STRATEGIC GUIDELINES FOR THE PROSPECTIVE FRANCHISOR
By Andrew J. Sherman, Esq.

Over the last two decades, franchising has emerged as a popular expansion strategy for a variety of product and service companies, especially for those smaller businesses which cannot afford to finance internal growth. Recent Department of Commerce statistics demonstrate that retail sales from franchised outlets comprise nearly forty-five percent (45%) of all retail sales in the United States, estimated at over $800 billion and employing some 8 million people in 1996. Notwithstanding these impressive figures, franchising as a method of marketing and distributing products and services is really only appropriate for certain kinds of companies. Despite the favorable media attention which franchising has received over the past few years, this strategy is not for everyone. This is because there are a host of legal and business prerequisites that must be satisfied before any company can seriously consider franchising as a method for rapid expansion.

Many companies prematurely select franchising as a growth alternative and then haphazardly assemble and launch the franchising program. Other companies are urged to franchise by unqualified consultants or advisors that may be more interested in professional fees that in the long-term success of the franchising program. This has caused financial distress and failure at both the growing company and franchisee level, usually resulting in litigation. Current and future members of the franchising community must be urged to take a responsible view towards the creation and development of their franchising programs.

Reasons for Franchising

There are a wide variety of reasons cited by successful growing companies as to why franchising has been selected as a method of growth and distribution. These reasons include:

• Obtain operating efficiencies and economies of scale;
• Achieve more rapid market penetration at a lower capital cost;
• Reach the targeted consumer more effectively through cooperative advertising and promotion;
• Sell products and services to a dedicated distributor network;
• Replace the need for internal personnel with motivated owner/operators; and
• Shift the primary responsibility for site selection, employee training and personnel management, local advertising and other administrative concerns to the franchisee, licensee or joint venture partner with the guidance or assistance of the growing company.

In the typical franchising relationship, the franchisee shares the risk of expanding the market share of the growing company by committing its capital and resources to the development of satellite locations modeled after the proprietary business format of the growing company. The risk of business failure of the growing company is further reduced by the improvement in competitive position, reduced vulnerability to cyclical fluctuations, the existence of a captive market for the growing company's proprietary products and services (due to the network of franchisees) and the reduced administrative and overhead costs enjoyed by a growing company.

Strategic Prerequisites to Launching a Franchising Program

The most important strategic prerequisite for the success of any business format franchise system is the operation and management of a successful prototype. This prototype location is where all operating problems must be resolved; recipes and new products tested; equipment and design decisions made; management and marketing techniques tested; a trade identity and goodwill established; and financial viability proven. It is not enough to have a prototype unit is "somewhat similar" to the system and format which will be franchised. The prototype should be as close as possible to an exact replica of the franchisee's location. In short, the franchisor is selling a tried and tested package to a franchisee, and the contents of that package must be clearly identified prior to sale.

The concept of a system or prescribed business format which is operated pursuant to a uniform and consistent trade identity and image is at the heart of a successful franchising program. Therefore, a prospective franchisor must be able to reduce all aspects of running the business to be franchised into an operations and training manual for use by franchisees in the day to day operation of their business. These systems must be adequately and clearly communicated in the initial and ongoing training program. If a company offers services that are highly personalized or a product that is difficult to reproduce, then franchising may not be the most viable alternative for growth because of the difficulty in replicating these systems or products in the operators manual or in the training program. Similarly, if all the "kinks" in the system have not yet been worked out, it is probably premature to consider franchising.

There are a number of other important business and strategic factors that must be considered before franchising. First, franchising should not be viewed as a solution to under- capitalization or as a "get rich quick" scheme. While it is true that franchising is less capital intensive than construction of additional company-owned sites, the initial start-up costs for legal, accounting, and consulting fees can be extensive. Secondly, franchisors must view franchising as the establishment of a series of long-term relationships, and the ongoing success of the company as a franchisor will depend on the harmony of these relationships. A field support staff must be built to provide ongoing services to the existing franchisees, as well as to maintain quality control and uniformity throughout the system. New products and services must be developed so that the franchisee can continue to compete with others in its local market. Innovative sales and marketing strategies must be continually developed to attract new customers and retain existing patrons of the franchised outlet. If the franchisor expects the franchisee to continue to make its royalty payment on gross sales each week, then an array of valuable support services must be provided on an ongoing basis to meet the franchisee's changing needs.

The Foundation for Franchising

Responsible franchising is the only way that growing companies and franchisees will be able to harmoniously co-exist in the 21st century. Responsible franchising means that there must be a secure foundation from which the franchising program is launched. Any company considering franchising as a method of growth and distribution or any individual considering franchising as a method of getting into business must understand the components of this foundation. The key components of this foundation are as follows:

• A proven prototype location (or chain of stores) which will serve as a basis for the franchising program. The store or stores must have been tested, refined and operated successfully and be consistently profitable. The success of the prototype should not be too dependent on the physical presence or specific expertise of the founders of the system;
• A strong management team made up of internal officers and directors (as well as qualified consultants) who understand both the particular industry in which the company operates as well as the legal and business aspects of franchising as a method of expansion;
• Sufficient capitalization to launch and sustain the franchising program to ensure that capital is available for the growing company to provide both initial as well as ongoing support and assistance to franchisees (a lack of a well-prepared business plan and adequate capital structure is often the principal cause of demise of many early-stage franchisors);
• A distinctive and protected trade identity which includes federal and state registered trademarks as well as a uniform trade appearance, signage, slogans, trade dress and overall image;
• Proprietary and proven methods of operation and management which can be reduced to writing in a comprehensive operations manual, not be too easily duplicated by competitors, be able to maintain its value to the franchisees over an extended period of time and be enforced through clearly drafted and objective quality control standards;
• Comprehensive training program for franchisees - both at the company's headquarters and on-site at the franchisee's proposed location at the outset of the relationship and on an ongoing basis;
• Field support staff who are skilled trainers and communicators who must be available to visit, inspect and periodically assist franchisees, as well as monitor quality control standards;
• A set of comprehensive legal documents that reflect the company's business strategies and operating policies. Offering documents must be prepared in accordance with applicable federal and state disclosure laws and franchise agreements should strike a delicate balance between the rights and obligations of growing company and franchisee;
• A demonstrated market demand for the products and services developed by the growing company that will be distributed through the franchisees. The growing company's products and services should meet certain minimum quality standards, not be subject to rapid shifts in consumer preferences (e.g. fads) and be proprietary in nature. Market research and analysis should be sensitive to trends in the economy and specific industry, the plans of direct and indirect competitors and shifts in consumer preferences;
• A set of carefully developed set of uniform site selection criteria and architectural standards that can be readily and affordably secured in today's competitive real estate market;
• A genuine understanding of the competition (both direct and indirect) that the growing company will face in marketing and selling franchises to prospective franchisees as well as that franchisee will face when marketing products and services;
• Relationships with suppliers, lenders, real estate, developers, and related key resources as part of the operations manual and system;
• Each growing company should develop a franchisee profile and screening system in order to identify the minimum financial qualifications, business acumen and understanding of the industry that will be required to be a successful franchisee;
• An effective system of reporting and recordkeeping to maintain the performance of the franchisees and ensure that royalties are reported accurately and paid promptly;
• Research and Development capabilities for the introduction of new products and services on an ongoing basis to consumers through the franchised network;
• A communication system which facilitates a continuing and open dialogue with the franchisees, and as a result reduces the chances for conflict and litigation with the franchise network; and
• National, regional and local advertising, marketing and public relations programs designed to recruit prospective franchisees as well as consumers to the sites operated by franchisees.