Role of Franchising in Business Growth
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CHAPTER ONE INTRODUCTION
Franchising has become one of the most recognizable business formats and an internationalization strategy for business practitioners globally and also in the United Kingdom especially in the way entrepreneurs are operating under other people's business concept. It has emerged over the years as a popular expansion strategy for a variety of product and service companies.
This research critically examines how franchising play vital role in retail business growth and expansion in the food industry, using the Strand Mc Donald's as a case study. The research looks at the importance of franchising, and will be very informative for organizations and stakeholders directly and indirectly involves in franchising business.
This chapter looks at the research background, organization background, the research problem, the aim and objectives of the study, the scope and limitations, brief introduction of the study area and the structure of the research.
Franchising is basically a specialized form of licensing in which the franchisor not only leases intangible property (normally a trademark) to the franchisee but also insists that the franchisee agree to abide by strict rules as to how it does business. The franchisor will often assist the franchisee to run the business on an ongoing basis, (Hill 2008.pp 408). It is similar to licensing, although franchising tends to involve longer term commitments than licensing.
Franchising is a method of distributing products or services. At least two levels of people are involved in a franchise agreement, namely: the Franchisor, who lends his trade mark or trade name and a business system; and the Franchisee, who pays a royalty and often an initial fee for the right to do business under the franchisor's name and system of operations, technically, the contract binding the two parties is the franchise. Franchising has emerged in recent years as a highly significant strategy for business growth, job creation, and economic development at both local and international retail business arena, (Hoffman& Prebble, 1995.p 80). It has moved from traditional product (trade mark) areas such as automobiles, petroleum and soft -drink bottlers to be a more proven format business concept.
Over 80% of Mc Donald restaurants worldwide are owned and operated by local businessmen and women. They adapted Ray Kroc's franchising business strategy of providing high standard of quality, friendly services, cleanliness and value, (QSCV). Also in the hotel industry, companies such as Marriott, Holiday Inn, Hilton and Accor have employed franchising as their primary growth strategy globally.
Of course, the most well known restaurant franchise in the worlds is McDonalds. So much has been written about Ray Kroc and the McDonalds' brothers that McDonalds and Crock have become an institution. The first McDonalds were opened in Des Plaines, Illinois, in 1955 and soon afterward, more McDonald's outlets continued to open. Today there are more than 30,000 McDonalds in 118 countries. There is no doubt that when it comes to franchising and fast foods in general, McDonalds is the leader of the pack. (Teixeira, 2005, p. 20).
The international franchise association estimates that American consumers spend approximately 1.3 trillion dollars on franchise goods and services on an annual basis. (Teixeira 2005, p.19). This shows that the franchise strategy is one of the important aspects in expanding business and economic development.
Different research methods will be used to analyze data/ findings for this research, and the sources of data will include observations and interviews.
This research therefore, focuses on the importance of franchising as a business growth and expansion strategy from both the franchisee and the franchisors perspective. It also examines the relationship that exists between the franchisee and the franchisor .The benefits of franchising to Mc Donald's (franchisors) in expanding its business globally and its international market position through leveraging its brand name and business process through the utilization of the capital and local management of its franchisees will also be examine in this research.
McDonald's Corporation (McDonald's) is one of the world's largest foodservice retailing chain. The company is known for its burgers and fries which it sells through more than 31,900 fast-food restaurants in over 100 countries. The company originated and operates mainly in the US and has expanded globally to over 100 countries including United Kingdom. It is headquartered in Oak Brook, Illinois and employs about 400,000people. The company recorded revenues of $23,522.4 million during fiscal year ending December 2008 (FY2008), an increase of 3.2% over FY2007. The operating profit of the company was $6,442.9 million during FY2008, an increase of 66.1% over FY2007. The net profit was $4,313.2 million in FY2008, an increase of 80.1% over FY2007. (McDonalds Corporation Company profile, (Data monitor) June 2009, p.16)
McDonald's restaurants offer a substantially uniform menu, although there might be geographic variations. In financial year 2008, the company operated more than 31,900 fast food restaurants in over 100 countries in the following geographic segments: the US; Europe; Asia Pacific, Middle East and Africa (APMEA); Latin America and Canada.
The company is one of the world's largest food service retailing chain, preparing and serving a range of foods. All McDonald's restaurants offer a standard menu, which comprise food items such as hamburgers, cheeseburgers, chicken sandwiches, Big Mac, Quarter Pounder with Cheese, Filet-O-Fish, Chicken McNuggets, French fries, salads, milk shakes, desserts and ice cream sundaes. Some McDonald's restaurants offer additional food items to suit local taste and preferences and sell a variety of other products during limited-time promotions. (McDonalds Corporation Company profile (Datamonitor), June 2009, p.5)
McDonald's generates revenues through company operated restaurants and franchisee restaurants where over 6,500 are operated by the company and over 25,400 are operated by franchisees and affiliates. The company's revenue comprises sales from company operated restaurants and fees as well as rent from franchisees and affiliates. Under the franchise arrangement, the franchisees invest in the equipment, signage, seating and decor, while the company owns or leases the land and building. Franchisees pay the company service fees and rent for premises. A service fee is set as a percentage of sales, while rent and other terms of occupancy are stipulated in the franchise agreement, which is drawn for a period of 20 years. (McDonalds Corporation Company profile, June 2009)
The company and its franchisees as well as affiliates source purchase food, packaging, equipment and other goods from approved suppliers. The company maintains quality standards through assurance laboratories around the world. A quality assurance board, including the company's technical, safety and supply chain specialists, provide guidance on all aspects of food quality and safety.
The major competitors of McDonald's include Starbucks corporations, Burger Kings Inc, Kentucky Fried Chicken (KFC), and other upcoming high streets food restaurants worldwide. (McDonalds Corporation Company profile, (Datamonitor) June 2009)
In October 1974, the company opened its 3000th restaurant and the first in the U.K in woolwich, south-east London, (Business franchise, 2009). The U.K headoffice was sited in Hampstead, North London.Web1 Also in 1986, the first U.K franchisee- operated restaurant opened in Hayes, Middlesex, (Business franchise,2009) and the first Drive-thru restaurants opened in U.K at fallowfield, Dudley, Neasden and Coventry. Web1
Research problem forms the basis of most academic research study. It is based on this that the aim, objectives and the research questions of most dissertations are formulated. There must be identified problems that the dissertation seems to tackle, mostly business problems.
