Where it all began. The evolution of franchising.
By: Carl J. Kosnar, Managing Partner, The Kosnar Group
There are references in American history to early business relationships which, while possibly not meeting the current FTC definition, were without a doubt, franchise/licensing relationships. These relationships existed in the selling of wares from town-to-town by peddlers, licenses granted for general stores at military outposts, and certain livestock sales and other goods in which exclusive territorial rights were granted to the "franchisees" by the holder of the rights. Unfortunately, while the relationships are mentioned in the literature, the names of these early franchise founders and the structure of the business arrangement are not.
Throughout its long history, there have been four constants that have fueled the growth of franchising, the desire to expand, the lack of expansion capital, the need to overcome distance, and managing people from a distant location.
The use of franchising can be traced to the expansion of the church and as an early method of central government control, probably as far back as the Middle Ages. Some have written that it may indeed date back as far as the Roman Empire or earlier and given the necessity of large territorial controls, coupled with the lack of modern transportation and communication at the time, there is reasonable basis for this assumption.
Franchising was also used in England and Europe, where Royalty granted land rights to powerful individuals. In exchange for these land grants, the noblemen were required to protect the territory for the monarchs by establishing an army and were free to set tolls and establish and collect taxes, a portion of which was paid to the monarch. As it was an agrarian society, the control over the land represented enormous power and was the foundation for the feudal system. It occurred to me recently, that the movie Robin Hood, starring Errol Flynn, was simply the tale of a franchise relationship that went bad, with King Richard as the franchisor, Prince John as the master franchisee and the Lockslie family as the vociferous, disenchanted franchisee.
This system of governmental control existed in England until it was outlawed at the Council of Trent in 1562. With the economic opportunities presented by the discovery of the New World, colonialism of the period, and the emerging international trading opportunities, franchising was again used by government to expand and exercise control.
The Dutch East India Company was founded in 1602 by the Dutch Republic to conduct all trade between the Cape of Good Hope and the Straits of Magellan. The Company was capitalized by stock valued at 6.5 million guilders. The company, acting as a sovereign power, conquered territory from the Portuguese and established its headquarters in Jakarta in 1619. From that base, it created a monopoly of trade with Japan in 1641 and fought off British attempts to break into the spice trades. Turning west, the company engaged the services of Captain Henry Hudson in 1609, who was formerly in the employ of the English Muscovy Company, a franchisee of England, to find the Northeast Passage, giving the Dutch claims over the Hudson Valley in upstate New York as far as Albany. In 1799 the Dutch East India Company filed for bankruptcy and its possessions and rights were assumed by the Dutch Republic.
In 1607 the London Company was granted a charter for Virginia by England and hired Captain Christopher Newport to locate and settle the area. The story of Jamestown, the first permanent British settlement in North America, and Captain John Smith, who succeeded Captain Newport in managing Jamestown, is well known. Following the massacre of 347 settlers by the Powhatan Indian Confederacy on March 22, 1622, the British Crown, charging mismanagement of the area by the London Company, withdrew its charter in 1624 and the Colony of Virginia came under direct British control.
Much of the colonization and exploration by the British and European powers was conducted under similar "franchise-type" relationships.
Franchising, as a business concept, was transplanted into the United States from England and Europe where it was used "commercially" in the tavern and brewery industries. Tavern owners, in exchange for financial assistance from the breweries, agreed to sole purchase agreements with the breweries. The breweries did not exercise any controls over the operation of the local tavern except for the sole purchase arrangement.
It is important to understand in examining the birth of franchising in the United States that prior to franchising there was limited experience in chain operations. Chain operations would ultimately form the foundation for the franchise method of distribution.
Not surprisingly, transportation and the growing mobility of Americans were the impetus for the establishment of retail and restaurant chains and franchising in the manufacturing segments of the economy.
The earliest known restaurant chain in the United States was founded in the 1850's by Frederick Henry Harvey, an Englishman who opened his first restaurant in 1852. This initial restaurant failed during the Civil War. In 1876, Frederick Harvey opened the first of the Harvey House restaurants in a terminal of the Atchison, Topeka & Santa Fe Railroad. The railroad wanted to open depot restaurants for its passengers and provided Frederick Henry with locations and free transportation of restaurant supplies. By 1887, there was a Harvey House restaurant every hundred miles along the 12,000-mile-long Atchison, Topeka, & Santa Fe line. Frederick Harvey believed strongly in quality control and established regular field visits to his restaurants similar to those used today by franchisors.
Following World War I, the advance of the automobile gave birth to another restaurant innovation, the drive in. In 1919, Roy Allen purchased the formula for his root beer recipe from a pharmacist and, together with Frank Wright, started A&W Root Beer. Needing capital to expand, Allen bought out his partner in 1924 and began franchising the A&W concept. A&W offered car-side service with "tray boys". Later A&W added female "car hops" on roller skates to service its customers.
One of A&W's early franchisees was Sherman and J. Willard Marriot who opened franchises in Fort Wayne, Indiana, and Washington, D.C. in the 1920's. The Marriots' first A&W in Washington was owned by J.W. Marriot and his partner Hugh Colton and grossed $16,000 in its first year. As with many of today's franchise systems, it was the Marriots as franchisees of A&W who brought innovation to A&W when they requested permission to add food to the restaurant to increase the unit sales.
Using the automobile, curb service, and an innovative hamburger cooked on onions, Billy Ingram and Walter Anderson opened their first White Castle restaurant in 1921 in Wichita, Kansas. White Castle is credited with many innovations in the fast food industry, particularly in their use of advertising and discount marketing, the first take-out packaging to keep the food warm and the folded paper napkin. While it is still a company-owned operation in the United States, White Caste has commenced international expansion via franchising. Copying the White Castle format, in 1932 R.B. Davenport opened the first Krystal restaurant and began franchising in 1990.
