South Africa Franchising Expert Interview
To better understand the franchising concept, Family Business Experts South Africa (FBESA) arranged this South Africa Franchising Expert interview with "Mimi", our franchise expert.
FBESA Q1: WHAT IS FRANCHISING?
MIMI: In simple terms, franchising is the granting of various rights by one party (the franchisor) to another (the franchisee), which are sufficient to enable the franchisee to develop and operate a "clone" of the franchisor's business concept in return for payments to the franchisor. The franchisee then exercises those rights and runs its business under the guidance of the franchisor.
The consumer's perception should be that there is no difference between one of the franchisor's own corporate outlets and a franchised one. The franchisor is licensing the franchisee the right to use its business format; hence the term 'business format franchising'. However, that right to use the business format is for a limited period of time. The franchisee gains no interest in the actual ownership of the format or the associated brand and trademarks. The rights the franchisee enjoys are similar to those of a tenant when leasing a house or commercial property. During the period of the lease the tenant has full enjoyment of the premises, but the day after the expiration of the lease he has no rights over the property at all.
FBESA Q2: WHAT KINDS OF BUSINESSES LEND THEMSELVES TO FRANCHISING
Virtually every business form you can imagine. The International Franchise Association now lists more than 75 different categories to describe its members. Typically, you would think of fast food and restaurants first when thinking of franchising, but franchising covers the spectrum from almost A to Z, from advertising/direct mail to construction to dating services to home inspection to security systems to video sales and rentals. Printing and copying services, maid services, computer services, cleaners, lawn care services, real estate, hotels and motels, and travel agencies are excellent examples of successfully applying franchising to established industries.
FBESA Q3: IS FRANCHISING A TRIED AND TESTED SYSTEM, CAN I POSSIBLY LOOSE MONEY IN A FRANCHISE?
Mimi: Franchising is still a business and by definition there will be some risk. It is therefore important that you do your own due diligence outside the franchise network you are interested in. The Franchisor can give guidelines and show you trends, it is also important you speak to Franchisees already in business and understand the challenges and successes of the franchise.
FBESA Q4: WHAT KIND OF INVESTMENT IS NECESSARY TO BUY A FRANCHISE?
Mimi: Each Franchise is different. What is important is your own contribution made to the business. The Franchisor will give the applicant the guidelines. Some require 35% own contribution and others as high as 50%. I recommend the former because the more you invest in your own money the higher you risk losing your hard earned capital. If the Franchise proves successful, you can increase the repayments and reduce debt to realize better returns.
FBESA Q5: DOES THE FRANCHISOR OWN FRANCHISES THEMSELVES?
Mimi: Some Franchisors are clear of their strategy and opt to leave the business operations up to Franchisees. They will have less than 20% ownership of total stores to use as training stores, in that way they have their finger on the pulse as to market trends. I am always skeptic with Franchisors owning too many stores and they begin to compete for good sites with Franchisees. In this way the collaborative partnership is compromised.
FBESA Q6: HOW FAST CAN I GROW MY FRANCHISE OUTLETS, AND HOW IS THE DECISION MADE?
Mimi: Operational capacity and liquidity will be the main determining factors. There must be the opportunity to expand. Other Franchisor set expansion criteria and these will vary from Franchisor to Franchisor. Growing too fast may be just as risky as growing too fast. Growth must only happen if necessary. Many Franchisors make the mistake of attempting to gain market share through growing the number of outlets. This has its setbacks too as it tends to slow down same store sales. I advise Franchisees to find ways to grow existing outlets organically rather than building more outlets. Spread geographically if there is REAL need.
FBESA Q7: HOW CAN I FRANCHISE MY CURRENT FAMILY BUSINESS?
Mimi: The subtleties of franchising take time to understand and not all businesses can be successfully franchised. Any business must take a long hard look at its business concept and potential for expansion before jumping into franchising. The failure of a franchise can be disastrous not only for the franchisor but also for the franchisees that have invested and joined its network.
STEP ONE: Getting Started
In order for a franchise to stand a chance of succeeding, the basic concept must be a sound one, the franchisor must have sufficient resources to support the growing chain, and the franchisees must be properly managed and supported.
