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In a world in which business strategies
and management techniques are continually improving,
superior customer relations and outstanding supplier
relationships are critical. In many ways the fast food
franchise relationship is the definitive expression
of this principle. A franchisor and its fast food franchisees
jointly contribute to a supply system for products or
services focused on the customer. They obligate themselves
to each other under an agreement and endeavor to establish
a durable, long-term relationship that will impact virtually
every aspect of their respective businesses and protect
that supply system.
Few other business arrangements are so all-encompassing.
Unless a franchisor and its fast food franchisee deliver
to each other what they have promised, the supply system
to the customer will be compromised. World class fast
food franchise systems are easily recognized by the
mutual commitment of the franchisor and fast food franchisee
to their network and the resulting consistently high
level of customer approval of their products or services.
The more important elements of successful fast food
franchise relationships and networks are discussed below.
A Fast food franchise Relationship
Must Have An Effective Structure
Franchising is a contractual relationship. The franchisor
and the fast food franchisee each make commitments and
agree to operate under certain constraints. In the aggregate,
these commitments and constraints constitute the structure
of a fast food franchise relationship. That structure
must protect the franchisor and all fast food franchisees
of the fast food franchise network and afford opportunity
and security to the fast food franchisee. There are
a number of elements of the structure of a fast food
franchise relationship that are critical to its effectiveness
as the foundation for an expanding fast food franchise
network. The most important elements are discussed below.
1. Control of products and
services that fast food franchisees are permitted to
sell
Franchisors control the products and services that their
fast food franchisees are permitted to sell in order
to control the quality of the goods and services sold
by fast food franchisees (i.e., by limiting the scope
of the fast food franchised business to those products
and services that are within the scope of the franchisor's
expertise) and to preserve a uniform image (i.e., the
means by which a franchisor defines its business). It
is common for franchisors to permit some fast food franchisee
experimentation and variation because fast food franchisees
are an excellent source of innovation, regional variations
may be necessary and different customer bases may require
variations in product or service mix or different emphasis.
2. Control of operating assets,
goods and services utilized and sold by fast food franchisees
Franchisors control the sources from which their fast
food franchisees purchase operating assets (equipment,
fixtures, furnishings and signs) and goods and services
required to operate the fast food franchised business
for one or more of four basic reasons:
(a) to control the quality and
uniformity of the goods and services sold by the fast
food franchisee;
(b) to assure sources of high and uniform quality goods
at prices that are competitive with or lower than those
available from other sources;
(c) to protect confidential information; and
(d) to be a profit center for franchisor.
These are all legitimate reasons for controlling the
sources of supply utilized by fast food franchisees,
provided that the restrictions
(1) do not cause the costs incurred
by fast food franchisees to exceed what such costs would
be for comparable products absent such restrictions
(ideally, and in many fast food franchise networks,
supply restrictions are part of supply programs that
lower costs to fast food franchisees), or
(2) the extra cost is disclosed to fast food franchisees
(and is presumably considered to be part of the consideration
paid for the fast food franchise). Fast food franchise
disclosure laws do require disclosure of such restrictions
and the revenue that the franchisor derives as a result.
Antitrust law also regulates such restrictions, but
under prevailing interpretations, does not have a significant
impact on the types of restrictions that a franchisor
may impose. As a general proposition, franchisors should
limit source restrictions to those products and services
that are important to the development and operation
of the fast food franchised business and cannot be simply
specified by brand, model and/or grade.
A franchisor also can derive revenue from supply programs.
Franchisors evaluate the total revenue produced by a
fast food franchised business from
(1) royalties and service fees,
(2) advertising contributions or fees,
(3) sales of goods to the fast food franchisee,
(4) commissions paid by other suppliers and
(5) rental income from leasing real estate.
Most franchisors have more than one source of revenue
from each fast food franchised business. Some franchisors
rely primarily on fee revenue and other franchisors
rely primarily on the sale of goods to their fast food
franchisees. For a few franchisors, rent is a significant
source of revenue.
