How To Franchise · Franchising - what is it? Franchising is a method of marketing goods and services but the term “franchising” has become more widespread with use by business

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Specially prepared international edition

HOW DO I FRANCHISE MY BUSINESS

by Martin Mendelsohn

Special edition for:

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How Do I Franchise My Business

Franchiseek Limited

IntroductionFranchising has established itself as a successful means of business expansion and if structured correctly will maximise the opportunity for success and reduce he risks inherent with starting any new business venture.

There are a number of resources available in each country and it is advisable to contact your local franchise association who can provide you with useful information and advice on franchising in your own country.

www.franchiseek.com provides impartial advice and information on franchising in over 21 countries worldwide. The clear and concise website provides investors the opportunity to identify specific business opportunities and subsequently connect them both through this clear and concise website. The Franchiseek Global Alliance Network currently has 13 members who operate in 14 countries worldwide and can assist with your franchise requirements.

In this handbook, Dr Martin Mendelsohn explains the steps that need to be taken if the new franchisor is to meet with the success it hopefully deserves and, in partnership with its franchisees, develop its franchise system into a position of leadership in the marketplace.

Dr Martin Mendelsohn is a leading authority in international franchising and Franchiseek Limited is honoured to have the opportunity to be able to publish his book as part of our handbook series.

Trevor Hart, Managing Director, Franchiseek Limited

You r Rou te t o a Suc ce s s f u l F ranch i s e…

www.franchiseek.com

Specially prepared international edition

HOW DO I FRANCHISE MY BUSINESS

by Martin Mendelsohn

Special edition for:



Specially Prepared International Edition

HOW DO I FRANCHISE MY BUSINESSBy Martin Mendelsohn

Contents11 Franchising - what is it?

17 What are pyramid and similar schemes?

21 Why Franchise?

25 Why buy a franchise?

29 Developing the business concept through pilot operations

39 Developing the operational manual

45 The financial aspects

55 Developing and marketing the franchise package

67 Selecting the franchisees

75 Developing the franchisor’s organisation

83 The franchise Contract

91 Working at the franchisor/ franchisee relationship

97 Franchise Associations

99 Appendix A The Block Exemption for Vertical Agreements

121 Appendix B World Franchise Council Association members

Published by: Franchiseek Limited 129A High Street Lymington Hampshire SO41 9AQ United Kingdom.

Tel: +44 (0)1590 689755 Web: www.franchiseek.com www.franchise.gb.com email: [email protected]

© 2005 Dr Martin Mendelsohn

All rights reserved. No part of this handbook may be reproduced or transmitted in any form or by any means, electronic or mechanical, including photocopying, recording or using any information storage and retrieval system, without permission in writing from Franchiseek, except that brief passages may be quoted by a reviewer in a magazine, newspaper or broadcast review.

This publication is designed to provide its readers with accurate and authoritive information with regards to the subject matter covered. If legal advice or other expert assistance is required, the services of a competent person should be sought.

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Specially Prepared International Edition

HOW DO I FRANCHISE MY BUSINESSBy Martin Mendelsohn




IntroductionThis book was first published in 1981 following as series of articles in the UK Franchise World publication on which David Acheson and I collaborated. It contains 11 chapters, four of which were added to the series of seven articles.

This international edition is based upon the sixth edition in England although there have been numerous editions published in other countries and in many languages. The Franchise Council of Australia (the franchise association) has published seven editions and the book has been translated and published in a number of other languages and countries. As will be appreciated, this book is not intended to cover the whole subject (for a full treatment see ‘The Guide to Franchising’, seventh edition, published by Thomson Learning which can be obtained from or through a business bookshop.

Davis Acheson moved to Australia some years ago and he and I decided after the fourth edition that the time had come for him to bring his collaboration with me to an end. This was particularly sad for me as David is a good friend of long standing but logistically we were left with little alternative.

The fifth edition was a substantial re-write with the introduction of much new material. In re-organising that edition I blended chapters together, introduced changes in the order of presentation and added new material including two new chapters. In this sixth edition I have revised and added to the material.

The original idea for this book from Robert Riding of Franchise World whose support and encouragement is ever present. Robert’s contribution to franchising in the UK id often under estimated. His original idea has resulted in a book which so far has had a 23-year life, six editions in the UK as well as several editions in Australia and publication in some seven to eight languages which proves the soundness of his judgement. My thanks to my secretary, Julie Woods, for her perseverance in resolving many puzzles set for her by may handwriting.

This edition of the book has been specially prepared for Franchiseek.





Chapter One.

Franchising - what is it?Franchising is a method of marketing goods and services but the term “franchising” has become more widespread with use by business people to describe more than merely the marketing method. It is now popularly used to describe transactions which involve licensing.

Thus, one speaks of a franchise granted for the running of a television station and many business people describe as a franchise what are in reality distributorship and agency arrangements. Franchising has reached the railway system; not that the way in which the UK Government have implemented it does much for the railways or for franchising. Indeed, the grant of a franchise by the Government is more typical of the ancient use of the word in England to describe a grant of rights by the Crown. Indeed, many of those ancient franchises still exist of which the right to hold markets is one.

On a more popular basis, there is character merchandising (often loosely described as franchising) in which a well-known person, or the creator of an invented character, grants franchises (licences) to others, entitling them to make use of a name or a cartoon character.

These basic arrangements are quite common. They have been with us for many years and no change has been made in these traditional relationships which would justify them now being called franchises, rather than continuing to be termed, agency, distributorship or licence agreements.

The more popular business use of the word franchise has arisen from the development of what is called the business format franchise. Some also call it a trade mark/trade name franchise. The former name is preferred because it is so descriptive. It is the business format franchise with which this particular booklet is concerned.



• The business format franchise is the grant of a licence by one person (the franchisor) to another (the franchises), which entitles (and usually requires) the franchisee to carry on business under the trade mark/trade name of the franchisor and in doing so to make use of an entire package (know-how), comprising all the elements necessary to establish a previously untrained person in the conduct of a business to run the business developed by the franchisor under a distinctive brand and to run it on a predetermined basis with continuing assistance.

These business format elements fundamentally comprise:

• The entire business concept (including the brand).

• A process of initiation and training in all aspects of the running of the business, according to the concept.

• A continuing process of assistance and guidance.

The entire business concept This involves the development by the franchisor of a successful way of carrying on the business in all its aspects. The franchisor will develop what may be described as a blueprint for conducting the business. This blueprint should-

1. Eliminate so far as possible the risks inherent in opening a new business. The product or service range offered should have been determined and all operational aspects of the business should be thoroughly market tested in pilot operations run by the franchisor. The resulting business should be identified with a brand developed by the franchisor.

2. Enable a person, who has never before owned or operated a business, to open up in business on his own account, not only in accordance with a pre-established format, but the franchisee will also have the continuing backing of an organisation (i.e. the franchisor’s) analogous to a ‘Head Office’ support team which would not otherwise be available to him.

3. Set out in detail exactly how the business should be run.



Process of initiation and training The franchisee must be trained in know-how comprising the business methods which are necessary to operate the business, according to the blueprint. This may involve training in the use of specialised equipment, marketing methods, preparation of the product, and application of processes. The franchisee should be trained so that he is relatively expert in all the spheres which are necessary for the operation of the particular business. This will include where appropriate stock selection, staff utilisation, staff selection and training, business management techniques, accounting and reporting methods, marketing and promotion. The training will be limited to the running of the Franchisor’s particular business in the manner specified by the Franchisor.

Continuing process of assistance and guidance A franchisor will in many cases provide the following range of services on a continuing basis, depending, of course, upon the particular type of business:-

• Access to the franchisor’s team at head office who should have the range of skills which should enable them to provide knowledgeable support which would not be available to a non- franchised business person.

• Regular visits from, and access to, field support staff to assist in correcting or preventing deviations from the blueprint which may cause trading difficulties for the franchisee.

• Liaison between the franchisor, the franchisee, and all other franchisees to exchange ideas and experiences.

• Product or concept innovation, including the investigation of marketability and compatibility with the existing business.

• Training and re-training facilities for the franchisee and his staff.

• National and local advertising and promotion.

• Bulk purchasing opportunities.

• Management and accounting advice and services.

• Publication of a newsletter.



• Research into materials, processes and business methods.

It should be understood that the business format franchise has as its basis a comprehensive and continuing relationship in which the initial concept will always be developed. The resources available for such development are contributed by the franchisor and all franchisees, and are, therefore, much more considerable than anyone individual could reasonably afford, or command.

Additionally, the nature of the relationship between the franchisor and its franchisees is very different from normal supplier arrangements found in distribution systems. There is a . pooling of resources which include the provision by the franchisee of financial and manpower resources in the establishment of the franchise business. The continuing relationship with the back-up and support which a franchisor provides represents a challenging conflict between the control of operations and development from the centre and the application by the franchisee of his own entrepreneurial skills to the franchised business.

As has been pointed out earlier, the expression franchise is now popularly used to describe more than just business format franchises.

It is important for a prospective franchisor to recognise what is the nature of the franchise which is to be created and it will then be clear what should be built into the structure of the franchise scheme and contract.

The word, franchising, can be used as a vehicle for abuse and indeed it has been in the past. It is the sort of transaction which readily lends itself to fraudulent practices.

Invariably, the transaction falls into two stages:- the first is the provision of pre-opening services; the second, the continuing relationship thereafter. If, therefore, the franchisor charges too much at stage one, and is not there to provide stage two, the scope for fraud is obvious. A fraud could also be committed by franchising an untried and undeveloped concept, resulting in a franchisee being charged fees for the right to conduct a business which in reality does not exist.



In addition to this sort of abuse there is the more sinister use of the word “franchise” to describe trading schemes which are not franchises in order to attract interest to what is a fraud. It is often not recognised that the use of the word “franchise” to describe some spurious business system is in itself a fraud resulting in unfair criticism of bona fide franchising.

This most frequently seen fraud invariably involves the distribution of a product or products for which little market exists. The “victim” will be expected to pay a relatively large sum of money to secure exclusive sales rights to a territory and to purchase a stock of the products. The problem is that no-one in the territory knows of the products and invariably they are too highly priced. At best, the fraudulent operator is using capital generated from the sale of territories to establish a business when he should be using his own capital for the purpose. At worst, he will disappear with the money and leave his “victims” high and dry.





Chapter Two.

What are pyramid and similar schemes?The most serious frauds which have been perpetrated were described as pyramid selling, which emerged in the 1960’s. Similar schemes have also been described as multi-level marketing and network marketing. These are not franchise schemes although they are often confused with franchises by those who seek to profit from the vulnerability of the unwary. They are presented as foolproof and very tempting methods of making easy money and they are often marketed by presenting successful participants, who speak of their great financial success.

Many of these schemes involve the sale of distributorships to purchasers who may divide and sub-divide them, and sell them on to those whom they recruit as sub-distributors. Expansion of these ‘enterprises’ takes place on the chain letter principle.

The ostensible objective is to build up a sales force which will sell the company’s products or services from door-to-door. In practice, selling the goods or services is very often difficult. The prices are usually high and there is no established market for the products, and nor is any attempt made to advertise and promote the sale of the products. Selling distributorships is much more lucrative and this becomes effectively the company’s business. Indeed, the evidence in a case heard by the English High Court in 1972 showed that in the particular scheme the highest sales of products in a year by any distributor did not exceed £130 in a year while many thousands of pounds were spent on purchasing rights to participate.

Examples of features of a pyramid scheme are the offer of a percentage payment of any sum paid to the promoter of the scheme for the recruitment of another participant, or persuading such a participant to purchase the right to progress to a higher position, or level of authority in the scheme. Other rewards



could include a profit or commission on sales, the provision for payment of services or training to other participants in the scheme, or a commission on the sales made by other participants in the scheme. Essentially there is so much more money to be made from selling rights to participate that no-one has any incentive to sell products.

These schemes were recognised by the UK Government as containing elements which are dishonest and indeed they have been described as fraudulent. Accordingly, the Fair Trading Act 1973 contains provisions which regulate pyramid-type schemes. The Government made a decision not to prohibit pyramid selling schemes but to permit them if they complied with regulations established under the 1973 Act.

The provisions in the Fair Trading Act have been amended by the Trading Schemes Act 1996. New regulations were made early in 1997. Single-tier franchising (i.e. franchisor to franchisee) is exempted from the regulations.

No bona fide franchise system can operate if it is required to comply with the new regulations any more than it could with the earlier regulations. This is no doubt what has persuaded the government to exempt single-tier franchising. In addition to single-tier arrangements, the master franchise arrangement is also exempt provided there is only one master franchisee (a master franchisee is one to whom the right to sub-franchise is given either to a whole or part of a country). The single tier would not permit any pyramid, multi-level marketing or network marketing schemes to be able to operate profitably.

If, however, the franchisor and the master franchisee are to franchise and sell franchises in the UK the basic single tier exemption will not be available. Likewise if there is more than one master franchisee granting sub-franchises that exemption will not be available. Where those cases apply there will only be an exemption if all participants are at all times registered for VAT. The VAT registration level rises with almost every budget and must be checked before proceeding. This means that area master franchising which is popular in many low turnover franchise “one man” operations will just not be possible. Unless all



franchisees register for VAT which would result in them having to charge 17.5% more than other non-franchised competitors

The definition in the 1996 Act is so wide that arrangements under which third parties engage in recruitment and in providing services to such franchise systems for franchisees can also be affected. If one is involved in a system with annual turnover levels below the current VAT compulsory registration level or which conducts a business which is exempt from VAT registration, legal advice will be essential.

If there is a franchisor (whether or not based in the UK) and a master franchisee in the UK selling sub-franchises the single tier exemption would not apply since there are three levels. If there is more than one master franchisee in the UK selling sub-franchises the single tier exemption would also not be available.

