Franchising Model

Franchising Model to Stimulate Business and Economic Development in Developing Countries

Som Karamchetty [1]

Abstract:

            Governments in developing countries strive hard at creating jobs and growing their economies. But their success is limited as government managers lack the necessary motivation, which comes from ownership of businesses. At the same time, private sectors in these countries are not strong enough to make large investments needed for high economic growth. In this context, franchising model offers an attractive alternative. In order to launch franchising businesses, governments should start with policies and regulations and identify sectors where this model will yield strong returns to all stakeholders. Franchisors should develop business models and work with franchisees in developing and expanding those businesses. As the franchisees bring their own finances and supply dedicated local management, businesses will expand rapidly. Franchisees benefit from the direction and guidance from the franchisors. Consumers benefit from the products, services, and the quality of service characteristic of owner managed businesses. Ultimately, the whole country benefits from rapid growth of profitable, successful, and quality conscious businesses. In this article, I have indicated and recommended a number of business areas that benefit rural populations, which constitute a majority in developing countries.

Motivation for this Paper

In developing countries, private enterprise is neither financially strong nor mature enough to tackle the very complex problems of development. Consequently, development of large-scale projects rests with governments. Execution of projects is undertaken with public funds (collected via taxes or public bonds) or international aid. In general, government managers’ record of goal accomplishment is abysmal for they are neither owners nor beneficiaries of programs or businesses. As funds invested in development projects do not belong to them, such managers do not know the pain of losing investment. Similarly, as they do not receive the fruits of their labors, the joy of profit does not motivate them. Hence there is an urgent need to explore alternative business models to government owned, and operated businesses, usually called public sector undertakings (PSU). It is in this context that I recommend the examination of franchising business model, as this model appears to be well-suited for certain public sector undertakings identified later in this paper.

The total concept of franchising is least understood by most people. Generally, when we mention the term franchising, people’s preconceived notions surface. Those people who have some knowledge of franchising usually focus on aspects that franchisees deal with. In this paper, I will show that franchising is a good opportunity for franchisors to raise capital, to get a large team of people to manage the operations and to grow a company and contribute to national economy. The franchisees constitute a large and dedicated team of operators and local business owners. Franchising model encourages win-win partnerships and turns principal workers in local franchises into franchise owners, called franchisees. The model allows participants to apply their respective strengths in a cooperative pursuit. Participants reap benefits proportional to a combination of their efforts and financial investments.

I have given a detailed description of franchising in the Appendix. In the following sections, I describe the concepts briefly and show the relevance of the franchising business model to national development. I also suggest a number of types of businesses that may be good candidates for development as prototypes. But first I begin with a statement of the problem.

Current Situation and Problem

It is universally recognized that developing countries are in dire need of economic development. Unable to attract private investors into a number of businesses, governments undertake massive programs to create jobs and to increase production. Depending on the availability of natural resources, a variety of specific heavy industries are set up by governments. Such industries are usually located in one specific place and are unlikely to be suitable candidates for the franchising model. Let us eliminate these industries from our discussion. Then there are a number of other industries undertaken by governments. Prime examples of the later type are agricultural and rural resource-based industries and businesses, which are dispersed countrywide.

Regardless of the type of business and country, government management of development programs is ridden with problems.  Absent ownership stakes, and being employees, top-level managers are not highly motivated in running public sector undertakings. Managers of business operations down the chain also consider themselves mere employees and they lack motivation to perform exceptionally. Profit motive and business success are down the bottom of the list of goals of employees at all levels in these government enterprises. Public ownership is indeed nobody's ownership. Monitoring and control of operations in these large enterprises are remote, diffuse, lax, and consequently ineffective. Objectives of the enterprise and individual operators or workers are orthogonal. The final result of these factors is that enterprises incur huge losses and are encumbered by inefficiency and waste. Public funds are wasted and national economic goals remain unmet.

Stakeholder attitudes in government undertakings contribute to the situation mentioned in the previous paragraphs. Political leaders see government undertakings as sops for continued success in their own elections to public office, as opportunities to benefit relatives, friends, and followers, and lastly, as possibilities to benefit own constituents. At the next level, top managers of government undertakings consider the PSU's as comfortable and well paying high level jobs, opportunities to benefit relatives, friends, and acquaintances, and chance to gain influence in society. Down at the bottom, the workers in government undertakings see the PSU's as reasonably paying jobs requiring moderate effort, opportunities to gain pensions and health benefits. In such a composition of stakeholders, no one is concerned about profits and growth of the business. In the end, hapless taxpayers and consumers (the other stakeholders) pay the costs of inefficient government undertakings. Taxpayers have little recourse. In the absence of free and open markets, consumers have no choice but to pay high costs and tolerate poor quality products and services.