During that same period, Howard Dearing Johnson acquired a pharmacy in Quincy, Massachusetts, and began to sell three flavors of ice cream together with a limited menu of cooked items. In 1935 Howard Johnson awarded its first franchise to Reginal Sprague. Over the years the concept increased to an expanded menu and to 28 flavors of ice cream. Developing a distinctive roadside presence from orange roofed locations, and featuring one of the first pylon signs with its name and logo, the company secured the first turnpike contract on the Pennsylvania Turnpike.
While it was the innovation of the restaurant pioneers that established their menus, methods of operations and standards, it was the automobile and the movement of a growing nation that created the opportunity for these early restaurant chains to grow.
Many of the legendary franchised restaurant chains that began franchised operations over the next three decades included Carvel, established in 1934; Kentucky Fried Chicken, established in 1930; Dairy Queen, established in 1940; Dunkin Donuts, established in 1950; Burger King, established in 1954; McDonald's, established in 1955; and The International House of Pancakes, established in 1958. The stories of these early pioneering concepts have been the basis for many books over the years and the lessons learned are evident in the many food service chains that followed.
Tracing back to the late 1800's, the automobile and the growing mobility of Americans again become the basis for other early developments in franchising.
The earliest non-food franchises were relationships in which manufacturers established licensed selling and service locations for their manufactured goods through franchising. This can be seen in the establishment of Singer Sewing Centers and McCormack Harvesting Machine Company Dealerships in the 1850's and 1860's and the birth of the automotive franchises at the turn of the century by General Motors and Ford. The first franchise for General Motors was issued in 1898 to William E. Metzger of Detroit.
The American Industrial Revolution began the mass production of consumer goods. It was mass production which created the opportunity for these companies to produce manufactured goods at lower costs which fueled consumer demand and the need to sell and distribute the products efficiently and cost effectively. Many methods of sale and distribution were tried before franchising including direct factory sales, sales through non-branded locations such as pharmacies, direct mail and traveling salesmen. While all proved to be insufficient to satisfy the needs of the company, local salesmen were the most effective.
By selecting franchisees, and providing them with exclusive territories, hard goods manufacturers were able to effectively and efficiently bring their products to market.
As the automobile manufacturers solved their distribution problems through franchising and began the changeover from steam engines to internal combustion engines, there became a need to establish locations for these vehicles to obtain fuel. Lacking the capital required to purchase the real estate and establish an adequate distribution system to meet the needs of the growing number of automobiles, over the next 30 years the oil industry began to establish dealerships through franchising.
At the turn of the century, because of the high cost of transporting the finished product and the reusable glass bottles, American soft drink bottling was a localized industry. By shipping syrup concentrate to its franchisees, and requiring the local franchisees to bottle under strict formulas and processes, bottlers were able to control the quality of their product in distant markets, and expand rapidly without the need for the capital which company ownership would have required. Franchisees obtained the rights to exclusive markets and a valuable trade name and the bottlers were able to overcome the transportation issues that had to that time restricted their growth. In 1901 Coca Cola issued its first franchise to the Georgia Coca Cola Bottling Company.
Most of the early franchises were all based on a product line sold to its franchisees. During the 1850's and 1860's both Singer Sewing Machine and McCormack Harvesting Machine Company began franchising the sales and service of their equipment. In 1902 Louis Liggett formed a manufacturing cooperative with 40 independent drug stores, each investing $4,000 to start the manufacturing cooperative under the Rexall name. Following the end of World War I, the Rexall cooperative began to franchise independently owned retail outlets under the Rexall trade name, supplying franchisees with branded Rexall products.
One of the great innovations in franchising came in 1909 with the establishment of the Western Auto franchise. Up to that time, product franchisers sought franchisees with industry experience and, except for the supply of branded product, did not provide any significant business related services. While still relying on the mark-up on product sales to its franchisees rather than royalties on sales, Western Auto provided its franchisees with many of the same services which modern franchisors provide today. These included site selection and development, retail training, merchandising, marketing assistance and other continuing services. Western Auto also sought franchisees without industry experience as many franchisors do today.
While franchising continued to grow up until the beginning of World War II, the truly explosive growth in franchising began at the end of the war.
Franchising emerged as a force to be reckoned with in the post war 1950's, taking advantage of pent up consumer demand, available franchisees, ideas from the returning veterans and capital provided by separation pay and the GI bill. The growth of franchising in America was further advanced when prospective franchisees were assured of safety using federally protected trademarks and service marks, essential to the successful local operation of a nationally established franchise system.
Before Congress enacted the Trademark Act of 1946, better known as the Lanham Act, trademark protection was at best inconsistent and uncertain.
Once potential entrepreneurs became confident of trademark and logotype integrity and protection, more and more individuals flowed into the selling stream of franchising in the 1950s and 1960s.
The franchising boom in the 50's and 60's achieved almost mystical stature. Franchisors of convenience goods and services grew. Companies like McDonald's, Kentucky Fried Chicken, Laundry and Dry Cleaners, Hotels, Rental Cars, automotive aftermarket and temporary help companies proliferated in the marketplace. By 1965 McDonald's had grown to approximately 1000 units in only ten years and made their first public offering opening at $22.50. It closed the same day at $30 and closed the first month at $50. Nate Sherman's Midas Muffler during the same period had grown to 400 locations, Kemmons Wilson's Holiday Inn grew to 1000 locations and Jules Lederer's Budget Rent A Car opened their 500th franchise.