Despite the popularity of franchising among business organizations and entrepreneurs nowadays as a business expansion and development strategy, it has been unacceptable to some entrepreneurs because of its disadvantages and risks involved. To these groups of individuals, setting up and management of owned business is the best option, no matter which forms it take to start. The assumption is that franchising is a system of building, expanding and adding value to someone else existing business, which many entrepreneurs will always avoid, as Norman(2006) indicated "Many conclude the time, effort, money and shift in emphasis from running a business to helping others run businesses is not right for their companies",(p3)
On the other side, some individuals choose franchising as their best option to start up business because of its merits and less risk involved in starting business. To these pro-franchising entrepreneurs, it plays a major role in business growth and expansion, especially in retail food industry globally.
This research, therefore critically examines these arguments and answer the question "how" is franchising vital to retail business growth and expansion according to the views of the pro- franchising business entrepreneurs.
SIGNIFICACE OF THE STUDY
Theoretically, a broad range of literature does exist on franchising concepts and in most instances, there seems to be gap between theory and practice in most business organizations. However, it is significant to find out the practicality of the literature in real life situations. It is essential therefore, to carry out this study in order to find out whether in reality the ideas provided by literatures are actually revolving around management issues and applied to business organizations.
The findings of this study will assist a wide range of stakeholders interested in franchising business including the government, private sectors, and local authorities to increase the general understanding and knowledge of franchising particularly in the food sector. To the researchers, academicians, it helps deepen further research in business development who will be interested in franchising in the future.
RESEARCH AIM AND OBJECTIVES
The main aim of this dissertation is to investigate how franchising play an essential role in retail business growth and expansion in the food industry.
In order to achieve the above stated aim, the following objectives will be specified:
- Analyze the impacts and importance of franchising (business format) on organizations (business) growth and expansion.
- Assess the benefits of franchised businesses on the socio-economic growth of the economy.
- To determine whether economic conditions affects the success of franchising as a strategy for business growth and expansion.
- Investigate the importance of the franchisee-franchisor relationship on the business growth and expansion.
- Examine the risks involved in the franchising relationship.
- Examine the effects/impacts of globalization on franchising as a business growth and expansion strategy.
- To make suggestions and recommendations based on the findings elicited by the study.
THE SCOPE OF THE STUDY
The study was carried out in London covering using one of the McDonald's restaurants as the study area. The content of the study was to understand how franchising contributes to business growth and expansion in retail business sector.
THE STUDY AREA
London is one of the cities of England; it is the capital city of England and the United Kingdom. It has 32 boroughs, of which 13 are in the inner London and 19 constitute the outer London. (Office for National Statistics Online). Web2cited.
It is a growing city spreading out and swallowing many villages and towns in the south east of England. Because of this, there are many conflicting definitions of London and Greater London and the population of London varies accordingly. As the capital city, London occupies over 6,267 square miles (16,043km2). London population is heavily concentrated at about 4,539 people per sq km/ 11,568 per sq mi. Web3
According to the figure from the April 2001 census, London population was 7,172,000. This represents 14.6 percent of the total population of Britain. The population as of mid 2005 was thought to have been increased to 7,517,700 of which about half of this figure lives in inner and central London and the remaining lives in outer boroughs. Web 3
London's population has grown every year since 1988, and it is likely that in the years to 2031, it will continue its steady growth. The study area lies in inner London borough of Westminster, which lies in the busy business environment of the city (central business district), It is very close to the seat of power, the parliament, and it is very close to many international business environments, busy London streets, tourist attractions like the London eye, Trafalgar square, British museum, National Gallery, National Art gallery, Covent Garden- since its redevelopment in the 1970's has become a popular piazza and nucleus for visitor activity in London's cultural district with theatre, opera and ballet venues. (Page et al, 2001.p122). London is a multicultural city, where different people from around the world lives and study, it comprises of individuals with diverse cultural background.
Because of the above description about the study area, it has become an important area to carry out this research, because of the concentration of other franchised business in the area.
STRUCTURE OF THE RESEARCH
Chapter One (Introduction): This state clearly the purpose of the dissertation, it includes the background of the study, significant of study, the statement of the research problems, organization background, the research aims and objectives, scope and limitations of the study. It also describes the study area briefly.
Chapter Two (Literature Review): This section deals with the academic review of texts, journals, articles and so on, relevant to this research topic. It also discusses model and relevant theoretical ideas on the subject matter.
Chapter Three (Research Methodology): comprises the methodology used for this study. It includes the styles and techniques chosen in collecting primary and secondary data/ informations for this research purpose.
Chapter Four (Data Analysis/ Research Findings): The chapter that report and describes the findings of the survey to be undertaken, it describes both primary and secondary findings.
Chapter Five (Conclusions and Recommendations): This chapter set out the main findings of the dissertations linking it with the literature reviews and the research findings. It also sets out clear recommendations which came out of the research work.
CHAPTER TWO LITERATURE REVIEW
This chapter provides a review of relevant literatures on franchising. It will be used as a base to throw more light on the importance of franchising concept and the roles it plays in business growth and expansion. The literatures were selected and critically evaluated in a bid to sift the relevant informations, and portray the opinions of relevant authors. It offers academic insight to research previously conducted by authors on the importance of franchising to retail business growth. Lastly, the section acknowledges the principal research questions for this study.
DEFINITIONS OF FRANCHISING CONCEPT
Hill, (2008) defines franchising "as a specialized form of licensing in which the franchisor not only sells the intangible property (normally a trademark) to the franchisee, but it also insists that the franchisee agree to abide by strict rules as to how it does business", (p.408). It usually involves long term commitments than licensing.