Approach to a Solution

     Franchising business model offers a solution, because in the franchising model, participants are owners of their franchises. The simple rule is that owners gain when their businesses succeed; owners fail if they neglect their businesses. Owners are responsive to customers as their businesses depend on loyal customers in a free market. Owners have neither a life time guarantee nor even a short time assurance of jobs. They have to keep businesses running efficiently in response to customer needs and market dictates. Franchising model is a cooperative enterprise that utilizes complementary skills of a franchisor and several franchisees, all owners.

Proposed Private and Public Partnership Franchise Model

The purpose of this paper is not to advocate the franchising model for the traditional (in the Western countries) types of businesses. Such businesses and models will take their own natural course. The plan here is to use the traditional franchising model for those businesses that need to be developed nationally in the developing countries. Since it is keenly interested in economic development and job creation in the country, the government of a developing country has a strong stake in encouraging the formation of franchisors and franchising businesses. Such encouragement may come in the form of models, loans, and grants to both franchisors and franchisees. Government laboratories and extension centers may assist franchises with technology transfer and ongoing product development expertise. In light of its regulatory responsibilities, government should develop necessary laws and regulations so that franchising businesses operate within a well-established legal framework. Guidance in this matter is readily available from laws and regulations in vogue in the Western countries.

People with different resources and knowledge capabilities would like to start businesses. In the area of agriculture small farmers may have the subject matter expertise but may lack business knowledge and other financial and technical resources needed for modern markets. It is also possible that people with financial and/or technical resources would like to enter a business but would like to receive subject matter knowledge and guidance. Owing to these reasons, government and business associations should develop an adapted franchising model that caters to the various types of entrepreneurs.
We have to develop a public sector franchise model so that the government gets out of being a business unless some extraordinary circumstances compel it to launch and operate a business. There are three key role players in this model: Government, Franchisors (high level managers), and Franchisees (local managers). Government enacts necessary legislation and develops regulations to promote franchising. It undertakes the development of generic franchising infrastructure and identifies specific product and service (business) needs and areas. It arranges finances in the form of loans, subsidies, and grants. Franchisors, or high level management, develop specific franchises (businesses), arrange capital, technology, manufacturing, and business method, and develop marketing, sales, supplies, and logistics. This group is the owners. Finally, franchisees, or local management, seek franchises, arrange capital for local units, receive franchising method, business knowledge, training, and skills, undertake production, run local businesses, and serve customers.

Each stakeholder in a Public Sector Franchise Model has specific set of incentives. Government is interested in economic development, production of desired goods and services, creation of jobs, and a good return on investment of tax payer advanced funds. High level management or franchisors have ownership stakes, lucrative returns commensurate with business success, and strong involvement. Local management or franchisees have ownership stakes in local franchises, incentive to work hard and smartly, economic returns directly related to success of franchise and gains of business knowledge, training, and skills. In the end, consumers gain from responsive and local business operators, and quality products and services. Figure 1 shows interactions between stakeholders in a generic franchising model.

Figure 1: Pictorial view of a Generic Model of a Public Sector Assisted Franchise.

Typical example candidates for the franchising model are presented in the list below.

• Agricultural farms
• Seed farms
• Animal farms
• Dairy farms
• Edible oil mills
• Water projects
• Sewerage infrastructures
• Horticulture farms
• Sericulture farms
• Aquaculture farms
• Cold storage houses
• Food processing plants
• Textile and clothing mills
• Handicrafts (e.g. Khadi & Village Industries Commission in India [2] [3]
• Arts, sports, and crafts establishments

Figure 2 presents a generic model for franchising and shows how various functions are shared between a government, a franchisor, and franchisees. Figures 3 to 10 show the model for some example candidate industries. {They also show the generic functions, which will be edited and expanded appropriately later on.}

Figure 2: Stakeholders and Their Roles in a Generic Franchising Model

Figure 3: Stakeholders and Their Roles in a Textiles and Garments Franchising Model.

Figure 4: Stakeholders and Their Roles in a Silk Garments Franchising Model.

Figure 5: Stakeholders and Their Roles in a Milk Products Franchising Model.

Figure 6: Stakeholders and Their Roles in a Leather Products Franchising Model.

Figure 7: Stakeholders and Their Roles in Oil and Gas Drilling Franchising Model.

Figure 8: Stakeholders and Their Roles in an Educational Franchising Model.

