FRANCHISING A BUSINESS AND FRANCHISE DEVELOPMENT - STRATEGIC PLANNING & MANAGEMENT OF FRANCHISE SYSTEMS
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WHY COMPANIES FRANCHISE
Imagine opening 20 new business locations without having to foot the bill for real estate, equipment and development costs or taking on any of the risk. Even more, imagine finding managers to run all those locations, who are just as committed to growing the company as you, and you don’t have to pay them a dime. Finally, imagine that these managers will hire, fire and manage all employees as well as foot the bill for all operating costs and expenses. Sound far-fetched? Not if you're planning to enter the franchise industry, one of the fastest ways to grow a small business without breaking the bank.
For many companies, franchising (or licensing) is a sensible way to achieve rapid, profitable growth without giving up any control or ownership. Going from a single location to a dozen in a couple years, or a hundred in ten years is possible and well-documented because franchise owner-investors put up all investment capital, shoulder all risk and assume all day-to-day operating responsibilities. It's expansion, using OPM - Other People's Money. Also, the franchise company gets paid handsomely for teaching others the secrets of how to operate its business. First, there’s the up-front “membership” or franchise fee of $20,000 to $50,000 paid for using the brand name and operating methods. In addition, there are continuing royalties of 5% to 10% of gross sales for ongoing advice and consultation. In essence, a franchise development program allows a company to get out of the trenches and become a highly-paid general overseeing its soldiers. Long-term options are also attractive. Build an empire and relax, or let the franchise company be acquired by an increasing number of large companies that look for small, but growing franchise companies. According to the International Franchise Association, 900 new companies have franchised in the last three years.
WHY COMPANY-OWNED CHAINS SWITCH TO FRANCHISING
Other companies who have not analyzed the company-owned vs. franchised option use their own internal resources to develop, open and run multiple locations, sometimes for a decade or more, only to realize they are immersed in an ever growing management and administrative structure that consumes time and resources without limit. While some of their units operate profitably, others barely break even or can even show a loss. Growth in these chains is slow, expensive and time consuming, allowing competitors to seize the best locations and market share. One founder of a fast-food chain that ultimately switched to franchising said "When I went from one company-owned location to two, my problems didn't double, they tripled. When we went from two to three, they quadrupled. It was downhill ever since – a geometric progression nightmare." After the switch from company-owned to to franchising, the company sold off all but its top-performing units as "turnkey" franchises. Under franchise ownership, even the locations with marginal financial performance turned around and became profitable. The binding nature of the financial commitment made by franchise owners, who often put all of their assets on the line (homes, retirement savings, etc.) and will do whatever it takes, explains the result.
Another company, the Mrs. Fields Cookie chain, started in 1977. Pursuing a company-owned strategy, the chain grew to hundreds of locations but almost went bankrupt in the process. In 1990, after tweaking and making adjustments, the company switched to a franchise model. The switch allows former company-owned locations to be sold off as “turnkey” franchises to independent operators. The new franchise owners assume day-to-day operating expenses and responsibilities like management, human resources, payroll, rent, inventory, etc, The franchise company is not only relieved from these burdens, it receives income from a variety of sources. First, it receives an initial franchise fee plus ongoing royalty payments. Second, because there’s the sale of an ongoing business, the franchise owner pays the value of the furniture, fixtures and equipment, plus an "established business" goodwill factor. Besides boosting its income, the franchise parent company benefits from new administrative economies of scale – large numbers of franchised locations require relatively few franchise personnel for training and support. In 1963, Colonel Sanders managed 600 franchised locations from an office built in the back of his home, employing 17 full and part-time employees. In 2000, Carl's Jr. had a management team of 19 individuals managing its 669 quick service franchised restaurants.
FRANCHISING VS. LICENSING A BUSINESS (Franchise vs. License) - Making Sound Strategic Decisions
Another topic that merits consideration is whether to use a license agreement as opposed to a franchise agreement. This is not a decision to rush or make summarily as there are significant, long-term legal repercussions that can come back to haunt the company for decades. For a discussion of some of the legal and business implications of the franchise vs. license decision, read our illuminating franchise article Franchising vs. Licensing A Business (Franchise vs. License) and Business Opportunity Expansion Options
ENTERING A NEW BUSINESS
A company that franchises must realize it is entering a new business, offering an entirely different service (training & support) to entirely new customers (business owner-operators). This new business requires different skills, abilities and expertise. In the new business of franchising, it is critical to develop evaluation, documentation, training and consulting skills, all within an ongoing and long term franchise relationship. Because these new skills are rarely present within existing personnel, outside experts are needed to plan the transition. The first step involves strategic planning to create a "blueprint" for successful expansion efforts. Experience shows that, just like a building, the foundation developed at the beginning will create lasting consequences affecting the relative success (or failure) of the entire venture.
