard franchise agreement, working manual and working capital requirements,
• A track-record of operations, and ample ability to supply materials,
• The ability to train the Chinese personnel and provide
• Long-term operational guidance,
• The franchise agreement must have a minimum three-year term.

Among other provisions:

• The franchisor is liable for certain actions of its suppliers
• Monetary and other penalties apply for infractions of the regulations.

The disclosure has to take place 20 days in advance. It has to contain:

• Details of the franchisor’s experience in the franchised business with scope of business
• Identification of the franchisor’s principal officers
• Litigation of the franchisor during the past five years
• Full details about all franchise fees
• The amount of a franchisee’s initial investment
• A list of the goods or services the franchisor can supply, and the terms of supply
• The training franchisees will receive
• Information about the trademarks,including registration, usage, and litigation
• Demonstration of the franchisor’s capabilities to provide training and guidance
• Statistics about existing units, including number, locations, and operational results, and the percentage of franchises that have been terminated, and
• An audited financial report and tax information (for an unspecified period of time).

Other elements of this legislation are:

• The franchisee’s confidentiality obligations continue indefinitely after termination or expiration of the franchise agreement
• If the franchisee has paid a deposit to the franchisor, it must be refunded on termination of the franchise agreement; upon termination, the franchisee is prohibited from continuing to use the franchisor’s marks.

India

The franchising of goods and services foreign to India is in its infancy. The first International Exhibition was only held in 2009.^[24] India is, however, one of the biggest franchising markets because of its large middle-class of 300 million who are not reticent about spending and because the population is entrepreneurial in character. In a highly diversified society, (see Demographics of India) McDonald's is a success story despite its fare's differing from that of the rest of the world.^[25]

So far, franchise agreements are covered under two standard commercial laws: the Contract Act 1872 and the Specific Relief Act 1963, which provide for both specific enforcement of covenants in a contract and remedies in the form of damages for breach of contract.

Kazakhstan

In Kazakhstan franchise turnover for 2010 is 1 billion US$ dollars per year. Kazakhstan is the leader in Central Asia in the franchising market. There is a special law on franchising which went into effect in 2002. There are about 300 franchise systems and the number of franchised outlets approaches 2000.^[26] Kazakhstan franchising began with the emergence of a "Coca-Cola" factory, opened to sublicense a Turkish licensor of the same brand. The plant was built in 1994. Other brands that are also present in Kazakhstan through the franchise system include Pepsi, Hilton, Marriott, Intercontinental, and Pizza Hut.

Europe

Franchising has grown rapidly in Europe in recent years, but the industry is largely unregulated. Unlike the United States, the European Union has not adopted a uniform franchise disclosure policy. Only five countries in Europe have adopted pre-sale disclosure obligations. They are France (1989), Spain (1996), Romania (1997), Italy (2004) and Belgium (2005).^[27]

The Code of Ethics of the European Franchising Federation is self-enforced in seventeen European states where their national franchise associations are members of the European Franchise Federation (EFF) and the International Institute for the Unification of Private Law UNIDROIT.

All formal disclosure countries are required to furnish "Contract Summaries" highlighting:

• The object of the contract
• The rights and obligations of the parties
• The financial conditions
• The term of the contract.

Legal consultation is needed before entering and finalizing the agreement(s). Most often one of the principal tasks in Europe is to find retail space, which is not so significant a factor in the USA. This is where the franchise broker, or the master franchisor, plays an important role. Cultural factors are also relevant, as local populations tend to be homogeneous.

France

France is one of Europe’s largest markets. Similar to the United States, it has a long history of franchising, dating back to the 1930s. Growth came in the 1970s. The market is considered difficult for outside franchisors because of cultural characteristics, yet McDonald’s and Century 21 are found everywhere. There are some 30 U.S. firms involved in franchising in France.^[28]

There are no government agencies regulating franchises. The Loi Doubin Law of 1989 was the first European franchise disclosure law. Combined with Decree No. 91-337, it regulates disclosure, although the decree also applies to any person who provides to another person a corporate name, trademark or trade name or other business arrangements. The law applies to "exclusive or quasi-exclusive territory". The disclosure document must be delivered at least 20 days before the execution of the agreement or any payments are made.