Figure 9: Stakeholders and Their Roles in a Sports, Athletics, and Games Franchising Model.

Figure 10: Stakeholders and Their Roles in a Fine Arts Franchising Model.

Conclusions and Recommendations

Franchise development can become a great alternative to the current practice of developing public sector undertakings and utilizing government employees to perform business functions. Franchisors, with initial government assistance and guidance, can become a strong economic force of the future for developing countries. Franchisees can produce and deliver a great variety of products and services to consumers in their countries.

In a developing country like India, with over 600,000 villages, franchising can make millions of people owners of their own businesses, albeit, franchises. Their combined buying power can bring in economies of scale, which cannot be realized if they operate individually. Once a production method or service method is developed, it can be replicated in the tens of thousands of franchises, contributing to cost savings, standardization, and quality of products and services. Such franchises will provide economies of scale as some activities and resources are obtained from a pooled level. With ownership deeply involved in the management of the franchises, their efficacy will improve.
With millions of owner-operated companies in operation, consumer care will get top billing. Millions of these franchise owners will gain self-esteem and psychological satisfaction in addition to financial rewards. Governments will accomplish economic growth at rates otherwise unattainable by conventional business models. There is likely to be all round gains.

I believe that there is a strong case to justify championship of the franchising model (duly adapted) by governments in developing countries for a number of industries. This model will assist them in improving and growing their economies.

Appendix

Detailed Description of Franchising [4, 5]

Franchising is a very specific business format or strategy for producing and/or distributing goods and services to satisfy customer needs and market demands. Franchising has been around in one form or another since the middle ages when local lords would grant the rights to certain individuals to hold markets, build roads, or hunt their land. Over several hundred years it has evolved from a simple right or privilege into the highly successful and sophisticated business format franchise model of today. The word franchise is an old French term meaning privilege or freedom. Franchising consists of a business model, a franchisor, and several franchisees. A franchisor develops a business model for a specific business, owns it, and licenses products, tools, advertising, and training to several franchisees. Each franchisee licenses and runs the business in a specific location. The business run by a franchisee is called a franchise. Its operation is governed by the terms of a franchise agreement.

For many local business people, the chief benefit of franchising is that they are able to capitalize on business format, trade name, and support system provided by the franchisor. Hence it is commonly stated, "Franchising allows people to go into business for themselves, not by themselves."

The dominant and most successful franchising concept is business format franchising with famous companies such as McDonald's [6] and Dunkin Donuts [7] (US Based companies) as leading examples. In this type of franchising, the franchisor makes a total transfer of a way of doing business, besides allowing the franchisee to use the name and sell the products or services of the Franchisor. This includes the transfer of marketing, operating, technical, training, and management methods and expertise developed and perfected by the franchisor. Any and all relevant information that may contribute to the success of the franchisee is transferred. In most cases the franchisor will also provide ongoing training and support throughout the life of the franchise agreement.

For example, the McDonald's Company trains its franchisees how to make various fast foods and supplies processing equipment. Manufacturing specifications and food and hygiene standards are rigorously laid out. The franchising agreements stipulate strict adherence to standards. The company continually carries out research into business methods, ingredients, recipes, supply chain, and restaurant lay outs. For the franchisees, all this knowledge is part of the package that comes with the license. For the consumers, the name implies and guarantees a certain level of quality and service. For the main company, viz., the franchisor, they do not have to invest funds to develop thousands of outlets. The franchisees fund their own local franchises. The franchisor benefits from the royalties paid by the thousands of franchisees. Part of the franchise fees and royalties is used by the main company to continue to refine the business model and product offerings to meet market demands and the ever changing customer tastes.

In a nutshell, franchising, more specifically business format franchising, is a strategic partnership or relationship that is governed by a contract or franchise agreement for a defined period of time between the franchisor and a franchisee. When a franchisee purchases a franchise he/she is investing in a proven and refined system that has a brand name, a successful operating system, and a history of quality service and success. The common goal for the franchisor and the franchisee is to dominate a particular market and keep customers coming back for more. All members (franchisees) of a particular franchise system share the responsibility of maintaining high standards of quality, consistency, convenience, and other factors that contribute to the success of building a dominant brand, loyal customers, and repeat business for everyone in the franchise. Thus, the franchisor and franchisee are partners with congruent objectives.

Franchising has a strong track record as seen by over 3,000 franchised businesses, covering nearly every conceivable industry, from well-known national brands like McDonald's, Holiday Inn, Mailboxes [8], down to smaller, local opportunities.