The growth in franchising did not come without problems. By the latter half of the 1960's the bloom was off the rose. Many franchisor companies focused more on the sale of franchises than on operating their franchise systems. Some franchisors made misrepresentation in attracting franchisees; some based their sales effort on the use of celebrity names and endorsements and failed. Some even sold franchises for concepts that didn't exist.
Due to the problems of the 50's and 60's several states led by California began to enact laws governing the disclosure of information provided to potential franchisees. These states required the franchisor to deliver to a potential franchisee a disclosure document providing information explaining the opportunity. It was not until the summer of 1979 that the federal government promulgated Federal Trade Commission Rule 436 which established minimum uniform disclosure requirements throughout the United States.
Today, the format and content of the disclosure documents are undergoing change to further strengthen disclosure and there are new laws being proposed at the federal and state level to further regulate franchising. Some would say that the pendulum has swung too far and unduly burdens legitimate franchise companies from utilizing the franchise system to establish new channels of distribution.
Today, more than 3,000 franchisors and over a half-million franchisees testify to the increasing growth of an industry that has burgeoned forth from roots dating back at least 2,000 years.
The evolution of modern franchising, created by the innovative companies and the pioneers that have led them, is an exciting tale in itself. The future, energized by still unimagined new concepts, new business techniques and international expansion, promises to add still more dynamic chapters to the continuing and growing adventure of franchising.
Thursday, April 8, 2010
Monday, April 5, 2010
GLOBAL ECONOMIC DEVELOPMENT THROUGH THE UTILIZATION OF THE FRANCHISE SYSTEM - Parts II & III
DEFINITION OF FRANSHIP SYSTEM
The Franship system is a comprehensive commercial joint venture in which one party (the grantor) grants to another party (the grantee) the right to operate a business selling products and/or services produced or developed by the Franship entity under the grantor's business format and identified by the grantor's logo and trademark. The Franship entity is owned jointly by the grantor and the grantee and receives a license to operate by the grantor in the grantee’s country. The grantor is usually a large franchise company and provides the training, support, and the entire business format. The grantee is a business group, company or governmental agency domiciled in the country where the Franship is located and operated and, in most cases, provides the majority of the funding to establish the Franship business activities.
The Franship system can also be thought of as a pooling of resources and capabilities. The grantor contributes the know-how and experience and the grantee contributes the initial capital investment, or supplemental capital investment, motivated effort, and operating experience within the country and its variety of markets. The Franship, like the franchise model, includes a format for the conduct of a business, a management system for operating the business, and a shared trade identity.
The Franship system is a business expansion method and joint venture relationship, not a franchisor-franchisee relationship, nor is it a buyer-seller relationship; it is a partnership with equity shared by both parties, and, in my opinion, is an acceptable business expansion model for countries that do not accept the Western “McDonaldization” of their economies.
THE FRANSHIP SYSTEM AS A MEANS OF IMPORTING ENTREPRENEURIAL ACTIVITY INTO DEVELOPING COUNTRIES
To date, franchising has been developed to a greater extent in the United States than anywhere else in the world, despite the fact that the concept had its early origins in Europe. The last 20 years, however, have witnessed an unprecedented spread of franchising across international frontiers prompted almost exclusively by American franchise companies wishing to cope with problems of market saturation and monopoly legislation at home. Exports by European franchise companies, by way of comparison, range from modest to trivial depending upon the country in question. Countries such as France, the United Kingdom, and Australia are becoming involved in international franchising activity but appear to be currently concentrating on ex-colonies and are geared towards serving expatriates.
Franchisor internationalization began initially by establishing a presence across industrialized nations with developed economies and language/cultural proximity and affinity to the United States. As markets began to become saturated in America, and as the export potential of franchising became more evident, the growth rate accelerated and global expansion has broadened.
In an increasing number of countries, escalating urbanization, rising disposable incomes, and expanding consumer markets provide conditions favorable to the growth of franchising.
U.S. ATTITUDES TOWARDS FRANCHISE GLOBALIZATION
High profile American involvement in international franchising is looked upon favorably at the highest levels in the U.S. government because of the strong benefits to the U.S. economy. From a balance-of-payments perspective, international franchising is considered (in the U.S.) as a safe and rapid means of obtaining foreign currency with a relatively small financial investment abroad. It is notable that it neither replaces American exports nor exports American jobs. These reasons make this business arrangement one of the most preferred and government-supported forms of international involvement. The same argument can be made for the Franship system.
The advantages of a global Franship, or franchise, program to an American company may be summarized as:
Fewer financial resources are required as the Franship entity (foreign partner) incurs the majority of the costs involved.
Raw materials can often be produced internally in countries under the Franship structure where direct imports may be limited under the franchising system.
There is less susceptibility to political, economic and cultural risks if the ownership is local under the Franship program. Property is less likely to be expropriated since the grantees are local nationals. China is a good example, as it begins to expand its nationalistic tendencies toward foreign corporations.
Grantees under the Franship program are more familiar with local laws, language, culture, and business norms and practices of the country. And, having ownership in the parent company creates more motivation rather than just owning an American franchise.
The Franship program also helps to avoid some of the following risks of employing franchising as a vehicle to international expansion from the franchisor's viewpoint:
Possible difficulties in repatriating royalties
Difficulties in protecting copyright and intellectual property rights
Difficulty in policing quality standards, unfamiliar laws, regulations, language, and business norms
Difficulties in servicing franchisees
Difficulties in terminating contracts because of local laws
Creation of local competition as the franchise concept is copied or products are bootlegged
TECHNOLOGY TRANSFER
The transfer of franchise know-how across national boundaries can be viewed as a process providing local franchisees with access to value-added businesses as well as the marketing techniques and managerial support implicit to firms developed in industrialized economies. However, not all countries and cultures readily accept Western franchising concepts.
