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ALL ABOUT
FRANCHISING

by Simon Lord,
last updated 11/04/2014

Franchising is one of the most popular ways to go into business in New Zealand - but how does it work? Simon Lord provides a beginner's guide to franchising and answers some questions.

In the past twenty years, franchising has become one of the most popular ways of doing business in New Zealand. But what is franchising and how does it work? Is it a licence to print money for someone with a good idea? Is buying a franchise a safe way to go into business for yourself? Is franchising just pyramid selling under a different name? Is the franchisor the only person who makes money?

In the following, we hope to answer some of those questions and to help those who are considering buying a franchised business for the first time to understand how franchising works.

What is Franchising? 

The basic principle behind franchising is that the initial creator (the franchisor) develops a business format and an operating system which has some advantages over other existing businesses in the market. The franchisor then replicates or clones his or her business in other geographic areas by granting the right to another (the franchisee) to operate the same business system under the same name. This right is usually granted for a fixed term.

The franchisor gains his or her income from initial and ongoing fees paid by the franchisee. In return, he or she must provide a variety of services to encourage the continuing profitability and growth of the franchisee's business. The franchisee receives their income from marketing a desirable product or service under a desirable brand name.

This basic approach - which is called business format franchising has proved to be the most dynamic form of marketing and distribution in the world over the past sixty years. 

Other forms of business arrangements are also sometime referred to as 'franchises' these days - the term is now common in the sporting world, for example, and moviegoers will be familiar with all the talk about the latest film in the Lord of the Rings 'franchise'. However, it is business format franchising which concerns us here.

How does it work? 

Mention the word 'franchise' to most people, and one name will spring to their mind - McDonald's. That's not too surprising - with over 33,000 restaurants in over 110 countries world-wide, McDonald's is the world's best-known brand. In fact, the Golden Arches are recognised by more people world-wide than the Christian cross.

McDonald's didn't invent franchising, but in the 1950's and 60's they led the development of franchising as we know it today. Let us use them, then, as an example of how franchising works.

When you go into a McDonald's, you're not going into part of a huge company-owned chain - even if it looks similar and sells exactly the same products as every other McDonald's in the country (or the world). You're actually going into a small, local business. That may sound odd but it is absolutely true. Your local McDonald's is usually owned and operated by a local person who has their own company. That company's business is running a McDonald's franchise. 

What does this mean? Well, this person - the franchisee - has gone to the McDonald's Corporation and said 'I like the look of your restaurants, I believe I could run one profitably, will you please sell me the right to operate a McDonald's in Avondale?', or wherever it might be. McDonald's have taken a look at this man or woman, checked that they are the right sort of person, put them through all sorts of tests, confirmed that they can afford to set up the business, then said 'yes, we might consider letting you operate the McDonald's in your area.'

That person is then trained in all aspects of running a McDonald's business - not just making hamburgers but developing staff, managing cash-flow, and all the rest of it. If they pass the training, they are then given the chance to go ahead. 

This is where money comes in. The first thing that they will spend their money on is the franchise fee - buying the rights to use the McDonald's name above the door of their own restaurant and to use the McDonald's operating system inside.

The second thing that they will spend money on is setting up the restaurant. 

McDonald's will organise this, but all the bills will be paid by the franchisee - because it will be the franchisee's business. McDonald's aren't going to take the profits from the restaurant - the franchisee is.

But the third thing they will spend money on will be an ongoing fee - otherwise called a royalty - which is paid to the McDonald's Corporation regularly. This money pays for the continuing right to use the name, and includes an element of profit for the McDonald's Corporation. It also pays for the research and development costs of new products and packaging and, most importantly, it pays for the field support people - the technical advisors - who visit each restaurant regularly and help the franchisee to overcome any little problems with his or her staff, or equipment, or marketing or whatever.

The other important thing that this money is used for is maintaining standards. If you have spent money buying a franchise with the most famous name in the world, you want to make sure that everyone else who is using that name is treating it with as much respect as you do. You don't want them to have dirty floors or underweight burgers, because if they get a bad name then it's going to spread to you. 

There will also be an advertising fee - in most franchises, a set percentage of turnover - which is combined with the contributions of all the other franchisees to pay for the advertising which constantly appears on your TV screens.

So the person who buys a McDonald's franchise ends up in business for themselves, but with the advantages of the best-known name in the world, a system for running a restaurant that has been tried and tested in 33,000 other restaurants, and a system of support and back-up which should give them every chance of succeeding.

They make the profit from all the thousands of burgers, chips and drinks they sell every day, and in return they pay a small percentage to the McDonald's Corporation. From the sheer size of the operation, it's clearly a very successful deal for all concerned. In fact, such is the demand for McDonald's franchises that a new one opens somewhere in the world every six hours!

Applying The System 

The important thing about franchising is not that is has been incredibly successful for McDonald's, but that it can be applied to almost anything.

Franchising first became established in the fast food market, where operational speed and efficiency, buying power and brand strength made an enormous difference to the profitability of chains. However, it soon spread to retail operations, to the automotive after-care industry, and more recently to home and commercial services.