On the other hand, Business format franchising is a joint venture between an independent person (the franchisee) and a business owner (the franchisor) who wants to expand its activities. The venture is governed by a contract. This gives the franchisee the right to operate using the franchisors trade name/ trademark, in accordance with a business format or blueprint. All aspects of the franchisees business are strictly controlled including image, products or service, systems and administration. (HSBC Bank, 2009.p1)
The franchisee pays certain amount of money for the right to use the franchisors trademark.
Firms use franchise arrangements to extend scarce firm resources, because the franchisee puts up both an initial fee and much of the capital investment, franchisors are able to expand their markets without having to generate capital by themselves, and in most cases exploit on the knowledge of the local entrepreneurs in expanding their business. This is an attractive option, particularly in mass consumer services such as fast food that require the construction of many units to achieve brand name recognition and increased market share like McDonald's Restaurants.
BRIEF HISTORY AND DEVELOPMENT IN FRANCHISING
Franchising is highly developed in the USA, although popular in the UK, but a recent phenomenon. Its development dates back to the end of the American civil war (1865), when the singer sewing company franchised exclusive sales territories to financially independent operators. In 1898, General motors used independently owned businesses to increase its distribution outlet. (Lancaster &Reynolds, 2005, p160).At some point, there were some form of disagreements and arguments among historians in the United States regarding when the franchise system first started.
According to Bythe &Bennett,(2008), "franchising began to gain acceptance as a viable business arrangement with the growth of automobile industry, and also in the petroleum industry during the 1930's", (p.234)
Franchising became one of the fastest growing types of retailing business in the United Kingdom in recent years.It was introduced into the UK in the early 1950's and since those early days, has become respectable and often very profitable business concept as a result of explosion in the number of franchises being operated. Today franchising encompasses products from pipes to pastries and includes such well known names as Body Shop, Kentucky Fried Chicken, McDonalds, and so on. (Lancaster &Massingham, 1999, p269).
For instance, Over 80% of Mc Donald restaurants worldwide are owned and operated by local entrepreneurs. They adapted Ray Kroc's franchising business strategy of providing high standard of quality, friendly services, cleanliness and value, (QSCV). Also in the hotel industry, companies such as Marriott, Holiday Inn, Hilton and Accor have employed franchising as their primary growth strategy globally.
The first McDonalds were opened in Des Plaines, Illinois, in 1955 and soon afterward, more McDonald's outlets continued to open. Today, McDonalds has over 300,000 restaurants in 119 countries outside the U.S or in non-traditional site locations in the US. There is no doubt that when it comes to franchising and fast foods in general, McDonalds is the leader of the pack. Of course, the most well known restaurant franchise in the world today is McDonalds and so much has been written about Ray krok and the McDonalds' brothers that McDonalds and Crock have become an institution. (Teixeira, 2005. p.20-21).
Teixeira, (2005, p21), indicated that during 1960s and 1970s, the growth of franchise industry exploded and continued to gain appeal with a boom mostly in Europe, on an increased rate, and this has been supported also by welsh (1992) in Doole &Robin (2004) "franchising has grown rapidly during the 1990's due to the strong interest in a variety of franchise formats", (p.230). These successes remain an ongoing process.
According to Ghauri & Cateora (2005, p.280), franchising has become the fastest growing market entry strategy, it is often among the first types of foreign retail business to open in the emerging market economies of Eastern Europe, the former USSR, and China.
It has become successful as it is evidenced in most retail food business, and it has now become a major business growth and development and marketing strategy globally. It can be viewed from these two perspectives.
McDonalds is a good example of organization that has grown with franchising strategy, (Hill, 2008.p.408).
Franchising explosion in recent years however has increasingly saturated the domestic market, where businesses are opening in airports, sports stadiums, colleges, hospitals, parks, casinos, pools and other strategic locations globally. (Kotler &Keller, 2006.p508)
Lastly, the surge in franchising has been underpinned by the efforts of different bodies who regulates the activities of franchised organizations, like the International Franchise Association, (IFA), British Franchising Association, (BFA) various franchising organizations globally, which has developed codes of practice for franchising entrepreneurs, and in doing so, has recorded progress and greatly helped to reduce the risks to both franchisees and the franchisors. (BFA& NatWest Bank, 1991).
TYPES OF FRANCHISING
Monir (1999 pp.164) identified two major types of franchising in his book. These include:
- First Generation/Product Distribution Franchising simply sells the franchisor's products and is supplier-dealer relationships. In product distribution franchising, the franchisor licenses its trademark and logo to the franchisees but typically does not provide them with an entire system for running their business. This is often common with soft drink-bottling industries, automobile, and in petrol retailing.
- Second Generation/Business format franchising by contrast, the franchisor transfers a much more comprehensive business package (the format) to buyers of the franchisee. This contains most of the elements needed by the buyer to establish and replicate the business. The buyer also receives detailed instructions and guidance on how to operate the franchise successfully, managerial expertise, training and perhaps financial support if need be.
Diagram 1: Showing Two major types of franchising
There have been other divisions of franchising as recognized by other authors identified as important for the understanding of this research. Justis & Judd, (2007, p.56) identifies two major types of franchising namely: product and trade name and business format franchising. Nathan, (2008 p.54) also classifies business format franchising into six major groupings as follows: executive, job, investment, management, retail, sales and distribution franchise. Also, on the other hand, Murray (2006, p.23), identifies four major categories as, Job, Retail, Management and Investment Franchising.
Beshel (2001,p3), reiterated that because of the possibilities of so many franchisors, industries and range of investments, there exists different types of franchise arrangements available to business owner. Two types of franchise arrangements were identified:
- Single-Unit(direct) franchise
- Multi-Unit Franchise ( Area development and Master development franchise)
A single-unit (direct-unit) franchise is an agreement where the franchisor grants a franchisee the rights to open and operate one franchise unit. This is the simplest and most common type of franchise. It is possible, however, for a franchisee to purchase additional single-unit franchises once the original franchise unit begins to prosper, it is then considered a multiple, single-unit relationship.
