Have you played with a puzzle before? Then you must agree with the phrase – the beginning is always the hardest part. It is the same with everything. Getting a business started does give every newcomer in the industry a headache. A bunch of questions go through your mind when it is time to take your first step – what is the most important thing to do? How should I do it? And you wish you knew all the answers.
Actually you can steal the know-how of running a business from somebody else who is well-known and successful in the market. This is known as franchising. It paves the way for the success of your new business. Basically, franchising does almost everything for you. It attracts consumers, demonstrates your ability to engage them and ease the eventual purchase.
I would like to share some essential tips on getting into franchising and I learnt it from one of my webinar speakers, Ms. Geetha from KASS International Sdn. Bhd.
WHAT ARE YOU GETTING YOURSELF INTO?
Franchising is cloning a business that has a similar look, feel, and concept with the initial business in different geographic areas of a country or in different countries. The initial business is known as the Franchisor’s business while the cloned business is known as Franchisee’s business. To simplify it, a Franchisee’s business is identical to the Franchisor’s business.
In order to achieve high visibility in the market, many businesses will either have a franchise system or open chain stores. Chain stores are retail stores in different parts of the nation or abroad that operate under the same company.
It is a good strategy to increase brand exposure but is very costly. You can do so if you have a lot of money in hand, but if you do not want to add the burden on your operating expenses, a franchise is the business model you are looking for. In fact, some big brands went viral because of their franchisee’s businesses operating everywhere, such as Starbucks and Mc Donald’s.
Franchise business is regulated in Malaysia and in many other countries like Australia, China, the United States and more than 30 countries around the world. It means that there is a legal act of Franchise that every franchisor and franchisee should mutually agree upon and obey.
In Malaysia, the act is named the Malaysian Franchise Act 1998 and its purpose is to protect the welfare of the franchisee because the franchisee has to pay a large amount of money to the franchisor for getting all those rights and know-how of doing business.
THE WORKING MECHANICS OF A FRANCHISE
Licensing means giving permission to certain intellectual rights that are owned by your business to the third party. Normally those intellectual rights include trademarks, patents, industrial design, and copyright. For example, a company gives another party the right to using his brand name.
When you give license to others, you can add on some terms and conditions such as your given trademark can only be used in specific services. Its aim is to ensure that the party you licensed it to will not affect your own business. You can only give permission on the rights or technologies that you own or have a monopoly on and the other party can use it to do whatever they want but within the terms and conditions.
To cite an example, a businessman approaches a famous apparel-selling company and is interested in using the brand name but he wants to sell his own-made accessories; in this case, using the same brand for different products or services is licensing, not a franchise.
Agency or an agent refers to the middle person between the principal (the main company) and the end client. The agent is acting for or on behalf of the principal. Insurance agents, for example, introduce the product to the client and the final purchase is done with the principal. The agent is just assisting with the process of business such as advising customers on the products or services available and explaining the features of the products. They make money by getting commissions based on the sales generated.
The risk of business arrangements for the agent is the lowest among the four business models we have discussed because the eventual purchase is done with the principal whilst the agent is only responsible for introducing and explaining the product.
3. Distribution agreements
A distribution agreement works when one party distributes the products of another party. The relationship in making final purchases is between the distributor and the end client. It has nothing to do with the principal (main business) although there is a middle person involved.
In the agreement, you can request for exclusive distribution rights from the principal. Exclusive distribution rights make you become the only party that can sell a product in that specific country. This is to prevent other companies from coming in and taking your business away.
The working mechanics is that you buy the product from elsewhere and you sell it to other parties, generating the profit by having a mark up of the product’s price. The risk of being a distributor is higher than the agent because distributors are responsible for warranties and refunds of the product.
Like I mentioned before, when one party adopts a successful business model of another under terms and conditions, it is called franchising. Franchising takes on a rather a bigger picture than the other business models we have discussed above. Licensing is one of the subsets of franchising. The franchisor gives the franchisee not only the trademark but also the operation manual, training manuals, business strategies, the materials and teaching the know-how of the product.
The franchisee usually has certain conditions to buy equipment or raw materials from the franchisor or his nominee (tie-in clauses). For instance, the franchisee of Coffee Bean &Tea Leaf only can buy and use the coffee beans that are used by the initial business. This is also a way for the franchisor to make money.