Franship-type joint ventures have traditionally been a more popular method for international development because the franchisor receives financial assistance with the costs of globalization. Sharing the equity with a local partner also assists the franchisor with the sensitivity needed to cope with cultural, political and administrative norms, and behavior patterns in the franchisee’s country.
In some Asian and Middle East countries there are relatively few, if any, foreign (or indeed home-based) franchise companies registered. There were, and are still, stringent foreign investment laws and a preference for Franship-type joint ventures rather than outright foreign ownership. In other countries even joint ventures were restricted to sectors specifically targeted by the national government.
GLOBAL UTILIZATION
As the major American franchise companies grow more competitive in the United States, the large chains have looked to overseas markets for their future growth. A dozen years ago, McDonald’s had approximately 3,200 restaurants outside the United States; today it has over 20,000 restaurants in over 125 foreign countries. It currently opens approximately 6 new restaurants every day, and at least 5 of them are overseas. The economic values and industrial practices of American franchises are being exported to every corner of the globe. American franchising systems have not only become symbols of Western commercial advancement, but have proven successful in helping to grow foreign economies as well. American franchise companies are often the first multinationals to arrive when the country has opened its markets, serving as the pioneers in the reconstruction of the local economy. Seventeen years ago McDonald’s opened its first restaurant in the Republic of Turkey, no other foreign franchisor or chain did business there. Turkey, now has hundreds of franchise outlets, including 7-Eleven, Nutra Slim, ServiceMaster, Re/Max Real Estate, Mail Boxes Etc, (now owned by UPS), Ziebart Tidy car, plus many others.
The anthropologist Yunxiang Yan has said that in the eyes of Beijing consumers, U.S. franchises represent, “Americana and the promise of modernization.” Thousands of people waited patiently for hours to eat at the city’s first McDonald’s in 1992. Two years later when a McDonald’s opened in Kuwait, the line of cars waiting at the drive-through window extended for seven miles. About the same time, a Kentucky Fried Chicken (KFC) restaurant in Saudi Arabia’s holy city of Mecca set new sales records for the chain, earning US$200,000 in a single week during Ramadan. In Brazil, McDonald’s has become the nation’s largest employer. Many international franchise businesses have become the center of commerce, and disperse economic benefits throughout the foreign city or country. Classes at the McDonald’s training facility in Oak Brook, Illinois, are taught in more than two dozen languages.
As the American franchise chains move overseas, in order to diminish the fears of American domination, the chains purchase as much food and supplies as possible in the country where they operate. Instead of importing food and supplies, they import their systems and procedures so that local businesses can learn and prosper by providing the needed products and services. Seven years before McDonald’s opened its first restaurant in India, the company began to establish a supply network there, teaching Indian farmers how to grow iceburg lettuce with seeds specially developed for the nation’s climate. A McDonald’s restaurant is just the entry point of a much larger system comprising an extensive food-chain, leading back to all the local suppliers and eventually back to the farms.
CONCLUSION
The Franship system, as a modification of the Western franchise business model can have a useful “role-model” effect in encouraging local entrepreneurs in countries with developing economies to set up their own franchises and even consider expanding these “home-grown” franchise models outside the country. An implicit feature of a Franship, and/or franchise system, is the concept of technological transfer to the learning organization or country, where technology refers to skills and know-how rather than just machinery and hardware. This broader process relates to methods of organization and operation, quality control, and various other manufacturing procedures.
Notwithstanding my belief in the Franship system rather than conventional franchise structures in some developing economies, there will be circumstances that exist within other countries that nevertheless warrant the use of master franchise relationships.
For governments of developing countries that wish to tap the potential of franchising and concentrate on promoting local businesses while resisting the downside factors of imported Western franchise know-how, the Franship model has proved effective.
However, it may well be that, in exchange for exposure to managerial, marketing and consumer know-how which imported franchise systems bring with them, there may a price to pay. The cultural homogeneity which exposure to Western tastes may bring, the loss of economic diversity, the possible displacement of existing local businesses, the repatriation of fees and profits, plus the notion of control from a distance, all need to be taken into account by policy-makers in developing economies before deciding to either embrace or reject this source of technology transfer and know-how.
Whatever posture governments of developing economies decide to adopt on franchising or the Franship system, one thing appears fairly certain: franchising as a business expansion concept cannot be indefinitely ignored.
The Franship system is a comprehensive commercial joint venture in which one party (the grantor) grants to another party (the grantee) the right to operate a business selling products and/or services produced or developed by the Franship entity under the grantor's business format and identified by the grantor's logo and trademark. The Franship entity is owned jointly by the grantor and the grantee and receives a license to operate by the grantor in the grantee’s country. The grantor is usually a large franchise company and provides the training, support, and the entire business format. The grantee is a business group, company or governmental agency domiciled in the country where the Franship is located and operated and, in most cases, provides the majority of the funding to establish the Franship business activities.
The Franship system can also be thought of as a pooling of resources and capabilities. The grantor contributes the know-how and experience and the grantee contributes the initial capital investment, or supplemental capital investment, motivated effort, and operating experience within the country and its variety of markets. The Franship, like the franchise model, includes a format for the conduct of a business, a management system for operating the business, and a shared trade identity.
The Franship system is a business expansion method and joint venture relationship, not a franchisor-franchisee relationship, nor is it a buyer-seller relationship; it is a partnership with equity shared by both parties, and, in my opinion, is an acceptable business expansion model for countries that do not accept the Western “McDonaldization” of their economies.