An idea cannot be franchised. In order to franchise a concept it must first be proved to work as a business. The franchisee is paying for the right to use a system that has proved to be successful, not to put someone's bright idea into practice.
Business format franchising can be considered a business system leasing arrangement. The franchisee acquires from the franchisor the license to duplicate the franchisor's existing and successful system of providing a product or service to the end user. The potential franchisor must therefore ask itself whether or not it has anything worth franchising. The right to sell a particular product by itself is not a business format franchise. It is an agency or distributorship that may well prove to be a profitable business in its own right, but it is not a business format franchise.
For a business to be franchisable there must be established knowhow and distinct ways of doing things that distinguish the business from others. Each element of the knowhow taken by itself may not be unique: there are for example only a limited number of ways to grill a hamburger, fry chips and make a milk shake. The combination of them, however, may be unique. When coupled with the franchisor's name and trade marks the business system should be identifiable and distinctive. It is this that will create the value of the franchise by drawing in customers.
The knowhow must be carefully identified and easily communicable. Intensive training courses and an operations manual will therefore be necessary. The potential franchisor must ask itself whether or not the concept in question lends itself to this.
STEP 2: The Legal Audit
Once the potential franchisor is satisfied that there is identifiable, communicable knowhow in the business, it must then carry out a legal audit of its intellectual property assets and make certain that the cornerstone of the franchise – the name, trademarks and other intellectual property rights – do in fact belong to it. A franchisor cannot grant its franchisees the right to use a name and trademarks over which it does not have any properly secured rights.
STEP 3: The Pilot Operation
Once a concept has been developed and its name and marks protected, it follows that it must be tried and tested in the market through a pilot operation. This will further test its profitability as a business for franchisees and allow the potential franchisor to further refine the system on the back of further practical experience.
STEP 4: Funding
Once the concept has been piloted, or indeed before, the potential franchisor must decide how it will make money for itself from franchising the business. Some business modeling with experienced assistance will typically be required. Most banks will fund respectable franchisors and their franchisees with sound concepts and plans.
STEP 5: Legal documentation
Before actively recruiting franchisees, it is essential that good quality legal documentation is prepared by a solicitor experienced in both the legal and commercial subtleties of franchising. This is not just a technical exercise, and a properly thought-through franchise agreement is the foundation of every franchisor's business.
STEP 6: Marketing the Opportunity
Once the franchise has been set up, the finances arranged and the appropriate documentation prepared, it is important to arrange the effective marketing of the franchise to potential franchisees. The best franchises require the least marketing effort. Once potential franchisees have seen outlets running and have had the opportunity to speak to happy and successful existing franchisees, the need to actively sell the franchises will be reduced.
STEP 7: Running the Network
Finally, the potential franchisor must be aware that its own role will change dramatically. It is no longer at the sharp end of the business, working with customers on a day-to-day basis. It should instead be continually developing and improving the system and its network, planning its strategic growth and nurturing and monitoring the franchisees to ensure that the high standards of the system and those associated with the brand are being maintained. Failure to understand and adapt to this change of role will result in both franchisor and franchisees experiencing unnecessary difficulties
FBESA Q8: WHAT FEES ARE PAYABLE BY FRANCHISEES TO THE FRANCHISOR?
Mimi: The fees charged by a franchisor should reflect the commercial bargain between the two parties. Care should be taken that the business remains financially viable for the franchisee and that any upfront fees do not inadvertently starve the franchise of much needed start-up capital investment. Typical payments include:
Development Fee, Exclusivity Fee or Initial Franchise Fee – an upfront fee for granting territorial exclusivity to the franchisee or the right to operate the franchise.
Store Opening Fee – an upfront fee payable on opening each franchised outlet.
Service Fee or Royalty – a percentage of gross turnover, usually payable monthly over the term of the relationship.
Purchase Price for products, equipment and other items supplied by the franchisor to the franchisee.
Marketing Contribution – usually expressed as a percentage of gross turnover, this is a contribution to local, regional or international marketing campaigns the franchisor will develop and run on behalf of the network. In addition, the franchisee may be required to commit to a minimum spend on its own local marketing campaigns.
