Franchising as a Business Growth Model
Franchising has been used since the Middle Ages; however, it was until after the Second World War that it became widely acceptable in the USA. For this reason, the USA is considered the cradle of the franchising business model (Stanworth et al. 2014)). Some of the first franchises in the USA include Coca-Cola, Singer, and McDonald’s which started as small businesses but used franchising to rapidly become multinationals (Bellin 2016). The successes of these firms propelled franchising into becoming a preferred strategy for accelerated business growth. According to Varotto and Silva (2017) franchising is a form of business where a reputable firm, also known as a franchisor, grants licenses to third party businesses known as franchisees to use its brand name, technology, procedures, and intellectual property. As much as this business model has been lauded for its ability to facilitate business growth, especially for small businesses, it has its disadvantages. It is upon this basis that this essay critically assesses the pros and cons of franchising as a growth strategy for small businesses. The paper further outlines possible tensions between a franchisee and a franchisor and elaborates how they can be resolved.
Critical Analysis of Franchising as a Growth Strategy
Franchising is a suitable model for small businesses wanting to grow without investing a lot of capital into their growth process. Such businesses might decide to go through the rigorous process of setting up a franchise after which, they license their intellectual property to other companies. Small businesses that become franchisors create advantages such as havng a continuous revenue stream. Stanworth et al. (2014) explain that franchsors charge royalties and monthly or annual fees on companies that use its trademark (Bellin 2016). Additionally, the nature of the franchise agreement could be adjusted so that the other businesses purchase supplies from the franchisor. As a result, the small business using this model creates an added source of revenue. Nowak (2020) further elaborates that some agreements require annual renewal which increases the revenue collected by the small business. For example, when McDonald’s began operations as a small business, it optimized its revenues using franchising. Today, franchisees pay $45,000 to use the McDonalds name and trademark. (Nowak, 2020). Using this business model, McDonald’s reported revenue of $9.2 billion from franchised locations in 2014.
Secondly, small businesses who use franchising as a growth strategy realize the advantage of rapid internationalization and brand development. Stanworth et al. (2014) report that expanding to new markets is capital intensive and unaffordable to most start-ups and small businesses. Thus, an entrepreneur could opt to use franchisees to reach new markets rather than borrowing funds to finance business expansion. In the process, the brand gains international recognition and acceptance, which in return, heightens its brand equity and brand value. Li and Xia (2019) add that brand value is further boosted as the franchisor adopts local, regional, and international marketing and advertising to enhance the brand’s visibility. The result mostly is a seamless and cost-effective global growth and brand development, where the franchisor eliminates expansion costs and risks. This advantage is illustrated in the case of Coca-Cola, which has used the franchising model since 1889. The company’s growth was initially confined to the USA; however, with this business model, Coca-Cola internationalized quickly and strengthened its reputation as an international brand (Prestige Franchising, 2020). Today, it has more than 275 franchises around the world.
There are several disadvantages of the franchising model to the franchisors. The franchise business model is founded on stringent legal regulations which could be expensive and unaffordable for small businesses. Rosado-Serrano, Paul and Dikova (2018) explain that franchising is a regulated business activity that requires adherence to state and federal franchise laws. Therefore, organizations that want to run a successful franchise are required to pay for experienced franchise lawyers to help them draft binding blueprints to guide the franchising agreements. The second disadvantage is that franchisors have to always worry about maintaining the reputation of the brand. Since the small business licenses franchisees to use its name and trademark, any misconduct in one branch could result in a negative reputation for the whole company. For instance, if a customer who has a bad experience with employees at one of the Costa Coffee branches in the UK might use electronic word of mouth to convince other users to boycott the franchise. The negative reputation of one coffee shop could potentially affect many other franchisees.
A small business acting as a franchisor is prone to losing its intellectual property (IP) to malicious franchisees, especially in emerging economies with weak regulations. Countries such as China have been criticized for weak enforcement of IP contracts, a trend that allows their local companies to imitate ideas from other companies. The weak enforcement of intellectual property in such countries makes it hard for the foreign franchisors to sue or take legal action against franchisors who breach the Franchise Disclosure Agreement (FDA) (Edward, 2011). For this reason, most franchisors opt for joint ventures in such countries as opposed to franchises. An example is when a Chinese firm violated the Starbucks trademark by duplicating its logo and name. As much as Starbucks won the case in 2006, it is notable that the enforcement of IP laws is discriminative in some countries, and this discourages franchisors. Aliouche (2019) reports that instances of breach of IP are common in developing economies since most have weak regulations and their government could easily side with the local firms since they contribute to the economic growth of their countries.
On the other hand, franchising as a growth strategy presents advantages and disadvantages to the franchisee. The first advantage is that the franchisee joins an established brand (Li & Xia, 2019). The intensive competition across specific markets in the UK makes it hard for small businesses to thrive on their own. This is mostly the case when the small business lacks differentiated and innovative processes and products. The lack of a strong brand could impede small businesses from selling and increasing their revenues. In such cases, the small business can opt to join an established brand that already attracts customers. As much as the franchisee will be paying some fees to the franchisor, the business will establish faster and make more returns in the long run. For instance, Tavern which is a German-based beer brewer uses its reputation as a trusted manufacturer of the SPATEN brand to license franchisees (Gitman, McDaniel, Shah, Reece, Koffel, Talsma & Hyatt, 2018). Since Germany customers prefer historical brands, small businesses prefer starting as franchises using the SPATEN brand to attract customers.