THE FRANSHIP SYSTEM AS A MEANS OF IMPORTING ENTREPRENEURIAL ACTIVITY INTO DEVELOPING COUNTRIES
To date, franchising has been developed to a greater extent in the United States than anywhere else in the world, despite the fact that the concept had its early origins in Europe. The last 20 years, however, have witnessed an unprecedented spread of franchising across international frontiers prompted almost exclusively by American franchise companies wishing to cope with problems of market saturation and monopoly legislation at home. Exports by European franchise companies, by way of comparison, range from modest to trivial depending upon the country in question. Countries such as France, the United Kingdom, and Australia are becoming involved in international franchising activity but appear to be currently concentrating on ex-colonies and are geared towards serving expatriates.
Franchisor internationalization began initially by establishing a presence across industrialized nations with developed economies and language/cultural proximity and affinity to the United States. As markets began to become saturated in America, and as the export potential of franchising became more evident, the growth rate accelerated and global expansion has broadened.
In an increasing number of countries, escalating urbanization, rising disposable incomes, and expanding consumer markets provide conditions favorable to the growth of franchising.
U.S. ATTITUDES TOWARDS FRANCHISE GLOBALIZATION
High profile American involvement in international franchising is looked upon favorably at the highest levels in the U.S. government because of the strong benefits to the U.S. economy. From a balance-of-payments perspective, international franchising is considered (in the U.S.) as a safe and rapid means of obtaining foreign currency with a relatively small financial investment abroad. It is notable that it neither replaces American exports nor exports American jobs. These reasons make this business arrangement one of the most preferred and government-supported forms of international involvement. The same argument can be made for the Franship system.
The advantages of a global Franship, or franchise, program to an American company may be summarized as:
Fewer financial resources are required as the Franship entity (foreign partner) incurs the majority of the costs involved.
Raw materials can often be produced internally in countries under the Franship structure where direct imports may be limited under the franchising system.
There is less susceptibility to political, economic and cultural risks if the ownership is local under the Franship program. Property is less likely to be expropriated since the grantees are local nationals. China is a good example, as it begins to expand its nationalistic tendencies toward foreign corporations.
Grantees under the Franship program are more familiar with local laws, language, culture, and business norms and practices of the country. And, having ownership in the parent company creates more motivation rather than just owning an American franchise.
The Franship program also helps to avoid some of the following risks of employing franchising as a vehicle to international expansion from the franchisor's viewpoint:
Possible difficulties in repatriating royalties
Difficulties in protecting copyright and intellectual property rights
Difficulty in policing quality standards, unfamiliar laws, regulations, language, and business norms
Difficulties in servicing franchisees
Difficulties in terminating contracts because of local laws
Creation of local competition as the franchise concept is copied or products are bootlegged
TECHNOLOGY TRANSFER
The transfer of franchise know-how across national boundaries can be viewed as a process providing local franchisees with access to value-added businesses as well as the marketing techniques and managerial support implicit to firms developed in industrialized economies. However, not all countries and cultures readily accept Western franchising concepts.
Franship-type joint ventures have traditionally been a more popular method for international development because the franchisor receives financial assistance with the costs of globalization. Sharing the equity with a local partner also assists the franchisor with the sensitivity needed to cope with cultural, political and administrative norms, and behavior patterns in the franchisee’s country.
In some Asian and Middle East countries there are relatively few, if any, foreign (or indeed home-based) franchise companies registered. There were, and are still, stringent foreign investment laws and a preference for Franship-type joint ventures rather than outright foreign ownership. In other countries even joint ventures were restricted to sectors specifically targeted by the national government.
GLOBAL UTILIZATION
As the major American franchise companies grow more competitive in the United States, the large chains have looked to overseas markets for their future growth. A dozen years ago, McDonald’s had approximately 3,200 restaurants outside the United States; today it has over 20,000 restaurants in over 125 foreign countries. It currently opens approximately 6 new restaurants every day, and at least 5 of them are overseas. The economic values and industrial practices of American franchises are being exported to every corner of the globe. American franchising systems have not only become symbols of Western commercial advancement, but have proven successful in helping to grow foreign economies as well. American franchise companies are often the first multinationals to arrive when the country has opened its markets, serving as the pioneers in the reconstruction of the local economy. Seventeen years ago McDonald’s opened its first restaurant in the Republic of Turkey, no other foreign franchisor or chain did business there. Turkey, now has hundreds of franchise outlets, including 7-Eleven, Nutra Slim, ServiceMaster, Re/Max Real Estate, Mail Boxes Etc, (now owned by UPS), Ziebart Tidy car, plus many others.
The anthropologist Yunxiang Yan has said that in the eyes of Beijing consumers, U.S. franchises represent, “Americana and the promise of modernization.” Thousands of people waited patiently for hours to eat at the city’s first McDonald’s in 1992. Two years later when a McDonald’s opened in Kuwait, the line of cars waiting at the drive-through window extended for seven miles. About the same time, a Kentucky Fried Chicken (KFC) restaurant in Saudi Arabia’s holy city of Mecca set new sales records for the chain, earning US$200,000 in a single week during Ramadan. In Brazil, McDonald’s has become the nation’s largest employer. Many international franchise businesses have become the center of commerce, and disperse economic benefits throughout the foreign city or country. Classes at the McDonald’s training facility in Oak Brook, Illinois, are taught in more than two dozen languages.
As the American franchise chains move overseas, in order to diminish the fears of American domination, the chains purchase as much food and supplies as possible in the country where they operate. Instead of importing food and supplies, they import their systems and procedures so that local businesses can learn and prosper by providing the needed products and services. Seven years before McDonald’s opened its first restaurant in India, the company began to establish a supply network there, teaching Indian farmers how to grow iceburg lettuce with seeds specially developed for the nation’s climate. A McDonald’s restaurant is just the entry point of a much larger system comprising an extensive food-chain, leading back to all the local suppliers and eventually back to the farms.
