Advantages and Disadvantages of Franchising
Write 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.
To 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 company’s prosperity and carry it confidently into the future. One of the principal tactics in doing business in today’s 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 1
advertising costs. This, in turn, will mean more funds will be allocated for research and development. The key operational benefit is the ability for the franchisor to have a far smaller centralized headquarter, compared to having to owning many business locations and developing then into franchisees. Moreover, the management can ensure conformity across the company, through the use of standardized procedures achieving consistent outcomes, greater productivity levels and better quality results. Another advantage is the ability to instigate effective quality control. Particularly where the franchise agreement is long-term (Holmes & Lofstrom, 2003), the franchise will feel like it has a greater sense of control, ownership and autonomy; this is likely to cause the manager to invest more into the business, in the forms of time, attention and money and this will result in a higher efficiency and productivity through following the approved guidelines (this is referred to as ownership mentality). The final result will be more satisfaction for the customers and increased sales. The main strategic benefit for the franchisor is that franchising allows for a more even spread of risks by increasing the amount of subsidiaries and this, of course, is enabled through the investment of franchisees. This means a more manageable risk level, by allowing for a rapid increase in the expansion of networks and by providing more opportunities to fluctuate with market requirements, which results in less pressure from competitors. The franchisee’s particular area of interest lies in taking part in initiatives for the expansion and proper operation of the enterprise as a whole. This sometimes can result in new alternative ideas, and also will allow the franchisor to franchises that are not complying to the specific operating guidelines and issues caused by other franchisees involved. This is of great benefit to the franchisor’s themselves as it aids them in ensuring the effective operation of the company. Finally, the administrative benefits include the fact that with a smaller central organization, the business can put into effect, specialized recruitment procedures for the area, resulting in a more efficient and productive labour force reflecting on a far more cost effective business. On the other hand, the disadvantages are also easily identifiable, and the franchisor must be aware of this possibility. First of all, when the franchise is first set up the franchisor must realize that he will have to provide 2
adequate training and support to all the new franchisees and staff entering the system; this requires a considerable capital and labour allocation in order to build the franchisee infrastructure and pilot operations. Moreover, the franchisor also runs the risk of the trade name being tarnished by some poor business decisions. Other risks include the fact that franchisees may exert excessive strain onto the franchisor adhere to any new guidelines and practices that they may want in place in their particular business outlet. In addition to this, the franchisor must inform all his franchisees of important yet confidential business practices and knowledge, constituting a risk to the business as a whole. A possible solution to reduce these risks lies in th e concept of “participation and support”. The mentality that the franchisor must convey to the franchisees is that they are all members of a far larger outfit; and if managed correctly, this of being part of a team and collaboration, which includes valuable input and creative-constructive participation on both sides, can create a system with a common identity and mutual respect. If this is achieved then not only will there be a level of fairness, but also a very profitable relationship for the franchisor. A ssuming the franchisee’s point of view, we can make a similar analysis. It is possible to classify four main areas where advantages for the franchisee lie: product acceptance, management expertise, meeting capital requirements and knowledge of the market. With regards to product acceptance, it must be said that the franchisee’s business is offering a desired service whether it be a specific type of product or service, as well as having an acceptable name, which is trusted built up over the years that the franchise has existed. This trust will have been built up over years of good service, helping franchisees to bring in customers who have had a good experience with that franchise. It would be unwise for an entrepreneur to try and enter into an unknown market place, where customers do not recognise the company. The potential customers would therefore require far more convincing for the business to be accepted in the market and be seen as a credible option. In this sense, one of the best advantages to being a franchisee is advertising: a franchisee never has to do advertising because the franchisor does advertisements across the country. With management 3
