Franchising Defined and As Compared to Other Business Relationships

What is franchising? What is a franchise?

• If Franchisor has a well-recognized Trademark and reputation, then Franchisees normally will enjoy almost instant customer goodwill on start-up. Uniformity in outlet appearance, operating methodology and products offered allows Franchisees to compete successfully against both single stores and large chain store operations.
• If Franchisor has an established, successful business model, then a Franchisee can use that model and Franchisor's expertise to avoid many of the risks of starting up a new business.
• Franchisees usually enjoy many of the benefits of combining their collective purchasing power with that of Franchisor to undertake advertising and promotional programs that would be prohibitively expensive for the independent store owner. Similarly, Franchisees usually enjoy many of the benefits of combining their collective purchasing power with that of Franchisor to obtain more favorable pricing for goods and services than is available to the independent store owner.
• Franchisees can take effective advantage of the continuing training that most Franchisors provide in how to operate a profitable franchised outlet, and the troubleshooting expertise of Franchisor should operational problems arise.
• Franchisees can take effective advantage of the market and product research and development that most Franchisors conduct and make available to their Franchisees.

• Franchisor earns a lower income stream from the franchised outlets compared to that earned by the owner of a comparable chain store operation.
• Start-up Franchisors need to sell franchises quickly to establish the credibility of the system, yet most have considerable difficulty finding suitable Franchisee candidates.  As a result, they relax their criteria and admit unsuitable candidates who later become disgruntled, or who cause widespread dissatisfaction by operating at substandard levels, or who incite other Franchisees to revolt and leave the system.
• Unlike the owner of a chain store operation, Franchisor has much less ability to control vital aspects of the Franchised Businesses, which significantly restricts the ability of the franchise system to respond quickly to competitive initiatives and changing markets.
• Although the franchise agreement normally contains clauses entitling Franchisor to terminate the franchise for a variety of causes, the legal process provides Franchisees with a broad array of legal weaponry which they can use to frustrate Franchisor's effort to terminate.
• Unlike the owner of a chain store operation, Franchisor must comply with the licensing requirements of the Trade-marks Act, and in many North American jurisdictions with statutory restrictions on the sale of franchises and the continuing franchise relationship.
• The Franchise Agreement usually contains clauses greatly restricting Franchisee's use and disclosure of Franchisor's trade secrets and confidential information and prohibiting Franchisee from engaging in competing activity both while the relationship continues and, to a limited extent, after the relationship ends.  The enforceability of such clauses is often uncertain, and Franchisors face a risk that their Franchisees may become competitors after the relationship ends.

Franchising also has disadvantages to Franchisee.

• Franchising is not for the individual who is too entrepreneurial, for s/he will soon chafe unbearably under the extensive controls imposed by Franchisor. Similarly, franchising is not for the individual who is overly dependent on Franchisor's assistance and control to succeed.
• Franchisees cannot use Franchisor's Trademark, know-how and systems for free: the individual who could likely succeed without the assistance of these could operate much more profitably as an independent.
• Franchisees often must invest significant "sweat equity" in their Franchised Businesses. In many systems Franchisees must work their outlets "hands on" for long hours, seven days a week, at low margins.
Franchisees must accept the significant restrictions which Franchisors impose on selling their franchises or involving others as additional owners of their franchises.
• It is often difficult for prospective Franchisees to adequately assess a franchise system, its Franchisor and the mind-set of Franchisor's senior managers.

What is the difference between franchising and other types of distribution arrangements?

Many different distribution arrangements share certain characteristics with franchises and in some cases may be difficult to distinguish from a franchise. These include Sales Agency, Dealership, Distributorship and other intellectual property licensing agreements. Notwithstanding, the distinction between these arrangements and a franchise, like a franchise in each of these arrangements the parties are independent contractors, each having no authority to bind the other contracting party.  