There are a number of counties which have adopted legislation to deal with the problems created by these schemes. This legislation ranges from outright bans to a system of regulation. As will be appreciated from the above, some of the legislation can impact master franchise and area development agreements.





Chapter Three.

Why franchise?Any business person wondering whether franchising is appropriate for his business will ask the question’ Why should I franchise?’

The answer requires a number of issues to be considered. The question will be asked by businesses at different points of time in development as well as established businesses.

There have been some examples of companies which have been confronted with a series of problems in the course of their business activities and resolved them in ways which have unwittingly had as their outcome the establishment of a franchise system.

There are those who start a business intending, after it is established, to expand by using the franchise method.

Established businesses have also found franchising offers opportunities for expansion. Not only are there opportunities to add to existing networks but franchising cannot only help to convert loss making or marginally profitable outlets into profitable businesses but can also play a role in filling in gaps in the market place. Retail traders in many countries who do not franchise in their domestic market, have found benefits from franchising into foreign markets.

Manufacturers can use franchising to secure outlets for their products. There may be some competition law issues to be considered.

Wholesalers with surplus storage and distribution, capabilities may also find that franchising has much to offer them.

Indeed, all businesses whether they deal in products or services may find franchising can assist their development plans. This does not mean that franchising will suit every business but certainly it should not be dismissed without consideration.



There can be many benefits although the business of franchising is very different from running one’s own outlets. The profit in cash terms will be lower but:

• the capital requirements will not only be lower because the franchisee will provide the capital to establish the outlets, but the franchisee will pay the franchisor a franchise fee. If the franchisor intends to convert existing outlets or some of them to franchisees it will be able to sell the outlets as going concerns;

• the number of staff a franchisor needs to run a franchise network is invariably far less than a business needs to run a network of company owned outlets. For example, a franchisor does not need to provide relief managers or other staff to cover holidays or illness. The franchisor provides a range of advisory services with focussed and specialised advice about the franchisees businesses which benefits from the cumulative experience of the whole network. (These services will be described in later chapters);

• the franchisor does not become involved in the day-today operation of each franchised outlet;

• the franchise network can grow as quickly as the franchisor can recruit and train franchisees, acquire suitable premises and most importantly, develop its infrastructure to cope with the expanding size of the network;

• the commonly held belief is that franchisees are better motivated than managers. This is undoubtedly true - there is anecdotal evidence that in cases where managed outlets have been converted into franchised outlets there have been significant increases in turnover. However, some franchisees can reach a comfort level which satisfies their needs - that is a challenge for a franchisor.

Franchising is not a panacea for the ills of an ailing business or a business operating in a declining market. The success of franchising is built upon the successful operation of franchised businesses by franchisees using proven successful formats and systems. Franchisees do not need a franchisor to lead them into failure - no-one needs a franchisor for that!



While franchising does not work for everyone, its benefits merit serious consideration and evaluation.

Before deciding to embark upon the franchise method, consideration should be given to the advantages and disadvantages of the system from the point of view of the franchisor.

Advantages to the franchisor 1. The franchisor will only require a compact organisation, consisting of a few highly specialised managers in the various aspects of the business with which the organisation is concerned, and their support staff.

2. The franchisor can earn a reasonable profit without becoming involved in high capital requirement or in the day-to-day detail and problems which arise in the management of scattered outlets.

3. Since the franchisor is using others’ resources and can by its training programmes equip them to utilise its business system, its organisation has an ability to expand more rapidly on a national, and eventually (if appropriate) on an international, basis, using a minimum of risk capital and management resources.

4. The franchisor will find it easier to exploit territorial areas which are not already within the scope of the organisation as franchisees with local interests and knowledge can be obtained.

5. The introduction of a franchisee to an existing branch in a multiple chain can convert a loss-making, or marginally profitable outlet, into a profitable outlet, thus enabling a business presence to be maintained when otherwise it might have to be closed down. This outcome is achieved by removing from the profit and loss account for the outlet such expense items as the cost of employment of the manager and staff, including the cost of holiday and sickness staff cover, as well as the proportion of head office overheads which will normally be allocated to the outlet. Although a franchise fee will be payable it will be considerably less than these items.



6. A franchisor has fewer staff problems with which to cope as it is not involved in the staff problems of each individual outlet.

7. The local management of each franchised outlet will be keen, well motivated, and extremely alert to minimise costs and to maximise sales - much more so than would be the case with a manager.

8. An existing business with multiple outlets can raise capital to enable it to reduce borrowing or to diversify its business interests by selling off some or all those outlets and simultaneously entering into a franchise agreement for the future operation of those outlets.

9. Franchising offers the scope to an existing single owner of a multiple chain to develop its future outlets by a franchise system rather than expanding its own outlets, thus reducing the calls upon its capital and manpower resources.

10. Certain types of franchise schemes are able to benefit from the development of national accounts. There are many large industrial concerns having a number of factories, offices and depots throughout the country which require the services offered by some franchise networks. Franchisors are able to negotiate with them for each franchisee to service the requirements of the local branches within his franchised area. None of the franchisees would have the ability or the capacity to negotiate or service arrangements of this nature on his own, yet the group as a whole has the capacity to do it. Each franchisee by the quality service which he provides to the franchisor’s customer ensures that the group as a whole retains the business of the large national multiple outlet company. Care must be taken not to overdo national contracting, since, if national contracts form too large a percentage of the franchisee’s business, it can prove to be a distincentive for him to develop his business and market to the full by his own efforts.



Chapter Four.

Why buy a franchise?Any business person considering establishing a franchise system needs to understand why anyone would want to become a franchisee.

There are a number of factors which affect the thinking of prospective franchisees.

There are many who would like to own and run their own businesses and. For a variety of reasons, they can find the financial resources but they lack knowledge and confidence and fear that they could lose what they have worked hard to obtain. Franchising provides knowledge and having someone available to help with advice gives confidence. Franchising, while not eliminating risk (no business can do that), provides a far better chance of success than a non-franchised business can expect.

All new businesses are vulnerable. The degrees of vulnerability vary depending on the operator’s knowledge, skill, financial resources and relevant abilities. Many who embark on a new business venture lack some or all of these’ assets’. Many of them fail because they cannot learn quickly enough before the money runs out. This is what is called the development risk. The greater the number of missing ‘assets’ the greater the risk and the more likely it is that the venture will fail.

Some may decide that instead of starting a new business they will buy an existing business with its established track record. There are risks in taking this course also because all the’ assets’ listed above need to be present for the would be business person to succeed. In addition, there is the risk that when purchased, the business may not be as good as the seller said it was and the buyer believed it to be.

It is against this background that one should consider franchising. Look back at the ‘assets’ listed above namely: knowledge, skill, financial resources and relevant abilities. So far as financial resources are concerned, whichever route is chosen



they will be needed. Even franchising requires a franchisee to have financial resources.

However, it will be easier for a franchisee to borrow from banks in some countries (see Chapter 7) and, through the advice the franchisor provides, the capital which needs to be invested in the business will be better and more cost effectively spent.

That is part of the benefit for a franchisee which flows from the lessons learned by the franchisor (see Chapter 5). It results, among other things, from the development risk run by the franchisor.

The other ‘assets’ comprising knowledge, skill and relevant abilities are also a part of the franchising equation. The franchisor provides the knowledge and skill which the franchisee needs through its training programmes. The franchisor when evaluating the suitability of the prospective franchisee for the particular business being franchised will have to satisfy itself that the prospect has the relevant abilities. No franchisor should accept as a franchisee someone whose abilities do not match what the business requires.

A franchisor should always be mindful of the fact that it is the franchisor which is the difference, for the franchisee, between a franchised and a non-franchised business. That may seem like stating the obvious but many lose sight of this fact or do not even realise it. The franchisee has a high level of dependence on the franchisor. The franchisor’s decisions about so many of the issues involved in running and developing the business are crucial to the success of the system. Never forget that franchisees need to feel that the franchisor is taking the right decisions and is concerned for the success of its franchisees (see Chapter 11).

Many franchisees enter a franchise system because they are enthusiastic about its potential to bring them success. Make sure they have a complete understanding of the realities and are not approaching the future on a wave of emotional feelings about a rosy future.

Apart from the issues discussed above, there are a number of other benefits for franchisees. Branding is the first to consider.



The more mature the development of the network the better known the brand and the greater the benefit likely to be obtained. Where one is dealing with a newish and developing network the benefits of the brand are not so immediate. At worst, the franchisee is in the same position as he would be if he started his own business with his own brand. In reality, the franchisor’s brand will be known to some extent, and with the growth of the network, will become better known and acquire a broader reputation more effectively than could the brand of one outlet.

The franchisee will also have available a range of the services which a franchisor should be providing (these are dealt with in some detail in Chapter 5). These services which provide continuing advantages to the franchisee in belonging to the network. These would not be available to a sole non-franchised business. In franchising they should be available and at a price which makes much sense to the franchisee.

A franchisor must appreciate that while its brand and system are valuable assets the franchisees in the system are also valuable assets which need to be carefully nurtured. (Chapter 11 examines this aspect).





Chapter Five.

Developing the business concept through pilot operationsThe establishment of a franchise system invariably arises in one of two ways. The first is when a decision is made to expand or convert an established business by using franchising. The second, is when a positive attempt is made to set up and establish a business with a view to franchising from day one.

There are also those cases where having started a business the proprietor learns that franchising may help it grow more rapidly. Sometimes the business proprietor has the idea planted in his mind by the interest shown by others in the business. It is not unknown for approaches to be made by those who are impressed with the business and seeking a franchise.

It is common for the proprietor of an existing business, which has the potential for a more rapid expansion rate than its capital and staff resources would permit, to turn to franchising as the means to exploit that potential to the fullest extent possible.

It should be understood that franchising is not a path to salvation for an ailing business. It will not produce, if ethically and soundly run, an immediate positive cashflow and profits. On the contrary, it will require to be developed in the same way as any other business method. Capital and manpower resources will have to be devoted to the development of the concept, its marketing and sustenance. As will be seen in chapter 7, it can be some years before profits and positive cashflow can be expected.

Franchising must, therefore, be developed from a sound financial and business base, which will support and not drain the resources which will have to be devoted to the development and expansion of franchising activities.

The franchisor will need to have sufficient capital resources



to sustain its franchising activities until the moment when profits are being earned which will depend on the healthy and sustainable growth rate which can be achieved.

It is essential, if one is intending to franchise, to keep the business simple. Others will have to be taught to operate it as successfully as the innovator, and the more complex it is, the more difficult it will be to recruit, train and sustain franchisees. So basically, the scope must deliberately be limited to a framework which is manageable by others. It will also be important that the business is easy to set up in terms of installation and equipment. It is not by accident that most franchised businesses concentrate on providing a limited range of products or services to a high standard.

Consider a fast food operation as an example. The more simple the design and layout of the kitchen and preparation areas, the more standardised the decor, design and layout of the take-out and/or restaurant area, the easier it will be to adapt premises to the design and the more quickly one can cope with the establishment of each operation. Shopfitters can prepare modules which make it easier, quicker and more economic to prepare the premises for the business.

There is also the need to keep the menu simple. This reduces inventory requirements and makes it possible to keep the preparation and serving of the food simple, quick and efficient. Also, one is more likely, with a simple and restricted menu, to limit the amount of equipment to be employed and thus reduce the requirements of the business in terms of space, levels of investment and maintenance.

Retail outlets provide another example of the activities which the franchisor must try to keep simple. Apart from the design, decor, and layout, which are all vital, there is the question of the stock inventory. The more extensive it is, the broader the range, the more complex is the task of all who have to deal with it, and the greater the likelihood of financial loss through poor stock choice, control and mismanagement. A franchise system growing in size can also make arrangements for frequent restocking to avoid franchisees holding large stocks. The use of EPOS systems greatly



assists in putting such arrangements into practical use.

The overall aim should be to simplify control, reduce paperwork and make the system as foolproof as possible. On the whole, these basic principles will apply whatever the business being franchised.

Another objective must be to provide franchisees with a support service and information which no single trader in a business with highly aggressive, low margin competitors could ever hope or expect to match. Thus, we see that the development of the concept requires meticulous planning and anticipation of needs.

It is also important that one defines clearly the market at which the business is aimed. There is little point in having a good idea and a great business in prospect if, for example, one is dependent for referrals upon others, who do not see the need to deal with you. They may already be coping with the work in question and will see no benefit to themselves in dealing with you. Such a situation might arise, for example, in a franchise which is providing a service to the automotive after-market and is relying on local garages to feed it with work.

The dangers inherent in aiming oneself at the ultimate consumer, if that consumer is likely to go to the established trade first, must be considered. This could arise if one is intending to provide a specialist service which is catered for by existing, more comprehensive business services. In such a case, there will probably be a heavy promotional cost to deliver the right message to the marketplace before the business becomes accepted in its own right. That is a burden which falls on the franchisor and its cost and likely effectiveness will be a factor in his decision taking.

One should aim to make the business distinctive in its total image. Each franchised business which is successful has its own innovative concept, which sets it apart from other businesses of the same type. This is what makes people choose to patronise that business as well as, or instead of, others in the same category. The existence of competitors can often be very healthy. It can help to develop the overall market and act as a stimulant to both franchisor and franchisee alike.



Do not simply copy or imitate others. In the long run, it will not be profitable. They may have legal sanctions which they can apply, but even if they have not, they are probably already working out how to update and improve upon what they are presently doing. They will no doubt through the development of their business and their experience, always keep one step ahead. It should also be understood that the copier does not have the benefit of laying the foundations of his knowledge through experience and that such a shallow knowledge and experience base makes his business vulnerable.

