Chapter 17

Franchising

The pattern

In Franchising, franchisors sell the right to use their business model to franchisees. The system permits a company to expand its business geographically very quickly without having to muster all the resources itself or carry all the risk (HOW?, VALUE?). Both these functions are handled by the franchisees, who act as independent entrepreneurs and therefore bear responsibility for the majority of all transactions. Franchisees benefit by gaining access to a proven business model with all its performance and differentiating features, such as products, trademarks, equipment and processes (WHAT?).

The entrepreneurial risk involved is much smaller than that of independently developing a novel business idea (WHAT?). Franchisees can take advantage of the franchisor’s expertise, which may include professional development, in-depth process knowledge and brand spill-overs (WHAT?, HOW?). In a best-case scenario, Franchising leads to a win–win situation where franchisors expand their business rapidly and franchisees participate in the profits.

The origins

Franchising was originally developed in medieval France, where it was used primarily by kings to allow third parties to produce specific goods in their name. With the advent of industrialisation, Franchising spread to the private economy as well. The Singer Corporation, founded in 1851, is an American manufacturer and distributor of sewing machines, and one of the first companies to be associated with the Franchising concept. Singer provided sewing machines in a form of franchise to retailers, who were then able to sell them under licence in a specified geographical area. The corporation also offered financial assistance to retailers in order to manufacture and sell sewing machines under licence. In return, the retailers were responsible for training people to use the machines. Singer generated revenue from royalties on the extended sales of the product and benefited from a wider distribution network, which would otherwise have been unattainable on account of prohibitive manufacturing costs.

Fast food giant McDonald’s reached worldwide fame through Franchising with its self-service restaurant chain. Sales representative Ray Kroc was instrumental in making McDonald’s a success story by convincing brothers Richard and Maurice McDonald to let him expand their restaurant countrywide. Upon their agreement, Ray Kroc in subsequent years recruited franchisees and business went so well that in 1961 he bought the rights for the brand from the brothers for US $2.7 million. Kroc went on to transform McDonald’s into the world’s largest restaurant chain and became one of the richest men in the United States. Today, McDonald’s restaurants operate all around the world. Entrepreneurs can apply to become a franchisee and, if accepted, McDonald’s supplies them with the necessary information, equipment and furniture to open a restaurant. Standardisation allows the company to sell the concept as a whole, including processes and products. As franchisor, McDonald’s generates revenue and profits through premiums earned from its large network of worldwide franchisees. The company focuses on its key service to provide competitively priced fast food, reducing costs on waiting staff and other overheads and increasing customer throughput and profit.

Franchising: how the business model works

The innovators

Widely popular in the food and beverage industry, Franchising is applied by a slew of well-known restaurant chains including Subway, Pizza Hut and KFC. Subway, for example, is an American fast food restaurant chain, best known for its ‘submarine’ (sub) sandwiches and salads. Franchisees adopt Subway’s business concept and apply it to restaurants in all sorts of locations worldwide. The menu varies from country to country, enabling Subway to achieve a wider reach and address regional tastes and customs. The company provides the information, premises and support for franchisees to ensure consistent representation of the brand in their chosen territory. For its part, Subway receives royalties from its extensive global network of franchisees and over 40,000 restaurants. Other large international companies that have successfully applied the Franchising concept are Starbucks and 7-Eleven.

The hotel industry also employs Franchising. One of the first companies to do so was Marriott International, founded in 1993. Marriott International is an American company specialising in the hotel and holiday accommodation business. The company manages and franchises facilities within its extensive worldwide portfolio. Marriott provides hotel facilities with a focus on business customers, plus holiday accommodation facilities. The Franchising business model enables Marriott to apply its brand and concept to locations worldwide, providing information, property and the necessary support to its franchisees to ensure standardised branding and consistency of service. Marriott International is paid an application fee by franchisees and receives ongoing royalties during operation. The franchisees also pay a fee for national marketing programmes and the use of Marriott International’s reservation system. Franchising has allowed Marriott International to establish itself successfully in some 130 countries, marking it as one of the largest hotel chains in the world.

Natur House is one of the largest Spanish franchisors, with 1,890 centres worldwide. Through its chain of stores, Natur House provides dietary advice, ongoing consultations and diet plans to its customers, as well as products such as food supplements, healthy food, cosmetics and body care products. Natur House enables franchisees to open up their own stores under the Natur House brand and offer products and advice in the fields of nutrition and dietetics. This is achieved by Licensing (#26) and the provision of ongoing support for franchisees within the chain. Natur House receives an initial payment from franchisees plus annual royalty fees. All in all, the company benefits from a growing identity, thus increasing customers and revenue.

Another successful example of Franchising is offered by Holcim, one of the world’s leading suppliers of cement and aggregates as well as further activities such as ready-mix concrete, asphalt and related services. In 2006, Holcim Indonesia launched an innovative Franchising business model under the name of Solusi Rumah. In line with its tagline ‘Datang bawa mimpi, pulang bawa solusi’ (‘Come with a dream, go home with a solution’), Solusi Rumah offers a one-stop housing solution to the Indonesian home builder by providing architectural services, building materials, access to finance for housing mortgages and/or micro finance and construction and property insurance under the roof of one single retail outlet. Those outlets are run by Holcim’s franchisees, who may be either concrete-product manufacturers or retailers without their own concrete-production activity. Solusi Rumah enables Holcim to expand quickly in the Indonesian market while offering franchisees the possibility to differentiate themselves from local competition by benefiting from Solusi Rumah’s positioning as a high-quality, premium brand. The success of Holcim’s Solusi Rumah business model is impressive: only a few years after its launch, 180 Solusi Rumah stores have been opened in Java, Bali and the southern part of Sumatra – the most populated islands in the country.

When and how to apply Franchising

You should consider the Franchising pattern if you have already built up important assets such as knowledge or brand strength and want to leverage these to grow fast with limited risk.