CONCLUSION
The Franship system, as a modification of the Western franchise business model can have a useful “role-model” effect in encouraging local entrepreneurs in countries with developing economies to set up their own franchises and even consider expanding these “home-grown” franchise models outside the country. An implicit feature of a Franship, and/or franchise system, is the concept of technological transfer to the learning organization or country, where technology refers to skills and know-how rather than just machinery and hardware. This broader process relates to methods of organization and operation, quality control, and various other manufacturing procedures.
Notwithstanding my belief in the Franship system rather than conventional franchise structures in some developing economies, there will be circumstances that exist within other countries that nevertheless warrant the use of master franchise relationships.
For governments of developing countries that wish to tap the potential of franchising and concentrate on promoting local businesses while resisting the downside factors of imported Western franchise know-how, the Franship model has proved effective.
However, it may well be that, in exchange for exposure to managerial, marketing and consumer know-how which imported franchise systems bring with them, there may a price to pay. The cultural homogeneity which exposure to Western tastes may bring, the loss of economic diversity, the possible displacement of existing local businesses, the repatriation of fees and profits, plus the notion of control from a distance, all need to be taken into account by policy-makers in developing economies before deciding to either embrace or reject this source of technology transfer and know-how.
Whatever posture governments of developing economies decide to adopt on franchising or the Franship system, one thing appears fairly certain: franchising as a business expansion concept cannot be indefinitely ignored.
Tuesday, March 30, 2010
GLOBAL ECONOMIC DEVELOPMENT THROUGH THE UTILIZATION OF THE FRANCHISE SYSTEM
GLOBAL ECONOMIC DEVELOPMENT THROUGH THE UTILIZATION OF THE FRANCHISE SYSTEM
By: Carl Kosnar
(Part I of III)
PREFACE
International franchising has fascinated me for many years. I still get excited seeing a familiar trademark when driving down a street in New Delhi, Cairo, or Paris. While traveling outside the United States, my wife and I will frequently play a game seeing who can point to a recognized sign first such as McDonald’s or Gold’s Gym with the same exuberance of children playing car-trip games.
Much has been written in recent years extolling the virtues of franchising as it exists in the United States. However, there has been a dearth of information and analysis of the economic impact and potential of franchising, or similar economic expansion systems, in developing countries. Most of what has been written about international franchising has dealt with the legalities pertaining to franchise law, licensing, and trademark and patent law, and their disparities from country to country. In spite of the scarcity of academic and research analysis, the period between the 1980s and the early-2000s witnessed a dramatic increase in international franchising and similar commercial expansion activity. This has occurred not only in Western Europe but also in Asia, South and Central America, Eastern Europe and, to a more modest extent, Africa and the Middle East. In this article, I attempt to point out some of the benefits and consequences of importing Western (essentially American) franchises and franchising techniques into developing economies.
PURPOSE
The success of the American franchise business model is well documented through volumes of books and articles, including those I have written, over the last twenty years. It is not my intent to add to the prolific amount of text that already exists, but rather to put forth the challenges that I perceive in attempting to transfer the American franchise business model to developing economies in other parts of the world. In order to be successful in many countries outside of the United States, it is my contention that the American version of franchising requires modification in order to be accepted and flourish.
One such modification is a related expansion technique that I have implemented in the United States and Canada with good results which I call the “Franship” system of growth, a composite of elements taken from franchising and joint venture commercial arrangements. I believe the term Franship has a connotation that is more acceptable in regions of the world that are reluctant to accept American-style franchising; it proposes a business relationship based on parity.
DEFINITION OF FRANCHISING
If one analyzes franchising systems worldwide, the structures tend to be hybrid forms of economic organizations that create various hierarchical relationships for the purpose of distributing goods and services. Part of the debate over the precise definition of franchising has revolved around the different business activities which franchising encompasses. The term franchise, in its generic usage, has been used to label business relationships as diverse as the right to broadcast television programs or operate professional sports teams within certain geographic territories to utilizing a complete business-format franchise package such as McDonalds.
However, a franchise is probably best defined as comprising a contractual relationship between a franchisee (usually taking the form of a small business) and a franchisor (usually a larger business) in which the former agrees to produce or market a product or service in accordance with an overall “business system” devised by the franchisor. The relationship is a continuing one with the franchisor providing ongoing support and advice, research and development, and help with marketing and advertising. In return, the franchisee usually pays an initial franchise fee and also an ongoing royalty or management service fee normally based on gross sales or a mark-up on supplies purchased from the franchisor. The franchisee provides the capital for the business and is a legally separate entity from the franchisor.
Although the franchisor is usually a larger business than the franchisee, most franchise companies do not meet the description of a large, national company. Most franchisors in America and Europe remain small to medium-sized enterprises (SMEs) and are regional in structure and size. Eighty percent of all franchise companies in the United States have less than 100 franchised units (source: International Franchise Association). The large franchise companies are almost invariably American in origin, and usually qualify as a Fortune 1000 Company, e.g., McDonald's Corporation, Coca-Cola, Pepsi, Holiday Inn, Burger King, KFC, Pizza Hut, Budget Rent-a-Car and Avis.
