Exam 16: Licensing, Franchising, and Other Contractual Strategies

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Franchising is an advanced form of licensing in which the focal firm, the franchisor, allows an entrepreneur, the franchisee, the right to use an entire business system in exchange for compensation. As with licensing, an explicit contract defines the terms of the relationship. McDonald's, Subway, Hertz, and FedEx are well-established international franchisors. Others that use franchising to expand abroad include Benetton, Body Shop, Yves Rocher, and Marks & Spencer. Franchising is common in international retailing. However, some retailers such as IKEA and Starbucks have a strong preference for internationalizing through company-owned outlets. Ownership provides these firms with greater control over foreign operations but also typically restricts their ability to expand more rapidly abroad.
Although there are various types of franchising, the most typical arrangement is business format franchising (sometimes called system franchising). The franchisor transfers to the franchisee a total business method, including production and marketing methods, sales systems, procedures, and management know-how, as well as the use of its name and usage rights for products, patents, and trademarks. The franchisor also provides the franchisee with training, ongoing support, incentive programs, and the right to participate in cooperative marketing programs.
In return, the franchisee pays some type of compensation to the franchisor, usually a royalty representing a percentage of the franchisee's revenues. The franchisee may be required to purchase certain equipment and supplies from the franchisor to ensure standardized products and consistent quality.
The advantages of franchising to the franchisee include:
1. Gain a well-known, recognizable brand name;
2. Acquire training and know-how; receive ongoing support from the franchisor;
3. Operate an independent business;
4. Increase likelihood of business success; and
5. Become part of an established international network.
However, franchisees face a number of disadvantages after establishing a business arrangement with a franchisor:
1. Initial investment or royalty payments may be substantial;
2. Franchisee are required to purchase supplies, equipment, and products from the franchisor only;
3. The franchisor holds much power, including superior bargaining power;
4. Franchisor's outlets may proliferate in the region, creating competition for the franchisee; and
5. Franchisor may impose inappropriate technical or managerial systems on the franchisee.