Advantages and Disadvantages of FranchisingTuesday, 23 November 2010Write an individual essay, developing the arguments both for and against franchising as a mode of foreign market entry, outlining also any elements of risk arising for franchisor and franchisee and how they may be minimized.
Tavano Filippo Dr.Paliwoda Stanley, Dr. Jafari Ali AkbarTo understand the effects of globalization and the challenges it presents is assisted through the use of modern communication technologies and also the ability to expand into newly opening local markets and exposing them to new methods of production and marketing (FranExcel, 2001). However new challenges often occur, such as the use of managerial insight and intelligence, to examine a variety of different systems that will be able to compete amongst the already established “local” competition, which in some markets can prove to be extremely severe. The ability to compete, hold a strong place in the market and position the company accordingly, can only be achieved by the employment of franchising. This system has an extremely successful track record and allows the user to ensure the companys prosperity and carry it confidently into the future. One of the principal tactics in doing business in todays current environment, particularly for SMSs, is franchising. This method has been improved ever many years through trial and error and has become a clear concise process. It has been exposed to many different business relationships such as agencies, distribution and licensing. Franchising has proved its worth as a more refined procedure by supplying the “business system” that guarantees that the company follows the set out standards and operating procedures.
The question of “why choose franchising?” (FranExel, 2010) is a common and understandable issue. However we can identify and summarize the possible responses putting in evidence all economic advantages for the franchisor. In this instance, he can extend and increase his units thanks to the investment risk assumed by other parties in the host country. One of the main financial benefits includes the fact that the franchisor gains from additional incomes such as franchisees fees and on-going royalties. This increase of capital improves profits and return on investments. McDonalds, for instance, sell their name for $1,800,000 a piece. This is huge for the franchisor because for every new McDonalds they open they make a profit from the name and products they sell to the franchisee and also have a stake in the profits that the franchisees make (AssociatedContent, 2010). Another financial benefit is the reduced operating, distribution and
e-commerce costs. It seems most obvious that franchisor is the most efficient business. And the fact that the franchisor invests in the brand’s production costs to maximise a profit is also a contributing factor. However, that does not mean that their costs are not a factor. For example, our survey of franchisors revealed that only 3% of franchisors took into account profits and losses incurred in maintaining our national and international operations (United States, European Union, American Indian, Russian Federation). It is also interesting that the franchisor is only 5% of its revenue or that it takes home between 3% and 4% of the profit. The fact that the franchisor does not have to deal with a huge cost of operation is only seen as a hindrance to their business model.
The most likely explanation for the negative consequences of franchisory is that it leads to a higher degree of competitive advantage over the larger global businesses, and is associated with higher prices, less operational efficiency, and a reduction in brand exposure, especially for the brand. An international case cannot even be made of franchising in which our restaurant competitors were more than willing to invest $3 million in the first place. The costs associated with a joint venture are low depending on the level of ownership between franchisors and their clients. There are also issues of ownership and licensing of the franchisee through the franchise. For example, the average franchise is an independent enterprise with rights of ownership for $1 million. This creates a significant competitive advantage for franchisers in terms of costs and profit margins and provides new entrants with a greater leverage in competing to be chosen as the franchisees to follow. The cost to develop a restaurant is also a strong factor in determining success of the franchisor’s business (Rivest, 2008), and by increasing the value of shares, it is often possible to reduce competition and reduce the cost to grow restaurants. Moreover, this can be done by increasing the number of franchises, raising the cost of operations, selling off the shares, investing in infrastructure such as new restaurants, expanding the franchise or selling off stock. We think that the primary cause of the positive effects of the franchisory might be the fact that a fast paced business is only profitable if the level of development costs are higher (the franchisor is undervalued). For these reasons, it is important for other players to take more aggressive risks and invest more capital and capital to grow their businesses.
Our survey suggests that other competitors may be looking for a competitive disadvantage in order to maintain or retain their position at the top. We find that the number of franchisors (4.3% of all franchises) who are willing to take risks of growth by the time it is completed is far superior to those who are not (e.g. Cramer, 2015). Moreover, the number of franchisors that have an internal market strategy that is highly aligned with the size and scope of the larger franchisory business is small compared to the scale and complexity of franchisor business on average. It is difficult to consider the role that this means in determining whether such an effect is a viable strategy, especially for smaller national businesses (United States, European Union, American Indian). Additionally, it seems that small and medium sized national businesses might be more successful when their business has an internal market strategy that is high in risk associated with profitability, but low in risk associated with size.
The number of individual or local franchisees (4.9%) is in some cases larger than the number of franchisors (5.7%) and is quite different and is not reflected in the statistics of franchisor in this survey (United States, European Union, American Indian
e-commerce costs. It seems most obvious that franchisor is the most efficient business. And the fact that the franchisor invests in the brand’s production costs to maximise a profit is also a contributing factor. However, that does not mean that their costs are not a factor. For example, our survey of franchisors revealed that only 3% of franchisors took into account profits and losses incurred in maintaining our national and international operations (United States, European Union, American Indian, Russian Federation). It is also interesting that the franchisor is only 5% of its revenue or that it takes home between 3% and 4% of the profit. The fact that the franchisor does not have to deal with a huge cost of operation is only seen as a hindrance to their business model.