The specific and important disclosures to be made are ^[29]:

a) The date of the founding of the franchisor's enterprise and a summary of its business history and all information necessary to assess the business experience of the franchisor, including bankers,

b) A description of the local market for the goods or services,

c) The franchisor's financial statements for the previous two years,

d) A list of all other franchisees currently in the network,

e) All franchisees who have left the network during the preceding year, whether by termination or non-renewal, and

f) The conditions for renewal, assignment, termination and the scope of exclusivity.

Initially, there was some uncertainty whether any breach of the provisions of the Doubin law would enable the franchisee to walk away from the contract. However, the French supreme court (Cour de cassation) eventually ruled that agreements should only be annulled where missing or incorrect information affected the decision of the franchisee to enter into the agreement. The burden of proof is on the franchisee. ^[30]

Dispute settlement features are only incorporated in some European countries. By not being rigorous, franchising is encouraged.

Italy

Under Italian law franchise ^[31] is defined as an arrangement between two financially independent parties where a franchisee is granted, in exchange for a consideration, the right to market goods and services under particular trademarks. In addition, articles dictate the form and content of the franchise agreement and define the documents that must be made available 30 days prior to execution. The franchisor must disclose:

a) A summary of the franchise activities and operations,

b) A list of franchisees currently operating in the franchise system in Italy,

c) Year-by-year details of the changes in the number of franchisees for the previous three years in Italy,

d) A summary of any court or arbitral proceedings in Italy related to the franchise system, and

e) If requested by the franchisee, copies of franchisor's balance sheets for the previous three years, or since start-up if that period is shorter.

Norway

There are no specific laws regulating franchising in Norway. However, the Norwegian Competition Act section 10 prohibits cooperation which may prevent, limit or diminish the competition. This may also apply to vertical cooperation such as franchising.

Russia

In Russia, under chapter 54 of the Civil Code (passed 1996), franchise agreements are invalid unless written and registered, and franchisors cannot set standards or limits on the prices of the franchisee’s goods. Enforcement of laws and resolution of contractual disputes is a problem:^{[citation needed]} Dunkin' Donuts chose to terminate its contract with Russian franchisees who were selling vodka and meat patties contrary to their contracts, rather than pursue legal remedies.^[32]

Spain

The legal definition of franchising in Spain is an activity in which an undertaking, the franchisor, grants to another party, the franchisee, for a specific market and in exchange for financial compensation (either direct, indirect or both), the right to exploit an own system to commercialize products or services already exploited by the franchisor with enough success and experience.

The Spanish Retail Trading Act regulates franchising.^[33] The contents of the franchise must include, at least:

• The use of a common name or brand or any other intellectual property right and a uniform presentation of the premises or the transport means included in the agreement.

• The communication by the franchisor to the franchise of certain technical knowledge or substantial and singular know-how that has to be owned by the franchisor, and

• Technical or commercial assistance or both, provided by the franchisor to the franchisee during the agreement, without prejudice to any supervision faculty to which the parties could freely agree in the contract.

In Spain, the franchisor submits the disclosure information 20 days prior to signing the agreement or prior to any payment made by the franchisee to the franchisor. Franchisors are to disclose to the potential franchisee specific information in writing. This information has to be true and not misleading and include:

• Identification of the franchisor;

• Justification of ownership or license for use of any trademark or similar sign and judicial claims affecting them as well as the duration of the license;

• General description of the sector in which the franchise operates;

• Experience of the franchisor;

• Contents and characteristics of the franchise and its exploitation;

• Structure and extension of the network in Spain;

• Essential elements of the franchise agreement.

Franchisors (with some exceptions) should be registered in the Franchisors’ Register and provide the requested information. According to the regulation in force in 2010 this obligation has to be met within three months after the start of its activities in Spain.^[34]

United Kingdom

In the United Kingdom there are no franchise-specific laws; franchises are subject to the same laws that govern other businesses. For example, franchise agreements are produced under regular contract law and do not have to conform to any further legislation or guidelines.^[35] There is some self-regulation through the British Franchise Association (BFA) and the UK Franchise Organisation.

However, there are many franchise businesses which do not become members, and many businesses that refer to themselves as franchisors do not conform to these rules.^{[citation needed]} There are several people and organisations in the industry calling for the creation of a framework to help reduce the number of "cowboy" franchises and help the industry clean up its image.^[who?]