A multi-unit franchise is an agreement where the franchisor grants a franchisee the rights to open and operate more than one unit. Beshel (2001, p3), also identifies two ways in which multi-unit franchise can be achieved:
- An area development franchise or
- A master franchise.
Under an area development franchise, a franchisee has the right to open more than one unit during a specific time, within a specified area. For instance, a franchisee may agree to open 5 units over a five year period in a specified territory, while master franchise agreement gives the franchisee more rights than an area development agreement. In addition to having the right and obligation to open and operate a certain number of units in a defined area, the master franchisee also has the right to sell franchises to other people within the territory, known as sub-franchises. Therefore, the master franchisee takes over many of the tasks, duties and benefits of the franchisor, such as providing support and training, as well as receiving fees and royalties, (Beshel, 2001, p3-4).
Blair & Lafontaine (2005, p.90) and Philip et al, (2006, p.77) also identifies the above four classifications as forms of franchising where all the four were grouped together.
Building a strong foundation for a successful franchising strategy
A successful franchising concept needs an appropriate business strategy and lots of facts have been identified as making a business appropriate to be franchised and make it worthwhile to invest in.
According to HSBC Bank, (2009, p1), a well established and proven business format franchise from the franchisee perspective should provide an established market for the franchisors products and services, proven sales, marketing and operational procedures, the benefit of an established business name, training (ongoing support and help in running the business), also, where appropriate, help in finding, fitting out and furnishing premises.
Hoffman & Prebble (2008, p.68) also add some factors that influence the appropriateness of a business concept using franchising including; valuable System to sell, proprietary process/ advantage for making the product in getting to the end customers, a satisfactory brand/ trade name like McDonalds which will be acceptable to the larger population, and high Profit Margin business.
On the other hand, Murray (2004,p.67), shows some possibilities in which potential franchisee get a proven business format and support from the franchisor, which includes, an entire business concept with no bits missing out, with the aid of the operating manuals, trademarks, logos, patents, and standard designs for the layout of the premises, colour and pattern of staff uniforms, accounting and financial systems, training and help to set up the business, continuing help and back-up once the business is operating, legal right to operate in an exclusive territory and marketing, public relations and advertising support, decor in case of retail franchises, the franchisor will provide design and advice for the fitting and decoration of the shop and the installation of any equipment necessary, records, the franchisor will provide the franchisee with sales report and accounts forms to assist the franchisee maintain accurate financial report.
On the franchisors perspectives, Sherman (2003, p414), explains that in order for business growth through franchising, a secure foundation from which company's franchising programme has to be launched. He uses the concept of the "responsible franchising" as the only way to avoid failure and to ensure a harmonious relationship with the franchisees. He outlines some of the key components of a responsible franchising strategy. These includes, proven prototype location/ chains of stores, strong management team, sufficient capitalization, distinctive and protected trade identity, comprehensive training programmes franchisees, proprietary and proven methods of operation and management, field support staff who are skilled trainers and communicators, set of comprehensive legal documents, demonstrated market demand for the company's products and services, set of carefully developed, uniform site selection criteria and architectural standards, genuine understanding of the competition, relationships with suppliers, lenders, real estate's developers, franchisee profile and screening system, an effective system of reporting and record-keeping, research and development capabilities, communication system, national, regional and local advertising, marketing and so on.
Sherman (2003, p.417), went further to acknowledge that "Responsible franchising starts with an understanding of the strategic essence of the franchising structure". He identified three critical components of the franchise systems from the franchisors perspective. The brand, which creates the demand, allowing the franchisee to initially obtain customers, the brand includes the company's trademarks and service marks, its trade dress, decor and all of the intangible factors that create customer loyalty and build brand equity, the operating system, which essentially delivers the promise, thereby allowing the franchisee to maintain customer relationships and build loyalty, the ongoing support and training that the franchisors provide, supplying the franchisee with the tools and tips to expand its customer base and build its market share.
Sherman, (2003,) also acknowledges the importance of customers in any responsible franchising business concept. He mentions that "the responsibly built franchise system is one that provides value to its franchisees by teaching them how to get and keep as many customers as possible who consume as many products and services as possible, as often as possible",(p.417).
He concludes that the focus must always be on the customer, where the franchisor essentially licenses and delegates the task of local brand building and market expansion to the franchisee in its local territory. (Sherman, 2003, p.417)
Importance of Franchising To Business Growth and Expansion
Franchising has gained much popularity in modern business environment over the years, because of its success in contributing to business growth and expansion globally which is the primary aim of this research. This can be viewed from the perspective of the franchisee and franchisor respectively.
Sherman (2003) acknowledges the growth of a business via business-format franchising in the United States. He maintains that "The ability to obtain operating efficiencies and economies of scale are among the reasons for franchising and one of the key components of a responsible franchising strategy is a proven type of location that will serve as a basis for a franchising strategy", (p.411).
Over the past three decades, franchising has emerged as a popular expansion strategy for a variety of product and service companies. Sherman,(2003), points to the importance of franchising, he states that "recent international franchise association (IFA) statistics demonstrates that retail sales from franchised outlets comprise nearly 50% of all retail sales in the U.S, estimated at more than $900 billion and employing some nine million people in 2000". (p.411)
Also in his view, Sherman,( 2003,p 411), points out to what has made franchising so popular in the U.S. and globally as a business development and expansion strategy, from the franchisors view, franchising represents an efficient method of rapid market penetration and product distribution, without the typical capital costs associated with internal expansion.On the other hand, from the franchisees perspective, franchising is regarded as a method of owning a business but with a less severe chance of failure due to the initial and ongoing training and support services offered by the franchisor.
According to Shay (2009, p.6) "franchising is the key to Global Economic Recovery and that franchise businesses represent some of the world's best brands". He went on to explain the rate at which franchise business are expanding globally.