Training Fees – an amount charged by the franchisor for training the franchisee to operate the business initially, and possibly for periodic training.
Miscellaneous fees – for example equipment lease rentals; software licenses and support fees.
FBESA Q9: CAN A FRANCHISEE TERMINATE THE FRANCHISE AGREEMENT AND WHAT ARE THE REPURCUSSIONS IF ANY?
Mimi: It all depends on the specific circumstances, and legal experts will make the determination. Under normal circumstances, if a Franchisee is opting out of the business, they may choose to sell back to the Franchisor. There is also another option to find a buyer approved by the Franchisor. There are normally clear guidelines enclosed in good franchise agreements.
FBESA Q10: WHAT SUPPORT IS GIVEN BEYOND INITIAL FRANCHISE TRAINING?
Mimi: The Franchisor often stipulate frequent reports that must be sent. This enables the Franchisor to evaluate the state of the business compared to the norm and intervene if necessary. The level of support will also be determined by the experience of the Franchisee. The most experience franchisee gets fewer visits and the least experience more visits.
FBESA Q11: WHAT ARE THE ADVANTAGES AND DISADVANTAGES OF FRANCHISING?
Mimi: From the Franchisee’s Perspective:
(i) The Advantages
The franchisee is the owner of its own business and typically owns the tangible assets of the franchise outlet. What it does not own is the goodwill in the business concept. Like any other business proprietor, the franchisee buys materials, pays rent and staff salaries and takes the profit (or loss) of operation, less royalty and service fees. Some franchisors, actually very few, control the real estate from which the franchised outlets operate.
Subject to various restrictions, the franchisee can sell its business when it wishes (usually subject to the franchisor's pre-emption right and on condition that the purchaser is approved by the franchisor). What makes a franchise business different from any other business is that the newly-franchised business gains from the franchisor the entire business concept with full training, assistance in every aspect of setting up and running the business, and access to necessary materials and supplies.
In essence, the franchisee invests in and operates the developed business concept and it is this, and the franchisor's careful selection of the franchisee, that makes failure of the business less likely.
Obviously the franchisee’s start-up costs entail more than paying the franchisor an up-front fee: it must invest in premises, fittings, equipment, materials and provide working capital until the inward cash flow starts. In addition, it must pay continuing fees to the franchisor: typically an initial fee plus ongoing regular payments to the franchisor in the form of royalties or management services fees or, in some cases, an agreed mark-up on supplies obtained from the franchisor. The brand presentation and profile from which the franchisee benefits by joining a franchised network could only rarely be achieved by an individual small business owner.
(ii) The Disadvantages
The franchisee is not an entirely independent entrepreneur. The franchisee must adopt the franchisor's business system. In the final analysis the franchisee must follow the franchisor's instructions on how to operate the business and present the brand. The lower risk (of start-up business failure) is off-set by the lower reward for success because of the fees paid to the franchisor. Ultimately, the franchise agreement may not be renewed when it ultimately expires, although franchisees are usually able to realize the value they have built up by selling their businesses during the term of the contract.
From the Franchisor’s Perspective:
Every business is different and must assess, with expert help, the pros and cons of using franchising as an expansion or re-engineering strategy. The short summary here is not comprehensive. Please contact us if you would like more information and an assessment for your business.
(i) The Advantages
Franchising allows the franchisor to expand its market penetration for the distribution of its products or services with minimum capital outlay and so accelerate the network's growth and profitability. Major global franchisors have thousands of outlets in many countries. Return on investment ratios tend to be high in well-run international networks, which is one reason why corporates sometimes re-engineer using franchising.
Self-employed individual franchisees are generally more highly motivated and incentivized than salaried managers by the profits from their outlets, and are more likely to produce better results for less expenditure of capital than the franchisor would achieve. Franchisees employ their own staff – which means franchisors' staffs and overheads can be kept leaner, with fewer employment issues. As the franchise network grows it will become easier to handle major national or regional customer accounts.
