What is a Franchise: The Meaning & Definition of Franchising

What is a Franchise: The Meaning & Definition of Franchising

The word “franchise” is of French origin and means both “privilege” and “freedom”. In this sense, franchising offers a unique opportunity to own, manage and direct your own business.

The franchisor (the franchisor) owns the rights to the name and trademark of the business. The franchisee (the franchisee) buys the right to use the trademark of the business for a certain period.

Due to the huge variety of franchises, as well as the characteristics it has in different countries, it is not easy to define it. There are many definitions of the term franchise.

The original version of the franchise in the United States

The original version of franchising in the United States is based on the provision of a trademark for certain goods or services by the franchisor to the franchisor, so that the latter can sell these goods or services to third parties using the provided trademark.

In this way, the franchisee has the opportunity to develop his business in a new way and under a well-known brand with a good image. According to Glickman (Franchising, N.Y., 1978), “Simply put, a franchise is an authorization granted by the owner of a trademark or trade name to another person to sell goods or services under that trademark or name.”

Methods of entering the franchise

The methods for franchising to enter foreign markets are very diverse, depending on the specific country. These may include direct licensing of individual sites; joint ventures; agreements for the development of a given territory; master franchising, etc.

Direct licensing is appropriate when there is geographical proximity and economic and social similarity between the markets. Reference: “Licensing Agreement: Definition, Example, Pros, and Cons”, https://www.vbprojects.org/licensing-agreement-definition-example-pros-and-cons/

Joint ventures are suitable if the franchisor wishes to acquire shares. Territorial development agreements and master franchising are the most popular methods of entering foreign markets, as they involve minimal investment and bring additional benefits – cooperation with an existing company with available staff, which is familiar with the conditions of the particular market and has established contacts at the local level. Reference: “What are leasing and a joint venture?”, https://www.dobrojutro.net/what-are-leasing-and-a-joint-venture/

Franchising is a vertical cooperative organizational system

Franchising is a vertically cooperative organizational system of independent legal companies selling goods and services on a contract basis. This system manifests itself as a single structure and is characterized by the distribution of functions between partners.

One company (called the franchisor or the parent company) gives the branch company (called the franchisee) a license to carry out a certain business activity. This is done under specific contractual conditions. Well-known franchise chains are McDonald’s, KFC, Pizza Hut, Coca-Cola, Holiday Inn, Hilton, and other famous brands. It covers over 60 industries in trade and services.

The franchisor’s production program is the so-called franchise package. It consists of know-how (structured business concept), rights and training of the franchisee, and an obligation of the franchisor to actively support its partners and to continuously develop the system. This package includes manuals, contracts, business plans, advertising samples, indicators, and other standards for success.

The franchisee is an independent company, working for its account, using the name of a famous brand. He has the right and obligation to apply the franchise package, to invest equity, and to successfully manage the system.

The franchisor develops a complete commercial concept

The franchisor develops a complete commercial concept, starting with the product, covering advertising, designing stores, and ending with training. And franchisees implement this commercial concept in their workplace.

Franchise systems enjoy a very good image and wide fame based on the common brand, advertising, and coordinated flow of the entire organization. At the same time, the management of the system must monitor, as part of the permanent quality control, the observance of clearly defined standards. Each franchise system is subject to expansion.

A successful trade concept is multiplied and after a certain period, its representations are created in different places. An important advantage of franchising is that it offers a system for the production of quality goods and services at stable prices.

Franchising allows for the realization of a wider network

Franchising enables the realization of a wider network than that of other companies in the industry and strengthens the competitiveness in terms of continuous support from the parent company.

The franchise system is a unique combination of the advantages of small businesses and large corporations.

The franchisee pays the so-called entrance fee or license. It pays for the costs incurred in advance by the franchisor (for the use of the approved brand, for training, for providing the most favorable location). The amount of this fee is different for each franchise package.

The franchisee also pays monthly or annual installments to reimburse the additional costs of operational management and training incurred by the parent company.

Franchising allows you to start a business with significantly less capital

Franchising allows you to start a business with significantly less capital than in the classic case of self-employment. This is possible thanks to the share of the parent company in financing the business in the form of preliminary studies and building the system of work. The lower risk in the activities of franchise companies also explains the willingness of financial institutions to support entrepreneurship through franchising.

Another advantage for start-up entrepreneurs is the training and assistance that the franchisor provides to the franchisee and this enables franchisees without any business experience or knowledge of the industry to create a very successful business.

The safest way to start a new business is through a franchise agreement

It is considered that the safest way to start a new business is through a franchise agreement. According to a study by the International Franchise Association, about 97% of franchise companies established during the five-year period in which the survey was conducted at the end of the fifth year were still on the market.