It has been argued that in the early stages of franchising in the United States, the franchisee was simply a managed outlet of the franchisor. Examples of this theory are the Singer Sewing Machine Company, which started franchising in the 1860’s, and the automobile dealerships and gasoline station franchises started at the beginning of the 20th Century. In these early franchise models, the franchisor exercised enormous control over the franchisee. At the other end of the pendulum are those that argue that the franchised small business may be viewed as an emerging form of independent small business whose distinguishing characteristic is its independence to operate, and profit, under the guidelines of the usually larger franchisor. As such, franchising, or in some cases modified versions, can be viewed as a means of nurturing and developing entrepreneurial talent in developing countries, and it is in this context, that I believe the Franship program can accelerate economic growth.
By: Carl Kosnar
(Part I of III)
PREFACE
International franchising has fascinated me for many years. I still get excited seeing a familiar trademark when driving down a street in New Delhi, Cairo, or Paris. While traveling outside the United States, my wife and I will frequently play a game seeing who can point to a recognized sign first such as McDonald’s or Gold’s Gym with the same exuberance of children playing car-trip games.
Much has been written in recent years extolling the virtues of franchising as it exists in the United States. However, there has been a dearth of information and analysis of the economic impact and potential of franchising, or similar economic expansion systems, in developing countries. Most of what has been written about international franchising has dealt with the legalities pertaining to franchise law, licensing, and trademark and patent law, and their disparities from country to country. In spite of the scarcity of academic and research analysis, the period between the 1980s and the early-2000s witnessed a dramatic increase in international franchising and similar commercial expansion activity. This has occurred not only in Western Europe but also in Asia, South and Central America, Eastern Europe and, to a more modest extent, Africa and the Middle East. In this article, I attempt to point out some of the benefits and consequences of importing Western (essentially American) franchises and franchising techniques into developing economies.
PURPOSE
The success of the American franchise business model is well documented through volumes of books and articles, including those I have written, over the last twenty years. It is not my intent to add to the prolific amount of text that already exists, but rather to put forth the challenges that I perceive in attempting to transfer the American franchise business model to developing economies in other parts of the world. In order to be successful in many countries outside of the United States, it is my contention that the American version of franchising requires modification in order to be accepted and flourish.
One such modification is a related expansion technique that I have implemented in the United States and Canada with good results which I call the “Franship” system of growth, a composite of elements taken from franchising and joint venture commercial arrangements. I believe the term Franship has a connotation that is more acceptable in regions of the world that are reluctant to accept American-style franchising; it proposes a business relationship based on parity.
DEFINITION OF FRANCHISING
If one analyzes franchising systems worldwide, the structures tend to be hybrid forms of economic organizations that create various hierarchical relationships for the purpose of distributing goods and services. Part of the debate over the precise definition of franchising has revolved around the different business activities which franchising encompasses. The term franchise, in its generic usage, has been used to label business relationships as diverse as the right to broadcast television programs or operate professional sports teams within certain geographic territories to utilizing a complete business-format franchise package such as McDonalds.
However, a franchise is probably best defined as comprising a contractual relationship between a franchisee (usually taking the form of a small business) and a franchisor (usually a larger business) in which the former agrees to produce or market a product or service in accordance with an overall “business system” devised by the franchisor. The relationship is a continuing one with the franchisor providing ongoing support and advice, research and development, and help with marketing and advertising. In return, the franchisee usually pays an initial franchise fee and also an ongoing royalty or management service fee normally based on gross sales or a mark-up on supplies purchased from the franchisor. The franchisee provides the capital for the business and is a legally separate entity from the franchisor.
Although the franchisor is usually a larger business than the franchisee, most franchise companies do not meet the description of a large, national company. Most franchisors in America and Europe remain small to medium-sized enterprises (SMEs) and are regional in structure and size. Eighty percent of all franchise companies in the United States have less than 100 franchised units (source: International Franchise Association). The large franchise companies are almost invariably American in origin, and usually qualify as a Fortune 1000 Company, e.g., McDonald's Corporation, Coca-Cola, Pepsi, Holiday Inn, Burger King, KFC, Pizza Hut, Budget Rent-a-Car and Avis.
It has been argued that in the early stages of franchising in the United States, the franchisee was simply a managed outlet of the franchisor. Examples of this theory are the Singer Sewing Machine Company, which started franchising in the 1860’s, and the automobile dealerships and gasoline station franchises started at the beginning of the 20th Century. In these early franchise models, the franchisor exercised enormous control over the franchisee. At the other end of the pendulum are those that argue that the franchised small business may be viewed as an emerging form of independent small business whose distinguishing characteristic is its independence to operate, and profit, under the guidelines of the usually larger franchisor. As such, franchising, or in some cases modified versions, can be viewed as a means of nurturing and developing entrepreneurial talent in developing countries, and it is in this context, that I believe the Franship program can accelerate economic growth.
Monday, March 29, 2010
Show Me the Money
I started in the franchise business in 1976 as a consultant to ServiceMaster Industries and have enjoyed many years of helping people to obtain their dream of purchasing their own business. Well, at least until the fall of 2008, because that’s when the fun ended. Franchise financing, which we all took for granted, suddenly came to a screeching halt and has stayed unavailable right up to the present time.
If you have tried to purchase a franchise in the last 18 months, you know that it is almost impossible to obtain a bank loan. But, you don’t need me to tell you that, all you have to do is go online and you will receive the depressing news for yourself. Here is what the International Franchise Association said in its January 2010 Franchising World trade magazine:
“Half of franchise business leaders cite access to credit as top concern.”
“A $3.4 billion shortfall in lending to franchise businesses in 2010 will result in 134,000 jobs not created and $13.9 billion in economic output lost, according to new data released in December by the International Franchise Association. Our data show that while there will be sufficient capital for franchise development in 2010, banks’ continued risk aversion is limiting their willingness to lend,” said IFA President and CEO Matthew Shay. “A slow recovery with limited job growth underscores the importance of protecting and encouraging lending to small businesses, which account for 60 percent of all U.S. jobs. Immediately passing enhancements to government lending programs can shore up the $3.4 billion shortfall in lending. New franchise businesses can create much needed jobs, which will speed the U.S. economic recovery.”