The aggregate revenue received from a fast food franchised
business must be sufficient to support essential franchisor
services that maintain system standards and keep the
network competitive, and to produce a profit for the
franchisor.
The aggregate of the revenue a franchisor derives from
a fast food franchised business must allow the fast
food franchisee to realize a sufficient rate of return
on its investment. Several fast food franchised networks
have reduced or eliminated royalties and advertising
contributions. Such networks rely on sale of products
to their fast food franchisees and the sale of services
at the fast food franchisee's option. If fast food franchisees
elect not to buy such services, the network's competitiveness
could be jeopardized. Such fast food franchised networks
also rely on advertising paid for by the franchisor
out of gross profit on sales of goods to its fast food
franchises and/or local advertising by fast food franchisees,
which may be partially supported by the franchisor.
This approach can be effective if the franchisor sells
to its fast food franchisees a proprietary product or
a product that it can sell competitively to them. A
franchisor might decide to reduce or eliminate royalty
and advertising fees in order to aid struggling fast
food franchisees and prevent a shrinkage of its product
distribution network.
When a franchisor relies primarily on product sales
to its fast food franchisees, its revenue base may be
less secure and competitors may target its fast food
franchised network, but it is less dependent on monitoring
its fast food franchisees to insure proper royalty calculation
and payment.
3. Control of the fast food
franchisee's business premises
Franchisors sometimes control the fast food franchisee's
business premises by leasing or subleasing the premises
to the fast food franchisee or requiring the fast food
franchisee to sign a collateral assignment to the franchisor
of the lease for his business premises. Control of the
fast food franchisee's business premises gives the franchisor
more effective control of the fast food franchisee and
his business. The premises continues to be part of the
franchisor's network even if the fast food franchisee
does not. However, such control increases the capital
requirements of the franchisor or involves contingent
liability and administrative effort and cost, unless
control is implemented by means of collateral lease
assignments. It is generally difficult to secure consent
to such assignments from regional malls and it may be
difficult to secure consent from any landlord without
at least some guaranty by the franchisor of the payment
of rent and common area maintenance charges for the
leased premises.
Control of the fast food franchisee's business premises
also confronts the franchisor with a potentially difficult
policy issue when the fast food franchise expires. If
the fast food franchise is not renewed, the automatic
transfer of the premises to the franchisor may transfer
the value of the fast food franchisee's business to
the franchisor. Such a fast food franchise would have
no residual value and a fast food franchisee that is
uncertain regarding renewal will be motivated to milk
every dollar he can out of his business in the later
years of the term of his fast food franchise, possibly
severely damaging the business. One possible solution
is a policy that enables a non-renewed fast food franchisee
to realize the location Goodwill of his business by
selling it to an approved successor fast food franchisee
during the last two or three years of the term of his
fast food franchise. The franchisor then grants a new
full term fast food franchise to the successor fast
food franchisee.
4. Grant of exclusive or protected
territories
Franchisors grant exclusive or protected territories
to their fast food franchisees to facilitate sales of
fast food franchises and to motivate effective market
development by the fast food franchisee who, theoretically,
will be more inclined to invest in the development of
his business if he has no same brand competition in
his territory. Franchisors should resist the temptation
to grant large exclusive or protected territories because
they may weaken the market penetration of its network
by leaving large areas unserviced or underserviced by
fast food franchises. Many franchisors have discovered
that they made inflated initial estimates of the population
base required for a successful fast food franchised
business (once their network trademark became more widely
recognized) and that large spaces between fast food
franchisees only invited competitors. Large territories
also may interfere with adjustment to changing markets
and inhibit the offering of additional fast food franchises
to productive fast food franchisees. A franchisor should
consider reserving from their grant of an exclusive
or protected territory the right to sell directly to
customers that buy for regional or national facilities,
to sell in other channels of distribution (e.g., mail
order sales, supermarkets and department stores) and
acquire, or be acquired by, a competitor with fast food
franchised or company-owned outlets in the protected
territories of its fast food franchisees.