The franchise method has proved particularly effective in highly-focused niche markets such as car servicing (Touch Up Guys, Midas, Pit Stop), garden care and house cleaning (Green Acres, VIP, @ Your Request) and business support (Speedy Signs, Small Business Accounting, Fastway Couriers).

But how do you apply the lessons of the fast food industry to something so totally different as, say, lawnmowing? In a restaurant, you deliver a standard product to the customer in a set of totally-controlled circumstances. When you mow a lawn, you deliver a uniquely varied service to the customer in their own environment.

The secret to the success of both lies in the application of an operating system which must have, as said at the start of this article, some significant advantages over other existing businesses in the market.

Consider the duties of an independent lawnmowing operator. In the course of an average day he or she must answer the phone, visit potential clients, quote on new work, maintain equipment, arrange advertising, organise invoicing, organise the bookings, handle any queries, travel from job to job over a perhaps widely-spread area - oh, and mow lawns. Funnily enough, it is only for the last duty - mowing lawns - that he or she actually gets paid.

Now consider how a lawnmowing franchise can streamline that system. Phone calls, client visits and quoting are often handled by the franchisor. Equipment is selected by the franchisor and bought at favourable (bulk-buying) rates, and a maintenance schedule set out which has been proven to minimise break-downs. The franchisee is trained in the most time-efficient ways to carry out common activities, rather than having to learn through trial and error. Well-researched advertising is arranged centrally, the budget is increased by the contributions of all the other franchisees, and an 0800 service provided to increase customer response. Scheduling is arranged by the franchisor, and invoicing may be handled centrally. The concentrated marketing effort also increases the amount of work available in any one area, reducing travelling time.

The result is that the franchisee can spend more time actually mowing lawns - the money-making bit - than the independent contractor. In this case, the franchise system has enough significant advantages to work. 

Master Franchising

Another aspect of franchising, and one which has led to its sometimes being confused with multi-level marketing or pyramid selling, is what is called master franchising.

Master franchising is used where the franchisor, for reasons of geographical or operational efficiency, appoints an individual or company to carry out many of the tasks of the franchisor in another area. This ensures that they get the benefit of local knowledge without having to create a long management structure to support franchisees (something which both reduces efficiency and increases costs).

For example, an Australian company seeking to expand its business into New Zealand might sell a Master Franchise locally. In the case of Speedy Signs, the US franchisor appointed Auckland coupole Grant and Sarah Archibald as master franchisees for New Zealand. They have responsibility for recruiting franchisees in this country and provide ongoing training, support and advice to the franchisees once they begin work. In this case ,franchisees receive their initial training at the franchise headquarters in the US, but sometimes the master franchisor is also required to set up a separate training function in the new country

Franchisees pay their initial fee and ongoing royalties to the master franchisee, who in turn pays a proportion of these fees to the franchisor.

The master franchise approach is also used within countries. North Island franchisors will sometimes appoint a South Island master franchisee, and vice versa. This practice is particularly well-developed within home services franchises, where the duties of local advertising, quoting, training and providing local support are commonly carried out by a local master franchisee. When you consider that a home service franchise commonly has 200-300 franchisees (Green Acres has over 800), it is easy to see why this is necessary. 

However, there are several important differences between master franchising and any form of multi-level marketing. First, there is no ongoing chain of commissions. There is a franchisor, a master franchisee and the ultimate franchisee - no more. The role of the franchisee is to deliver the product or service successfully and profitably, not to recruit additional franchisees.

In addition, the franchisee will usually have a defined territory, and no other franchisee will be permitted to operate within that territory. This ensures that both the master franchisee and the franchisor depend for their income upon assisting the franchisee to be as successful as possible, rather than upon appointing as many franchisees as possible in the hopes that one will be successful. 

Franchising In New Zealand 

Although franchising has existed in some form or another in New Zealand since at least the 1960's, it only really became established in New Zealand during the 1990's. Some of those early franchise names would still ring a bell, notably the Mr Whippy ice cream vans and the Wimpy hamburger bars.

The mid-1970's saw the arrival of McDonald's and other fast food brands, and that set the scene for the cautious exploring of franchising by New Zealand entrepreneurs in the 1980's. Companies such as Pit Stop, Stirling Sports and Rodney Wayne were in the vanguard of local franchise development at this time. Many other systems were imported, often from Australia where franchising was really taking off, and while some succeeded others proved to be either unsuited to the New Zealand market or under-developed.

The general perception of franchising was damaged by these failures, and in the early 1990's tests showed that including the word 'franchise' in an advert in the Business Opportunities column of newspapers actually reduced response by 50%. This low opinion of franchising was shared, with a few exceptions, by the legal and accounting professions and many of the banks. 

The situation was not helped by the actions of a few who touted franchising as a licence to print money and who encouraged retailers, restaurateurs and other business people to 'franchise' their businesses with insufficient preparation (and sometimes regardless of the true potential). Such people are, unfortunately, not unknown in franchising, which makes it essential that prospective franchisors select their advisors carefully. 

A further restraint to the growth of franchising may have been that, while Kiwis are generally keen on self-employment, we are as a breed self-reliant and were initially disinclined to pay money for a new business when we could copy the idea for ourselves without paying fees and royalties at all. It was only as competition increased and the value of brands, systems and training became apparent, that New Zealanders became more interested in the idea of buying a ready-made business format.

