Franchising - What is it?


What do you think of, when you hear about “Franchising”?

We bet that the majority would think about “McDonald’s”. It is the best-known example of franchising, also known as Franchising ICON. The first “McDonald’s Bar-B-Q” restaurant was opened in 1940 in California. Famous Ray Kroc, who became a founder of “McDonald’s”, as we know it today, joined the company in 1955 by opening his first own restaurant in Illinois. In 1959, the 100th restaurant under “Golden arches” was opened. International expansion of “McDonald’s” has begun in 1967. Today, “McDonald’s” chain combines more than 36000 restaurants in more than 100 countries. More than 80% of McDonald's restaurants worldwide are owned and operated by independent franchisees. However, “McDonald’s” is only the third largest franchising chain in the world. The largest chain, expanding by selling its franchises, is “7-eleven” with more than 60000 units. Second biggest is “Subway” with more than 44000 locations worldwide.

So, how did they managed to grow and quite successfully operate such a giant chains? The answer is simple and obvious. Franchising is the common phenomenon that enabled such development and continue to contribute to their growth.    

The word “franchise” translates as freedom, the granting of rights or privileges from ancient French. Historically, “franchise” meant permission or an exclusive privilege to conduct certain activities, which the feudal lords would grant to ordinary peasants. Usually these were breweries, strong alcoholic drinks distilleries, fur workshops and other similar crafts. By granting such privileges, feudal lords not only controlled the extent of the activities of different crafts within their holdings, but also increased their income from peasants who paid for the granting of privileges. In the modern business world, franchising is a business model when one entity (the franchisor) temporarily transfers the right to use the franchised business model, its “know-how” and corporate identity to another entity (franchisee) within the defined territory for a defined fee.

Below we will explain some of the key definitions related to franchising:

  • Franchise — intellectual property, which consists of the franchisor’s proprietary franchised business model, “know-how” and rights to the corporate identity elements, combined with support, which is for a defined fee temporarily transferred to the franchisee for the purpose of replicating the franchised business model and using it for profit earning.
  • Business model — a set of measures by which a business identifies its consumers, develops and differentiates its goods or services, determines tasks which it shall perform individually and tasks which shall be outsourced to external suppliers, structures required resources, accesses the market, creates value for its consumers and receives profit.
  • Franchisor — the entity that grants the rights to use the franchised business model as well as its proprietary “know-how” and corporate identity elements and provides related services to the franchisee under a franchise agreement.
  • Franchisee — the entity who acquires the rights to use the franchised business model as well as the “know-how” and corporate identity elements proprietary to franchisor under the franchise agreement.
  • Franchised business – franchisor’s business that forms the basis of the Franchise.
  • Franchise agreement — an agreement under which the franchisor grants the right to temporarily use its brand name, goods and/or services marks, marketing system, production and service provision technologies, and business management methods to the franchisee for a certain fee.

There are couple important characteristics of franchising:

  • The franchisor grants not only an already created and proven business model and the “know-how” to the franchisee, but also undertakes to provide services that continually provide the franchisee with proven business model improvements, newly generated “know-how” and methodological support.
  • The franchisor grants, but not sells, the business model and the “know-how” to the franchisee. Under the definition, their relationship is temporary, although long-term.
  • The franchisee is related, but legally independent from franchisor. Franchisee accepts its own business risk by buying a franchise and developing its own business based on a franchised business model.  

However, not always does the “thing” called “a franchise” actually meets all the characteristics of franchising. Often franchising is confused with distribution or licensing, though these are different business organization models:

  • Licensing — a business organization model in which one entity transfers legally protected intellectual property owned by it to another entity for an established fee, i.e., trademarks, industrial design, software, an invention or a business process. Usually a license is granted for the use of strictly defined objects of intellectual property. The franchise, too, includes strictly defined elements such as trademarks or recipes, as well as objects that are complex and hard to define, such as an accrued business experience and methodological support.
  • Distribution — a business organization model in which one entity sells products produced by another entity and marked with the trademarks belonging to the latter. The distributor does not acquire the rights to use the producer’s trademark for its own purposes and the producer has very limited control over the distributor’s business organization processes and only to the extent that is related to the delivery of the distributor’s goods to the consumers and their sale. Retail franchising, for example, usually includes distribution arrangements, however it also includes other rights and obligations that surpass the limits of distributions.

In countries where the legal regulation of franchising is not too strict, such confusion between the business organization models is not critical and, in the worst scenario, it may become the source of disagreements between the parties of the business transaction. However, in countries where franchising is strictly regulated by laws (i.e., USA), it is essential to make a clear distinction between these business organization models and apply the one which is most suitable for a particular business situation.

After introducing the basic concepts of franchising, let us move forward and explore the wide variety of franchises. You can read more about the variety of franchises here >>>>


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