Structuring the fast food franchise to enable the franchisor
to achieve greater market penetration by granting limited
territorial protection and reserving rights to sell
to some customers within the fast food franchisee's
territory will tend to result in more system expansion
conflicts with existing fast food franchisees. The franchisor
must be sensitive to these conflicts and develop internal
procedures to resolve as many as possible. Such procedures
may include participation by existing fast food franchisees
in expansion decisions and payment of compensation to
impacted fast food franchisees.
5. Control of the geographic
scope of the fast food franchisee's business
The corollary of the exclusive or protected territory,
a right granted to the fast food franchisee, is a restriction
on the area within which and the customers with whom
the fast food franchisee may conduct his business. If
fast food franchisees have the ability to sell outside
their immediate markets and are able to market and sell
in the territories of adjacent fast food franchisees,
restrictions on such marketing may be necessary to make
exclusive or protected territories meaningful. Franchisors
also impose such restrictions to force a fast food franchisee
to fully exploit his assigned territory and to maintain
the quality of the product or the service sold by the
fast food franchisee, (e.g., by restricting the distance
that a fast food franchisee may deliver perishable products).
Such restrictions frequently include a ban on mail and
telephone order sales and sales to dealers for resale
(in order to restrict the source of the franchisor's
product or service to fast food franchised outlets that
comply with format, appearance and service requirements).
Confining fast food franchisees to their specific markets
can result in troublesome enforcement problems for the
franchisor. The franchisor will be expected to enforce
the restriction against the invading fast food franchisee
(and may have a legal obligation to do so). The invading
fast food franchisee may be highly productive, have
effectively penetrated his own market and invade the
territory of the adjacent fast food franchisee primarily
because that territory has not been effectively penetrated.
Disciplining a productive fast food franchisee to aid
a lazy or ineffective fast food franchisee is not an
enviable task. Some competition among fast food franchisees
may be beneficial to the network.
6. Exclusive relationship
Franchisors typically prohibit their fast food franchises
from having investments in or performing services for
a competitive business. This prohibition is intended
to protect confidential information, maintain the franchisor's
revenue, prevent use by competitors of the franchisor's
know-how and focus the fast food franchisee's efforts
on his fast food franchised business.
Such prohibitions are sometimes limited to the fast
food franchisee's territory or a larger territory, but
frequently have no geographic limitation. Prohibited
competitive businesses may be defined narrowly (e.g.,
to include only a business primarily selling the same
type of product or service) or broadly, including related
types of business (e.g., all fast food service businesses).
Such prohibitions typically apply not only to the fast
food franchisee but also to its owners and members of
their immediate families. Such prohibitions are enforceable
under the laws of most states, but not necessarily as
broadly as they are sometimes drafted. Many franchisors
elect to prohibit both direct and remote competition
over a large geographic area, assuming that the prohibition
will be partially, if not fully, enforced. Such prohibitions
are a deterrent to the fast food franchisee, who risks
termination of his fast food franchise if he does not
comply.
For the fast food franchisee, a detailed breakdown of
his investment requirements, working capital needs,
operating income and expenses, and anticipated return
on investment should be developed. Unless the franchisor
makes what is referred to as an "earnings claim"
(which includes any statement of actual or projected
sales, costs or profits), these projections of operating
income and expenses and return on investment cannot
be provided to the fast food franchisee before the fast
food franchise is sold.
For the franchisor, a financial plan projecting four
years of anticipated growth in number of operating units,
fast food franchise fees, royalty income, expenses,
profits, and organizational requirements and costs must
be created. This plan is needed as an operating budget
to know initial funding and cash flow requirements.
The plan is also an aid for obtaining outside capital
and investment.
Part
I: Introduction to Franchising
Part
II: In What Ways Is Franchising A Superior Expansion
Method?
Part
III: When Is A Company Ready To Franchise?
Part
IV: Buying A Fast Food Franchise
Part
V: Elements Of Successful Franchising
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