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Opportunities in franchising.

Opportunities in Franchising

What do McDonald's, Texaco, H&R Block, Holiday Inn, Coca Cola, and 7 Eleven all have in common? Franchises. Like many other companies, they use franchising extensively as a means of expansion and growth. In 1983, more than 5 million people were employed in franchise outlets, or about 1 of every 20 workers. This article examines the nature of franchising, its pros and cons, patterns of growth, and outlook.

The Nature of Franchising

Franchising offers a way for established companies to expand their operations and increase their profits without assuming much additional risk. In exchange for helping people establish a business, the companies gain access to the financial resources of these small business owners. This allows the company to expand into more localities than it could on its own. As more outlets are created, the company profits from increased royalties as well as from increased sales of goods and services to the small business operator.

A franchise contract is a legal agreement between a company, known as the franchisor, and an individual or group, known as the franchisee. Basically, the franchisor sells the right to use the company's trademark, tradename, and even the format of the business to the franchisee in exchange for an initial fee and royalty payments (usually a set proportion of sales). Two types of franchise systems exist in the United States: Product or tradename franchising and business format franchising. When a business that is already operating becomes a franchise, it is called a conversion franchise.

Product or tradename franchising refers to a distribution system in which the franchisee is licensed to sell items manufactured by the franchisor. Some examples of this type of franchise are gasoline service stations, automotive dealers, and soft drink bottlers. This is the predominant form of franchising in the United States, accounting for over $312 billion in sales in 1983. As chart 1 demonstrates, however, sales volume has grown very slowly over the last decade, with resulting declines in the number of firms and employees.

Business format franchising is broader in scope than product or tradename franchising and usually includes a business format in addition to a product line or tradename. This format typically includes a marketing plan or strategy, a well-defined operating plan, and quality control.

Business format franchising accounts for most of the growth in franchising since 1970 and is the most familiar type to consumers. These franchises accounted for over $110 billion in sales in 1983. As chart 2 indicates, sales volume as well as the number of firms and employees grew rapidly over the 10-year period. This type of franchising includes restaurants; nonfood retailers, such as hardware stores; convenience stores; personal services like hair salons; and business aids and services, such as personnel agencies and tax preparation services.

The success of business format franchising has given rise in recent years to conversion franchising. This occurs when an independent company converts to a franchise operation. For example, a local real estate brokerage firm may decide to affiliate with a national company, such as Century 21, in order to break into a wider market or to maintain its competitive position.

From Franchising to Self-Employment

The appeal of franchising is that it enables people without previous business experience--a major source of small business failures--to become their own boss. By having access to the managerial and financial resources of a large organization, individuals can reduce many of the risks associated with establishing a new business. And these risks are considerable! The Small Business Administration estimates that 2 of every 3 new businesses fail within 5 years. In contrast, the International Trade Administration estimates that only 2 or 3 of every 100 business format franchises are terminated each year.

Franchising is a relatively safe way to become self-employed for several reasons. Franchises generally offer a proven business format, a way of selling goods and services that is likely to succeed in any area. Most franchisors also offer extensive training programs that range from how to keep the books to how to hire and fire personnel. Other services helpful to the newcomer may include site selection to insure maximum traffic, store design, and assistance in lease negotiations. Some franchisors even assist in arranging financing for the venture.

The franchisor continues to provide services to franchisees throughout the life of the franchise contract. Ongoing services vary among franchises, but typically include centralized purchasing to obtain quantity discounts and lower prices, quality control to ensure customers' satisfaction, market research to help meet customer preferences, advertising and promotion to expand the customer base, and refresher courses on various aspects of the venture. These services help the owner develop a clientele more quickly than an independent firm would.

Duties and Drawbacks

Regardless of the type of franchise, most franchises manage as well as own their business; thus, it is not surprising that they perform a wide variety of managerial tasks, ranging from keeping the books to supervision employees.

Occasionally, the franchise is owned by a group of investors and managed by a salaried employee; this practice is the exception rather than the rule, however, and is largely restricted to hotels and restaurants that have unusually large initial capital requirements.

The way franchisees spend their time differs by the industry in which they operate. In the restaurant industry, for example, an owner may spend his or her time supervising employees, maintaining records, ordering supplies, and even preparing food. This franchisee may work 60 to 70 hours a week. On the other hand, the owner of a personnel agency may spend the day interviewing prospective clients, talking to employers about job vacancies, and keeping the office running smoothly. This person is more likely than a restaurant owner to work a typical 40-hour week.

As these examples indicate, making the decision to franchise is not a matter to take lightly. A prospective franchisee --like any business owner-- should carefully assess his or her abilities, values, and finances before making a decision. The accompanying box lists some important steps to follow when considering a franchise.