THE STRATEGIC FRANCHISE PLANNING PHASE
Assuming the business is franchise-able (see Franchise Articles I and Menu of Services pages of this site), a successful franchise development program begins with a solid strategic plan - a foundation for franchising. Especially in the franchise industry, if you don't plan for success, you set yourself up for failure. The long-term goal is to establish balanced, integrated, successful franchise relationships with qualified individuals who support your company's goals and image. Creating enduring franchise relationships requires a comprehensive strategy that addresses all aspects of the franchise development endeavor. The starting point is a detailed analysis that covers: (1) identifying profile characteristics of who will be the best franchise owners for your type of business;
(2) competitive and image positioning to make your franchise stand out from the other 3,000+ franchise companies;
(3) geographic scope - where and when will franchises be sold initially;
(4) analysis of your company's organizational strengths and weaknesses relative to franchising;
(5) identifying the appropriate organizational structure as well as staffing requirements and responsibilities; and
(6) structuring the franchise relationship for a balanced, win-win scenario. What should emerge from this detailed analysis is a specific strategic plan and framework for guiding virtually all franchise efforts. Franchising vs. licensing issues must be addressed. Despite the long-term importance of the strategic franchise planning process, too many emerging franchise companies enter the franchise industry with no plan or strategic franchise planning - other than “let’s try and sell a lot of franchises.” They rush through (or entirely neglect) the strategic franchise planning process, thereby creating future land mines that are franchise lawsuits waiting to happen. Often, this is because they only utilize the services of a consulting or general practice legal firm, where little or no attention is paid to critical strategic franchise planning, operational and organizational issues. Normally, these firms draft a “boilerplate” franchise offering circular based on a questionnaire completed by their client, who is presumed to have made all strategic decisions. The legal documents (franchise offering circular, franchise agreements, etc.) are presented, along with an invoice and a handshake - hardly the ingredients for success in the new business of franchising.
As an example of how NOT to plan, consider the Wholly Crap pet waste removal service. Per Entrepreneur Magazine's website and records, the company completed its franchise development program and started franchising in 2003 after it's single company-owned prototype opened in 2002. They haven't sold a single franchise to date. Hardly a name or image a prospective franchise buyer wants to associate with. It's a classic "Franchise 101" strategic franchise planning mistake that's never been corrected Yet other franchised pet waste removal companies have done well, scooping up the profits, so to speak.
DoodyCalls started franchising in 2004 and by 2006 had 13 franchises. Pet Butler, another franchised competitor, combines waste removal with dog walking and pet sitting. Having the better name and image, combined with a more diversified business, were advantages that carried over to the franchise program. According to the company’s website, they are #1 in the #2 business. Franchising started in 2005 and the year ended with 4 franchises. By 2006, the network mushroomed to 50 franchises. Whether this growth was too quick, too scattered, and done without sufficient management depth (the franchise company only has 1 person – the founder) are different issues.
THE FRANCHISE DOCUMENTATION PHASE
If your company has made doing a good job at the planning stage a priority, franchise documentation goals will be apparent. The business name and other proprietary assets (like recipes, formulas, methods, branding, operating techniques and customer information) need to be identified and protected. A trade secret protection program is designed and implemented. A catchy and appropriate name, logo and tag lines are registered as trademarks or service marks. A franchise operations manual and franchise training program are developed, often from scratch, to impart business operating skills to the franchise owner as well as ensure uniformity of products and services. The franchise operations manual and franchise training program curriculum must be drafted or edited with a particular focus. Certain topics, chapters and policies used in manuals for company-owned locations, for example, are entirely inappropriate in a franchise environment, creating significant franchise liability issues for the franchise company. For a detailed discussion of franchise operations manuals read the entire franchise article Effective Planning & Management Of Franchise Systems. The support aspect of the franchise relationship needs to be carefully considered, structured and incorporated into the franchise operations manuals.