expertise, when it comes to managing the franchise store the franchisee is at a great advantage, as there is the support network from the franchisor, which can come in the form of a training programme provided by the franchisor covering all the key aspects of running a business, such as accounting, personnel management, marketing and production. The fact is, if a franchisee needs technical or managerial support they can count on the franchisor, which has a vested interest to make them as successful as possible and this will then result in the highest profit margin possible. In terms of capital requirements, starting a new business is financially daunting as it is usually very costly in both money and time. Franchising gives the possibility to enter upon a new business where there is already a support network provided by the franchisor, which could save the franchisees resources, time and money. The initial investment required to purchase a franchise is generally a fee, construction costs, and the purchase of equipment. Moreover, if franchisees get into debt or trouble they can always get some financial support from the franchisor. Finally, in terms of knowledge of the market, franchising business supplies years of experience in the market, and the franchisor can show this knowledge in a plan, explaining all the details of the target customers as well as the strategies to be put into effect when starting and leading the operations. In addition to this, the franchisee is expected to have a market awareness of the local economy and area he is in. Even for the franchisee, some disadvantages must be considered and many risks can arise. The first disadvantage deals with cost: franchisees sustain an up front fee and ongoing fees. Setup costs will not allow for shortcuts. However, it is more likely that consumers will be attracted by a strong brand image and break-even should be achieve more easily. In this way, the risk of the cost of ongoing fees will be counterbalanced by multiplied sale advantages which derive from the support of the franchisor. Another disadvantage lies in control: even if franchisees own the infrastructure of their businesses, they must suit to the franchisor's operational instructions. A person determined to "do it their own way" can be stressed and this can cause conflicts. Moreover, there can be a limitation on the sale of the business: selfemployment operators are free to sell their business wherever and to whomever they choose. They do not need to worry about the adhesion to 4
someone’s directives, as is not the case of the franchisee. In the end, the main risk is
constituted by the franchisor failure: even expertises compare franchising to a marriage, where franchisees are linked to franchisors "for better or worse". In the case that the franchisor take a bad business decision, possibilities for the franchisor to achieve success may be seriously affected. To minimize their risks (FranchiseDirect, 2003) the franchisee must be able to plan for the future as well as concentrating on the daily activities of the business. Recognizing strengths and weaknesses, maintaining good working relationships, listening to the advice of the franchisor, monitoring cash flow, creating effective long-term networks, strategic planning and time management are all criteria that can help ensure the franchisee’s success. An example of different strategies concerning franchising is represented by the Italian fashion industry. In particular, two of the most popular brands, Giorgio Armani and Dolce & Gabbana, have opposing views about franchising and their annual reports prove that is possible to be profitable whether opting for franchising or not. The Armani Group have invested more than 95,000,000 euro since 2007 in developing its retail network through the opening of 49 new stores; today the company’s retail network consists of 539 stores worldwide, of which just 31% is groupowned. The group announced its financial results for the year 2008 (Armani Press, 2010), which confirm both the success of the company’s unique multi -brand and lifestyle strategy and the effectiveness of its management approach. Wholesale revenues, which show an increase in all product categories, demonstrate the strength of the group’s brands and the positive impact it has in all locations of its worldwide expansion strategy. On the contrary, Dolce & Gabbana have been moving toward greater vertical integration in the 2000s. By taking control of much of its own production, and bringing in-house most of its formerly licensed products, they have managed to maintain the high quality of their product and keep a direct and strong control on the brand image. In 2003 the company moved to take firmer control of its retail network, with a drive to buy out its franchisees. By the end of the year, the company directly controlled 60 stores. By 2004, the 5
company's sales had risen to 475,000,000 euro (Dolce & Gabbana, 2010). Dolce & Gabbana had managed to become a fully vertically integrated and independent business. The real-life examples of two different stances on franchising and international marketing strategies, which both produce successful results, demonstrate that some companies may conclude the disadvantages and risks of starting a franchise exceed advantages and benefits, or vice versa. This is why there seems to be no way generalizing the importance of franchising in today’s global marketing. The debate remains very much open.6
REFERENCE LIST Dolce Associated Content, Business and Finance (2010) The Pluses to Being a Franchiser or Franchisee. Available at http://www.associatedcontent.com/article/1438099/advantages_of_the_franchiser_and _the.html?cat=35 (Accessed: 06 November 2010) Armani (2010) Annual Report 2008. Available at http://www.armanipress.com/pressRelease/pressSection?language=en§ion=FI (Accessed: 10 November 2010) & Holmes FranExel (2010) Franchising and globalization. Available at http://www.franexcel.com/resources.php?id=26 (Accessed: 07 November 2010) Franchise Direct (2003) Operate a successful franchise. Available at http://www.franchisedirect.com/information/thefranchiseesperspective/operateasuccessf u lfranchise/9/434/ (Accessed: 07 November 2010) Gabbana (2010) Annual report 2008. Available at http://www.dolcegabbana.com/corporate/club/subscribe/ (Accessed: 10 November 2010) & Lofstrom, LLP (2003)The advantages and disadvantages of franchising. Available at http://www.HolmesLofstrom.com (Accessed: 07 November 2010)
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