Next, I will describe some franchising details to emphasize the fact that franchising is a business commitment and not an itinerant vocation. [9] The first fact is that a franchisee is committed, as a franchise agreement is a binding contract, and can be quite restrictive. A franchisee is locked into certain business practices, fees, and even the look of the business. Once signed, if the franchisee does not agree, he or she has no recourse except to adhere to these guidelines. Therefore franchisees should be cautious in selecting a franchise. Government regulations and monitoring activities can play a useful and natural role in ensuring the fairness of the process.

A franchise model should project a good image ¾ it is important that the public has a positive image of the franchisor, since a franchisee is basing his or her business on the franchisor's reputation. A franchisee should look for a concept that can expand nationally so that the franchisee's business can grow locally. Integrity and commitment are the next important criteria. This will be evident when a franchisor spends a lot of time checking franchisees out. Such a thorough vetting process ensures all franchisees that the franchisor has strong requirements for all its franchisees, since their success is intertwined. The franchise should be in a successful industry in sectors that are growing.

A franchisor starts an industry and expands rapidly through licensing of franchises. The franchisor raises capital for the expansion by an initial up front fees. This up front fees is what a franchisee pays the franchisor for the rights to open a franchise. Essentially, a franchisee is purchasing the rights to use the franchisor's trademarks, business methods, and distribution rights. This licensing charge can be significant, especially for a well-known, established franchise ¾ it is not unusual for it to be in the tens of thousands of dollars (for US businesses). Often, it is also based on the value of the territory or trading area, so the larger the market, the more a franchisee will end up paying.

In some instances additional fees are charged to include items like training costs, start-up promotional fees, inventory, build-outs, equipment/fixtures, and other costs that are necessary to open a business. Franchisors require franchisee space to incorporate specific architectural elements, specific equipment and fixtures procured from the franchisor in order to maintain a quality image.

Franchisors also charge ongoing fees for a franchise to maintain the rights to the franchise. They charge a royalty fee, typically a percent of gross sales ¾ not profits. This royalty fee can range from 1 percent to as much as 15 percent, although 5 percent is typical. Some franchisors charge a regular fee (payable weekly, monthly or quarterly) in lieu of royalty payments. This type of fee may also be part of the mark-up charged for goods or services a franchisee is required to purchase. It is also common for franchises to pay a portion of the franchisor's local, regional and national advertising and promotional costs. These fees are usually put into a cooperative advertising fund that ultimately benefits all franchises through increased exposure to the trade name.

The ultimate success of a franchisee (individual franchise owner) is based on the proven success of the franchisor. If the franchisor offers a proven product or service with a well recognized brand name, a history of success with company units and existing franchises, is well financed and motivated, franchisee's chances of success are very high.

A list [10] of traditional franchise applications prevalent in the western countries is presented below.

• Small business center/postal service
• Ice cream and frozen yogurt
• Bakery, deli, and catering
• Dog/pet grooming
• Deli/restaurant or Coffee house
• Business consulting
• Auto transmission repairs
• Retail beauty products & services including salon and day spa
• Mobile blinds and window coverings
• Picture and art framing
• Home improvement & handyman repairs
• Upscale pizza & pasta restaurant
• Haircuts for men and boys
• Real estate investing
• Wireless/ mobile communications
• Residential home cleaning
• Dry cleaning
• Casual quick serve restaurant
• Residential homeowner services

            In some instances, a franchisor licenses a master franchise or a regional franchise. The owner of a master franchise gets rights to sell or license the franchises within that territory. Master franchising is the next best thing to coming up with the idea of a new franchise concept that explodes in an area with dozens of new units opening up. With master franchising one gets all the benefits mentioned above but without the expense of having to develop the concept from scratch. The master franchisee gets control of the successful franchise system in a specific geographic area, with a proven track record, and a brand name. Master franchising's main job is to act as a business consultant to franchisees and help them succeed in their own businesses. He or she will be associated with the elite brand name of the franchise as the main developer of an area even though it will be the franchisees investing their money. If a franchisor operates from a national headquarters, master franchisors can operate from each state or district head quarters and assist their local franchisees. In a country like India with many regional languages and geographic variations, master franchisors can become key links and interpreters.

Chief benefits of Franchising [11] over starting from scratch are reduced risk, strength in numbers, and a proven business process. Franchises traditionally have a much lower failure rate than other start-up businesses. Because a franchisee buys a business concept where most of the kinks have already been worked out by someone else. The guesswork usually associated with starting a business is taken care of. When one becomes a franchisee, he or she has the buying power of the entire network, which can help him or her get product and compete with larger national and global chains.

