EXPANDING A BUSINESS BY FRANCHISING

EXPANDING A BUSINESS BY FRANCHISING

? DLA Piper US LLP This article is reprinted by permission of DLA Piper US LLP

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TABLE OF CONTENTS

I. INTRODUCTION ...............................................................................................................1 A. The Origins of Franchising ......................................................................................1 B. Modern Franchising .................................................................................................6 C. Types of Franchise Relationships ..........................................................................11 1. Introduction................................................................................................11 2. Product Franchises and Selective Distribution ..........................................16 3. Business Format Franchises.......................................................................17 4. Manufacturing Licenses.............................................................................18 5. The Conversion Franchise .........................................................................19 6. Quasi Franchise Relationships...................................................................20 7. Single Outlet and Area Franchises.............................................................21 a. Single and Multiple Outlet Franchising.........................................21 b. Area Development Franchising .....................................................22 c. Subfranchising ...............................................................................24 d. Area Representation.......................................................................26 8. Area Franchising Considerations...............................................................27 D. The Economic and Financial Relationships of Franchisors and Franchisees ........29 1. General Economic and Financial Characterisits of Franchising................29 2. The Franchisor as a Supplier of Intangibles and Services .........................30 3. The Franchisor as Supplier of Tangible Products......................................31 4. The Franchisor as a Source of Capital ......................................................32 5. The Franchisor as Landlor .........................................................................32 E. In What Ways Can Franchising Be a Superior Expansion Method.......................32 1. Benefits related to capital furnished by franchisees ..................................33 a. Rapid expansion of the franchise network.....................................33 b. Franchisees share risk of expansion of the franchise network.......35 c. A franchising company can realize a higher return on its capital..35 d. Franchise networks can realize economies achieved by company-owner outlets through joint procurement.......................36 e. Reacquisition of franchised business .............................................36 2. Benefits related to the motivated management of franchised outlets ........33 a. Franchisees are motivated owner-managers ..................................36 b. Franchisees are idea/information resources to a franchisor...........37 c. A franchising company has a simpler and more efficient management structure ....................................................................38 d. Franchising offers opportunities for employees to acquire franchises .......................................................................................38 3. Personal Satisfaction..................................................................................39 4. Franchising from perspective of the Franchisee ........................................39 F. Significant Elements of a Business Format Franchise...........................................32 1. Trademarks and Trade Dress .....................................................................41 2. Business Format and Operating System ....................................................44 3. Site Selection and Business Facility Development....................................46 4. Advertising and Marketing ........................................................................47 5. Training......................................................................................................47 6. Continuing Assistance and Guidance ........................................................48

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7. System Standards .......................................................................................49 8. Term Renewal and Transfer.......................................................................51 9. Other Significant Terms and Conditions ...................................................53 10. Fees ............................................................................................................53 G. A Comparison of Alternative Distribution Structures with Franchising ...............55 1. The Vertically Integrated Chain.................................................................56 2. Joint Ventures ............................................................................................62 3. Independent Dealerships............................................................................64 4. Cooperatives ..............................................................................................64 5. The Internet................................................................................................66

II. SIGNIFICANT ELEMENTS OF THE FRANCHISE RELATIONSHIP...........................9 A. Introduction..............................................................................................................9 B. The Decision to Expand by Franchising................................................................71 1. The Decision to Expand.............................................................................71 2. Expansion Methods....................................................................................71 3. Sound Concept ...........................................................................................73 4. Ready to Franchise.....................................................................................74 a. Prototypes ......................................................................................74 b. Financial Criteria ...........................................................................76 c. Business Plan .................................................................................76 d. Sufficient Capital ...........................................................................78 e. Capable Management.....................................................................79 C. Grow The Franchise Network with the Right People, In the Right Places and At a Manageable Rate............................................................................................80 1. Selecting High Potential Franchisees.........................................................80 a. Core Values and Other Characteristics ..........................................82 b. Recruit High Potential Franchisees................................................84 c. Evaluating Prospective Franchisees...............................................85 d. Do Not Mislead Prospective Franchisees ......................................86 e. Grant Franchises - Don't Sell Them...............................................86 2. Developing Leads to Prospective Franchisees...........................................87 a. The Internet....................................................................................87 b. Printed and Other Sales Materials..................................................90 c. Existing Franchisees ......................................................................92 d. Referral Networks..........................................................................93 e. Public Relations .............................................................................95 f. Evaluating Lead Sources................................................................95 g. Be Responsive................................................................................96 h. Support of Franchisees...................................................................98 i. Expand At a Manageable Rate.......................................................99 D. Building and Maintaining Cooperative Franchise Relationships ........................101 1. A Brief Analysis of the Franchise Relationship ......................................101 2. Current Franchisor Thinking....................................................................102 3. The Critical Role of Franchisor Management .........................................104 4. The Profile of Current Franchisees ..........................................................105 5. The Importance of Trust ..........................................................................106