Often the parties to these arrangements use different terminology to describe themselves, their relationship and the contract governing the relationship.  For example, parties to a distribution arrangement may title their contract "Dealer Agreement", "Distributor Agreement", "Sales Agency Agreement", "Sales Representation Agreement", License Agreement" or a variety of other titles, and in the contract may refer to themselves as "Distributor/Dealer", "Seller/Distributor", "Manufacturer/Sales Agent", "Licensor/Licensee" or a variety of other titles and combinations.  But the names by which the parties choose to call themselves or their contract are not determinative of their relationship: what counts is the legal substance of their relationship, and that can be determined only by examination and analysis of the contract.  As Shakespeare said, "What's in a name? That which we call a rose would by any other name smell as sweet."

In a Sales Agency arrangement one person (the "Sales Agent") sells goods supplied by another person (the "Supplier") to end users for the Supplier's account, title to the goods passing directly from Supplier to end user through the agency of the Sales Agent. Usually, the Supplier delivers the sold goods directly to the end user, although in some arrangements the Sales Agent may assume this obligation, maintaining a stock of goods on hand. The Supplier usually compensates the Sales Agent on a fixed or variable commission basis and (less often) may reimburse the Sales Agent for expenses it incurs.

In a Dealership arrangement one person (the "Dealer") also sells goods supplied by another person (the "Supplier") to end users, but now for the Dealer's account, title to the goods passing from Supplier to Dealer, and then from the Dealer to the end user upon resale by the Dealer. Normally the Dealer maintains a stock of the goods, but sometimes the Supplier will drop ship the goods directly to the end user on behalf of the Dealer. The Dealer generates profit by marking up the goods it resells and is responsible for expenses it incurs. Although Dealers in a Dealer network may share some common characteristics with each other and the Supplier, normally each Dealer adopts its own business style and image, displaying the Supplier's Trademark only in a secondary manner (e.g., on the goods, their packaging or point of sale advertising). Dealers may carry the goods of several different Suppliers or just a single Supplier; in the latter case it may be difficult to distinguish the Dealership arrangement from a product franchise.

A Distributorship arrangement is similar to a Dealership arrangement except that in this case one person (the “Distributor”) buys the goods from the Supplier for sale in quantity to Dealers or to one or more other Distributors at a lower distribution level, rather than for sale at retail to end users. As in a Dealership arrangement, a Distributor usually adopts its own business style and image, the Supplier's Trade-mark appearing only in a secondary manner on the goods or packaging and the Distributor's advertising material.

In a "simple" intellectual property Licensing arrangement (despite the name such arrangements can be quite complex), the owner of intellectual property such as a patent, trademark or know-how (the "Licensor") grants another person (the "Licensee") the right to use the intellectual property to make, use and/or sell goods for the Licensee's own account. Typically, the Licensee pays the Licensor a royalty based on production, sales or on some other formula basis. Common "simple" Licensing arrangements include:

• One-on-one Trade-mark Licensing, where the Licensee manufactures Trade-marked goods in accordance with the Licensor's specifications.
• Collateral product Licensing, where the Licensor's Trademark, which is well-known in one context (e.g. a soft drink), is licensed for use in a different context (e.g. cups or other decorative items embossed with the Trade-mark).
• Cross-licensing, where two or more Licensors license each other to use some or all their respective intellectual property in order to take advantage of available synergies.
• Licensing entered into during the course of settlement negotiations in infringement litigation, where the Licensor will grant the alleged infringer a license to use the intellectual property mark for a specified time period.

What are the basic elements of a business format franchise?

The basic elements of a business format franchise comprise:

• a system of operations and merchandising developed and maintained by a Franchisor in association with an identifiable trade name or Trademark.
• the grant by a Franchisor to a Franchisee of the right to: i) operate its business in accordance with Franchisor’s system and standardized format; and ii) identify with Franchisor’s trade name or Trademark; and
• a contractual relationship between Franchisor and Franchisee outlining each party’s respective rights and obligations, usually including the obligations of Franchisee both to operate the Franchised Business within the system parameters established by Franchisor and to pay to Franchisor certain fees in consideration for the right to utilize the system and the trade name or Trademark.

What are the types of franchising?

It is possible to structure a franchise arrangement which combines different elements of the three subcategories of business format franchise. For example, Franchisor may permit the Subfranchisor to develop and operate its own outlets, thereby hybridizing subfranchising and unit franchising. Other interesting hybrids are possible.

Variations of unit franchising