In order properly to protect the exclusive recognition of the business image it is best if at all possible to structure it around a trade mark registration for goods and/or services. Most people who select a name try to use one which is descriptive. This may seem a good marketing idea but it will be doomed to failure as a trade mark which can be registered since descriptive names are not permitted. The reason for this is that a registered trade mark gives the monopoly right to use it. If it describes the business or what it does it would prevent others from being able to describe their business or what they do.

In selecting a trade mark there are some basic principles which must be borne in mind:-

• It should be easily pronounceable.

• Beware of words which sound good in one language but which may be offensive or send the wrong message when translated into another language. (If the business takes off and international development is on the agenda this can be a factor).

• It should be an invented word, which is more readily registerable as a trade mark.

• It should be short.



Remember above all, that the franchisee’s business will not only have to provide sufficient profits to enable the franchisee to obtain an acceptable return on capital and a reasonable income from his work, but it must also provide sufficient money to enable the franchisee to pay a fee to the franchisor for the provision of all the continuing services which will be available. Unless the business can generate sufficient for these purposes it probably is not capable of being established as a franchise.

Many successful franchises are businesses where a high degree of personal service to the customer is important (e.g. retailing, fast food, quick printing) and they require the personal presence and commitment of the franchisee at the point of sale. Regular features of such businesses are long hours, coupled with fast, reliable and friendly service. The length of the hours to be worked by the franchisee will not necessarily be confined to the hours during which the business is open to the consumer. There will always be work to do, administrative, accounting, marketing and promotion, as well as “thinking time”.

In assessing whether or not a business can be franchised the following criteria should be considered:

I. The concept must be proved by practical experience to be demonstratability successfully. This is usually achieved through pilot operations which are discussed below (see Chapter 5).

2. The business should be distinctive in its brand image and in its systems and methods.

3. The systems and methods must be capable of being passed on successfully to others through training programmes within an economically sensible time frame.

4. The financial returns from the operation of the franchised business must be sufficient to enable:

a) the franchisee to obtain a reasonable return on the capital employed in his business,

b) the franchisee to earn a reasonable, if not good, reward for his labours, and,

c) the franchisee to make payment to the franchisor of a



reasonable fee for the services which he will continue to supply to the franchisee.

5. The franchisor must be able to make a sufficient on-going profit from fees received from franchisees.

Having developed a business concept, it is essential that at least one pilot operation, and probably in most cases a number of pilot operations should be established. How many pilot units are required will depend upon how representative the planned outlets in the network are the locations of the pilot operations.

It may be that before the franchisor can be sure he is ready to provide a range of experience to franchisees, piloting takes place in different locations which are similar to or representative of the locations in which it is expected that franchisees will operate. It may also be necessary to keep the pilot operation running for extended periods generally over 12 months, particularly where seasonal factors have to be taken into account. A franchisor with an established business will be able to benefit from experience gained from the operation of its existing outlets, but even if they exist it should still operate at least one pilot operation under the same conditions as will apply to the proposed franchise system to ensure that the system works in practice. It will be prudent to run more than one pilot unit so that there may be eliminated any distortions arising from the results of one unit through the close attention it receives or the uniqueness of its location.

It has been suggested to the author from time to time that a pilot operation is not always possible or relevant, and that the franchisor can guarantee the operation on a money-back basis. In the author’s view, this is a dangerous attitude and one which negates the fundamentals upon which business-format franchising is established.

Fundamentally and essentially, the franchisor is selling a sophisticated package of proven know-how. If the franchisor has not proved his ability to operate its package with success and put his own money at risk to do so it has no right to market the franchise. Nor, indeed, will it have established the goodwill, reputation and identity of the name which should be associated



with its package.

It is irresponsible to seek to establish a franchise by the trial and error, and at the expense and risk of the initial franchisees. Initial franchisees do not have as their function the operation of pilot units.

A guarantee of money back is no substitute for a lost business, a lost opportunity or in some cases a lost dream. Anyway, how, with an untried and untested concept, does one ensure that the franchisor will be there with adequate money to pay back those who claim. Even if the franchisor and the money are there, inevitably there will be disputes about whether the failure was that of the franchisor’s concept, or the franchisee’s in not complying with the franchisor’s guidelines.

The great responsibility which a franchisor has to its franchisees cannot be emphasised too strongly. Franchisees will be invited to part with what are for them substantial sums of money (which may often represent their life savings), change their whole way of life, and to become to a great extent dependent upon the franchisor, the concept and the franchisors system for the welfare of themselves and their families.

Apart from these justifications for the pilot operation, it will fulfil the following functions

a) As it will put the brand name before the public the viability of the concept in practice will be developed and become established as acceptable and exclusively associated with the brand name in the mind of the consumer.

b) It will identify problem areas and enable the franchisor to provide solutions in relation to:

i) Marketing

ii) Acceptability and availability of product or service

iii) Methods of marketing, promotion and merchandising



iv) Compliance with:

• Local bye laws Building regulations • Fire regulations

• Health and safety at work requirements

• Disability legislation Planning requirements

• Employment laws

v) Streamlining of shopfitting methods

vi) Staff availability and training requirements

vii) Taxation, including VAT and other sales taxes, and

viii) Other factors of a legal and business nature relevant to the particular type of business

c) It will enable the franchisor to experiment with layouts (see later comments) and to discover the best combination of equipment as well as the cost effectiveness of the use of the resources necessary for the conduct of the business. Alternative approaches to the decor and design of the interior and exterior of the premises can be tried out so that the most effective can be used.

d) The potential of and actual trading experience at different types of location can be obtained. This will include experimenting with opening hours to discover what are the optimum hours during which the business should be operating. It should be borne in mind that in deciding which hours to open, one must give consideration to staff hours and shifts if need be. It could be that the ongoing costs of opening at certain times, owing to the need to introduce additional staff, might make it uneconomic to be open. On the other hand, trade may sometimes only develop slowly at certain times (e.g. early morning, late at night or on Sundays). It may not develop at all unless a commitment is made to be open at those times for at least a period of several months.

e) It will be appreciated that as training in the operational side of the business is necessary so too, of course, is training in the business management and accounting techniques. In



developing the pilot operation, particular attention should be paid to the introduction of simple and effective systems of accounting, stocktaking and controls.

f) The franchisor will need an operations manual (see Chapter 6). The pilot operation will provide the basic information from which the operations manual will be prepared and the franchisor must be careful to record the lessons learned so that they are effectively employed to the benefit of the franchisees.

So far as the layout of the premises is concerned, the requirements will obviously differ from case to case. Some businesses are very dependent upon the way in which goods are merchandised, while others will not be.

Taking a fast food take-away business as an example, the layout will have to be carefully planned so that the preparation and service is progressed by logical steps without the need, so far as possible, to retrace one’s steps. The whole operation of preparation will in all probability be timed. If the layout is such that a few unnecessary seconds per operation are inevitably required this could add up to an additional employee. The availability within easy reach of what is required is essential if staff are not continually to be getting in each other’s way. This is essentially the practical application of basic work study techniques. Portion control and size will have to be established to ensure customer satisfaction and to enable guidance on pricing policies to be established. If these factors are not resolved they could result in a reduction in the profit potential of the operation. The cumulative effect of failure to pay attention to such details could make the difference between a business which could be franchised and one which could not.

Even when the viability of the concept has been proved this does not mean that the need for continuous “pilot” operations ceases. The need, in fact, is greater, except that from being called “pilot operations” they become what are called company-owned units.



The franchisor has to remain ahead of the game. It must continually be experimenting and developing, and by being in the field in the marketplace it will be able to put its experiments and developments into practice in its own outlets. It will be able to prove to the franchisee that what it suggests has been proved and tested in the field by it and at its expense. It is just as important that the continuing developments are proved and tested as it was to prove and test the initial concept by the establishment of the pilot operation.

A franchisee may at some time need to be persuaded that the store needs refurbishment; that equipment should be replaced; and that the appearance of its store must be updated. What better way to persuade than to be able to demonstrate by the performance of the company owned stores what can be achieved. “Do what I have done” is much better than, “do what I say.”

The experience obtained in developing and pilot testing the franchisor’s business concept will provide the foundations for the preparation of the operational manual.



Chapter Six.

Developing the operational manualThe need for an operational manual (or manuals) has already been pointed out. Indeed, it is stating the obvious.

The manual will contain in written form the complete systems and methods for conducting the franchised business. It will invariably have the benefit of copyright protection which an oral explanation could not have. It thus forms an essential part of the legal methods by which the franchisor protects his ideas, know-how and trade secrets. It will, therefore, be appreciated that the manual should be extremely comprehensive and cover in detail all aspects of the day-to-day running of the franchised business.

In practice, the franchisee will first have contact with the manual when attending for training and then it will be provided on loan to be used as a continuing guide to the conduct of the business.

It is difficult in a publication of this nature to cover all types of franchised operations. This chapter will deal with what might be regarded as the sort of provisions one would expect to find in every manual and then provide some specific ideas which may be appropriate for particular types of franchised businesses.

Introduction Each manual should contain some introductory remarks explaining the basic nature of the operation and the business philosophy which the franchisor wants all franchisees to embrace. The introduction should spell out in broad terms what the franchisee can expect from the franchisor, and what the franchisor will expect from the franchisee.

Operational system There should then follow a detailed description of the operational system which explains how the operation is set up, and how and why the various constituent elements fit in with



each other.

Equipment This section should deal with the equipment which is required for the operation of the business. It will give a detailed explanation of what the equipment is, what is its function, and how to operate it. Guidance should also be given on how to troubleshoot basic and common faults, which are likely to develop. There will be a directory of telephone numbers in the manual and this shall include the telephone numbers of supply and service centres for the equipment (see below).

Operating procedures This section will probably be broken down into a number of sub-sections. The following are suggested.

a) Opening hours/days.

b) Trading patterns.

c) Staff schedules and rotas.

d) Use of standard forms and procedures.

e) Requirements as to staff appearance (e.g. uniforms).

f) Staff training procedures.

g) Procedures for employing staff and compliance with statutory obligations. There are also many anti-discrimination laws, e.g. racial and disabilities, or which franchisees need to be aware in running their businesses.

h) Procedure for disciplining staff and the statutory obligations imposed on the franchisee as an employer.

i) Pricing policies. (It is likely that it will be illegal for the franchisor to seek to impose prices on the franchisee. This will not prevent the franchisor from issuing a recommended price list, but the recommendations must not be enforced).

j) Purchasing policies (These can be affected by competition (antitrust) laws, see Appendix A) and delivery arrangements.

k) Product standards (quality and quantity) including



customer complaints procedures.

I) Service standards.

m) Staff duties - a detailed job description for each member of the staff should be included which sets out not merely the nature and extent of the duties, but also the methods and procedures to be adopted in performing them.

n) Reporting requirements and how to comply with them.

o) Payment of franchise fees - the detailed procedure for calculating and accounting for fees with specimens of the appropriate forms.

p) Accountancy - the specified accounting methods to be employed by the franchisee and the flow of information to be provided to the franchisor to assist him in the provision of guidance to the franchisee. Advice on VAT or sales tax requirements and tax treatment of staff salaries and how to complete the necessary paperwork should also be given.

q) Cash control and banking procedures, including procedures for dealing with cheques, cheque cards, switch cards and credit cards.

r) Advertising and marketing - basic guidance on standard point-of-sale advertising, marketing and selling techniques to be employed, with a list of do’s and don’ts.

s) Requirements in regard to the presentation of the franchisor’s house style and the way in which the franchisor’s trade mark and/or service mark should be used.

t) Insurance - details of cover recommended and any schemes offered by or through the franchisor. Alternatively, guidance on how to go about getting the cover required.

u) Stock control procedures.

v) The franchisee will need advice about the increasing volume of laws which affect the way in which he conducts his business. Anti discrimination (whether sexual or racial) laws as well as disabilities legislation are examples of what all employers need to know.



w) Any other information which is necessary to explain how the business system is to be run.

Standard forms There should be a section devoted to standard forms which will include all those already referred to in relation to specific sections. Additionally, there could be the following.

a) Contracts of employment which comply with current legal requirements.

b) Agreements with managers or staff requiring them to keep the franchisor’s trade secrets, methods, etc. secret and confidential and not to use or disclose them for any purpose except in the discharge of their responsibilities as employees.

c) Contract forms to be used in dealings with customers in the course of the conduct of the franchised business.

Technical Manuals These are to be found in businesses where equipment has a vital part in preparing the end product for the consumer. They will contain more detailed technical information about equipment than is contained in the section dealing with detailed operational methods. It is not uncommon to see manufacturers’ explanatory literature supplemented by material prepared by the technical staff in the franchisor’s organisation.

Franchisor’s directory A directory of who’s who in the franchisor’s organisation, and whom to contact for particular aspects of the franchised business.

Telephone and email directory A directory of all useful telephone numbers and email addresses, such as service centres, suppliers, etc.

These are the core provisions which one would expect to find in most manuals with such variations from business to business to reflect the difference in their nature and/or in the way the franchisor has organised the business system. In appropriate cases (two are now offered as examples) one would expect to



find further sections, as well as some consequential variation of the sections previously mentioned.

Fast Food • Recipes

• Menu content and variations according to time of day

• Methods of preparation of food

• Kitchen procedures, include kitchen layout

• Times for preparation, cooking, holding and serving of each menu item

• Portion quantities, including how many portions should be produced from a given quantity of ingredients

• Stock requirements (range as well as quantities)

• Display and merchandising techniques

• Local advertising, promotion and PR

• Customer complaints procedures

• Special industry applicable legal requirements, e.g. health, safety and hygiene

• Planning: - bye laws - disposal of litter - night operations - noise - parking - work permits for foreign staff - Cleaning routines

Retail outlet • Stock requirements

• Approved or nominated suppliers

• Supply arrangements

• Quality and quantities of products

• Range and shelf 1ife of products



• Store layouts

• Display and merchandising techniques

• Customer relations

• Issuing guarantees and dealing with claims

• Customer complaints procedures

The list could be almost endless as one looks at the variety of franchise offers - hotels, car rentals, print shops, opticians, clothing and hair salons - are but a few diverse examples.