This percentage is significantly higher than the average success rate among all companies, which for the United States is estimated at 40% after the first two years of business creation and 10% after 10 years.
The roots of the economic phenomenon of “franchising” date back to distant

European history, where the system of trading in privileges has spread to virtually all leading countries of the Old World – England, France, Germany. For example, something similar to the franchise system was used by many European brewers, giving the owners of inns a loan in exchange for the right to sell their beer there.

Modern franchising

Modern franchising dates back to the 1950s, and one of its first examples was a network of hotels in South Wales, concluding a franchise agreement in full accordance with the traditions of breweries.

In the United States, franchising was used by the Western Union’s communications system, which included railroads. In the second half of the 19th century, Singer began selling the right to sell and service popular sewing machines to independent entrepreneurs around the world.

In the 20th century, the development of franchising was closely linked to the rapid growth of the restaurant business. The trend was established in 1919 with the fast-food chain A&W Root Beer. In the 1930s, franchising reached the hotel business, where Howard Johnson set up a hotel chain.

It can be said that for the last half-century most international business giants have adopted the franchise scheme to expand their business. Examples include companies such as Coca-Cola, McDonald’s, Kodak, Sheraton, and many others.

Nowadays, franchising is one of the most popular ways to enter the field of fast food (a classic example – McDonald’s), retail, and many other services. This form of business organization allows relatively small companies to start quickly, relying on a well-known brand and a ready-made formula for doing business, rather than building a new business and creating a brand from scratch in conditions of high competition.

A large-scale survey conducted by the Franchise Business Review in 2006 showed that most franchisees were satisfied with their decision to invest in a proven business system: 86% of respondents “positively assessed the franchising opportunities” and 71% said that they would “repeat.”

Today, franchising has taken a stable position in the world in various areas of business (In the US, for example, there are over 75 types of activities). One of the areas in which franchising has become most widespread around the world is real estate.

This is explained by many specific features of this type of market:

  • Territorial distribution;
  • Market capacity;
  • Demand stability;
  • Large financial flows.

Features of modern large franchise networks

The main characteristics of today’s large and successful global franchise networks are:

Careful selection of participants and strict control to comply with internal standards of customer service.

Preservation of the legal independence of each participant in the system, which allows preserving the effect of the free partnership.

Using the opportunity for “territorial division of labor” and elimination of internal competition.

The rapid expansion of the total number of customers attracted by the reputable brand and quality service.

Dynamic growth of income of all participants in the system.

Official statistics from all markets around the world convincingly confirm the benefits and sustainability of franchising as a modern form of business organization.

Thus, according to the International Franchising Organization (IFA), franchising will soon become the predominant method of doing business in retail and already occupies a strong position in the field of services. The revenues of franchise companies in the United States and Western Europe are estimated at tens of billions of dollars a year.

If these indicators are combined and turned into a gross domestic product, then according to the Financial Times, this would create the 7th largest economy in the world. In the United States, franchise companies (more than 1,500 large networks) create about 13% of the gross national product. The volume of the European franchise market (of which about 40% belongs to France) is estimated at $ 35 billion. The German Franchise Association forecasts annual franchise growth for the country of 10-15% per year.

In the development of any business, priority is given to stability and security, so characteristic of franchise companies. According to the US Small Business Administration, out of 100 small companies, only 15 remain operational after the first three years, and the rest go bankrupt.

On the other hand, for companies operating based on franchising, the statistics are quite different: out of 100 small businesses starting a business, 86 continue to operate after three years. In Germany, the figures are even better – for the last five years, the bankrupt franchise companies are only 8%.

The success of the franchise

The success of the franchise in the modern economy can be judged by the following facts:

In the initial three-year period of development of each company, only 2-4% of the companies operating under franchise go bankrupt, while at the same time 65% of the start-ups go bankrupt.

The reason for the franchise to be more successful lies in the established business rules developed by the franchisor, which eliminate the fatal mistakes that lead to the bankruptcy of other companies.

This form of company cooperation is widely used in modern business and especially in the following areas of the economy: hospitality, catering, gas stations, entertainment business, production and bottling of soft drinks from delivered concentrate, and others.

The great use of franchising mainly in the field of services is not accidental – it is in this sector of the economy the reputation of the company offering services, as well as the presence of a well-known brand, is crucial for their preference by consumers.

In addition, the services offered are very similar and lack the factor of uniqueness or copyright protection – a factor that determines the intense competition in the industry and the need to seek competitive advantage in the service itself and not the service or product itself.