"Franchise businesses around the world have seen steady growth in the past decade particularly in most emerging economies, and more often International Franchise Association members are eyeing overseas expansion as an important way to diversify their portfolios". (p.6)
HSBC (2009, p.1), identified some reasons why entrepreneurs (franchisee) will be willing to adopt franchising as a strategic business option instead of setting up owned business and the roles of franchising to business growth and expansion including, Proven Format, the franchisee enjoy the advantages of an established business, such as a tried and tested product /service, set of established operational guidelines and so on, trade name, particularly where a franchise operation is well established, customers will be familiar and comfortable with the product or service that are been offered, training and support, the franchisee is trained in all aspects of the operation including product knowledge, customer service standards, VAT returns, and any legal matters such as health and safety, advertising and promotional support, undertaken by the franchisor both locally and nationally, bulk purchase and negotiating Power, where the purchase usually come from the franchisor, where significant discount may be negotiated.
Aboud (2009) also acknowledges the importance of franchising in business development globally. He said that "Franchising is a business format that has no boundaries to success, anyone from any walk of life can become an entrepreneur and enter into a profitable business venture and the model is ideally suited to small and medium-sized enterprises. It encourages small business growth in every imaginable business sector and is a great catalyst for job creation, skills training and wealth creation", (Aboud, 2009).
In their views, Shook & Shook (2008, p.56), also indicated franchising is a small business development and a viable growth strategy for small firms. It is both a means of raising capital for small firm's development and of harnessing motivation and commitment. In most cases the problems experienced by franchisors are not franchise specific and many of the problems associated with small firm growth remain.
Norman, (2006, p.3) explains that as franchising has grown and succeeded for thousands of companies, thousands more have explored this avenue for growth globally. She also identifies some characteristics of a business where franchising can be regarded as growth vehicle. The business needs to prove its concept with a successful, profitable prototype store and office, the business must have systems for doing every aspect of the business, the business must be capable of being replicated in other markets, and the business should have a distinctive niche and brand to differentiate it from competitors. (Norman, 2006, p.3)
Finally, Aboud (2009), concludes "that small business that join a franchise, enjoy instant visibility in the market, better brand recognition, pooling of advertising and marketing resources and expertise to help improve the business operations and systems, therefore rather than re-inventing the wheel, they can ride on the success of the franchisor".
The Socio-Economic Impact of Franchising On the Economy
The importance and impact of franchising in economic growth and development globally is very important and it has contributed immensely to the vibrancy of many economies globally since its inception. Some of the impacts includes the capital flow due to the franchising activities in the economy, tax paid to government through franchising activities, the transaction activities, employment generation, and so on.
Aboud, (2009), throws more light on the socio-economic impact by concluding that "franchising is without doubt, the answer to unemployment and has proved worldwide to be the job creator of the future", and over the years, franchising has shown remarkable strengths in weathering the economic ups and downs and even in the face of the recent global slowdown, the franchise sectors has remained upbeat and a significant global force, (Aboud, 2009). The impact of franchising on the economic growth has gained much popularity by authors and this effect in most instances has always been positive. For instance, to explain the impacts of franchising on the economic development, Kotler &Keller (2006, p508), indicated that "franchising accounts for more than $1 trillion of annual U.S sales and nearly one third of all retail transactions". They went further to states that more than 320,000 small businesses are franchises; employing one in every 16 workers in the U.S. Franchising provides employment for more than 9 million Americans. This is the case in the U.K and most EU countries and other parts of the world where franchising is increasingly developing. According to a study conducted by PriceWaterhouseCoopers in the U.S, there were 767,483 establishments in franchise systems in the United States In 2001 which provided 9,797,117 direct jobs. (Teixeira, 2005, p19) Franchising plays an important role in providing employment to individuals without a higher education or specialized skills. It also provides first-time job seekers with an entry into the business world and provides the jobless individuals with an opportunity to supplement their purse. (Shook &Shook, 1993, p258).
In response to global economic downturn(economic recession), for instance in the United Kingdom, where most organizations were embarking on mass retrenchments, there has been high profile employment recorded in McDonalds restaurants and most retail sector in the economy, this according to record has assisted individuals out of job in getting back to employment.(Sky News, April,2009). In his article, Shay (2009,) reiterated that "franchising industry can create jobs, and increase the quality of goods and services to improve the quality of life on a faster schedule". (p.6)
This figure had always been increase yearly and this is the case globally. Because franchising is a business format that has no impediments and no boundaries to success, anyone from any walk of life can become a successful entrepreneur and enter into a profitable business venture.
Also, the recession has contributed positively to retail franchising globally, because of the reduction in individuals (customer's) disposable income, therefore customers now opt for low priced and cheap food globally. For instance, McDonald's announced sales increase in the year ended 2008 despite the economic instability.
In the final company financial revenue publication for the year ended 2008, the company recorded revenues has increased to $23,522.4 million, an increase of 3.2% over 2007. For FY2008, the US, the company's largest geographic market, accounted for 34.3% of the total revenues. The company identifies each segments based upon geographical regions of operations. The company generates revenues through four business segments: Europe (42.2% of the total revenues FY2008), the US (34.3%), APMEA (18.0%), and other countries and corporate (5.5%), (McDonalds Corporation Company profile, (Data monitor) June 2009, p.16)
Revenues by Geographic Business Segments
Europe accounted for 42.2% of the total revenues in FY2008. Revenues from Europe reached $9,922.9 million in 2008, an increase of 11.2% over 2007.
The US, McDonald's largest geographical market, accounted for 34.3% of the total revenues in FY2008. Revenues from the US reached $8,078.3 million in 2008, an increase of 2.2% over 2007. APMEA accounted for 18% of the total revenues in FY2008. Revenues from APMEA reached $4,230.8 million in 2008, an increase of 17.6% over 2007. Other countries and Corporate accounted for 5.5% of the total revenues in FY2008. Revenues from other countries and corporate reached $1,290.4 million in 2008, a decrease of 45.2% compared to 2007. (McDonalds Corporation Company profile, (Data monitor) June 2009, p.16)
The above analysis has shown evidence of the increased sales and success in franchising at McDonalds despite the recession, especially in the European countries, therefore supporting the contribution of franchising to the economic growth and stability of the operation's country's economy.
