The UK franchise sector has a turnover of £10.3bn, employs more than 364,000 people and is responsible for introducing approximately 3,000 new small businesses into the UK each year .
It is well known that brand and brand recognition are key to companies’ attempts to build up a customer base, but perhaps it is not fully appreciated just how these brands can be exploited to develop a business further. Some companies choose to exploit the value of their brands by entering into licensing arrangements with third parties. Virgin is one of the most diverse brands in the world, and an obvious example of how such licensing arrangements can work successfully – Virgin Brides, Virgin Wines and Virgin Atlantic all operate under the same umbrella brand but are run independently of each other.
Successful as simple licensing arrangements can be, many brand owners, particularly those operating in highly competitive retail sectors, wish to retain tighter control of their brand, and the quality and type of products or services and business formats associated with it. This is where franchising comes in – under this model of brand licensing, the brand can only be used by the licensee in respect of business formats that mirror very closely the formats established by the licensor.
In a franchise relationship, one party (the franchisor) licenses the other party (the franchisee) to carry on the business under a particular brand. Although each business outlet is traditionally owned and operated by independent franchisees, the franchisor retains control over the way in which products and services are marketed and sold, and controls the quality and standards of the franchised business.
As an example, Burger King is operated by third parties all around the world, but the uniform system of delivery means that from the perspective of a customer walking into a particular outlet, the brand is the same, the product is the same and way they are served is the same. It could be argued that the franchising model should not be attractive to companies who have developed and are now profiting from their existing owned and operated outlets. After all, why share the benefits of successful brand and business format with third parties or even potential competitors?
A number of reasons are outlined below, but perhaps the most important point is that franchising gives a retail enterprise the opportunity to increase the size of its business and value of its brand using outside resources.
The business is able to grow not only bigger (and take advantage of economies of scale), but also faster. For minimal (or possibly no additional) set up cost the franchisor can take advantage of the valuable local knowledge of the franchisee, watch the business grow and share in the profits by receiving a percentage of annual turnover. So for many in the retail sector, the franchise model might provide the perfect compromise between (a) expanding the owned and operated network of outlets which can be costly and high risk; and (b) appointing local distributors for the retailer’s products which is low risk from a capital expenditure perspective, but high risk from a loss of brand control perspective. In simple terms, the interplay of control v investment for various business models can be shown Who franchises and why?
The high street is packed with franchised outlets – from Snappy Snaps to McDonalds, and Threshers to Bang and Olufsen, but it is worth noting that each franchisor has their own reason for adopting a franchising model and may have done so at a very different point in their economic development. So for example:
Starting a new business – franchising can be a way to develop a network of outlets very early on in the life of a business, especially if the business idea is easily replicated (eg Snappy Snaps).
Developing an existing business – a business may have already expanded organically and want to expand further or into a slightly different market. For example, sandwich retailer Benjy’s has launched a ‘vanchise’ operation, Benjy’s Delivered. Franchisees receive a specially designed van to sell the chain’s sandwiches, hot snacks and coffees on designated routes.
Switching business model to franchising – Threshers is offering existing owned and managed outlet to franchisees across the UK.
International expansion – many companies use the franchise model to expand internationally. Indeed franchising seems particularly attractive in the international arena. When businesses expand outside their traditional geographic borders, a business model that puts a large degree of capital risk on to a third party is inevitably attractive. In addition, a local franchisee is likely to be better placed to play to local customer preferences and to understand local regulations and processes that have to be complied with. Finally, in countries where foreign business are severely restricted in the forms in which they can compete (such as India), franchised outlets may be the only way to lawfully extend a business and to build brand awareness in that jurisdiction.
Of course, it is important to be aware of possible obstacles to franchising:
- franchisors will inevitably have to divulge potentially valuable know-how and business methods to third party franchisees;
- franchisors lose a degree of direct control over their all-important brand. They rely on the franchisees to maintain brand integrity and value, and increase the possibility that third parties might try to piggy back off the success of legitimate franchise networks; franchising may mean that flexibility at an operational level is decreased as franchisees will be dissatisfied or confused if the franchisor implements frequent policy or product line changes;
- it might be difficult in practice to terminate relationships with franchisees who have made a significant contribution to the growth of the business; and
- franchising can raise complex regulatory issues including compliance with European competition law legislation.
However, putting in place careful legal documentation to underlie the franchise arrangement can manage these risks. For example, the franchise agreement should require strict adherence to the confidentiality procedures of the franchisor, set out a detailed regime for quality control and mystery shopper audits and provide a timetable for training and regular brand control meetings. The franchisor needs to be rigorous in enforcing its intellectual property rights by taking legal action against third parties who attempt to use its brand or business format without entering into an authorised franchise relationship.
The table below summarises some of the key issues that companies looking to make use of the franchise model need to bear in mind.
Whatever the potential legal and commercial issues, there is no doubt that the franchising model is worth serious investigation by companies across the sector irrespective of their stage of development. Indeed as the market matures, a number of companies are making use of the franchising models in ever more creative situations – as adjuncts to corporate transactions or as methods of circumventing local regulations. As ever in the retail sector, companies with ambition cannot afford to rest on their laurels.