The specific manual requirements of each business (even those which compete with each other) will differ both in nature and scope.

All franchisors should be conscious of the need constantly to keep their methods under review and to introduce changes and variety so that their operation is at the forefront of the market. Such changes and variations should be reflected in supplements and amendments to the manual or manuals so that the franchisee is always kept informed and up-to-date.

This is likely to apply particularly to the marketing, advertising and promotion section of the manual. For this reason, the marketing section is often produced as a separate volume in order more readily to facilitate the updating process.

It is also not necessarily good enough just to send franchisees details of changes and amendments. Many franchisees may not read the material sent, or if they do, it will not register in their minds and the supplements or amendments may not find their way into the operational manual. The franchisor has to ensure that franchisees do assimilate the material and act upon it. Increasingly franchisors are looking to use the internet or to create an intranet to communicate with franchisees. Quite apart from the need to institute legal safeguards before using these methods of communication, the risk of franchisees not responding to them is at least as great as it is with written material.



Chapter Seven.

The financial aspectsFor a franchisor the financial implications have two dimensions. The franchisor has the cost of establishing its business as a franchisor and then sustaining it and making a profit from it. There is also the position of the franchisee to consider. The franchisee will need a business which, after paying the costs of having a franchise, will be sufficiently profitable to make it worthwhile.

There are so many variables depending on the nature of the business and the decisions which the franchisor may make that it is not possible to put a meaningful figure forward representing the set up costs. Suffice it to say a franchise system will not become generative of positive net cash flow and produce profits overnight. It will take time. How long will depend on the nature of the business and the rate of healthy growth which can be achieved. It can take between two or three and up to five years for systems to produce a net positive cash flow and profitability.

This means that the franchisor will have to ensure that it has budgeted for sufficient working capital to ensure it can survive until it becomes profitable. The franchisor may be able to support its franchise programme with the profits which its pilot operation or operations may produce.

Undoubtedly, the franchisor will need a business plan which incorporates at least a five year projection for franchisee development and its own income and expenditure as a basis for making an informed decision on what its capital requirements are likely to be (see more below).

The franchisor should appreciate that its growth in costs will probably comprise a number of steps. The cost of its infrastructure on day one may well enable it to recruit, establish and support the first 10 franchisees (may be more). The next step with its increases in resources may well support a network of up to 30 franchisees and so on. It is a big mistake to grow



franchisee numbers without the appropriate infrastructure in position. A decline in franchisee services which would result would put back the growth of the system.

Franchise fees There is often great difficulty in assessing the right level at which to fix franchise fees. There is no such thing as the “norm”. The fees will vary depending on many factors; the most major of which are the nature and extent of services to be provided by the franchisor and their value to the franchisee.

From the franchisor’s point of view, the franchise fee income is its gross revenue out of which it has to meet its expenses of operation and generate a profit. From the franchisee’s point of view, he will expect value for money and will undoubtedly not expect to find his franchisor is taking too large a slice of his income.

In order to establish a level of fees, the franchisor will have to build into the business plan and projections a calculation of what income it needs to generate in order to provide the necessary level of gross income. These projections will have to be based upon realistic growth targets and will need to amortise the establishment costs over a reasonable number of franchisees - choose the wrong number and the cost of the franchise may have to be too high, or the achievement of profitability delayed too long.

If the projections show that the income level of the franchisee will be reduced by the amount of the franchise fee demands of the franchisor to such a point that the franchisee’s profit will be unrealistically low, then the question of whether the scheme can be franchised at all will have to be considered.

Unless there is enough profit generated from the franchisees’ activities to provide for the franchisor’s reasonable requirements and to leave each franchisee with a reasonable return on capital and a reward for his labours, then it is difficult to justify franchising.

Initial franchise fees vary widely and some impose a heavy burden on the prospective franchisees who must be able to



satisfy themselves that they are getting value for money.

The initial franchise fee should not be used as a method of milking the franchisee at the front end of the transaction.

It may be possible to raise the initial franchise fee in the course of time to reflect the growing strength and success of the franchise, and it would indeed be prudent to review it to reflect inflation. The franchisor would do well to remember that one of its prime tasks is to help the franchisee make the most of his investment and get him into business effectively, while keeping the level of investment as modest as possible. The higher the entry cost, the greater the cost of establishing the franchisee’s business, the fewer candidates there will be with the necessary resources. Financial sources who now understand franchising may be unwilling to lend to franchisees if they believe the franchisor is too greedy.

Source of income Each franchisee should represent a secure and growing source of income to the franchisor, provided that the franchise is a good viable system, and is kept that way by the sensible management of the franchisor. Furthermore, successful existing franchisees will provide a source of additional expansion for the franchise if they seek to reinvest their profits by opening further units. It is not uncommon to find that existing franchisees are a significant source of franchisees for new outlets.

So far as the financial health of their businesses are concerned, franchisees will need to have support available. For this to be achieveable the franchisor will need information and so will the franchisee so that he can properly manage his business.

Finance (accounting) For the new franchisor, the financial aspects should be capable of being dealt with by whoever is looking after its company operations (which may just be the pilots). They should be able to devise and develop a simple accounting system for the franchise network, and be capable of giving financial advice to the franchisees and in relation to the operation of the accounting system. Regular returns and accounts will be required from



franchisees and it is vital that each franchisee understands from the outset exactly what is required in this respect. This understanding should be imparted during training.

The information which is required should fulfil two objectives.

a) It should enable the franchisor to monitor each franchisee’s performance as well as provide the basis for calculating the fees to be paid.

b) It should enable the franchisee to see for himself how his performance compares with the objectives, which he and the franchisor have set, and with the performance of other franchisees in the network.

The task of providing the information should be made as simple as possible, but that does not mean that essential steps should be avoided. The information required will invariably be in three categories.

a) Gross revenues

b) Profit and loss statements

c) Capital expenditure

There will be provisions in the franchise contract requiring the franchises to submit the various categories of information at stated intervals.

Gross revenues. Information relating to gross revenues will be required by the franchisor at the same intervals as the franchisee fees are required to be paid. The period fixed for such payment should be as short as possible, weekly if feasible. The franchisee will be required to discipline himself to attend to his financial records each week and to write out a cheque for fees each week. If his finances are shaky and fees are delayed, a problem is then discovered sooner, rather than later so that early remedial action can be taken. The disciplines of attending to financial records each week will ensure that up-to-date financial management information will be available to him and the franchisor. The franchisor should require the franchisee to provide it with a copy of the relevant



information.

A simple form for weekly reporting could well follow the form set out below. It is assumed that the week finishes at the close of business on a Saturday.

Profit and loss statement. Weekly gross revenues

fee remittance form/tax invoice Address of store/operation....................... Store number.................................

Accounting reference number.................. Week ending..................................

Total Less VAT Total Number Average gross for fee customers value per revenues calculation customer

Sun

Mon

Tues

Wed

Thur

Fri

Sat

Fee calculation

Total revenues (per column 3) £

Management services fee @ ....% thereof £

Advertising contribution @ ....% thereof £

Total £

VAT @ 17.5% thereon (or sales tax) £

Total remitted bt cheque herewith £

I certify that the figures set out above are true, correct and complete.

Signed Name in full

Franchisee Date

This will identify whether margins have gone astray and can



help identify existing or developing problems. Again, the more frequently the information is available, the better. If possible a profit and loss account should be prepared weekly. In most businesses, the five most important factors to check are sales, gross margins, stock, cash, and wages. They are the chief variables. It is important that all should be checked on a weekly basis.

If the level and range of stock were such that weekly checks are impracticable, a monthly check should be carried out. Any longer period results in inadequate financial management information being available to franchisees and to the franchisor. The lack of such information prevents the franchisor from providing supporting monitoring advice to the franchisee and hinders the franchisee in the management of his business.

The sales should be checked frequently, with takings being reconciled between the cash register and the bankings at least every day. If the business operates a shift system, the takings should be physically counted and agreed before those responsible for the shift which is ending leave the premises. Some businesses take hourly till readings to develop information to assist in the anticipation of the business flow and staffing needs.

Where credit is given, great care must be exercised to ensure regular payment of receivables as cash flow is as important as sales. There is no point in achieving high sales if the money is not available to be used by the franchisee. A lack of positive cash flow could destroy what could otherwise be a successful business. The higher the level of receivables, the more capital the franchisee must have available to finance his business.

If the business involves product sales, a system must be devised for checking the stock of products at regular intervals. The longer the interval the less valuable will be the available information. Without this, there is no check on shortages, theft or gross profitability. Proper ordering is difficult if the franchisee does not know what stock he has sold or has in the store. Electronic point of sale systems, which can record stock movements can assist, but cannot replace actually checking physically to ensure that what the machine says is what is really there.



A typical profit and loss statement would probably look as follows.

Gross revenues xxx,xxx

Less VAT (Sales Tax) x,xxx

Total revenues xxx,xxx

Less cost of sales xx,xxx

Gross profit xxx,xxx

It should be noted that there may be differences in the breakdown of these items. In a fast food operation, there would be a breakdown between the cost of food and cost of consumables (e.g. paper goods). Where there are separate elements involved it may be wise to break them down as it assists in the monitoring of performance and controls. Additionally, if the operation involves the carrying of stock, the opening stock and closing stock figures have to be taken and netted off to provide an accurate gross profit figure.

Other deductions need to be made before the net profit figure can be calculated.

Less:

operating expenses

Salaries/wages

Rent, business rates (property taxes), service charges

Management services (franchise) fee

Advertising fee

Additional local advertising

Insurance

Telephone

Electricity

Gas

Repairs and renewals



Travel expenses

Sundry expenses

Bank charges and interest

Allowance will have to be made for depreciation before the net profit is accurately stated.

Upon receipt of the profit and loss statement, the franchisor should check the figures to see whether they reveal any departure from the performance criteria which he has established on the basis of experience.

In order to facilitate the rapid production of the required information, the franchisor should provide simplified profit and loss statement forms. The variable items of revenue, cost of sales, gross profit, wages and franchise fees are entered every week with standard amounts entered for the other items, e.g. rent, business rates, etc.

This method enables useful information to be produced within a day or two of the end of the week so that the franchisee himself, and the franchisor, are both rapidly aware of any problems and how the business is developing in general. The standard amounts can be updated and changed as they vary.

A useful check is for the franchisor to publish the key criteria, e.g. revenues, cost of sales, wage percentage, spend per customer, etc. to all franchisees on a weekly basis. The data would produce an average covering all units, franchisee and company owned, accompanied by a brief commentary on any significant features. The franchisor should know what a properly performing franchisee should achieve. The data will be of interest to franchisees and can often be used as a basis to create competition between franchisees who seek to be the best performers in the network.

Capital expenditures are more difficult to control. The danger is that a franchisee does not appreciate that his expenses have to be deducted from his gross revenues before he has any profit for himself. There is a tendency to spend prematurely on the good things in life. It is wise to call for a balance sheet at periodic



intervals so that some indication of the financial health of the business is available.

It is useful to have full accounts verified every quarter or at least every six months by external accountants and audited accounts on an annual basis.

The franchisor’s existing financial and administrative staff should also provide advice and a brief guide to such matters as the payment of wages, employment regulations and VAT returns.

In time, it may be necessary to have additional accounting staff for the franchised side of the business, but certainly not initially. Indeed, there is much to gain from using the existing staff. They will be able to advise from a basis of knowledge and experience of the business and also they will doubtless deepen their own understanding of the company’s business in the process.

Some franchise companies develop in-house computer capacity and provide an accounting service to franchisees, which provide a greater facility, both to the franchisor and franchisee to enable them respectively to monitor and manage the franchisee’s business.

One cannot review the financial aspects of franchising without mentioning the role which many of the banks play in some countries. From a bank’s point of view the reduction in risk which franchised new business start-ups provide compared with non-franchised new business start-ups makes franchising a prime target.

In the UK, it was in June 1981 when, what was then National Westminster Bank launched the first bank franchise finance department. Since then other banks have come and gone and currently the banks prominently active in the market are: NatWest; Royal Bank of Scotland; HSBC: Lloyds TSB and the Bank of Scotland which recently re-emerged after a long absence.

Apart from the provision of financial facilities to the franchise community the banks have been very supportive of the British Franchise Association by their affiliate membership and sponsorships as well as their support for educational



programmes.

The banks operate in a similar fashion by having a central focal point with a franchise literate team which gathers market information as well as franchisor systems information. Apart from the two Scottish banks lending decisions are made by local managers to whom “briefing” information is provided. The two Scottish banks have the lending decisions made by the franchise manager whom then liaises with a Business Relationship Manager who deals with the day-to-day running of the account.

The Royal Bank of Scotland who acquired the NatWest Bank has established a corporate and commercial franchise department to work with franchisors and larger multi-unit franchisees. This department is dual branded by contrast with the two group retail bank’s franchise departments which compete with each other.

Each bank has developed its own approach to franchisee finance and franchisees are likely to find that healthy competition exists between them.

The support by the UK banks is not repeated in every country where franchising exists although there are many countries where such finance is available. In some countries venture funds support larger franchises. It is very much the case of that country must be reviewed individually.



Chapter Eight.

Developing and marketing the franchise packageThe successful running of the pilot operation is essential to the preparation of the franchise package. The experience obtained in setting up and running the pilot operation will provide the basis upon which the elements in the package are structured. The package involves bringing together all the features of the business, reflecting the accumulation of the franchisor’s total operational experience in a transmittable form. Clearly the factors which are dealt with in this chapter will not necessarily apply in all cases and the detail will differ from business to business.