McDonald's involvement in community investment programmes focus on education, health, combating poverty, charity sponsorship etc, which varies according to local needs around the world. For instance, in the U.K, McDonalds has been sponsoring grassroots community football by sponsoring 4500 local clubs, training coaches, sponsoring the F.A community shield football and sponsorship of the Ronald McDonalds House of Charities in support of the families in the hospitals and homeless individuals and so on.
Because of the popularity in franchising nowadays, entrepreneurs prefers to adopt franchising because of less risks involved instead of embarking on individual business set up, and according to the literatures and observations, the largest franchise sectors are represented within the hospitality industry (food, restaurants, and lodging sectors). Hoy& Stanworth (2003), also argued``that "Business format franchising has been the primary driver of the extraordinary growth experienced in the restaurant, hotel and recreation sectors of the hospitality industry".
Aboud, (2009), maintains that franchising has yielded unprecedented results globally. For instance in the United States, which leads the field in franchising success, about 50% of all retail business is conducted by franchised networks. The U.S franchise industry has over $1.5 trillion in sales annually, while 80% of private businesses will eventually fail, less than 5% of the nations franchises fail yearly. He stressed further, that with more than 760,000 franchised businesses, a new franchise opens somewhere in the U.S in every 8 minutes, employing around 9.7 million people.
Aboud(2009), also takes a critical look at other economy outside the U.S that is really doing well with franchising sector, he indicated that, Canada is another economy that is doing great with the effect of franchising businesses, with 45% of its retail business in franchise sector, Australia has 26%, far east countries( Taiwan, Japan) with 12-13% figure. As franchising now becoming saturated in the developed world, the emerging markets including Far East, South America, Eastern Europe, Caribbean, and Africa is now becoming fertile grounds for franchising to take root. South Africa is currently accounting for an estimated 7% of franchised businesses in its economy, although it lags behind most countries, the economy proves that the potential for growth is unlimited in Africa, (Aboud, 2009).
Over the years, the developed nations have proven that franchising plays an essential role in the economic growth and development of most countries, this therefore, needs to be extended to the new emerging markets and new territories globally in order to sustain growth and increased turnover. Emerging markets therefore play a critical role in the global expansion of franchising, although facing some cultural problems, despite this contributing to the economic development.
The franchise business activities have added vibrancy to the local business scene of most global economies and their strong identity and high business efficiency have spurred many local entrepreneurs to adopt franchising as a strategic business option, thereby contributing to the business and economic growth. He therefore concludes that with franchising, entrepreneurs gain access to a proven business model and still enjoy the flexibility and freedom of being their own boss. And that "successful franchisors and franchisees have it all worked out". (Aboud, 2009). Aboud(2009), cited Trinidad and Tobago, and most developing economies are now recording high impact of franchised business, with KFC, Papa john's, Subway, Burger King, Beni Hanna, Ruby Tuesdays, Dominos, Church's Chicken and so on now dotting the business landscape of Trinidad and Tobago.
Franchising plays an important role in providing employment to individuals without a higher education or specialized skills. It also provides first-time job seekers with an entry into the business world and provides the elderly with an opportunity to supplement their retirement benefits, and jobless individuals with an opportunity to supplement their purse. (Shook & Shook, 1993, p258).
Finally, Shay, (2009), concludes that "international expansion of business format franchising is not only important for the continued growth of the franchising industry and the particular sector, but it is an important component of economic recovery globally".
Franchising As a Strategic and Mutual Relationship (Franchisee-Franchisor Relationship)
Strong Relationship is the key factor of any successful business who adopts franchising as a business option. This relationship is regarded as strategic and mutual between both parties, and the terms and conditions ensures both parties entering into a contractual relationship with each other, and it's classified as the key successful business growth which is usually long term.
According to Kotler &Keller, (2006, p.508) "Franchising is mutually beneficial to both the franchisor and the franchisee", and the relationship has been a major growth and success in most franchise business globally.
Kotler &Keller, (2006, p.508), explained some of the importance of mutual relationship in any franchised business, and stress that among the benefits reaped by franchisors includes the motivation and hard work of employees who are entrepreneurs rather than "hired hands", the franchisees familiarity with local communities and conditions, and the enormous purchasing power of the franchisor, and also, franchisees benefits from buying into a business with a well-known and accepted brand name. They find it easier to borrow money from financial institutions, and receive support in areas ranging from marketing and advertising to site selection and staffing and so on.
Although, franchisee do walk a line between been independent and loyal to the franchisor, but the independence can allow more flexibility. In most instances, maintaining a cordial franchisor- franchisee relationship play a major role in franchise system (business) growth and success.
Aboud,(2009), explains the concept of "sustainable franchising", as part of maintaining the relationship existing between the two involved parties( the franchisee and the franchisor).
"In order to ensure that the franchise concept is sustainable in the long run, franchisors should design and develop the business model with the end in mind, which is aim for the regional and global market, not just the domestic market. He indicated that having the end in mind will ensure that the systems put in place can be readily upscaled as the business expands".
As part of the mutual relationship, franchisors provide effective support in bulk purchasing, sales promotion, business management systems, advertising (including national), training and so on, to franchisees, as this is evidenced in McDonald's restaurants franchising globally.
Sherman (2003, p.419), also throws more light on the importance of the strategic relationship in franchising. He said that when an entrepreneur consider franchising as a growth strategy, it's always important to remember franchising is about the establishment and continuation of strategic relationships. Both parties are depending on each other for success, knowingly and voluntarily agreeing on a long term relationship. Franchising in this case, ensures both parties making a voluntary and bilateral decision to create a mutually beneficial relationship, with the aim of coming and working together for each other's benefit. In the long run, if the parties are to stay committed with each other, then they both must respect one another, stay loyal and each day search for ways to strengthen their bond. In most cases, it has been observed that most franchising relationships end up with the desired aim and objectives of coming together.