By the end of the 1990's, franchising had become an important, fast-growing and generally better understood part of the New Zealand economy. That growth has continued since, with mainstream media now reporting on franchises as part of regular business coverage and the listing on the stock exchange of groups owning franchised companies such as The Mad Butcher, BurgerFuel and Esquires.

In 2012, a survey showed that New Zealand has around 450 franchisors and 22.400 franchisees, making New Zealand the most franchised country in the world on a per capita basis. Franchises allow small business operators to compete with the large companies that would otherwide dominate our retail and service markets.

The Future 

In fact, today franchising has become established throughout much of the world, with the fastest growth occurring in Asia, South America and the Middle East. Although in many cases the growth was initially spurred by the entrance of the major US franchises into new markets, the result has been that local entrepreneurs have rapidly caught on to the potential offered by the franchise method.

For example, while the first major franchises in New Zealand may have been the US chains, around 70% of franchises offered for sale in New Zealand are now locally-developed. In addition, many local companies have taken advantage of the opportunities and experience provided by franchising to export not just their products (such as Lockwood) but their intellectual property - business systems such as that of Les Mills, whose Bodypump exercise programmes are franchised to over 70 countries.

One widely-quoted figure suggests that sales through franchised outlets now account for more than 50% of all retail sales in the US. While this figure is hard to substantiate, it is clear that the US still leads the field in terms of franchise maturity and that there is plenty of room for further growth in most other markets.

Perhaps the greatest indication of the value of franchising comes from those Asian governments which have recognised that inviting overseas franchises to enter their markets represents not a threat to their native cultures, but an opportunity to upskill their labour forces. Countries such as Malaysia, Singapore and the People's Republic of China have all started to promote franchising positively as a way of encouraging local people to acquire business skills by learning from successful systems. 

In Malaysia, for example, the government gives grants to new franchisors and loans to both franchisors and franchisees who qualify under their scheme. They recognise the high failure rate of most new business start-ups, and the significantly reduced risk of failure that comes from franchising.

Significant Advantages 

Franchising has also been recognised as offering significant advantages in three of the major areas identified by management gurus and future-watchers over the past twenty years.

The first of these is reduced management structures. A franchise organisation is, by its very nature, almost as flat as it is possible to be. The 'branches' are self-contained business units to the extent that the franchisee reports to no-one save himself - not even the managing director of the franchisor company. There may be a field support person who is responsible for contact with the franchisee, but that person does not control them. 

The second area in which franchising is well-placed is in being suited to what are now becoming known as 'knowledge-based businesses'. Franchising is a way of capitalising upon both intellectual property - brands, trademarks and proprietary products or services - and upon other assets such as business systems, methods and practices.

The ability to franchise such intellectual property offers enormous attractions to New Zealand companies, for whom geographical isolation need no longer be a barrier to successful exporting. The next KFC or Burger King could be created, grown and remain based in New Zealand just as easily as it could from the US (give or take some enthusiastic travelling). 

The third area in which franchising is ahead of the trend is in the development of what the researchers call 'Spider's Web' or 'Lattice' Organisations - dynamic networks of geographically-dispersed teams held together by common goals and operating systems. As Auckland University lecturer Leith Oliver once said, 'It's as if the business gurus have just discovered something that franchising people have known all along.'

Franchising is probably the most dynamic and efficient form of doing business that has yet been invented. What is certain is that it has not yet achieved its full potential either in New Zealand or world-wide. The result is that franchising still has a great deal to offer both the individual and the corporation.

Franchising Terms 

Franchising has its own jargon, which can be confusing at first. Following are some of the terms you will come across most often.

Franchisor - the owner of the business name, the trademark and goodwill, and the developer of the business system.

Franchisee - the party (individual or company) who is granted the right to use the franchisor's name and product/service. Some franchisors prefer to call franchisees 'franchise owners' or 'franchise partners'. For reasons of clarity, we always use the term 'franchisee' in Franchise New Zealand magazine and website.

Master Franchisee - a national or regional person or company granted the right to recruit, train and/or support individual franchisees within a set territory as part of a 'three tier' franchise system.

Franchise Fee - the upfront one-off payment made by the franchisee for the above rights. Cost varies according to the value of the opportunity and awareness of the business name.

Royalty - also called 'ongoing fee' or 'management service fee'. Paid by franchisee for support and ongoing services from franchisor. Occasionally a regular flat charge, but often expressed as a percentage of turnover (not profit). Percentage varies, but 4-10% reasonably common.

Advertising Fee - often required from all franchisees as a contribution to a consolidated advertising fund. Often expressed as a percentage of turnover. Sometimes split into national/group advertising and local promotion.

Franchise Agreement - legal document which sets out the precise terms and conditions under which a franchise is granted.

Disclosure Document - a document provided to an intending franchisee which contains information about the way in which the franchise operates, and sets out details of financial and legal obligations.

Manual Set - the manuals contain the 'blue-print' for the business which set out the correct procedures and standards to which the franchisee must adhere.

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