Now, I realize that we all are starting to read upbeat articles online and in the newspapers, but as a person who deals with franchise candidates seeking financing on a daily basis I can tell you that nothing has changed since October 2008. I work with franchise candidates who have 780 FICO credit scores and have equity in their homes, and they still cannot get a bank loan with or without an SBA-backed guarantee.
Here is an actual example of a candidate who was interested in purchasing an LA BOXING gym franchise. She and her husband live in a western state and own a very successful wood floor installation business that they started 7 years ago. She completed an LA BOXING franchise application and was approved by the company. She told me that she knew the president of the local bank and that procuring a loan to purchase the franchise would be a “slam dunk.” The short version of the story is that the bank and SBA declined her loan because she did not have experience in the “gym business.” It didn’t make any difference that she operated a profitable flooring business, met a payroll every week for over 10 employees, and would have a successful franchise company that would provide a total turnkey franchise to her with training and ongoing support. How successful is her flooring business? It produces a net profit after all expenses of over $15,000 per month and she and her husband have equity in their home. Here is a successful businesswoman who loves to exercise and wants to get into the health and fitness business and can’t get a loan because of her bank’s continued risk aversion policies.
What I don’t understand is, the banks received billions in the bailout from TARP, so why can’t a bank make a loan to a person who has business experience, a good credit score and equity in her home? I’m not suggesting that banks revert back to the ridiculously loose lending practices that caused the financial crises, but isn’t there some middle ground that can be achieved so as to allow credit-worthy small businesses to obtain funds to operate profitably and help create new jobs?
So, what is the solution for anyone interested in purchasing a franchise today and doesn’t have, say, $200,000 liquid? I can tell you that most of the franchises I am selling involve financing from friends and relatives or taking in a money-partner. But even friends and relatives want assurance that loans will be repaid and partners are going to expect equity in your business and a portion of net profits. You will need to prepare a business plan and first assure yourself that the franchise you purchase has a reasonably good chance for success before you approach investors. Most of the information that you incorporate into you plan will come from the franchise company and speaking to some of their franchisees.
And finally, the current economic climate will absolutely change in the future and banks will certainly begin to make loans again; the problem is that no one has a crystal ball so we don’t know exactly when that will happen.
If you have tried to purchase a franchise in the last 18 months, you know that it is almost impossible to obtain a bank loan. But, you don’t need me to tell you that, all you have to do is go online and you will receive the depressing news for yourself. Here is what the International Franchise Association said in its January 2010 Franchising World trade magazine:
“Half of franchise business leaders cite access to credit as top concern.”
“A $3.4 billion shortfall in lending to franchise businesses in 2010 will result in 134,000 jobs not created and $13.9 billion in economic output lost, according to new data released in December by the International Franchise Association. Our data show that while there will be sufficient capital for franchise development in 2010, banks’ continued risk aversion is limiting their willingness to lend,” said IFA President and CEO Matthew Shay. “A slow recovery with limited job growth underscores the importance of protecting and encouraging lending to small businesses, which account for 60 percent of all U.S. jobs. Immediately passing enhancements to government lending programs can shore up the $3.4 billion shortfall in lending. New franchise businesses can create much needed jobs, which will speed the U.S. economic recovery.”
Now, I realize that we all are starting to read upbeat articles online and in the newspapers, but as a person who deals with franchise candidates seeking financing on a daily basis I can tell you that nothing has changed since October 2008. I work with franchise candidates who have 780 FICO credit scores and have equity in their homes, and they still cannot get a bank loan with or without an SBA-backed guarantee.
Here is an actual example of a candidate who was interested in purchasing an LA BOXING gym franchise. She and her husband live in a western state and own a very successful wood floor installation business that they started 7 years ago. She completed an LA BOXING franchise application and was approved by the company. She told me that she knew the president of the local bank and that procuring a loan to purchase the franchise would be a “slam dunk.” The short version of the story is that the bank and SBA declined her loan because she did not have experience in the “gym business.” It didn’t make any difference that she operated a profitable flooring business, met a payroll every week for over 10 employees, and would have a successful franchise company that would provide a total turnkey franchise to her with training and ongoing support. How successful is her flooring business? It produces a net profit after all expenses of over $15,000 per month and she and her husband have equity in their home. Here is a successful businesswoman who loves to exercise and wants to get into the health and fitness business and can’t get a loan because of her bank’s continued risk aversion policies.
What I don’t understand is, the banks received billions in the bailout from TARP, so why can’t a bank make a loan to a person who has business experience, a good credit score and equity in her home? I’m not suggesting that banks revert back to the ridiculously loose lending practices that caused the financial crises, but isn’t there some middle ground that can be achieved so as to allow credit-worthy small businesses to obtain funds to operate profitably and help create new jobs?
So, what is the solution for anyone interested in purchasing a franchise today and doesn’t have, say, $200,000 liquid? I can tell you that most of the franchises I am selling involve financing from friends and relatives or taking in a money-partner. But even friends and relatives want assurance that loans will be repaid and partners are going to expect equity in your business and a portion of net profits. You will need to prepare a business plan and first assure yourself that the franchise you purchase has a reasonably good chance for success before you approach investors. Most of the information that you incorporate into you plan will come from the franchise company and speaking to some of their franchisees.
And finally, the current economic climate will absolutely change in the future and banks will certainly begin to make loans again; the problem is that no one has a crystal ball so we don’t know exactly when that will happen.
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