Not surprisingly, the benefits of franchising have a cost. One of the biggest drawbacks is the inflexibility of the franchise contract. Franchisees are legally required to adhere closely to the operating manual and business format of the franchisor. Deviation from the standard policy can lead to the termination of the contract. Innovative people who like to conduct business in their own way may not be happy with the typical franchisee-franchisor relationship.

The biggest drawback to starting any business, however, is the capital requirement. It is widely believed that it costs more to establish a franchise outlet than to establish a comparable independent business. The Commerce Department's annual survey on business format franchising reveals that the average initial investment ranged from $7,000 to $750,000 in 1983. Table 1 summarizes these data for a wide variety of franchises. The least expensive ones generally are those providing business and personal services-- because relatively little equipment is required --while the most expensive, as one would expect, are hotels and restaurants.

The total investment in a franchise may encompass a wide variety of costs: An initial fee to establish the business, payments to the franchisor for leased equipment or real estate, and various fees for products and services. In addition, royalties are assessed on gross sales over the life of the contract.

Past Trends

Franchising's growth can be measured in any of three ways: By sales volume, employment, and the number of establishments. Table 2 summarizes these data for the period between 1973 and 1983.

During this period, sales volume increased throughout most segments of the industry. In terms of employment and the number of establishments, however, a different picture emerges. There has been a dramatic reduction in the number of product or tradename franchises, notably automobile dealers, gasoline service stations, and soft drink bottlers. The number of gasoline service stations declined as the shift to self-service boosted productivity. Moreover, sales of cars and soft drinks have become increasingly dominated by large firms that can be operated more efficiently.

Business format franchises, on the other hand, have thrived during this period. Growth in sales, employment, and the number of firms has been especially strong in restaurants; business aids and services; recreation, entertainment, and travel services; and in construction, home improvement, maintenance, and cleaning services. Business format franchises --especially restaurants and recreation, entertainment, and travel services --have benefited from rising disposable incomes, derived largely from the growing number of dual-income households. Furthermore, as disposable incomes increase, families are less likely to spend time on routine household chores such as cutting the grass or cleaning the carpet--benefiting franchised construction, home improvement, maintenance, and cleaning services.

Low capital requirements in conjunction with a growing recognition of the benefits of franchising spurred growth in business aids and services. For example, the number of franchised accounting services has grown as more and more accountants have seen the benefits of affiliation with a national firm--extensive advertising, customer recognition, and data processing services.

In recent years, growth has been especially strong in convenience stores and in hotels, motels, and campgrounds. The growth in the number of franchised convenience stores reflects the change in shopping habits as more and more women entered the labor force. Men began to do more shopping and are more likely than women to patronize convenience stores. Increased personal and business travel has contributed to the growth of hotels and motels.

Future Trends

The outlook for franchising depends in large measure on local economic conditions as well as wider acceptance by manufacturers, retailers, and service firms.

In recent years, business format franchising has profited by rising incomes and the large-scale entry of women into the labor force. These trends are expected to continue for the immediate future, and the growth in franchising can be expected to remain strong. Restaurants are expected to remain in the forefront of the franchise movement. Continued growth also is anticipated for security systems services, automotive maintenance and repair, video equipment and rental stores, travel agencies, home furnishings stores, maid services, and home repair services.

On the other hand, there is less certainty about the future prospects for product or tradename franchises. Some believe that the number of establishments will stabilize at 1983 levels, while others argue that the number of firms will continue to decline sharply.

In general, franchising has established itself as a viable marketing concept that is advantageous to both the franchisor and franchisee. Prospects seem favorable because an increasing number of firms are finding franchising to be an easy and relatively inexpensive way to expand, and franchisees benefit from their access to the financial and managerial resources of a larger firm.

As Mr. Andrew Kostecka of the Commerce Department summarizes, "Economic improvement, stable prices, a slower growing population, and increased competition for market share will turn many large corporations and managers to franchising.'

Table: 1. Average initial investment required for business format franchises in 1983

Table: 2. Percent change in sales volume, employment, and number of franchise establishments, 1973-83

Photo: Chart 1. Sales of product or tradename franchises grew slowly . . .

as the number of firms plummeted . . .

and employment declined.

Photo: Chart 2. Sales of business format franchises soared . . .

as the number of firms grew rapidly . . .

and employment more than doubled.
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Title Annotation:nature, pros and cons, patterns of growth, outlook
Author:Austin, William
Publication:Occupational Outlook Quarterly
Date:Sep 22, 1986
Previous Article:Matching yourself with the world of work.
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