Finally, and only after all of the above are underway, a Franchise Offering Circular (after 7-1-08 the FTC's Franchise Disclosure Document - FDD), similar to a securities (stock offering) prospectus, is prepared by competent franchise counsel along with the various franchise agreements. Franchise companies must provide detailed information, presented in twenty-three items or chapters as follows:
Item 1. The Franchisor and any Parents, Predecessors and Affiliates
Item 2. Business Experience
Item 3. Litigation
Item 4. Bankruptcy
Item 5. Initial Fees
Item 6. Other Fees
Item 7. Estimated Initial Investment
Item 8. Restrictions on Sources of Products and Services
Item 9. Franchisee's Obligations
Item 10. Financing
Item 11. Franchisor's Assistance, Advertising, Computer Systems
and Training
Item 12. Territory
Item 13. Trademarks
Item 14. Patents, Copyrights, and Proprietary Information
Item 15. Obligation to Participate in the Actual Operation of the Franchise
Item 16. Restrictions on What the Franchise May Sell
Item 17. Renewal, Termination, Transfer and Dispute Resolution
Item 18. Public Figures
Item 19. Financial Performance Representations
Item 20. Outlets and Franchisee Information
Item 21. Financial Statements
Item 22. Contracts
Item 23. Receipts
The entire document, sometimes running into hundreds of pages, is then registered with various regulatory agencies to comply with applicable federal and state laws. A franchise registration-review process is required before any franchises can be advertised or sold in those states having a registration requirement. Having one firm author, edit and review all documents is not only cost-effective - it also avoids inconsistencies that can plague the franchise company as legal pitfalls in the form of future franchise litigation (see discussion below).
AVOIDING LEGAL PITFALLS IN THE FRANCHISE DOCUMENTATION PHASE
From the snapshot above, it should be obvious the Franchise Disclosure Document contains an enormous amount of information. Very detailed disclosures made by the franchise company in this document often spell the difference between success and failure in future claims that someone was misled. Franchise companies must think of their Franchise Disclosure Document (FDD) not as a sales tool but more of a franchise risk management tool. As discussed below, another key component is adopting and implementing a carefully crafted Franchise Disclosure Compliance Program sm to manage disclosure documents and control the dissemination of information.
As an example of documentation difficulties, consider the plight of franchise companies that get sued by disgruntled franchise owners, looking to break away from the franchise network and their franchise agreements. A favorite technique is to carefully examine the Franchise Offering Circular, looking for things that were either not disclosed as required, or were disclosed inconsistently. For example, Franchise Offering Circular or Franchise Disclosure Document says “x” whereas franchise agreement say "y" or the franchise operations manual says "z” about the same topic.
All of a sudden, violations of franchise disclosure and registration laws arise, and unhappy, disgruntled franchise owners are given a springboard to break away and recover damages. A studied examination of these cases invariably shows the same cause – the legal documents were not drafted by a franchise attorney or franchise expert. Instead, a general practice attorney undertook a “learning experience” paid for by the client. Or, a franchise consulting group used boilerplate documents, changing most (but not all) occurrences of “hamburgers” to “tax returns.”
franchise disclosure document update – FTC Franchise Rule amendment
On January 23, 2007 the Federal Trade Commission, following a twelve year review, announced a sweeping amendment to its Franchise Rule. These changes, with a permissive effective date of July 1, 2007, and a required effective date of July 1, 2008 require all franchise companies to make substantial changes to their franchise offering circulars (called "franchise disclosure documents" under the FTC Franchise Rule Amendment). The previous option to elect between the FTC format and the UFOC format no longer applies - all franchise companies must follow the FTC format and produce what is known as a Franchise Disclosure Document (FDD) with the 23 items or chapters detailed above.
THE IMPLEMENTATION PHASE
With the documentation phase over, momentum gathers with the start of the exciting implementation phase. This is where the sparks begin to fly as franchises are sold, teaching and training are done and opening assistance is provided. It’s also when most new franchise companies make serious mistakes that haunt them for years or even decades to come.
Often resources are wasted because the company has not been schooled in the art of selling franchises. Or franchises are sold without carefully screening the would-be franchise owners. As the saying goes, one bad apple can ruin the entire barrel. Even in the best case scenario, any marketing “mistakes” result in a significant diversion of franchise management time and effort on a continuing basis as attempts are made to cope with marginal franchise operators. Or, as marginal operators become increasingly disgruntled franchise owners, they can and often do file franchise lawsuits to break away from the network and recover monetary damages.