Many franchisors provide their franchisees with various proven systems including financial and accounting systems; ongoing training and support; research and development; sales and marketing assistance; planning and forecasting; inventory management; etc. They'll show the franchisees the techniques that have made the business successful and help them in utilizing those successful techniques. Some companies will help finance initial franchises. Franchisees also get site selection assistance, advertising, and promotion.

Franchising enables a company to establish a large number of business outlets in a relatively short time period leading to a rapid expansion of the distribution system. The capital and much of the work to locate and acquire sites and develop outlets is supplied by the franchisee. In most situations, a franchisor does not have the asset base or business experience to raise the amount of capital that will be furnished by its franchisees to expand the franchise network. Such a company might be able to raise additional capital periodically for expansion (as long as the great majority of its outlets were profitable), but its growth rate would be severely constrained. It is the unique opportunity offered by franchising, for an individual to own a business that is part of a network of similar businesses that motivates such individuals to offer substantial amounts of capital for the expansion of a franchise network. If good locations for outlets are not abundant and are being sought by competitors, rapid expansion of a network enhances its chances of acquiring good locations and thereby acquiring market share at a faster rate. Rapid expansion builds consumer recognition and understanding of the product or service sold by the franchise network and creates recognition and value of the network trademark and consumer expectation of uniform quality at network outlets.

Franchisees furnish most of the capital required to expand the franchisor's network. A franchisee furnishes equity and borrowed capital to pay for real estate, leasehold improvements, equipment, fixtures, furnishings, inventory and working capital required to establish the franchisee's outlet. In addition, the franchisee pays the franchisor a fee for the grant of the franchise that is usually set at a level that will cover most or all of the franchisor's cost of franchisee selection, training and pre-opening assistance. The franchisor's cost of expansion is usually limited to the overhead costs associated with franchisee recruitment, training and pre-opening assistance that is not covered by initial franchise fees. Continuing fees paid by franchisees will support advertising and marketing programs (which enhance recognition and goodwill of the franchisor's trademark), product and service development and expansion of the franchisor's network.

A franchising company is less vulnerable to cyclical fluctuations and outlet failures. Changes in fee revenue due to the fluctuation of sales of franchised outlets will be significantly less than fluctuations of profits at franchisor-owned outlets. A failing franchisee has a lesser financial impact than a failing company-owned outlet.

A franchising company can realize a higher return on its invested capital because the investment in the development of outlets is typically made by franchisees, A franchisor is able to operate with few fixed assets other than the outlets that it owns. Therefore, though its revenue from franchised outlets (composed of fees and product sales to franchisees) is substantially lower than it would be from owned outlets, a higher percentage of the revenue is profit and that profit is generated with a much lower capital investment.

Of course, franchising has its disadvantages or such perceptions. Lack of complete control, and initial costs are chief among them. This may be difficult for some people, especially those that are more entrepreneurial. This type of person may find it hard to conform to someone else's system. It can take a good deal of cash to open and operate a franchise. Just as a franchisor's reputation can benefit an individual business, the franchisor's problems are also the franchisee's problems. So if the parent company comes upon hard times, an individual franchise may also suffer because of how closely they are tied in.

Barring minor and occasional disadvantages discussed in the prior paragraph, franchising is a highly successful model. The benefits for the franchisors are capital for expansion and dedicated business people acing as local managers and work force. The country benefits because the burden of developing and running a national business is lifted off its shoulders and on to entrepreneurs who are ready to take risks, work hard, and gain immensely in the returns.

References:
[1] Som Karamchetty, PhD, somkdsr@verizon.net 

[2] http://www.kvic.org.in/v4/homepage.asp

[3] http://planningcommission.nic.in/plans/planrel/fiveyr/10th/volume2/v2_ch5_4.pdf

[4] http://www.azfranchises.com/whatisfranchising.htm

[5] http://www10.americanexpress.com/sif/cda/page/0,1641,5285,00.asp

[6] http://www.mcdonalds.com/corp/franchise.html

[7] http://www.dunkin-baskin-togos.com/html/home.asp

[8] http://www.mbe.com/wfo/index.html

[9] The information is gathered from the sources quoted in the footnotes of this article.  https://www.franchising.com/guides/the_franchise_agreement.html

[10] The following source gives an additional list of franchise opportunities: http://www.azfranchises.com/frachiselistalphabetical.htm

[11] Source: http://www.franchise.org/resourcectr/partII.asp

Note:

This was a paper developed in 2005-2007 and is now edited and enhanced a little for publication in this Blog.