Developing a Franchise System Correctly

By Michael Seid, Managing Director, MSA Worldwide

Franchising offers an attractive method for many manufacturers, retailers, and service providers to expand their businesses. The principal reason many companies choose to franchise their businesses, is that franchising allows for business expansion with lower capital expenditure that other methods. However, franchising is only one of many expansion alternatives businesses should consider.

Many of the perceived advantages and disadvantages of a franchise system are also found in other methods of distribution. While franchising can be an exceptional method of distribution, for some companies, other methods may be more suitable and advantageous.

Franchising is not the simplistic “sure-fire,” “rapid,” “inexpensive” method of company expansion portrayed by some entrepreneurial media. Conversely, franchising does not have high failure rates, overly burdensome regulations, excessive litigation, or high start-up costs to the extent portrayed in other business publications.

Franchising Your Business

In determining whether franchising is the appropriate expansion method for your business, first consider the advantages and disadvantages of franchising, some of which include:

• control
• motivation
• alternative growth capital sources
• contingent liability
• equity dilution
• market penetration
• trademark enhancement
• collective buying power
• local management
• sources of capital
• program development, maintenance, and management costs
• independence and interdependence
• franchisee relations and franchise legal requirements

These must all be considered before your company commits to the development of a franchise system.

Franchising Feasibility Analysis

Even after considering these issues, your company needs to examine whether your business is ready to franchise. This “franchisability” test (also called a feasibility analysis, or threshold analysis) includes a critical review of a company’s:

• Industry segment
• Existing operating systems
• Marketability of the franchise offering
• Geographic strategy
• Ability to protect its trademark and trade name
• The organization required to franchise
• Obligations of the franchisor and the franchisee
• Training requirements to transfer operational knowledge
• Role and size of field organization
• Alternative methods of expansion
• Prototype development issues
• Sources of franchisor revenue
• Franchise development costs (franchisor and franchisee)
• Financial projections and analysis (franchisor and franchisee)
• Sources and availability of capital

If, after completing the feasibility analysis, the results are positive (that is, franchising, on balance, appears to be the best alternative for the company), the next step is to plan the development of the franchise system.

Franchise Strategic Plan and Strategy

It is important to understand that the franchise system will be your offering, and that the franchise system will guide both franchisor and franchisee to success.

Many franchise packagers advertising in entrepreneurial publications (both legal and consulting) portray franchise development as mainly a legal and marketing process. But the legal documents and marketing materials, while required and necessary to sell franchises, are not sufficient to operate a successful franchise program.

The builder of a successful franchise program needs to follow a detailed business blueprint. This business blueprint, often referred to as a business or franchise strategic plan, examines the issues and makes the determinations needed to implement your franchising strategy.

While each company differs, areas to consider in a franchise strategic plan include:

• Accounting/control/reporting systems
• Advertising/publicity/promotion
• Capital requirements
• Communication
• Cooperatives and buying groups
• Conversion strategy
• Development of internal structural elements – implementation
• Dispute resolution and dispute prevention
• Franchisor field services
• Financial planning and analysis
• Franchisee operations
• Franchisee recruitment and relations
• Franchisee staffing and training
• Franchisor organization and training
• International
• Insurance
• Investment hurdles
• Legal documentation and agreements
• Location –
  • selection
  • acquisition
  • management
• Location construction
• Market research
• Market strategy
• Merchandising
• Management information systems and point of sale systems
• Monitoring mechanisms
• Ongoing services
• Packaging/labeling
• Policy formation

The franchise system you ultimately develop, and the franchisor/franchisee relationships you establish, are all shaped by the determinations your make in your strategic plan. Planning, policies, procedures, ongoing administrative monitoring, and support services are decided upon in your strategic plan.

Your strategic plan gives you, as a franchisor, a basis for the development of franchise program components. Those components include the operations manuals and training programs; operating systems; marketing programs for franchisees and retail customers; fee structure; and required documentation developed by specialized franchise legal counsel.

Franchise System Legal Documents

The last product of your initial strategic development should be the legal documentation of your franchise system. The legal documentation should be based on the determinations made in all other areas of the strategic plan; it spells out the relationship between the parties, and describes the franchise system:

• The Franchise Disclosure Document (FDD) provides prospective franchisees with at least the minimum information required by law and professional practices.
• The Franchise Agreement incorporates these disclosures into the contract between the parties.

While minimum disclosure standards are specified by law, some of the issues addressed in your franchise system legal documentation will include:

• initial and ongoing fees
• franchise terms
• renewal policies
• termination rights
• transfer rights
• assignment rights
• territorial exclusivity
• protection of trademarks, service marks and trade secrets
• lease/sublease policies
• site selection and criteria
• franchisee’s reporting and audit responsibilities
• purchasing requirements
• retail performance
• marketing and advertising

It’s essential that you engage specialized legal counsel with current experience to develop your franchise system’s legal documents, because the laws and practices governing franchising evolve constantly. Your FDD and Franchise Agreement are not the place to trust well-intentioned general practitioners.

Action Plan and Implementation Strategy

Finally, you should develop an Action Plan that organizes and schedules the tasks to be completed in implementing the Plan. Your Action Plan should provide for controls and feedback to ensure a clear direction for your company.

Control over the timing of the plan’s implementation is critical. Your Action Plan needs to ensure that something happens when it needs to happen, so ensure your business plan includes an effective implementation strategy. Lack of an implementation strategy is one of the major causes of strategic drift — without a clear implementation plan, the business planning process is fairly useless as a management tool.

Resources for Franchise System Success

One criticism of a planned strategic development is that it is time-consuming and costly — that it can limit a company’s ability to franchise because the required professional fees limit the capital available to initially operate the system. Nothing could be further from the fact.

As all the resources required are detailed in your feasibility assessment, before the majority of the professional fees and other costs are expended, a planned strategic development protects the franchisor and its future franchisees from being undercapitalized.

The reason that start-up franchisees have a higher success rate than independent start-up companies has little to do with the quality of products or services, ambition and hard work of the owners, or available capital. The reason for this advantage is that when a franchisor follows the process outlined above, their franchisees are better prepared to operate their businesses because the franchisor has provided them with the tools they require to succeed.