The local market presence and focus of the franchisee can be critically important – particularly in international expansion into new countries, where a major local company may become the country franchisee, and in territory-based domestic services businesses where franchisees are required to focus on their local patch. Franchisees often come up with excellent business development ideas, and the pooling together of marketing funds enables a group of relatively small businesses to punch significantly above their individual weight in terms of brand promotion and advertising.
(ii) The Disadvantages
The franchisor has to control and coordinate a network of semi-independent businesses and ensure that they build and maintain a favorable image for the whole franchised operation. This means that the franchisor's own role changes drastically. It is no longer simply an operator of its own business. Its principal role is to recruit, train and motivate the right franchisees and grow and develop the performance of the entire network.
The policing and monitoring of standards by the franchisor is vital, although franchisees will understand the need for excellent brand presentation. The franchisor will sometimes have to resort to the use of both carrot and stick mechanisms to get franchises to try new techniques or improve under-performance.
The dynamics of the franchisor-franchisee relationship are such that a lack of trust can on occasions creep in, making life more difficult than it should be. This may be due to personality clashes between the franchisee and members of the franchisor's team, perhaps where a particular franchisee business is not performing, or because the franchisee does not find it easy to live within the constraints imposed by a franchise.
It is the franchisor's duty to minimize tensions and conflicts and ensure that they are satisfactorily dealt with. Learning best practice franchisor management skills from an experts is essential.
While an individual corporately-owned outlet may be more profitable for the franchisor than an individual franchised outlet, the increased number of franchised outlets and reduced corporate overhead will often mean that the franchised business as a whole will be more profitable than one that is entirely corporately owned.
FBESA Q12: ARE THERE SPECIFIC TREDS IN FRANCHISING TO INVEST IN?
Mimi: I recommend attending Franchise Trade shows, reading Business publications. Research the industry you are interested in investing in. This will ensure that you make a well informed decision. As my rule of thumb, good and profitable franchises are rare. I want to emphasize that a trend in one area may not be a trend in the next. Do your own research!
FBESA Q13: IS IT NECESSARY FOR A FRANCHISE TO BELONG TO A FRANCHISE ASSOCIATION?.
Mimi: Being aligned to a franchise association, brands are aligned to an internationally body that adheres not only to international best practices but to the sound business ethics established through the various legislative channels including the Consumer Protection Act. Members can also network with other franchise owners in diverse sectors and have access to affiliate members such as suppliers, consultants, financial institutions and attorneys
FBESA Q14: WHAT ARE FEES AND ROYALTIES?
Mimi: The terms are often used to mean different things by different people. A fee can include the up-front amount paid to the franchisor for the use of their name, know-how, operating systems, etc. This is one component of the overall start-up cost of a new franchise.
Ongoing fees (or royalties) are usually paid to the franchisor for providing ongoing business, management and technical support, etc. This fee may be fixed as a percentage of the franchisee's turnover, which may vary as trading conditions change.
Alternatively, a flat fee may be levied every month irrespective of turnover.
No two franchise systems may have the same fee structure, and some may use a combination of fixed and flat. Fees are most often paid monthly from the franchisee to the franchisor. In addition to the management fees levied by a franchisor, franchisees may also be required to pay into a central advertising or marketing fund, and this may also be done on the basis of percentage or flat contributions on a weekly, monthly or quarterly basis. In South Africa, it is a legal requirement that the Franchisor account on how the funds contributed are utilized by The Franchisor.
FBESA Q15: WHAT HAPPENS IF THERE IS DISPUTE BETWEEN MYSELF AND THE FRANCHISOR?
Mimi: If you have a dispute with your franchisor, you need to identify the underlying issues behind the dispute and attempt to resolve these by mediation. Disputes may occur from a misunderstanding of an aspect of the franchise relationship, which is outlined upfront in the franchise agreement.
Franchisees and franchisors join together in a commercial marriage in which both become stakeholders in each other's businesses and future commercial success. Under the Code, disputes should be settled by mediation, using a mutally agreed third party as a mediator, if no agreement can be reached by direct negotiation. In most cases this will result in a mutually acceptable compromise to solve the problem, and enable the relationship to continue.
Litigation is considered a last resort for extreme dispute cases where mediation has not been successful.
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