Franchising

Franchising as a Business Method

Franchising as a business method works as follows. A franchise is a legal contract between the owner [Page 618]of a production process and a trademark (the franchisor, such as McDonald's) and a local businessman (franchisee) to sell products or services under the franchisor's trademark employing a production process developed by the franchisor. When a franchise contract is signed, the franchisee pays a lump sum, a franchise fee. After signing the contract, the franchisor gives the franchisee services needed to open the unit, including training and blueprints for the production process and, in some cases, support for site selection or construction management. The franchisee typically makes all necessary investments in land, building, and equipment to open the particular site.

After opening, the franchisor provides periodic inspection of the franchise (to ensure that operating standards are being followed), access to trademarks, and marketing services (such as advertising and new product development). In return for these services, the franchisee pays a royalty on sales (typically ranging between 1 percent and 10 percent) and a royalty for marketing expenses (from 0 percent to 6 percent), commonly called the advertising fee. The franchisor is compensated for the trademark and its management; generally, franchisees do not sell products of the franchisor (although exceptions exist). The franchise chain is composed of units franchised to local operators and units owned by the franchisor. Both types operate the same production process and sell under the same trademark, but most franchise chains are primarily composed of franchised units.

As an organizational form, franchising has a large and visible presence in consumer industries such as restaurants, lodging, auto repair, real estate, hair styling, and specialty retailing, where it has captured typically 30 percent to 40 percent of sales (Michael 1996). Business services where franchising is prominent include temporary employment, commercial cleaning, printing and copying, tax preparation, and accounting services. Recent areas of growth include home health care, business signage, and child development and education. Moreover, franchising's share of sales ranges from 71 percent of the printing and copying market to 0.5 percent of the accounting market. But the wide range of shares indicates the importance of industry-specific factors in the choice of organizational form. Product differentiation in these service and trading businesses is large, grounded in the physical dispersion and localized monopolies of units and in the heterogeneity of customers' tastes.

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