The franchisor will have to know where one can establish an outlet and the criteria by which the location or the scope of a territory can be judged.

Some franchise operations are dependent upon the specific location from which trading is to be carried out, others may depend upon advertising and marketing, followed by telephone contact. Retail and fast food franchises are typically in the former category, while mobile franchises are in the latter. Furthermore, experience with the pilot operation should have indicated when custom is likely to arise and what time of day or week is likely to produce the peaks of business activity.

It is suggested that the following guidelines should be taken into account in assessing the degree of business activity a particular site may be capable of generating. The requirements will differ in some cases and so may the conclusions to be drawn from the information revealed by enquiries.

It may be thought that these guidelines would apply to every business whether or not it is franchised. That is so as there is no reason why their aspects should differ. What is different is



that the franchiseee is expecting to benefit from the franchisors know-how and experience while in the non-franchised sector the individual has to work it out for himself. But in franchising, since one is offering to provide know-how to others, the franchisor’s research must be done thoroughly to ensure that the franchise sold and the advice given are soundly based. A franchisee does not have a franchisor to make uninformed decisions for him. He can do that himself.

The following guidelines are example of what can be considered:

- Type of street and neighbourhood

- Environmental issues

- Foot and/or road traffic volumes and flows

- The degree of identification and exposure which the premises will provide

- Landmarks, leisure and other facilities, e.g. tourist attractions and the business which they may generate

In the case of a mobile franchise, where the franchisee visits the customer, careful evaluation has to be made of catchment areas and their potential to provide adequate business on a continuing basis in order to determine what is a realistic territorial allocation. Experience will have to be obtained of the different considerations which apply to urban and non-urban areas. There can be variations in density of population in urban areas.

Having decided that a particular location is acceptable by the relevant criteria, one also has to assess the premises for their suitability for the purposes of the specific business. This would be the case, of course, regardless of the fact that there will be a franchise involved. The factors to be considered, and the effect they may have on the business, would include:-

a) The size of the premises and whether one can fit into them all the necessary fixtures, fittings and equipment (if any), while still providing sufficient selling space or space for providing any on-site service.



b) The suitability or otherwise of the premises for conversion into the end product. This must take into account such factors as the need to provide adequate ventilation and to comply with health and safety and disability access requirements so far as may be appropriate to the type of business and to accommodate disabled staff and customers.

c) The availability of the essential public utility services at the premises.

d) The amount of any premium which may have to be paid, and level of rent and business rates.

e) The terms upon which the lease will be granted.

f) An assessment of the cost and the likelihood of obtaining the following, drawing upon the experience gained in running the pilot operation:

i) planning consents, ii) building bye law consents and fire certificates, iii) complying with any of the statutory or local authority bye law requirements which apply in a particular area. iv) landlord’s permission to carry out any works and to the assignment of the lease.

The experience gained in running the pilot operation will enable the franchisor to prepare standardised plans and specifications, packages of equipment and/or shopfitting (which may be modular) which can be varied and amended so as to fit in with the requirements of the particular premises.

The basic needs in terms of fixtures, fittings and equipment will have to be established, as will the correct layout for the particular premises. The franchisor will also have to be able to give advice on the decor of the store so that it reflects the established brand image. It should also be possible with the information available to the franchisor to streamline the preparation of any applications, which are necessary for planning and bye law requirements and to anticipate the problems which may have to be faced. These applications can often be supported with brochures which explain and illustrate what is proposed.



The franchisor may make arrangements with suppliers of the basic material or goods in which the franchised business deals for their sale to franchisees at competitive prices. These arrangements may extend to suppliers of any bags, boxes, or other materials, which are utili sed at the point of sale. It may also be arranged that these materials will bear the franchisor’s trade mark or trade name. Arrangements will have to be made with equipment suppliers so that proper supplies are available to meet the franchisee’s demand for equipment (and spare parts) and for its repair and servicing.

Systems of work will have to be put into written form. Job descriptions will have to be prepared explaining the scope and all the facets of each employee’s activities so as to fit in with the overall scheme.

Promotional literature, including point-of-sale material, will have to be created as will any common format literature and notepaper.

The franchisor will have to set up training schedules and training facilities for franchisees and their staff. The importance of a properly structured training programme cannot be over emphasised. This is not something which can be relegated to the category of “We will work something out when we see the first franchisee”. The training requirements for the franchisee and his staff should be identified, the length of the course and how it will be presented must be carefully structured. The contact between the franchisor and franchisee in the initial training phase will have a considerable bearing on the quality of the relationship. The training course will have to cover all facets of the conduct of the franchisor’s business system so that the franchisee on completing it will be capable of running the business and complying with his contractual obligations. However, while standards must be high, the course must not be so long that the franchisee cannot afford to attend it because it may affect his financial viability.

The franchisor should prepare simple accounting procedures and business systems which are to be operated by the franchisee. The training course should include tuition in the use of these



systems.

The accounting procedures and business systems will fulfil two purposes. The first is to ensure that the franchisee has the correct flow of information available to enable him to know how the business is performing from the financial point of view. Without proper up-to-date financial management information it is difficult to make the right business decisions. The second is to provide the franchisor with the information to enable it to provide continuing advisory and follow-up services as well as forming part of its control mechanisms. The franchisor will also have information available to be used in its dealings with prospective franchisees. The flow of information from all franchisees will enable the franchisor to accumulate valuable information about the system’s performance and to detect more easily where franchisees are going wrong.

The franchisor may develop or have available information to enable it to give advice to the franchisee about the leasing of premises or equipment, and other contracts into which the franchisee may have to enter with suppliers and with those who provide maintenance services generally for the equipment which is used in the franchised business.

The franchisor will need to explore the availability of financial facilities for its franchisees. In doing so it will learn whether it has prepared its franchise proposition sufficiently well to convince the sources of such facilities that it is acceptable. in some countries, the banks have established an influential role in franchise development by the expertise which they have acquired (see Chapter 7).

All these factors are finally brought together into what is called the franchise package. This is the basic ‘product’ which the franchisor is offering to sell to its prospective franchisees. Having done this the franchisor has to market the package to potential franchisees.

The franchisor will need to be satisfied that a market for franchisees exists. It will need a supply of people who have the quantities and skills the franchise opportunity requires and they



must have the financial resources.

The franchisor will have to be satisfied that the market for possible locations for outlets will provide a flow adequate to match the available prospective franchisees at rents which make sense. None of these factors will help if despite the success of the pilot operation(s) the market sector in which the franchised business operates is not healthy with good prospects. A new and bright idea with limited life span or popularity will not work.

Marketing the Package The best way for a franchisor to market a franchise package is based upon its ability to demonstrate its success. No matter how impressive the franchise package looks it is the quality of the underlying business which is all important. For the newly established franchises the track record to date will be crucial. If there is one pilot its performance will have to be very convincing to satisfy the franchisee marketplace that it is worth an investment. If the franchisor has been able to develop more than the pilot the case to present to prospective franchisees may be better. If there have been more and the piloting has been as comprehensive as is suggested in Chapter 5 and has produced good and convincing results the marketing of the franchise becomes easier.

Many franchisors maintain a low profile in the marketing of the initial few franchises. It can be very tempting to respond to many requests (as often happens) for franchises from prospective franchisees in the early days when the franchisor has spent a considerable amount of money in developing the franchise and is anxious to generate a positive flow of income.

Many franchisors have suffered a great deal of difficulty with early franchisees whose recruitment was premature and whose credentials were not as thoroughly assessed as they should have been because the franchisor was more interested in rapid sales, or under financial pressure to respond to the short-term need for cash flow, rather than accepting the risks to the careful development of his network which going down this route will undoubtedly bring.



In marketing franchises, many have found that editorial comment in local and national newspapers is an effective method of attracting enquiries. This can, of course, only be achieved if the franchise, or someone connected with it, provides material to the media which is attractive to them. There is also luck to be taken into account since even newsworthy items get dropped if something better turns up. One can employ public relations consultants, but doing so may involve perhaps a greater expense than most franchisors could afford at such an early stage. However, since this approach can be effective it should be investigated for likely cost effectiveness before being dismissed.

It should be appreciated that most franchisors make contact with their franchisees in one of the following seven ways.

1. A customer of a non-franchised business may ask the owner to grant a franchise to him.

2. A customer of one of the pilot operations may ask to become a franchisee.

3. The prospective franchisee may be attracted by a friend who has taken up a franchise, or by talking to an existing franchisee.

4. The prospective franchisee will respond to a news item advertisement or feature in a newspaper or magazine mentioning the franchise.

5. The prospective franchisee has seen an advertisement in specialised franchise media or the business opportunities sections of the various newspapers.

6. The prospective franchisee will meet the franchisor at a franchise exhibition.

7. By visiting a website of the franchisor or the Franchise Association which has links with its member’s websites.

A grand opening of one or more of the pilot operations can create a public event at a relatively modest cost which could attract media interest particularly on a local level.

Attention to detail is essential for little credit will be given to



a launch where the arrangements go wrong. Suppliers can sometimes be persuaded to provide products at specially-discounted prices and/or to take advertising space in a special feature in a local newspaper, but the franchisor may need to have persuasive arguments to obtain such support.

Having achieved some measure of public awareness through the success of the pilot operations, the franchisor could then make some similar public display to mark the decision to expand using the franchise method of marketing. It is crucial that the early franchisees, and their locations or territories are carefully chosen. At all costs, the franchising operation must avoid a false start. Successful early franchisees are a very effective demonstration of what their successors may hope to achieve. By contrast, if the early franchisees experience difficulties, whatever the reasons, it will be more difficult for the franchisor to attract new franchisees.

The financial terms (i.e. initial franchise fee, plus on-going franchisees turnover-based fees, or mark-up on supplies or other sources of the franchisor’s income) must be structured to ensure that the franchisee will obtain a proper and attractive return on his capital and income for his labours. (see Chapter 7).

The opening of the first franchised unit may be approached in the same “grand event” manner as the pilot operations.

All the facts and data provided must be truthful and accurate, of course, and presented in a direct, positive manner which can be easily assimilated. It is likely that a well organised opening event will be so hectic and well attended that there will be little time for lengthy explanations with complex details. This means that the written material made available is important. It is likely to form the basis of most of any editorial comments which may be made in any news items which may subsequently appear in local newspapers.

The aggressive approach does not appeal to all, nor indeed is it necessarily the right approach in each case. Some may take the view they do not want significant publicity at such an early stage of development. A quiet build up of the network is considered more important and the more extensive publicity can follow



when the franchise is soundly established and ready to move forward at a quicker pace.

However, one factor which is undoubtedly essential is that the franchisor must be patient at this crucial stage. He must not try to expand more quickly than his capacity to attract well qualified franchisees and to service them allows.

The franchised business will be advertising for customers for its products/services and the side effect of such advertisements may well generate enquiries from prospective franchisees.

Having gained publicity or obtained a lead for a prospective franchisee, the franchisor must not produce, in response to enquiries, a brochure or other literature which does not do the franchisor justice. There are many franchisors who let themselves down by the poor quality of their printed material. It must never be forgotten that the material supplied in response to enquiries will be part of the franchisor’s “shop window”.

It is sensible to prepare an attractive set of literature. This should explain who are the people involved in the franchise and their experience, and it should give the history of the business and a description of the franchisor’s services. It is always a good idea to include some pictures of the business premises and/or vehicles, and of the people involved in the business. By this stage, the franchisor should have a business of which he is proud and will be pleased to promote its virtues to prospective franchisees.

Many franchisors follow a set procedure when marketing the franchise. It should be appreciated that out of every 100 enquiries, 80 will probably never get beyond the initial communication, 10 will on submission of personal details be unsuitable, 10 may be worth meeting and discussing the proposition with. Of the latter, two or three may be suitable and finally buy a franchise. This means that it will be all too easy for a franchisor to waste a lot of money on expensively produced marketing material. There are two ways to cope with this. One is to be very careful in deciding what to spend on the material; the other is to be careful about distributing it so that less is wasted.

Marketing the franchise requires considerable patience (no



apology for repetition - it is important). No franchisee worth having is waiting with pen poised impatiently to sign the contract.

The franchisor has to consider the suitability of the prospective franchisee. This involves the consideration of a wide range of factors which are considered in detail in Chapter 9, but consideration should also be given to factors which are calculated to ensure that the prospective franchisee has considered his position very carefully and that certain basic elements are present. These include:-

1. Is the prospective franchisee suited to the rigours of self employment with the stress involved?

2. Is the prospect fully committed and capable of undertaking all that is involved in running the franchise?

3. Will he fit in and get on with the franchisor’s head office and field team?

4. What is the prospective franchisee’s past history?

5. Does he have adequate financial resources?

6. Is his commitment supported by this family?

The franchisor should bear in mind that it is not only in its own interest to ensure that its franchise and self employment are right for the prospective franchisee, but also in the prospective franchisee’s and all other franchisees’ interests.

The franchisor will also have the task of explaining the contract and the reasoning behind its provisions which will call for thoroughness and a great deal of patience. It must be remembered that, for the franchisee, this can be the biggest financial decision in his life. There will be disappointments for the franchisor as some prospective franchisees, whom the franchisor would consider ideal, will decide against buying the franchise.

What then is the procedure which should be followed? It is very important to get this right. First impressions always count a lot and the written presentation will tell a lot about the franchisor



and just how business-like and professional is his operation.

1. The franchisor may receive a letter or phone call from the prospective franchisee. The initial contact may be made at a franchise exhibition when such preliminary discussions can take place. No franchisor should ever “sign up” a franchisee at the exhibition at which the first meeting has taken place. All normal investigations and procedures must still be followed, particularly in such a case where the prospective franchisee may have been influenced by the euphoria of the event. The franchisor will respond by sending out or handing over an illustrated presentation describing the franchise company and its success story. Sometimes this is presented in a question and answer form. Some companies explain briefly what franchising is. The franchisor may find it convenient at some stage to send prospective franchisees a copy of How to Evaluate a Franchise (published by Franchiseek). Franchisors find that this guide puts franchising into perspective for prospective franchisees and their professional advisers, who may never previously have had contact with a franchise transaction.