The second advantage derived by the franchisees is that they benefit from the established business systems set by the franchisors. Barringer (2012) states that franchise businesses are based on a tried-and-proven approach to operation. Owners of new businesses using the franchise model are trained on proven strategies to sales and even provided with support in all areas of the business. Therefore, using established procedures and systems reduces risks inherent in other start-ups. This point is illustrated with the case of Dominos Pizza where the company provides not only the standard methods for preparing its meals across all its pizzeria’s but also ensures that all the eateries have a familiar layout. The standardization, together with consultation, and training make it easy for new business owners to manage their businesses. Nowak (2020) adds that most of the franchises, including Dominos Pizza, Coca-Cola, and McDonald’s continue offering training and support to their franchisees. This strategy ensures the continued development of the business and knowledge sharing, which is vital in achieving wholesome business growth.
Franchisees could experience several disadvantages. Stokes and Wilson (2010) argue that small businesses that become franchisees encounter different types of cons when either setting up or conducting their business operations. One of the significant challenges facing small business franchisees using this business model is the lack of experience in managing a business of this nature. As illustrated by Sun and Lee (2016), small businesses are characterized by the absence of systems, lack of resources and the use of a distinctive approach to management. The authors add that small organization have many management issues mostly resulting from their firm’s life cycle. Besides, small businesses serve small market areas and have smaller teams of employees. Assuming that the owner of a small business opts for a franchise deal with a big brand, it becomes hard for them to manage the new business which is larger and more complex.
Secondly, franchisees might find themselves in a dilemma where consumer wants are different from the standard procedures set by the franchisor. In such a case, the franchise agreement might bind the business owner to produce specific products that do not align with consumer wants (Barringer, 2012). For instance, a tire manufacturer using the franchise model might need new tires for Sub-Saharan terrains. However, following a standard procedure for manufacturing tires for the European roads might disadvantage a franchisor based in countries with rough terrains. It might need intensive market research to ensure the brand adjust their value proposition to meet the needs of the local customers.
One of the prevailing tensions between the franchisor and franchisee is a conflict of interests. Such tensions arise from expectation gaps. Research by Cuddy (2020) showed that most franchisees have higher expectations than reality, especially during the pre-entry stages of joining the franchise system. Similarly, it is noted that the primary goal of the franchisor is to optimize market share and sustain an excellent reputation for their brand while franchisee worries more about profitability. These differences might create a conflict when either party feel taken for granted. For instance, the franchisee might opine that the franchisor is not supportive of their business. On the other hand, the franchisor might have the impression that the franchisee is not complying to their systems, standards, and procedures as per their agreements (Barringer, 2012). An example is Keller Toyota, where the franchisor decided to sell the dealership to Wheeler Autos without consulting Toyota. This source of tension can be resolved through proper documentation of the franchise agreement where the roles, responsibilities, and expectations of all the parties in the franchise deal are stipulated and outlined (Miller, 2016). By adequately describing the interests of each party, conflicts could be reduced.
The second source of tension is miscommunication between the parties in an agreement. Grossman (2020) highlight that in some cases, the franchisee might fail to read through the contract before signing. Conflicts arise when there is a miscommunication on the procedures and systems to be used by the franchisee. Such conflicts arose when an Australian Pizza Hut decided to charge $5 for its pizza’s contrary to the expected $14.50 (PizzaInn., 2020). By undercutting the price, the company underpaid its employee’s contrary to the agreement signed in the franchise agreement. The franchisor was forced to take damage control measures and oversee the payroll functions of the Pizza Hut franchises in Australia (Frazer, Weaven, Giddings & Grace, 2012). To resolve such tension, it is advisable that the franchisees read the agreements carefully and if possible, with the help of a lawyer to understand every clause (Brookes & Roper, 2011). The franchisor should also prepare the agreement using simple terms that can be understood by the franchisees to avoid such misunderstanding and miscommunication.
This essay acknowledges that franchising is a viable growth strategy for small firms. As much as this business model is usable, it has its advantages and disadvantages. The dynamics of using the model are varied depending on the perspective of the franchisor and the franchisee. For this reason, the benefits derived by the franchisor include creating a continuous revenue stream, rapid internationalization and brand development. The franchisor is predisposed to disadvantages such as high legal requirements estimated at £42,200 by BFA and possible breach of intellectual property in developing countries. From the franchisee’s viewpoint, franchise deals are advantageous since the new firm joins an established brand. Secondly, it benefits from using tried and proven business systems set by the franchisors. Franchisees face challenges such as lack of prior experience in managing a business and differences in business culture. The two likely conflicts between franchisee and franchisors are conflicting interests and miscommunication. These tensions can be solved by clearly outlining the responsibilities of each party and through careful structuring and reading of the franchise agreement.
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