On 22 May 2007, hearings were held in the UK Parliament concerning citizen-initiated petitions for special regulation of franchising by the government of the UK due to losses incurred by citizens who had invested in franchises. The Minister of Industry, Margaret Hodge, conducted hearings but resisted any government regulation of franchising with the advice that government regulation of franchising might lull the public into a false sense of security. The Minister of Industry indicated that if due diligence were performed by the investors and the banks, the current laws governing business contracts in the UK offered sufficient protection for the public and the banks.^[36]

United States

Isaac Singer, who made improvements to an existing model of a sewing machine in the 1850s, began one of the first franchising efforts in the United States, followed later by Coca-Cola, Western Union, etc.^[37] and by agreements between automobile manufacturers and dealers.^[38]

Modern franchising came to prominence with the rise of franchise-based food service establishments. In 1932, Howard Deering Johnson established the first modern restaurant franchise based on his successful Quincy, Massachusetts Howard Johnson's restaurant founded in the late 1920s.^[39][40] The idea was to let independent operators use the same name, food, supplies, logo and even building design in exchange for a fee. The growth in franchising accelerated in the 1930s when such chains as Howard Johnson's started to franchise motels.^[41] The 1950s saw a boom in franchise chains in conjunction with the development of the U.S. Interstate Highway System.

In the United States, the Federal Trade Commission has oversight of franchising, rather than the U.S. Securities and Exchange Commission. The FTC administrates oversight via the FTC Franchise Rule.^[42]

The (FTC) Federal Trade Commission requires that the franchisee be furnished with a Franchise Disclosure Document (FDD) by the franchisor at least fourteen days before money changes hands or a franchise agreement is signed. The final agreement is always a negotiated document setting forth fees and other terms. Whereas elements of the disclosure may be available from third parties, only that provided by the franchisor can be depended upon. The U.S. Franchise Disclosure Document (FDD) is lengthy (300-700 pp +) and detailed (see Uniform Franchise Offering Circular (UFOC) for elements of disclosure), and generally requires audited financial statements from the franchisor in a particular format, except in some circumstances, such as where a franchisor is new. It must include such data as the names, addresses and telephone numbers of the franchisees in the licensed territory (who may be contacted and consulted before negotiations), estimate of total franchise revenues and franchisor profitability.

Individual states may require the FDD to contain their own specific requirements, but the requirements in state disclosure documents must be in compliance with the federal rule that governs federal regulatory policy. There is no private right of action of action under the FTC rule for franchisor violation of the rule, but fifteen or more of the states have passed statutes that provide this right of action to franchisees when fraud can be proven under these special statutes. The majority of franchisors have inserted mandatory arbitration clauses into their agreements with their franchisees, some of which the U.S. Supreme Court has dealt with.

There is no federal registry of franchises or any federal filing requirements for information. States are the primary collectors of data on franchising companies and enforce laws and regulations regarding their presence and their spread in their jurisdictions.

Where the franchisor has many partners, the agreement may take the shape of a business format franchise - an agreement that is identical for all franchisees.

Social franchises

In recent years, the idea of franchising has been picked up by the social enterprise sector, which hopes to simplify and expedite the process of setting up new businesses. A number of business ideas, such as soap making, wholefood retailing, aquarium maintenance, and hotel operation have been identified as suitable for adoption by social firms employing disabled and disadvantaged people.

The most successful example is probably the CAP Markets, a steadily growing chain of some 50 neighborhood supermarkets in Germany. Other examples are the St. Mary's Place Hotel in Edinburgh and the Hotel Tritone in Trieste.

Social franchising also refers to a technique used by governments and aid donors to provide essential clinical health services in the developing world.

Event franchising

Event franchising is the duplication of public events in other geographical areas, retaining the original brand (logo), mission, concept and format of the event.^[43] As in classic franchising, event franchising is built on precisely copying successful events. An example of event franchising is the World Economic Forum, also known as the Davos forum, which has regional event franchisees in China, Latin America, etc. Likewise, the alter-globalist World Social Forum has launched many national events. When The Music Stops is an example of an events franchise in the UK, in this case, running speed dating and singles events.

See also

• Franchise termination
• Franchise agreement
• Franchise consulting
• Franchise Disclosure Document
• Franchise fraud
• List of franchises
• The Franchise Rule
• U.S. Securities and Exchange Commission

References

External links

Look up franchise in Wiktionary, the free dictionary.

• International Franchise Association