A good relationship between both parties is identified as been critical for the success of the whole system. Beshel (2001) concludes that "since franchising establishes a business relationship for years, the foundation must be carefully built by having clear understanding of the whole franchising system, therefore, there need to be a strong agreement between both parties" (p.7).
Also, there has been extension of the relationship to various franchising regulated bodies locally and globally like the International Franchising Associations (IFA), the British franchising association (BFA), and various local franchising bodies.
Shay (2009,p6), stressed that in helping members learn the fundamentals of franchise laws in foreign markets, the market potential of particular countries, and the actions needed to expand overseas and improving on the existing markets, IFA hosts several educational events, seminars for its registered members. And on the other hand, promote franchising as a proven method of economic development, IFA also participates in many franchise expositions and meetings globally. An example of this was the recent franchising seminar held in Birmingham, in November, 2009 organized by the British Franchising Association (BFA) where members visit IFA stand to ask questions and make enquiries. This promotes a very strong tie between the IFA and different franchisees and franchisors from different sectors globally.
Assessing Risk in Business Franchising
Franchising is widely seen as a business model and strategy. The consistent growths in the concepts over the past years have proof substantial that it can live up to its implied promise. However, this does not mean that every business venture labeled a franchise is automatically successful. (Cross, 2008 p.10).
According to Murray (2006), "Franchising has the capacity to ease new entrepreneurs into the world of business",(p.34). He maintains that the success of any franchise system depends on the following: the franchise must be built on solid foundations, the quality of the business mode must be beyond reproach, the network's support infrastructure must be fully developed, and the franchisee must be willing and able to follow the business model.
Despite its success as an international entry, marketing, business growth and expansion strategy, franchising is not without its problems/risks, and "like all investment decisions, there are business risks involved in franchising". (Aboud, 2009).
The risks in franchising are usually associated with both parties, although the degree of risk taken varies, where in most cases the risks faced by franchisors are not prominent as compared to that of the franchisees and therefore franchising is considered as "risk taken business option". The franchisee is mostly seen as the risk taker, where the franchisor only faces fewer risks in the whole relationship, as is the case with most McDonalds franchising.
Hill & Jones (2008, p.15), identifies some of these risks faced by entrepreneurs (franchisees) in adopting franchising. The royalty must be paid even if a loss is incurred which is often a percentage of the gross sales. The franchisor has the power to withdraw/cancelled the agreement if some provisions are not met. Oversaturation could occur if too many franchisees are located in one geographical region. Due to overzealous selling by some franchisors, franchisees potential income required managerial ability, and investment may be incorrectly stated. The franchisees may be locked into contracts requiring purchases from the franchisors or certain vendors, For example this is the case with most McDonald's franchisees worldwide.
HSBC (2009, p.3), also identified some possible risks faced by franchisees including, devaluation of trade name, for example a widespread outbreak of food poisoning is traced back to one of the outlets of a well known franchise, if this gains media attention, the particular outlet and all other franchises may suffer accordingly, failure of the franchisor may mean failure to the whole franchisees under the franchisor, this could create a major problem for the whole business, lack of Independence, and so on. On the other hand, some of the risks that may be incurred by franchisor includes careful examination and assessment of the potential franchisees, costs risks, proper monitoring and control the franchisees, not delivering sufficient support, business conflicts, selection of franchisees for wrong reasons and so on, whereby most of the risks are not prominent as compared to that of the franchisees.
The Franchise Agreement
Beshel (2001), p.1 describes franchising as the agreement or license between two legally independent parties which gives:
- A person or group of people (franchisee) the right to market a product or service using the trade mark or trade name of another business (franchisor).
- The franchisee the right to market a product or services using the operating methods of the franchisor.
- The franchisor the obligation to provide rights and support to franchisees.
A franchise agreement is a contract between two (legal) firms, the franchisor and the franchisee. (Rubin, 1978 p.224 in Stanworth &Hoy, 2003, p.22). It is the legal written documents that governs the relationship and specifies the terms of the franchise purchase and the agreement also enjoys a "cooling off" period.
A good relationship between both parties is identified as been critical for the success of the whole system as identified by Beshel (2001, p.7), that since franchising establishes a business relationship for years, the foundation must be carefully built by having clear understanding of the whole franchising system. Therefore there has to be a strong agreement between both parties.
Beshel (2001, p.3), identified two types of the agreement. The single unit and the multi-unit franchise agreement. She explains further, two ways in which the multi-unit franchise agreement can be achieved in any relationship. These include through an area development and a master franchising agreement.
The franchise agreement usually contains informations on the franchise systems, including the trademarks and products, the territory, rights and the obligations of both parties, procedures, training, assistance, advertising, terms of the franchise, payments arrangement, and the termination and or the right to transfer the franchise. (Beshel, 2001) p. 8.
Finally, Morrison, (1996) in Hoy &Stanworth, (2003, p.198) stated that " maintaining a harmonious franchisor- franchisee relationship is a major determinant of franchise system growth and success, while Justis et al( 1993) in Hoy &Stanworth, (2003, p.198) argues that this is one of the most difficult and frustrating challenges in franchising.
The Concept of Proprietary Advantage
Business entrepreneurs think of expanding their business scope when they have the opportunity to do so. Hymer (1976) in Shane (1996, p.76) argued that firms expand because they possess a proprietary advantage that makes them able to outcompete local entrepreneurs. In most cases, franchising to franchisor can be regarded as an example of proprietary advantage, where the business system is unique to the franchisor (Calvet, (1981) in Shane (1996 p, 76).
Proprietary advantage is an essential concept in any business using franchising model as an expansion strategy. Most companies with proprietary advantage have the opportunity to expand fast both locally and overseas, the advantage becomes useful in foreign markets at little or no marginal cost over the cost of developing the advantage in the domestic market.(Caves,(1971) in Shane (1996 p.76).
For instance, McDonalds Corporation uses this concept in their business franchise networks globally with the proven format system and other operational procedures unique to the company.
The concept of Franchisee Opportunism
One of the important dimensions of a franchisor's business system is the set of mechanisms developed to control franchisee opportunism. In a market setting, when business relationship is established between two independent parties, each entity has an incentive to act opportunistically. (Williamson, 1985 in Shane (1996, p76).