2. The presentation is often accompanied by an explanation of what the franchisor does for his franchisees in terms of setting them up and in continuing to service their needs and requirements thereafter.

3. Specimen financial projections are also usually despatched with the initial material. These must never be presented to franchisees as suggestions of what they will achieve. Rather, they should illustrate a profit performance which may be achieved if certain levels of business are reached. These figures must be prepared with care and contain a proper explanation of what they do represent so that the prospective franchisee is not misled and so that the franchisor is not creating possible problems for himself later on if things go wrong. Any projections which are presented to franchisees must be based on verifiable actual performance achieved by the franchisor or a franchisee. In some countries there may be laws which affect or regulate such projections.

4. The prospective franchisee will also be invited to complete



an application form to provide the franchisor with details about him. This will enable the franchisor to find out whether he is a suitable person with whom to proceed further.

5. After the application form is received and evaluated, the franchisor will have to decide whether or not to arrange an interview with the prospective franchisee. A franchisor should understand that many of the requests it receives will not be from serious enquirers and may be from other franchisors, or prospective franchisors, who wish to see what it is offering.

6. There should be a series of meetings before a final decision is made about whether or not to proceed to signing a contract.

It is emphasised that considerable time and effort will be involved in finalising the first few franchise contracts and getting the new franchisees open for business and trading. The process will be even longer where suitable property has to be acquired and converted.

So the franchisor should not rush its fences, or expect rapid results in the initial stages of its franchise programme. In particular, such a franchisor should never allow itself to get into the position where it does not feel comfortable about saying ‘no’ to a prospective franchisee if it does believe that the relationship will work if the franchisor is under financial pressure.



Chapter Nine.

Selecting your franchiseesThe selection of franchisees is not an easy subject on which to give advice particularly as it is of crucial importance. It is one of the ironies of life that one has to learn by one’s mistakes in order to gain experience. Franchising is no different and the skill of choosing the right franchisees is, of necessity, developed with experience.

It is not uncommon to find that a franchisor will have more problems from among the first ten franchisees than from those who subsequently join the network. It is also not unknown for some of those early unsatisfactory franchisees to poison the atmosphere later on by stirring up the network because of their dissatisfaction with their under achievement. This may have arisen because they were not suited to the role of a franchisee or because they did not make a success of their businesses and they are angry. They feel they have something to settle with the franchisor.

One of the most common mistakes which is made by new franchisors is to be too ready and willing to establish the initial franchisees and to give them special deals. This is quite understandable, since at that point the franchisor has spent a great deal of time and money on establishing his franchise and in running his pilot operation. He wants to expand quickly and see a return on his investment as soon as possible.

He is at the point of maximum vulnerability just when he requires the strongest nerve. It is a great mistake to accept as a franchisee someone who is willing to buy the franchise unless he matches up to the franchisor’s requirements in every respect. That is just as important with the first, as it is with the hundred and first, franchisee. Standards of selection must never be relaxed or compromised. In the early days in particular the franchisor must be patient and have the ability to turn down applicants if



he is not absolutely certain that they will be good franchisees.

There are many franchisors who, having become established, express the wish that they could be rid of some of their earlier franchisees whom they accepted because they were available, and not because they matched up to the franchisor’s requirements. These franchisees would not qualify for acceptance when the franchisor is established and can afford to be more selective and patient.

Would one set up a pilot operation in a totally wrong location merely because it was available, or would one wait patiently for the right site? One would, of course, wait for the right site. So with the initial franchisees it is essential to be patient. Wait for the right person. It will pay in the long run.

There are those franchisors who give special deals to initial franchisees to lure them in, again as a means of starting up quickly. This is also a mistake and, as experience shows, on the whole builds up problems later on when one has to exercise control over such franchisees, who still rate themselves as “special cases” and feel that they are always entitled to “special treatment”. Additionally, franchisees do talk to each other (indeed in some countries the franchisees have the legal right to form associations), and special deals cause ill feelings with attendant difficulties for the franchisor as the later entrants to the network discover that they have different less beneficial terms. This creates resentment which can escalate into real difficulties.

Many franchisors develop what they call a franchisee profile as the number of their franchisees increases. This reflects the pattern of the qualities and qualifications of the franchisees which they have set up in business. As an example, a franchisor may be able to say that his franchisee is most likely to be a married man, aged 39 - 45 with two children and with the following attributes and attitudes:- a successful career in middle management, fed up with lack of prospects and stifled by company policies, keen and anxious to be his own boss, supported by his wife in his ambitions, no previous experience in the type of franchised business on offer, adequate finance, backed by a fairly good equity in his house on which he can borrow.



It is important that the prospective franchisee has enough money to get started. While the franchisee may have to borrow some of the funds, perhaps as much as the 70 per cent which is available from some of the banks which support franchising, the rest should be his own cash. (see chapter 7).

Any borrowing should be arranged with an ethical source of funds (e.g. a reputable bank, finance house or insurance company) and over a sufficient length of time to enable the business to repay the borrowed funds, and the interest thereon, while leaving sufficient for the franchisee to live on. Five to ten year loans should be satisfactory for most purposes.

It is as well to remember that if the franchisee has to put in no funds of his own, or alternatively is too rich, then he may be tempted to walk away from the franchised operation if difficulties are encountered, rather than work his way through them. A financial commitment, the loss of which would be significant to the franchisee, is a considerable incentive and should be regarded as an essential feature of a franchise transaction.

An ambitious committed individual is the ideal prospect who is likely to prove to be a successful franchisee but one must be certain that his ambition will not lead him to become creative so far as the franchisor’s system is concerned. No matter how ambitious, the franchisee must accept that he is operating someone else’s system and not his own.

In some cases large companies have become good franchisees, and there are some very successful multiple franchisees, notably in hotel, fast food, and retail businesses.

The large corporate franchisee by contrast with the small proprietorial corporate franchisee can present problems for a franchisor. It is more difficult in such a case to control the spread of the franchisor’s know-how, and secret and confidential information. An economically strong franchisee, who may be more financially powerful than the franchisor would be a powerful opponent in the event of any disputes.

The large company may find the constraints imposed upon it by franchising too restrictive and may gradually introduce what



it thinks are improvements to the system. Such a situation is challenging since the large company may consider its experience in its own operations equips it better than the franchisor. For these reasons it may be sensible for most franchisors not to deal with large companies as franchisees, certainly not until the network is strong enough for the franchisor to be able to withstand the pressures to which it could be subjected.

However, the more common relationship is basically between the franchisor and the individual franchisee (who may form a company) and is a very personal one. The success of the personal relationship is indeed the key to the successful growth of the whole operation.

Franchisors will look for many qualities in their franchisees. They should be healthy and able to endure the stresses and strains of self employment with no-one else to hand over a salary periodically as will have been the case in the past. Facing up to the prospect of losing all can be very stressful.

The franchisor should have at least one meeting with the prospective franchisee and family in their own home. Seeing them together, and the way in which they live, and keep and maintain their home can tell a lot about them. Those who live in a sloppy manner are likely to run their business in the same sloppy way. Do not find out too late when a simple additional procedure can provide the information required. Meeting the whole group will also enable the franchisor to judge just how committed the family is to the proposed venture and whether there will be support or interference. Such interference does occur from time to time and can only put the franchisor/ franchisee relationship at risk.

Most franchisors do not require their franchisees to have prior experience of their particular trade as full training will normally be provided. Indeed, some franchisors believe that the person with experience of their type of business will be more difficult to train in the franchisor’s particular methods. On the other hand, there can be some businesses where the background knowledge of the trade is essential and since it cannot be taught within an economically viable time frame, the prospective franchisees must



have the requisite knowledge. In such a case, the franchisor’s training will have to be very thorough and so will the continuing supervision of operations.

Age is relatively unimportant in many cases so long as the prospective franchisee’s health is good and unless his age renders him unsuitable for the particular business.

In some franchises, the husband and wife team is an ideal combination with both partners active in the business. Even where this is not required, it is important that the prospective franchisee has the total support of his spouse. In these days when more men and women live together although they are not married, the franchisor needs to consider what would be the effect of their parting. Divorce can also create problems, particularly if the married couple operate under the framework of a partnership agreement. There may be telephone messages to be taken and relayed at unsocial hours of the day and night, normal mealtimes will often be missed, and there may be widespread disruption of the normal pattern of social and domestic life.

The prospective franchisee must be independent enough to be able to manage a business on his own. However, he must be dependent enough to want to work within the rules of the franchise and not continually be challenging the franchisor and seeking an excuse to break away.

It is essential in view of the relationship which exists in a franchise for the franchisor and franchisee to have mutual trust and respect. The franchisee must be someone whom the franchisor can trust with his name and goodwill. Will he be honest in his financial returns on which the management services fee income will depend? Will he give his staff and customers honest and fair treatment?

On the other hand, can the franchisee trust the franchisor, and does the franchisor deserve that trust? The franchisor in turn must demonstrate a successful record in ethical business practice.

Can the prospective franchisee, with the franchisor’s help, cope with running his own business, probably for the first time? The



first couple of meetings should provide clues on this score. The franchisor should be able to tell if the prospective franchisee is serious in his approach by the way he asks questions about the operation and also the effort which he puts into visiting outlets and generally vetting the franchise proposition. The prospective franchisee should be encouraged to ask questions and to talk about himself and his aspirations.

Will the franchisee be receptive to the training and guidance which he will be given? Does the franchisor feel that the franchisee will have the capacity to cope with the assimilation of information and be able to apply it in practice?

Finally, the franchisor will have to decide whether he likes the applicant. Since both parties will doubtlessly see (and hear) a lot of one another and are mutually dependent, it is most important that they get on well with one another and have mutual respect for each other. The “chemistry” must be right. After all, both parties will be working considerable hours for the same end - the success of the franchise. The franchisor really does need the franchisee to be successful. The success of both the franchisor’s and the franchisee’s business will be inextricably interwoven.

Assuming the prospective franchisee is keen to proceed the ultimate decision must be made by the franchisor. This is a decision which has long-term consequences for both parties who must be happy with the arrangement.

If the franchisor chooses to make use of the services of a consultant, the two must work very closely with each other. The reputable consultant will know that it is the franchisor who should select and ultimately make the decision to appoint the franchisee and he will want the franchisor to be interested and involved. An ethical consultant may help the franchisor in acquiring the skills involved in selecting the right franchisees, but the consultant should never sell the franchise. The consultant should be paid a professional fee for services actually rendered and never a commission on sales.

In summary, the franchisor should select his franchisees deliberately and cautiously, and allot sufficient time to do the



job properly. He must be patient and never rush his decision. Remember, it is a crucial decision for both parties. The franchisee will often probably have at stake his whole life savings and life-style. The franchisor for its part will have at stake the reputation of its business, its future income and his credibility in selling further franchises.





Chapter Ten.

Developing the franchisor’s organisationAs in any business, it is sensible to set up and expand the franchisor’s organisation gradually in line with the development of the business. It would not be financially sensible to take on too many additional staff initially when there are as yet no franchisees.

On the other hand, it is essential that all the franchisees (especially the early ones) are fully serviced, therefore, the franchisor must have properly trained staff available to deal with the requirements of the network and may not leave the hiring of the requisite staff until after franchising commences. It is a matter of timing and judgement on the part of the franchisor to ensure that he has sufficient staff resources and skills to provide for the franchisee’s needs. It can make a lot of sense for the franchisor to recruit the managers of pilot operations with a view to their broader involvement in the network’s development as for example operations directors or training directors.

There will undoubtedly be expenses incurred in establishing the franchisor’s organisation to accommodate the development of franchisee recruitment before there is any income. It is very likely, indeed invariably the case, that the franchisor will suffer net losses in the first years. How many years it will be before profits are made will vary from case to case and will be affected by the growth rate of the system, but the time span can be as much as three to five years.

There will be unavoidable expenses of trade mark registration, brochure production, staff salaries, office expenditure, travel, advertising, promotion, legal and accountancy advice, etc. before and while the franchisees become established and the fees on turnover, or mark-ups on the supply of goods, begin to flow to the franchisor.



It is neither a solution nor good practice to charge unrealistically high initial franchise fees; this can be counter productive. The franchisor must plan to receive the majority of his income from the on-going fees on turnover derived from the successful operation of the business by the franchisee. The initial franchise fee should be a fairly modest sum of money and represent the “entrance fee to the club” - covering in some degree the value of membership of the network, and providing a contribution towards the establishment expenses incurred by the franchisor, including site and franchisee evaluation, training and supervision.

Monitoring Services These fall under two headings:

- Financial performance

- Operational standards

We shall consider each in turn:

Financial Performance The franchisor should monitor the franchisee’s financial performance. To do so it needs to receive a regular flow of information (see Chapter 7). The information which is reported to the franchisor enables the franchisor to assess the efficiency and competence of the franchisee in achieving the gross and net margins which the system should enable him to achieve. The analysis of that information will assist in ascertaining whether there are problem areas developing. For example, reducing gross sales may indicate operational standards are declining; marketing and promotion is weak; and franchisee/franchisor relations leave much to be desired. The failure to achieve the projected gross margins could indicate either that the franchisee’s prices are below what they should be, he is not putting all the sales through the till, there is wastage from staff, customer thefts, or that staff are not putting all sales through the till. If the other expense items are not at the levels at which they should be there could be some fundamental issues to resolve.

The franchisee should know how to understand the financial information (this should be part of the training) so that he can



work out for himself where he may be going wrong.