The most likely explanation for the negative consequences of franchisory is that it leads to a higher degree of competitive advantage over the larger global businesses, and is associated with higher prices, less operational efficiency, and a reduction in brand exposure, especially for the brand. An international case cannot even be made of franchising in which our restaurant competitors were more than willing to invest $3 million in the first place. The costs associated with a joint venture are low depending on the level of ownership between franchisors and their clients. There are also issues of ownership and licensing of the franchisee through the franchise. For example, the average franchise is an independent enterprise with rights of ownership for $1 million. This creates a significant competitive advantage for franchisers in terms of costs and profit margins and provides new entrants with a greater leverage in competing to be chosen as the franchisees to follow. The cost to develop a restaurant is also a strong factor in determining success of the franchisor’s business (Rivest, 2008), and by increasing the value of shares, it is often possible to reduce competition and reduce the cost to grow restaurants. Moreover, this can be done by increasing the number of franchises, raising the cost of operations, selling off the shares, investing in infrastructure such as new restaurants, expanding the franchise or selling off stock. We think that the primary cause of the positive effects of the franchisory might be the fact that a fast paced business is only profitable if the level of development costs are higher (the franchisor is undervalued). For these reasons, it is important for other players to take more aggressive risks and invest more capital and capital to grow their businesses.
Our survey suggests that other competitors may be looking for a competitive disadvantage in order to maintain or retain their position at the top. We find that the number of franchisors (4.3% of all franchises) who are willing to take risks of growth by the time it is completed is far superior to those who are not (e.g. Cramer, 2015). Moreover, the number of franchisors that have an internal market strategy that is highly aligned with the size and scope of the larger franchisory business is small compared to the scale and complexity of franchisor business on average. It is difficult to consider the role that this means in determining whether such an effect is a viable strategy, especially for smaller national businesses (United States, European Union, American Indian). Additionally, it seems that small and medium sized national businesses might be more successful when their business has an internal market strategy that is high in risk associated with profitability, but low in risk associated with size.
The findings of this analysis show that as many as 1,000 different companies have a similar level of franchisorship in their portfolios. In addition, as several of these small, medium, and large corporations all have significant operating companies that compete for business that are outside the same spectrum, this may also reflect more a diversity of strategies than a lack of competitive factors in their organizations. Of course this has always influenced the composition of the U.S. franchisory industry. In this case, the biggest franchisor is certainly New York City, which is where the largest share of smaller franchisors will compete for a large share of their annual financial capital.
The fact that the total number of U.S. and Canadian franchisors is higher than is currently commonly believed makes it more difficult to make sense of the results of this study. While the average size of U.S. and Canada’s franchisors is approximately 1,000, the number of smaller companies is nearly the same amount as of the U.S. and of China in the same number of terms, whereas American, Japanese, Canadian, and Japanese franchisors have an average size of about 800. To help understand the size and scale of franchisor industry, we conducted qualitative and quantitative data analysis where available so that we could identify key factors that may increase or decrease performance of franchisor businesses. Among the relevant data included are total number of franchise locations, total franchisorship sites, total percentage of franchisees that operate a franchised business, average turnover of franchisees in each location, average revenue per affiliate and total operating revenues of franchisor businesses.
Among the top 10 most successful and highly competitive franchisors, we found that most franchisors are located in highly developed cities, with the largest number located in California, where one out of every four U.S. franchisors makes a move. As stated earlier in the study, the United States is where the largest franchisee businesses are based. As we pointed out a few years ago, California stands out in terms of franchisorship location for their wide range of franchisor locations. However, in 2013 that is likely to change as the number of small, medium size local U.S. and national franchisors increases in size and expands in strength. This raises the question of why is the number of franchisor companies that are located only in California so large compared to the number in other states? The answer may lie in the geographic diversity of these smaller, medium-, and large franchisors across the country that are more open to potential competition.
Conclusions and Recommendations
The results of our research indicate that large, small, and medium sized U.S. franchisors compete for revenue within a strong business environment. They are also competitive for a variety of reasons, such as their level of experience in the traditional business segment, or their willingness to invest in technology that can make their businesses more attractive to big business. To our knowledge, no other comparable study in the history of the business has examined such a market. Moreover, this year (May 2014) a few U.S. franchisors were added to our survey and now the number of franchised franchises in the United States appears to be increasing. It seems that the top 50 largest U.S. franchisors for both large and medium sized franchises, as well as for small and medium sized U.S. franchisees, are located not only in major metropolitan areas, but also in smaller regions of the country. We suggest that these results represent a major step forward in the design of modern franchisorship in today’s market, and help guide changes in these areas of the industry. We thank the following authors for their thoughtful comments on this project: Thomas A. Hahn, Ruediger G. A, and Andrew N. Fertz for their comments on this study.
REFERENCES
Budell, P. L. (2015). The New
The number of individual or local franchisees (4.9%) is in some cases larger than the number of franchisors (5.7%) and is quite different and is not reflected in the statistics of franchisor in this survey (United States, European Union, American Indian