'Franchise' is explained in detail and with examples in the Corporate Finance edition of the Herold Financial Dictionary, which you can get from Amazon in Ebook or Paperback edition.
A franchise can be defined in many ways. The definition from the International Franchise Association describes franchising as a means to expand a business so that goods and services can be distributed more effectively via a licensing relationship. The word itself legally means a specific kind of license. Ultimately, franchising refers to the personal relationship which a franchisor maintains with its franchisees.
In this arrangement, the franchisor licenses out its trade name as well as its operating methods, or systematic way of doing business, to a particular franchisee. In exchange for this arrangement, the franchisee pledges to run the business as per the terms of this license. The operating method here refers to the franchisor’s system and way of doing business.
Franchisors guarantee their franchisees will have their support and help. They also maintain a certain level of control over specific parts of the franchisee business. This is critical for the franchise owner to safeguard its intellectual property rights as well as to be certain that the franchisee keeps to the guidelines of the brand itself. The quid pro quo of this is that the franchisee typically delivers a one time start up fee (known as the franchise fee) to the franchisor. The franchisees also pay a royalty fee to the franchisor, which is periodic and continuous. This enables the franchisee to utilize the franchisor’s operating system and trade name.
The franchisor itself carries little responsibility for involvement in the daily management of the business of the franchisee. This is because franchisees exist as independent operators. Neither are they joint employers with their franchisors. This gives the franchisees a free hand in hiring employees, paying them according to their wishes, scheduling their shifts as they see fit, arranging their employment rules and practices, and even disciplining their own employees, all without requiring any approval from their franchisor. However, the uniforms which the employees wear will be stipulated by the brand and operating system of the franchisor.
Franchising is about a contractually defined relationship between the two parties. The franchisees and franchisor will share the brand in common. Despite this, both are distinctly separate businesses in both real terms and legally. The role of the franchisor is simply to build up its business and brand as part of supporting the various franchisees. The part which the franchisees play is to operate and manage their own business according to the specific terms of the franchise agreements.
It is interesting that definitions of franchises range from one state to the next according to the various laws which different states enforce. Some states include among the various elements of franchising the responsibilities of the franchisor to deliver a marketing plan to its franchisees. Others insist that the franchisor maintain an interested community of the business jointly with the franchisee.
Business Format Franchises are the most readily recognizable types of these arrangements for the everyday individual. These relationships typically cover the whole of the business and its format, not only the products, services, and trade name of the franchisor in question. In this common type, franchisors are expected to give their franchisees training, operating manuals, standards for the brand, a marketing plan and strategy to carry it out, quality control monitoring, and more.
Examples of the idea make these distinctions clear. Pizza Hut does not license out pizzas or breadsticks. Burger King does not license out hamburgers or chicken sandwiches. The two mega franchise operations instead license out components of their intellectual property. In this case it includes both their business systems and their trade marks, or their ways of producing these food items and company-described premises and atmosphere.
The history of these and other brands demonstrates that both services and products have changed significantly over the decades. Among the various advantages to these types of business format franchises and their arrangements is that they have the flexibility to do so effectively.
Today there exist numerous kinds of franchises throughout a constantly expanding array of industries and market segments in not only the United States and Canada but around the globe. Estimates state that more than 120 separate industries utilize the concept and practices of franchising now. The greatest share of franchising by far is still the food and restaurants businesses. Nowadays even medical services and home based health care rely on franchising though.