The introduction of franchise litigation, attorneys, discovery and hearings in arbitration or court is very expensive, not to mention the toll it takes on the entire franchise organization. A retrospective look back at these troubled franchise networks reveals the cause – they failed to realize they were in a new business: the business of franchising. They believed everything could be done by existing personnel, and the only “expertise” needed was the franchise offering circular and franchise operations manual they were given, along with an invoice and a handshake. Just when the new franchise management team needs training by an outside franchise expert the most – when the franchise development program begins – companies make a critical mistake of trying to cut costs and do it on their own. This accounts for the fact that many new franchise companies disappear within a few years of their entry into franchising, and 75% are history within ten years.
A number of important implementation steps can and should be taken to minimize these franchise risks and liability, including:
1. FRANCHISE MARKETING SYSTEMS
Two key considerations for all new franchise companies are the careful screening of franchise applicants and adopting the proper media plan, schedule and budget. Only the cream of the crop should be allowed to join the franchise network. Eliminating applicants at the entry stage is far easier than waiting for inevitable and costly problems later on. An examination of franchise networks plagued by troublesome franchise owners (who often ripen into franchise lawsuits) shows a lack of planning and attention to this relatively simple concept.
Given the unlimited personal liability risk inherent in franchising, companies neglecting this important concept, or those using franchise brokers, are simply asking for trouble. Before marketing efforts begin, your company should adopt a customized Franchise Lead Processing System that includes instructing key personnel in: (1) adopting the proper organizational structure to operate the franchise entity;
(2) defining the profile characteristics of prospective franchise owners;
(3) developing effective interviewing techniques, marketing materials, procedures and checklists;
(4) using a series of tests and other measures to ensure that inappropriate candidates are disqualified before joining the franchise network;
(5) detecting (and then avoiding) red flags that arise in the franchise marketing cycle; and
(6) adopting the appropriate media plan, schedule and budget.
2. FRANCHISE LEGAL COMPLIANCE PROGRAMS & FRANCHISE OFFERING CIRCULARS
Inconsistent or misleading communications when a franchise is first sold can form the basis for future franchise litigation. And the cost of defending any franchise lawsuit, even a frivolous one, can be enormous. Franchise management involved in litigation are shocked to discover their company has fallen into a quicksand that swallows up time and money without limit. The cost of prosecuting even a "small" franchise litigation lawsuit can easily exceed $100,000, and up.
The starting point is having a solid, consistent Franchise Offering Circular. But, it is almost impossible to avoid potential liability unless a genuine program of education and instruction is conducted with franchise marketing personnel as well as middle and executive franchise management. An integrated Franchise Disclosure Compliance Program sm that specifies rules and expectations, manages disclosure documents (franchise offering circulars) and controls the dissemination of all information is absolutely essential. It is also one of the best investments a franchise company will ever make. For all of the above reasons, the use of "franchise brokers" is definitely NOT recommended. Their statements (or other actions) made to "close the deal" will make the franchise organization (and the personal assets of its officers) liable for violations of federal or state franchise laws. This also explains why the overwhelming majority of successful franchise organizations set up their own in-house marketing department so that actions and statements made during the franchise marketing cycle can be monitored and controlled within the framework of a Franchise Sales Control System (sm).
3. FRANCHISE SALES CONTROL SYSTEM (SM)
Franchise Sales Control is the other half of the entire compliance equation. While legal compliance specifies rules and expectations, franchise sales control is the mechanism for detecting gaps and inconsistencies. When detected, their causes can be identified and corrected before injuring the expansion effort. A Franchise Sales Control System should be designed with this in mind, and should include a variety of feedback mechanisms to monitor performance and retrieve pertinent information for review by franchise management. This not only increases the effectiveness of franchise marketing efforts - it also greatly reduces the likelihood that sales personnel will deviate from established procedures in selling franchises. And a dedicated Franchises Sales Control System will create a complete back-up file for each franchise sold - a company's best insurance against potential problems in the future.
4. MAINTAINING FRANCHISE RELATIONSHIPS
The communication lines that develop between the parties will have a major impact on the success or failure of the ongoing franchise relationship. Controlling who is brought into the network through the franchise marketing steps outlined above is the critical first step. Once inside the franchise network, franchise owners must be taught to realize they are members of a system of mutually-dependent outlets, each working for the better of the entire network. Developing an awareness of this concept early in the relationship will create a positive attitude, encourage innovative ideas from franchise owners, ensure timely royalty payments and prevent franchise relationship problems later on.