The risk of being a franchisee is even higher than that of the franchisor because the franchisee has the exact same operation manner as the franchisor, providing products or services to the end client. So the franchisee has to take full responsibility to sort out every issue that happens at his store.
Although franchising is risky, you have a full set of guidelines to teach you how to solve problems and support from the franchisor. Since franchising uses a tried and tested method, it makes you start your business a lot easier.
There are two types of payment methods for franchising. Upfront franchise rights payment is a one-time payment where the franchisee clears all the fees required. A periodic payment is often based on sales volume subject to a guaranteed minimum amount and it lessens the burden of franchisees who do not have enough money to clear all the fees at once.
Whether you are a franchisor or franchisee, you have to know about a few basic regulations stated in the Malaysia Franchise Act 1998. First and foremost, any sale and purchase of the franchise from in or outside the country must be registered if the business franchised is carried out in Malaysia.
Secondly, your franchise agreement should contain certain conditions in order to make your agreement take effect. You do not need to be too worried because the act states detailed procedures for registration of franchise businesses to guide you in drafting the agreement.
Thirdly, the act specifies how the parties’ conduct and terminate the franchise agreement, any offenses, and penalties as well as the enforcement of the Act.
ADVANTAGES AND DISADVANTAGES
As a franchisor or franchisee, there are plenty of reasons why you should go for franchising. Yet, to be frank, it does have a dark side, like a double-edged sword. Hence, it is good for you to know the reasons why you shouldn’t go into franchising.
Advantages of the Franchisor
1. Franchising allows you to increase the number of outlets with minimum capital outlay. You don’t need to spend on operation expenses of the new outlet such as rental, renovation, electricity, etc. You do have to provide materials and training but you do get paid for it. With the increase of outlets, it accelerates your network’s growth and profitability.
2. Franchisees are the best resource to help your business grow in comparison to managers of chained stores. According to a research in the UK, franchised outlets generate up to 40% higher level of sales than a managed outlet. Franchisees are independent and creative business people. They have their own thoughts on how to run a business while a manager’s expertise only mainly lies in managing human resources. Plus, salaried managers are less motivated or committed than self-employed franchisees.
3. Your business’s human resource problems will be lessened due to the smaller number of staff. Franchisees and their staff do not count as your staff so you can open more outlets with fewer staff responsibilities.
4. You have a greater degree of operational consistency. It is kind of hard to maintain the quality of your product or staff when you have many chained outlets. Yet you do not need to worry about quality control if you are the franchisor. Your franchisees will have to follow the training and operation manuals provided to conduct the business according to your standards and regulations.
Disadvantages of the Franchisor
1. You have to accept your new role as a business advisor.
Your role changes, you are no longer a business owner only but an advisor as well. You are not only managing your own staff, but you also have to control and coordinate a network of semi-independent businessmen and ensure that they build and maintain a favorable image for the whole franchised operation.
2. Policing and monitoring of standards by the franchisor.
Due to the nature of semi-independent franchisees, they almost always have strong personal viewpoints. In this case, using the “carrot and stick” method to obtain the desired performance is vital. “Carrot and stick” means that you have to make yourself a stick to the franchisees by using the agreement to make sure the franchisees gain high revenue if they do well. This advantages you as you end up gaining high loyalty. On the other hand, you can pull back your franchise if they continually fail to obtain ideal results.
3. Ensuring franchisees do not under-report their turnover.
This is exclusively for those franchisees taking periodic payments because their payment is based on sales volume. This is likely to affect their loyalty and as a franchisor, you have the right to proper auditing of the franchisees’ operation to prevent this from happening.
4. You will probably face relationship challenges when the two parties are lacking in trust and control.
Advantages of the Franchisee
1. You still own a business although it is buying from a third party.
You have your own stores, machines, staff, and other tangible assets. The only difference between this and a self-built business is that you are selling somebody else’s product.
2. You can sell the business back to the franchisor or to a third party when you do not want to continue running or think that you are not capable of doing it anymore, yet this is subject to the conditions in the agreement. This is to protect the franchisor as well because the franchisor is not likely to hand their business to someone who cannot handle its operations.