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6. Ending Wrong Relationships ...................................................................107 E. Effectively Documented Franchise Relationship.................................................108

1. Franchise Documents...............................................................................108 2. Uniform Franchise Offering Circulars and Franchise Sales

Materials ..................................................................................................108 3. Operations Manuals .................................................................................109 F. Collaborative Relationships With Franchisees ....................................................114 1. Franchisor Atitudes and Actions..............................................................114 2. Respect and Responde to Franchisee Concerns.......................................115 3. Franchise Experience and Innovation......................................................116 4. Negotiation With Franchisees..................................................................117 G. Communication....................................................................................................118 1. The Role of Communication....................................................................118 2. Effective Communication ........................................................................119 3. How Do Franchisees Regard the Franchisor ...........................................119 4. Intranets....................................................................................................120 H. Franchisee Advisory Councils and Associations.................................................121 1. Advisory Councils ...................................................................................121 2. Franchise Associations.............................................................................122 3. Working With an Advisory Council or Association................................125 I. Furnishing Valuable Services to Franchisees ......................................................126 1. Operating System and Services ...............................................................127 2. Site Selection and Development ..............................................................128 3. Training....................................................................................................132

a. Training Programs .......................................................................132 b. Training Technologies .................................................................133 J. Advertising and Marketing ..................................................................................134 1. Franchisor Advertising and Marketing ....................................................134 2. Franchisee Advertising and Marketing....................................................135 K. Supply Programs for Franchisees and Restricting the Suppliers from Whom They May Buy...........................................................137 1. Procurement Programs.............................................................................137 2. Supply Source Restrictions ......................................................................138 3. Buying Cooperatives................................................................................139 4. Insurance ..................................................................................................139 5. Cost Reduction.........................................................................................140 L. Field Service and Support....................................................................................141 M. Research and Development..................................................................................144 N. Financial Services and Guidance .........................................................................145 1. The Need for Financial Services..............................................................145 2. Sources of Finance...................................................................................146 3. Franchisor-Lender Relationships .............................................................146 4. Franchisor Credit Enhancement...............................................................147 5. Small Business Administration (SBA) Loans..........................................149 6. Direct Franchisor Financing ....................................................................150 7. Other Types of Financing ........................................................................151 8. Financial Guidance ..................................................................................152

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O. Resale Programs...................................................................................................152 P. Exploit Technology and the Internet....................................................................153

1. Franchise Network Websites ...................................................................153 2. Single vs. Multiple Websites ...................................................................154 3. Business to Consumer Ecommerce Policies ............................................155 4. Intranets and Extranets.............................................................................157 5. Who Owns Electronic Databases.............................................................159 6. Management Software .............................................................................159 Q. System Standards .................................................................................................162 1. Formulating Standards .............................................................................162 2. Avoiding Causes of Noncompliance .......................................................163 3. Inspections ...............................................................................................165 4. Enforcement.............................................................................................166 R. Adapting to Change .............................................................................................167 1. Resistance to Change ...............................................................................167 2. Presentation of the Need for Change .......................................................167 3. Opportunities Arising Out of Change ......................................................169 4. Preparation for Change ............................................................................169 5. Change by the Franchisor ........................................................................170 S. Disclosure Regulation Compliance......................................................................171 T. Audit Programs ....................................................................................................172 1. Purposes of an Audit Program .................................................................173 2. Detecting Underreporting ........................................................................174 3. Audit Procedures......................................................................................176 4. Conducting an Audit ................................................................................176 5. Other uses of Audits.................................................................................177 U. Dispute Resolution...............................................................................................178 1. Effective Dispute Resolution Procedures ................................................178 2. Preparation for Litigation.........................................................................180

a. Documentary Evidence................................................................180 b. Document Retrieval .....................................................................181 c. Monitoring Communications .......................................................182 d. Arbitration and Other Litigation Considerations .........................182

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