5. DEVELOPING A FRANCHISE MANAGEMENT INFRASTRUCTURE AND ORGANIZATIONAL STRUCTURE FOR FRANCHISING
Many new franchise companies fail to adopt the proper franchise organizational structure as well as develop the critical franchise management infrastructure as franchises are first sold. In most cases, money and lack of proper strategic planning are the culprits. Lacking funds, the new franchise company can’t afford to hire a qualified individual with competence in operating a franchise company and managing franchise relationships. Or, a “why do we really need to do that - we can do it ourselves?” mentality prevails.
One franchise company mistakenly assumed they could do everything on their own, sold a dozen franchises, and when extra funds were available, hired a franchise marketing person to . . . sell more franchises. Unfortunately, franchise marketing skills have nothing to do with managing franchise relationships, and selling too many franchises too soon is a classic franchise marketing pitfall. Franchise relationship “issues” inevitably developed due to the firm’s lack of sensitivity and misguided direction. The seeds of franchise revolt fermented. Left unchecked, it culminated with the disgruntled franchise owners collectively hiring a franchise litigation attorney to seek a "solution" to their problems. The result: all franchise owners successfully broke away from the franchise network, leaving the franchise company in ruins. Tragically, this franchise owner revolt was 100% preventable.
Our firm offers a unique program that helps new franchise companies navigate the complexities of operating a franchise company and deal with ongoing franchise relationships without having to hire expensive franchise personnel. Called Franchisor Mentor, it allows a franchise company to access our twenty-five plus years of successful franchise industry experience, train existing personnel in how to operate the franchise company, and provide ongoing advice on an as needed basis. See our Menu Of Services page for further details.
WHERE DO WE BEGIN? - LEARN FROM A FRANCHISE EXPERT, FRANCHISE ATTORNEY AND FORMER FRANCHISE OWNER
A series of franchise management and franchise marketing workshops and seminars are offered, either at your offices or at our executive retreat located in California’s Napa Valley Wine Country. Instruction is given by our Director of Operations, Kevin B. Murphy, an internationally-known franchise expert, franchise attorney, author and instructor who is known in the industry as “Mr. Franchise.” Mr. Murphy’s background and qualifications are listed in detail in the Franchise Expert Qualifications page of this website. In addition to consulting with new and existing franchise companies, he is also retained by franchise litigation attorneys as a franchise expert to review documents and develop effective legal strategies in franchise lawsuits. Finally, Mr. Murphy owned and operated a successful franchise in 2002-2003. So his wealth of knowledge and first-hand experience will not only help your company develop an effective franchise development program, it will also provide a focus for managing franchise relationships and avoiding franchise legal pitfalls. Many clients benefit from having Mr. Murphy perform an on-site inspection and analysis of their business before serious franchise development work begins. That way, he can determine what needs to be fine-tuned or developed for the franchise program. Part of this process includes providing guidance and direction so as much of the groundwork as possible can be done by existing personnel. This has proven to be a very effective approach, significantly reduces franchise development costs - and results in a professional end product. Finally, our fee structure is based on doing this work for over 25 years, so your company benefits from "learning curve" pricing as well as experience and expertise based on almost three decades in the franchise industry.
EVALUATING FRANCHISE ATTORNEYS & FRANCHISE CONSULTANTS
The firm selected to franchise a business will be the most critical decision a company ever makes. Use a high-priced franchise consulting firm and you'll run out of money before you've even had a chance to enter the franchise industry. Or, your firm will be so desperate to recoup its $100,000-plus consulting fee that you'll sell a franchise to just about anyone. The consulting firm forgot to mention the fine print of their contract. It requires you to hire an attorney to review everything they do. Why? It's because they're providing legal documents that affect legal rights, but they're not attorneys. It's called the unauthorized practice of law and you're suckered into it. Or use a franchise attorney or law firm to do the legal work, assuming the complexities of operating a new business in the franchise industry will somehow work themselves out, and you've just fallen into another hole. Business mistakes here can cost tens, if not hundreds of thousands of dollars. For a comprehensive list of questions to ask and issues to consider that will eliminate 95% of the individuals or firms claiming expertise in franchising a business, read our illuminating franchise article Evaluating Franchise Attorneys & Franchise Consultants: Critical Questions To Ask
FOR FURTHER INFORMATION CONTACT US BY EMAIL OR CALL 1-800-942-4402
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