Role of Franchising in Business Growth
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Published: Tue, 06 Feb 2018
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 fra
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