Operational Standards The monitoring of operational standards is essential for the protection of the reputation associated with the brand and the maintenance of the quality standards which the franchisor has established. This is achieved by the franchisor visiting the franchisee’s outlet. Many franchisors have field support staff who are available to franchisees for advice and assistance. It is advisable to ensure that field support staff visit franchisees at regular intervals. There should be an established routine with quality control as a central core. Reviewing financial performance with the franchisee is also a sensible part of the routine although the need for such support will vary from franchisee to franchisee depending on performance levels and the franchisee’s ability to understand the figures and to respond to them.

Mystery shopping is also a method which can be used to gauge what the consumer service is like.

Franchise sales The proprietor of the business should initially do the selling of franchises himself; indeed, there is a considerable case for him to continue to do that. Selling is not necessarily an appropriate word in the normal sense. It is much more a case of explaining the proposition, the services offered, the contractual basis and terms, and making a judgement call as to whether there is scope for the development of a successful relationship.

The proprietor of the business is the appropriate person, as he should fully understand the motivation and concerns of the prospective franchisee about to go into business on his own, probably for the first time.

Recruiting a specialist salesman from outside is potentially dangerous at any time but this is particularly the case in these delicate early stages - such a person would not know the business and the franchisor would not know him well enough to rely utterly on his judgement and his ethics when it comes effectively to parting people from their life savings. The use of outside consultants for the sale of franchises is not



recommended.

When extra help is required for the sales effort, those to be involved should be taken on one at a time, with impeccable references from previous employers. They should be very carefully screened and thoroughly trained. They must also understand the ethics of franchising and that they must become experts at the “soft sell”. Hard selling should not have any place in franchising. Alternatively, the franchisor could consider transferring someone from his own operational organisation to assist on the sales side. The advantage of recruiting from existing staff is that they will have the systems knowledge and their integrity is known.

These comments advocating that the proprietor should carry out the sales function are made on the assumption that the franchisor is an individual or a proprietorial company. Where this is not the case (e.g. where the operation to be franchised is part of a large organisation), then the head of that division - the director in charge, or the managing director of the subsidiary company - should similarly personally devote himself to the initial selling effort.

Any individual who is responsible for sales should be paid a good salary, with regular reviews, good conditions of service, plus a modest performance bonus. The aim should be to attract and retain a career-minded individual with a commitment to a long term job, who will produce a steady flow of high quality results. He will provide an essential future link with franchisees, who will often consult him as an “uncle figure” when problems arise. Ethical franchising should not be a foot in the door, immediate performance, high bonus, or “you’re out” type of selling operation. The financial incentives used to attract that type of salesman are totally inappropriate in franchising.

Marketing the product or service

In the early days of franchising activity it is unlikely that the franchisor will need any specialist additional marketing staff. If the franchisor already has a marketing capability for company operations, it should be used. If the franchisor employs an



advertising agency, they should also be briefed on the franchising plans. If the franchisor does not have an advertising agency it is recommended that one is appointed. If the franchisor is too small at that stage for an agency to be interested the franchisor should obtain experienced assistance.

Expenses have to be carefully watched, especially in the early stages when resources may be limited. However, good design work to establish the image will be needed. Some of this may already exist, but in switching to a franchise it may be wise to take another look and perhaps ensure greater distinctiveness. There are specialist design firms who offer such a service.

There will be advertisements to be placed and PR events/ releases to be handled. All these items should be carefully considered and it is best to start with a modest programme and ensure that the money spent is wisely invested. At that stage, more than any other, it is vital to obtain full value for money.

Although specialist agencies exist, as the franchisor’s organisation grows, so too will the capacity to do a great deal of promotional, marketing and design work in-house. The franchisor should give consideration to employing staff who will specialise in promotion, marketing and design work. The franchisor will need to liaise with specialist agencies and with the franchisees in the field. There will be considerable advantage to be gained from discussions with franchisees about various marketing and promotional ideas. The introduction of new marketing ideas is often worth trying in company-owned outlets and then with selected franchisees before its introduction throughout the network.

A continuous and positive approach to marketing and promotion from within the franchisor’s organisation is also good for the morale of franchisees. It encourages enthusiasm and will assist in demonstrating in practice the franchisor’s concern with the success of the franchisees’ businesses.



Operations (including innovations)

The franchisor will undoubtedly need sufficient staff to provide the franchisees with the detailed help they require to prepare and launch their new venture. The franchisor has the obligation to continue to monitor and advise the franchisee and if necessary support and control him after the launch.

An obvious source for a candidate will be one of the existing operational staff from a company operation. At first it should only require one person, who is an experienced all rounder, particularly good in practice. He must be able personally to perform all the tasks necessary and be prepared to roll up his sleeves and actually work alongside the franchisees in the early days.

The preparation of the operations manual should be the responsibility of the person chosen to be in charge of operations.

In the early days, training is likely to be carried out at the company-owned operations by one of the franchisor’s experienced managers, using the manual which has been written. If the company already has a training officer, well and good, but most new franchisors will not be so well resourced and will need to maximise the use which can be made of the franchisor’s existing operational staff and facilities. It should be recognised that franchising is different from employment and the person engaged in training will have to adjust his thinking to the different discipline which is required in dealing with franchisees.

As the franchise network develops the franchisor will be able to provide a classroom with a mock-up of an operational unit. This may be sited conveniently on the floor above, or in space behind, an existing company operation. The staff involved in operations will expand with the growth of the business and the operational side of the franchise business wiII develop along a number of paths.

a) There will be the training of new franchisees and staff.

b) There will be the continuing re-training of franchisees and staff. Much of this can be done at the franchisees’ premises.



Its main purpose will be to work out operational flaws and to eliminate bad habits developed by the franchises, or to introduce new methods. Field staff will also be able to train the franchises in new techniques and systems.

c) There will be the team in the field offering operational advice.

d) There will be those dealing with product or service innovations and experimental ideas. These should always initially be tried out in the franchisor’s company operations.

The quality of the franchisor’s field support and monitoring services is important. The franchisor even in the early stages of his development has to anticipate that there will be difficulties. He must be ready to cope with them.

The franchisor will also have to consult with his bankers, accountants and solicitors. The franchising project should be fully explained to them at an early stage, as it is possible they may not know too much about the subject.

The bankers may be helpful in providing finance for the franchisees and may be able to introduce the franchisor to their franchise managers for discussions and guidance. It is not generally sensible for the franchisor to be involved in financing franchisees itself, either by lending funds or by guarantee. The function of the franchisor should be to introduce the franchisee to the sources of finance which are available and provide any necessary information which the source reasonably requires while being conscious of what it cannot say.

The accountants can be asked to advise on methods of monitoring the franchisees’ financial performance. The solicitors will need to advise the franchisor about the protection of his rights; they will prepare the contractual documentation and should also review any franchise sales literature and ensure that the contract correctly reflects what is in that literature.

In summing-up, the initial organisational requirements for the new franchisor with limited resources could be the following:



Franchise salesProprietor or Managing Director, plus a good PA.

Marketing of the product or serviceProprietor or Managing Director, plus a PA., with advice from designers and an advertising agency.

OperationsOne person transferred from one of the franchisor’s existing operations who may be an outlet manager originally selected with this role in mind.

Shopfitting and equipmentThe operations person, plus outside suppliers/shopfitters.

TrainingA manager of one of the franchisor’s own operations.

Finance and administrationExisting company personnel, plus help from the franchisor’s bankers, accountants and lawyers.

There remain three important considerations to remember.

1. The owner of the franchise must be fully involved personally since he must be prepared to demonstrate his faith in his business and in franchising.

2. The maximum use should be made of existing company staff for reasons not only of economy, but also knowledge, experience and dependability. The choice of initial supporting staff is, therefore, vital and should be made with an eye to the future and what larger role they may be capable of performing.

3. There can be no franchise activity unless and until a successful and sufficiently profitable pilot operation is first established.



Chapter Eleven.

The franchise contractThe franchise contract is the legal document in which the whole transaction is drawn together. It must accurately reflect the promises made and it must be fair, while at the same time ensuring that there are sufficient controls to protect the integrity of the system.

The contract is, of course, important, although there does seem to be a disproportionate amount of emphasis placed upon it.

It is the quality of the underlying business which is important. The contract must fulfil the following requirements.

a) Deal correctly, in legal terms, with the various property rights owned by the franchisor.

b) Contain the operational structure and controls.

c) Provide the franchisee with security in his operations and in his ability to develop and sell an asset.

In the final analysis, it is an insurance policy for both parties if things go wrong. If the contract has to be read after signature by either party, it will usually be because there is a problem and not because one of the parties has insomnia for which dull legalese may be a cure.

There are some countries which have franchise focussed laws which may require:

• registration before the franchisor can embark on a sales programe

• the delivery of a pre-contractural disclosure document

• certain phrases to be inserted in or omitted from the contract

Personal relationship The personal relationship between the franchisor and franchisee, together with their common desire to succeed in their respective



roles as the business relationship develops, are far more important than the formal contract. In most franchise schemes, the franchisor will own the following.

a) A trade mark, or trade name, and the goodwill with which it is associated.

b) A business format system recorded in an operational manual or manuals which as a whole will be secret and confidential.

c) Where appropriate, recipes, formulae, specifications, design drawings and operational documents.

d) Copyright in some of the above items, which are in written form and capable of copyright protection.

The recruitment literature of the franchisor will certainly have indicated the nature and extent of the initial services he will provide; the range of continuing services upon which the franchisee will be able to call; and the cost of joining and belonging to his franchise system. We shall now look at each of these factors in turn.

Cost of the system The initial cost will include all the items necessary to open for business. The franchisor may or may not contract to provide the franchisee with initial equipment and shopfitting.

The franchisor will very likely charge an initial franchise fee to cover the cost to him of providing the initial range of services to the franchisee, as well as a charge for entering into the system. There can be no hard and fast rule as each system differs (see Chapter 10).

Continuing fees enable the franchisor to finance the provision of his on-going services and back-up.

It is vital that the franchisor should not have undisclosed sources of income at his franchisee’s expense, nor should he be able arbitrarily and unfairly to increase the cost of the products which he supplies to his franchisees.

Franchise fees, however they are described, are essentially a



payment by the franchisees to the franchisor, in return for the services provided by the franchisor. They provide the franchisor with his gross income to finance the provision of his franchise services.

Advertising contributions Most franchise systems provide for advertising and promotion to be handled by the franchisor who will receive from franchisees a contribution for that purpose. The most common method of calculating the contribution is the same as for franchise fees, namely as a percentage of the gross revenues of the franchisees.

In some cases, a franchisor may include the advertising expense in the franchise fee and undertake to spend a percentage of the fee on advertising and promotion. There are also cases where local advertising, rather than national, is more important and a franchisee may find the franchisor does not seek a contribution, but imposes on the franchisee the obligation to spend a certain sum on approved local advertising.

Initial services The nature of the initial services will vary, bearing in mind the type of business. Obviously, a van-based franchisee does not need site selection assistance, and conversely, a shopbased franchisee does not need to be taught how to contact his customers, as does the mobile operator.

The general principle is that the franchisor’s initial services (including training) should be sufficiently comprehensive to set-up a previously inexperienced person in business so that he can trade effectively in accordance with his chosen franchise system as soon as he opens his business. (The range of such services is covered in Chapter 5).

Continuing services Having established the franchisee in business, the franchisor now has the responsibility to sustain a continuing range of services to support him. These include the following.

a) Performance monitoring to help maintain standards and profitability.



b) Continuing training.

c) Continuing update of methods and new innovations.

d) Market research and development.

e) Promotion and advertising.

f) Benefit of bulk purchasing power.

g) The provision at “a head office” type of organisation of a specialist range of focussed management services.

h) Communications.

The contract

The normal features of a contract will be as follows.

a) The establishment and identification of the franchisor’s proprietary interests. This will clearly deal with such things as trade marks, trade names, copyright materials and the franchisor’s confidential business system and know-how.

b) The nature and extent of the rights granted to the franchisee. This will deal with areas of operation and the formal granting of rights to use trade marks, copyright material, etc.

c) Territorial rights. It is relevant at this point to mention territorial rights, since these create practical problems. There are two aspects to the problem which arise when exclusive territorial rights are a feature.

Firstly, there are the commercial considerations and these have caused many problems for franchisors over the years. It is very difficult to determine a territorial allocation, which is fair to both parties, especially when the extent of the likely penetration of the market cannot be judged. Indeed, quite often, even the total size of the potential market cannot be estimated with any degree of accuracy.

In the past, many franchisors, who have chosen the exclusive territorial route, have found that there was no effective way of



ensuring that the potential of the area was fully exploited. The effect of this is to harm the whole network. Quite apart from the fact that within the area a market and demand is being created by advertising and promotion which is not met by resources, the way is prepared for competition to move in and do better. Also, disgruntled customers, or potential customers, are not likely to look elsewhere within the same network for their requirements. The network thus gets a bad name.

The obvious response is to suggest that performance targets should be established. Since the assessment of fair performance targets is dependent upon the same factors as have to be considered in defining a territory, the problem remains basically the same. Additionally, if performance targets are set they should take into account the potential expansion of the business as well as inflationary factors. These are also difficult matters to deal with in a fair and equitable way.