3. Franchisee learns a business model that is proven to be a success.
You are able to understand how to run a business, how to manage the staff, how to produce a product and literally everything from another’s experience when you are absolutely fresh to the industry. Although there are intellectual rights that belong to another, you have learned something that you can start a business using the same model in years to come.
4. Small chance of failure.
This is the most advantageous point. You are actually using another’s tested method, reputation, and existing consumers to build your own business. Research in the UK showed over 25% of ordinary businesses fail but less than 5% of franchised outlets fail.
5. You can quickly start running your business if you pick up the training and guidelines in a short period of time. Since the learning curve is short, you have to spend the high start-up costs. This could be a disadvantage, but you do not need to gradually build up your business and instantly start running it.
6. Enjoy international, national or regional promotions and advertising campaigns.
In some franchise agreements, there is a condition where you need to pay a 2% fee for the brand promotions and advertising campaigns. You no need to think of the advertising and promoting strategy but your franchisor does it for you.
7. Your financing is easier than new self-built business.
Banks are more willing to lend money to a known brand. Many new start-up businesses suffer while trying to get loans from banks but you are free of this problem if you choose to run a franchise.
8. Your relationships with suppliers have been established by the franchisor.
Same as banks, the suppliers will trust you more although you are purchasing fewer materials or types of equipment. Sometimes you can get discounts that are not usually offered to newcomers.
Disadvantages of the Franchisee
1. You own your business but do not own goodwill.
Goodwill is reputation, concisely the brand value. A business should come attached with some sort of extra value in order to obtain the loyalty of consumers which proves it to be effective. With Starbucks, for example, people are not only buying their coffee, they feel connected to the brand and support it in action. There are people who only buy coffee at Starbucks no matter where they are.
As a franchisee, you are not building a good reputation for your own store even you do well but you are building it for the franchisor. Even though you use another’s reputation to build your business at first, your effort into growing the brand is ultimately for the benefit of another’s brand.
2. The franchisee is not totally independent. You have to take instructions from the franchisor.
Therefore, your creativity is limited; you cannot do something innovative or different from the franchisor’s business. It might confuse the consumers about the concept of the brand. For instance, if one of the McDonald’s outlets is suddenly selling steak, as a consumer, you might feel weird and confused as to why the fast-food outlet is selling a different type of food.
3. Lower risk is off-set by lower reward for success.
Your net income will be lower in the first one or two years. You pay lots of money to start a business, so it is hard to completely cover your budget and start earning revenue. And the costs you paid for getting a franchise may be higher than expected. The sum of the money includes the franchise fee, royalties, marketing contributions, product costs, equipment costs, etc.
4. Other franchisees’ bad antics will reflect on the entire brand including your unit franchise.
You are part of the team of the franchise system, your performance affects other unit franchises, and so the others will affect yours too. Consumers will not trust a brand if they have bad experiences in its outlets even if it may not be yours.
ROLE OF INTELLECTUAL PROPERTY IN FRANCHISES
Before you decide to go into franchising, there is one more thing you should understand – the importance of intellectual property in a franchise. Intellectual property is an umbrella term of various types of intellectual property rights, including trademarks, industrial designs, patents, copyright, and trade secrets. These play a crucial role in franchising and there are some examples of how intellectual property comes into franchising.
First of all, intellectual rights give a unique selling point to the franchise and make the franchise stand out from others. The special design or exclusive great idea that is only promoted by your business definitely attracts consumers to spend their money at your outlet. However, in order to get intellectual rights, you have to go through a lot of legal processes and legal documents.
It allows you to get premium pricing which means only you and your franchisor can charge higher prices for the product that is under intellectual rights. Plus, the business cannot be replicated. If somebody else copies your idea, they can be sued.
Besides this, intellectual right is a monopoly owned by the franchisor for a certain period of time. You are allowed intellectual rights from the franchisor and enjoy its specialties for a certain period of time only. In Malaysia, trademarks last for 10 years, design rights last for 25 years and patent rights last for 20 years. You can request for the intellectual rights from the franchisor again when the time lapses.
Written by: Evanna Phoon
This article was first published on 9 January 2018