What is franchising?

The general concept

In simple terms it is the granting of certain rights by one Party (the franchisor) to another (the franchisee) in return for a sum of money. The franchisee then exercises those rights under the guidance of the franchisor.

The consumer's perception should be that, save for any express statement to the contrary, there is no difference between one of the franchisor's corporate outlets and a franchised one. The decor of the shop premises, the livery of vehicles, the selection of the goods or services and uniforms of the staff should be identical to the franchisor's own outlets. The franchisor is renting the franchisee the right to use its business format; hence the name 'business format franchising'. However that right to use the business format is for a limited period of time. The franchisee gains no interest in the actual ownership of the format or associated marks. The rights he enjoys are similar to those of a tenant when leasing a house. During the period of the lease the tenant has full enjoyment of the demise, but the day after the expiry of the lease he has no rights over the property at all.

The commercial bargain

In crude commercial terms the reason for both the franchisor and franchisee entering into a contractual relationship with each other is to make a profit. The franchisee makes a profit from supplying the goods or services to the customer. The franchisor makes it from allowing the franchisee to use its package of know-how and intellectual property rights. The bargain is struck between two independent legal entities of supposedly equal bargaining power. In reality however, the more successful and established the franchise becomes, the more eager the franchisee and the wider the choice of potential franchisees the franchisor enjoys. To obtain a McDonald's franchise for example is nowadays a major achievement.

In order to be able to strike a bargain both parties must have something to offer. The franchisor must have a proven business format comprising continually developing know-how and a package of intellectual property rights. The franchisee must have sufficient capital to invest in the franchise and be of appropriate character and ability. Without the requisite "assets" neither party can enter into the bargain.

Ironically however, as the franchisors' bargaining power grows with the growth of the franchise network so does the chance of the value of its package being eroded by existing franchisees or pirates. For example, the value of the Yum Yum Pizza franchise is the reputation it enjoys for producing a uniform quality product. If a franchisee starts to experiment on its own accord or a pirate sets up shop, the goodwill in the franchise will suffer and decrease in value accordingly. The franchisor must constantly police the franchise, ensure that its standards are carefully maintained and that pirates are swiftly dealt with.

The real beauty of franchising is its adaptability. There are a number of classic forms of franchising which are usually sufficient to meet most demands. However, there are always some situations that present new challenges. Franchising can usually be adapted to meet these.