According to Shane (1996, p76), under such circumstances, the parties to the transaction need to invest in mechanisms to detect and prevent cheating. These mechanisms becomes part of the franchisors set of capabilities.
Shane (1996, p76), therefore states that "the mechanism for franchisee opportunism is greater in international transactions than purely domestic ones".
Globalization and Franchising (Diffusion of Franchise Systems)
Globalization refers "to the shift toward a more integrated and interdependent world economy", (Hill, 2005.p6). The globalization of markets refers to the merging of historically distinct and separate national markets into one huge global marketplace.
With increased globalization of markets, food and culture, international franchised opportunities have recorded lots of development and growth over the years. For instance, global economic integration as a result of lowering trade barriers in the European Community (EC), the passage of the North American Free Trade Agreement (NAFTA), and the reduction of entry barriers in many former communist countries like Russia, Central and Eastern Europe, are some of the reasons for this increased international franchised opportunities, (Hoffman &Prebble, 1995, p80). Mostly, these nations has been experiencing deregulation of industries at an accelerated basis, and because of these, many developed countries are experiencing trends that made it possible for rapid franchising success in their region (Ayling, (1988) and Chan & Justis,(1992) in Hoffman &Prebble,1995.p80).
The taste and preferences of consumers in different economies are now beginning to converge on some global norm, thereby increasing the emergence of the global market. McDonald's restaurants have been a benefactor of this trend and also facilitator by offering a standardized product worldwide. (Hill, 2005.p6 and Johnson et al, 2005, p69).
With globalization of market, expanding urbanization and a shift to service dominated economies globally, there has been increased demand for goods and services (food inclusive) globally, which has therefore responsible for increased in franchised businesses globally. This had led to increased homogeneity of consumer tastes in foods (fast-foods), and has encouraged the opening of McDonald's restaurants in almost all the countries of the world.
For instance McDonald's has aggressively pursued the strategy of geographical expansion through new restaurant openings. McDonald's has spent more than $2,000 million in FY2009,and about half of this amount were used to open about 1,000 new restaurants while rest were reinvested in existing restaurants globally. About 30% of these new units were open in affiliated and developmental licensed markets, such as Japan and Latin America, where the Company does not fund any capital expenditures.(McDonalds Corporation Company profile, (Data monitor) June 2009, p.19)
The success of franchisors in their home markets coupled with the small domestic market and also response to increased globalization, has caused local franchisors to internationalize their operations, and this has caused increased number of franchise businesses. Therefore, there has been increasing development of non U.S franchisors globally and now makes franchising business more popular, global and a fascinating venture.
Globalization also had a great impact on marketing, brand names, identities and advertising as identified in Johnson et al, 2005 p69. These further generate global demand and expectations from customers and provide marketing cost advantages for global operators. For instance, 90% of McDonald's restaurants use the same advertising concept and strategy for all their products either company operated and franchised and this has contributed to their success in gaining strong brand names and identities worldwide.
Furthermore, Hill, (2005) concludes "falling barriers to cross border trade have made it easier to sell internationally, thus greater uniformity replaces diversity in the world market through franchising",(p7)
International/ Global Franchise Network Expansion
Franchising has emerged in recent years as a business growth model, job creation economic development globally.(Hoffman &Prebble, 1991 in Hoffman &Prebble, 1995, p80).
International franchising is the foreign market entry mode that involves a relationship between the entrant the (franchisor) and a host country entity, in which the former transfers under contracts a business package (or format), which it has developed and owns, to the latter. The host country entity can either be a domestic franchisee, a master franchisor, a foreign franchisee and an entity that is partly owned by the franchisor himself. (Ngowi 2009, p.45)
There has been increase in global franchise business, and it has become a popular internationalization strategy adopted by entrepreneurs, mostly service firms. Usually, Franchisors grow by expanding the size of its franchise systems, and this expansion may take two forms namely through the establishment of additional company owned outlets or through the establishment of franchised outlets using the advantage of the local franchisee network. (Shane, 1996, p.74). On the other hand, entrepreneurs prefer to expand their business using franchising in geographically distant areas, and research has shown that franchisors prefer to grow by establishing geographically focused franchised systems, which may leads to geographic saturation, and then expanding to a new location. (Martin, 1988 in Shane 1996, p74).
Hacket(1976), and Aydin &Kacker(1990) in Shane (1996,p.75) and Duckett, (2008,p.58) argues that entrepreneurs will always choose to move international because of the expansion of their business overseas, desire to take advantage of foreign markets with great potential, reduction of costs, spreading of risks, growth saturation in domestic market and also to gain established brand name. Walker (1989) and Walker & Etzel (1973) in Shane (1996, p.75) on the other hand explained that international expansion occurs in response to inquiries of potential franchisees.
Global Expansion Problem
Global business environment possess much uncertainties than the domestic ones, and these uncertainties also affects franchising been international business strategy.
Morgan and Katsikeas (2007p, 76), identifies some barriers which normally discourage entrepreneurs from involving in international business including: insufficient pool of resource which create strategic obstacles, firm's cost base and margins which lead to operational obstacles, lack of fit between firm's strategy and its environment may result in limited knowledge of market opportunities creating information obstacles, and a firm may be unable to maintain necessary interactions with key parties because of limited resource leading to process-based obstacles.
Another major factor that affects international business expansion is the factor of the "country risks", which needs to be considered by a prospective entrepreneur before transacting an international business. Country risk involves those political, legal, economic and social conditions within country that cause an investment to be seriously impaired. Miller(1992) in Shane(1996 p76), states "the political, governmental, currency, cultural and macroeconomic differences across nations make international business more uncertain than business within countries and that currency misalignment, high rates of inflation, and transfer pricing make it difficult to measure performance across borders".
Another factor affecting franchising expansion is the monitoring of franchisees which pose serious difficulties in international business than domestic, it is expected that there would be a higher risk of franchisee opportunism in international business
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