Secondly, there are the legal considerations. The involvement of EU Competition Law with franchising following the decision of the European Court of Justice in the Pronuptia case has also raised the issue of exclusivity. The European Commission having previously adopted a block exemption regulation for categories of franchise agreements has now adopted a broader block exemption regulation for vertical agreements. This can affect the ability of some systems to grant exclusive territorial rights. The provisions of the regulation are briefly explained in Appendix A. This approach is followed in competition law throughout the European Union. Competition law is an important element for franchising in many countries and specialist advice should be taken.

d) Term of agreement. The contract will also specify the period of the agreement. The basic principle to be adopted here is that the franchise relationship should be capable of subsisting on a long-term basis. There may be various reasons (including legal reasons where the agreement involves the tied supply of products) for a relatively short initial period, say five years, but most franchise schemes allow for the franchisee to be able to exercise a right of renewal.



e) Franchisor’s services. The nature and extent of the services to be provided by the franchisor to the franchisee, both initially and on a continuing basis. This will deal with the initial services, which enable the franchisee to be initiated, trained, and equipped to open for trading. On a continuing basis, the franchisor will be providing services which should be detailed in the agreement (see above under the heading Continuing services), including the possibility of developing and introducing new ideas.

f) The initial and continuing obligations of the franchisees. These will range from accepting the financial burden of setting-up in compliance with the franchisor’s requirements to operating accounting and other administrative systems to ensure that essential information is available to both parties. These systems will be described in the operational manual to which the franchisee will be introduced in training and which he will have available as a reference guide after he has opened for business. The manual should constantly be updated as the system develops.

g) The operational controls imposed upon the franchisee. The controls are to ensure that operations are properly controlled - failure to maintain standards in one unit can harm the whole network. Franchisees will rightly be alarmed if any of their counterparts fail to maintain standards and the franchisor allows them to continue to do so. Often operational controls are very detailed with a cross reference to the operational manual. The contract will contain the obligations, and the manual will explain how the obligations are to be discharged.

h) Sale of the business. One of the reasons for the success of franchising is the motivation it provides to the franchisee, which comes with self-employment and the incentive at the end of the day of making a capital gain. For this reason, the franchised business should be capable of being sold. However, there will always be controls since this is the only occasion when someone other than the franchisor recruits a prospective franchisee. If there are none, it should be a matter for suspicion. After all, if a franchisor is



highly selective when considering applications for franchises, there is every reason for him to be equally selective about those who want to join the network by buying a business from an established franchisee.

The criteria by which a prospective purchaser will be judged by the franchisor should be set out in the contract. The procedure to be followed should also be provided in the contract. Some franchisees insert into the contract an option to buy the business if the franchisee wishes to sell. If such a provision is inserted in the contract, it should provide for the payment of at least the same price as is offered to the franchisee by a bona fide arms’ length purchaser. Any artificial formula which might enable the franchisor to buy at less than market value should be resisted.

i) Death of the franchisee. In order to give the franchisee peace of mind, provision should be made to demonstrate that the franchisor will provide assistance to enable the business to be preserved as an asset to be realised, or alternatively taken over by the franchisee’s dependants if they qualify as franchisees.

j) Arbitration. Arbitration is in reality private litigation with a judge (arbitrator) chosen by the parties. It has advantages in that the proceedings are private; the arbitrator chosen can be selected because of his special knowledge of the business which is the subject of arbitration; the timing of the proceedings can be fixed to suit the parties’ convenience; the parties may establish the rules for the arbitration and save time and expense in so doing.

There are disadvantages also:- not every dispute under a franchise contract will be resolved by the decision of an arbitrator, e.g. the franchisor will not want an arbitrator to judge whether his quality standards and system are being maintained; the franchisor’s right to an injunction may be impaired if the arbitration agreement does not reserve those rights to him; the wrong choice of arbitrator may result in a compromise decision which will not satisfy either party. Bearing in mind the long-term relationship involved, those areas where genuine misunderstandings can arise may be considered suitable for



arbitration, e.g. fee calculations, rights of renewal.

k) Termination provisions and the consequences of termination. Invariably, there will be express provision for the termination of the agreement in the event of a default by the franchisee. Usually, the franchisee will be given the opportunity to put right minor remediable breaches so as to avoid termination, providing that he does not persist in making such breaches.

The consequences of termination will usually involve the franchisee in having to take steps to ensure that he ceases to display any association with the franchisor. The franchisee will no longer enjoy the use of the trade mark/trade name, and other proprietorial rights, owned by the franchisor. In addition, the franchisee will be under an obligation for a period of time not to compete with the franchisor, or other franchisees, nor will he be allowed to make use of the franchisor’s system, or other methods.



Chapter Twelve.

Working at the franchisor/franchisee relationshipThe franchisor/franchisee relationship is not a natural one. It is based upon the reality that there are a number of areas of likely conflict between them. A simple example is it may be in the interests of the franchisor to introduce marketing schemes calculated to increase gross sales while sacrificing some margins. As the franchisor who is paid franchise fees based on gross sales will do better it clearly has a vested interest in this approach. For the franchisee it is a disaster - work harder for lower margins and if the increase in gross does not bring added value to the bottom line, why bother?

The relationship will often start with high hopes and expectations on both sides. To quote from’ The Guide to Franchising’:

‘There is an analogy to be drawn between parent-child relations on the one hand and franchisor-franchisee relations on the other. In the early stages of the franchise relationship the franchisee, like a child with a parent, is dependent upon the franchisor for his sources of information and the understanding of how to apply the knowledge acquired. As the franchisee gains practical experience he becomes less dependent, and in some cases so independent that he no longer sees the value in his association with the franchisor, or at best, a diminished role for the franchisor. He regards himself as being totally responsible for his success and he resents the payments he is making to the franchisor and the controls to which he is subjected. Furthermore, he may see no need to continue to be supplied with any products or services by the franchisor.

This is similar to the developing parent-child relationship as the child grows older so he becomes less dependent and more fiercely independent. The child has his own ideas, cannot see the need for



parental control and rejects parental influence. So both the franchisor and parent face a similar problem. It is the recognition of a response to the changing and evolving nature of the relationship which is an essential element in the skill of both franchisor and parent. Those who deal with this problem best are the most successful in practice.

There is also a vital difference, for when the child becomes an adult he is free to do whatever he wants to do. Respect for parental feelings and guidance mayor may not be considered, but even so it is the child’s final choice of career and the country in which she wishes to pursue that career which dictates events.

The franchisee, however, is locked into the franchise relationship throughout the term of the contract (and any renewals) or until he sells his business. That he is a mature franchisee with years in the business behind him will give him no greater freedom to run his business than the newest recruit to the system. That is fundamental to the franchisee method. The fact that the intelligent, ambitious, entrepreneurial franchisee does well and applies himself diligently to the development of the franchised business has to be recognised. His input should be encouraged and he should be treated with respect, as should the ideas which he can contribute. However, the franchisor cannot allow the franchisee to take over the control of the franchise system and its development. The fundamentals remain true at whatever stage one finds oneself. The franchisees operate the franchisor’s system using the franchisor’s names and trademarks and the franchisor must have the final word on what can and cannot be permitted. Indeed, without centralized control the franchise system and network could rapidly lose its corporate identity and uniformity of branding, range of products and services provided.’

There are any number of events which arise which can cause friction in the relationship. Some may have nothing to do with anything either party has done or failed to do.

In a recession a franchisee with falling sales and making losses will expect the franchisor to do something. Whether that is a realistic expectation is not relevant to that franchisee since that is what he believes the franchisor is there for.

There may be road closures, parking may be restricted or banned



so that the pedestrian traffic flows are so changed that the franchisee loses business - what are you going to do about it, he will ask the franchisor?

The franchisee may not be happy with the value to him of the franchisor’s services.

The franchisee may consider the franchisor is autocratic and lacking in sensitivity to what concerns the franchisee.

The franchisor may not be happy with the way the franchisee is behaving:

- he may be challenging the system

- he may be late in sending reports and paying fees

- he may be doing something which is not part of the system

The list can be lengthy - there is a very full treatment of this subject in ‘The Guide to Franchising’ if further information is required. (7th Edition 2004 published by Thomson Learning. www.thomsonlearning.co.uk)

Both franchisor and franchisee should recognise the downsides in the relationship and behave responsibly towards each other to produce the success of the relationship which can be achieved.

Care must be taken in communications between franchisor and franchisee to ensure that misunderstandings do not arise.

The relationship starts to develop from the first point of contact. The franchisor should even then have in the forefront of his mind the question - can we get on together? Are we on the same wavelength? Does this prospective franchisee have some mental blocks which make it difficult for us to relate to each other? Is the chemistry between us right? All these questions need to be asked by the franchisor’s staff who will have dealings with that prospective franchisee. The franchisee may well be considering the same questions in relation to the franchisor.

If the franchisor has doubts or even reservations when considering these questions, then dealings with that individual as a franchisee are likely to be difficult.



Apart from communication skills the franchisor must be able to gain and sustain the respect of the franchisee for the business format which it has developed and the quality of its on-going support services and development.

The franchisor must also show respect for skills which the franchisee brings to the system and encourage him to offer enthusiasm and suggestions to improve the system based on his experience.

If and when stresses arise in the relationship, it is in the joint interests of both to seek ways amicably to resolve their differences rather than allow the relationship to deteriorate to the point where it cannot continue.

An understanding of each other’s points of view is crucial but the franchisee must be made to understand that there are some issues on which a franchisor cannot compromise. In this category come such matters as trade marks, trade names, reputation, goodwill, the system with its secret and confidential know-how, and quality standards. This should clearly be understood by the franchisee before entering into any franchise transaction and certainly by the time he has completed his training.

The franchisor should always make the franchisee feel that he is getting more value in services than the actual cost in franchise fees.

Franchisees need to be kept informed so they know what the franchisor is planning - they should be listened to - they may have something worthwhile to contribute. How the franchisor achieves this will depend on his own views of what is the best way to liaise and exchange ideas with franchisees.

Certainly direct contact is the best, but as a network grows, this sort of liaison with each franchisee or separate group of franchisees becomes more difficult. This, of course, would be in addition to the field support visits or other contacts with the franchisor’s head office team.

Many franchisors establish franchisee advisory councils with regional or national elections by franchisees to a committee



which will liaise with the franchisor on their behalf. In such a forum, matters of common interest can be discussed. It provides the franchisor with an opportunity to explain its marketing and advertising plans and system developments in a constructive way.

It is no accident that those franchisors who develop the best relationships with their franchisees do best.





Chapter Thirteen.

Franchise AssociationsFranchising is reputed to be found in 140 countries, but there are not, so far as the information available indicates anything like 140 national franchise associations. See Chapter Twelve.

There is a great deal of cooperation between franchise associations. In the European Union there has long been the European Franchise Federation which has as its members the national franchise associations in Europe. There is also a World Franchise Council to which many of the national franchise associations from around the world belong.

A franchise association provides a focal point for franchising in its country. It should be established by franchisors and should set standards of ethical conduct with which all members should comply. It can provide sources of information for prospective franchisors and franchisees - it can explain franchising to government. Collectively its members can ensure that the ‘outside world’ knows about and accepts franchising and its business and job creation advantages.

Many franchise associations provide access to publications and organise adequate educational seminars and activities.

In addition to having franchisors as members, associations in some cases provide franchisees with the ability to make their views known in the franchise community to enhance the relationship between franchisors and franchisees. Those who provide services and products to the franchise sector can usually also join franchise associations as affiliate members.

This concentration of the franchise community through an association assists the wider public in identifying with this sector.

Prospective franchisees should always contact the national Franchise association to discover whether the franchisor with whom they wish to deal with is a member.

See Appendix A for a list of Franchise Associations.





Appendix A.

The Block Exemption for Vertical AgreementsMention has been made in the text of Competition (antitrust) Law. The issues which arise will often include market sharing - exclusivity - price fixing. The European Commission has issued a regulation exempting agreements which comply with its conditions. This Appendix will illustrate how the commission has approached the issues. It should be understood that not all competition law authorities or the courts in other countries will adopt the same approach. Member States of the European Union will follow the same approach for cross border systems but may also deal with domestic markets in a similar way.

Readers will find the full text of the Block Exemption Regulation immediately following this explanation. The explanation cross refers to the text.

The process of preparing for this Regulation began on 27 January 1997 with a publication by the European Commission of a “Green Paper on Vertical Restraints and EC Competition Policy”. Following the consultation period, the Commission published a “Follow-up to the Green Paper on Vertical Restraints”. The first draft regulation which followed did not appear to reflect the views of the majority of those making representations.

The Commission produced a number of draft versions of the regulation. The first was a disaster. We have now ended up with a document which while it mayor may not be called a disaster, has a number of features which many would argue are plainly wrong for franchising.

Before looking at the regulation it is important to understand that there have been other changes in the law which are significant. It will no longer be the case that agreements have to be notified to the Commission for individual exemption at the time they are entered into. There will be no presumption that the Agreements or possible anti-competitive provisions are void. Agreements entered into after 31 May 2000 will be capable of being notified at any time and the Commission will be able to backdate any exemption it may grant to the date the Agreement was entered into.



This means that those franchisees who have been encouraged, when there is a dispute, to adopt the stance that restrictive or anti-competitive clauses are void will no longer be able to apply that sort of pressure. This may mean less use of this approach, more rapid settlements of disputes and, if all else fails, the national Courts will be encouraged to make decisions about whether Article 81 (3 ) (the exemption mechanism) is potentially applicable. Indeed, the Commission is currently engaged in a review of its competition procedures which are likely to lead to national competition authorities and the national Courts playing a much more active role.

The Commission have issued guidelines to explain the regulation and how the Commission will apply competition law to agreements which cannot benefit from the regulation. The Commission have made it quite plain that they really do not want to be saddled with notifications except in significant cases. The position they adopt in the guidelines is that they will attach no particular urgency to the consideration of notifications except if they arise from a request by a national Court or as a result of complaints. It should be appreciated that these rules apply in the UK in relation to the relevant national market.

To turn now to the regulation. It follows the usual pattern with preambles which seek to explain the reasoning behind the regulation and then the terms of the regulation itself. If we look at the preamble it is quite clear that the Commission has not really taken the trouble to explain much. There are references to what can or cannot be presumed without explaining why this is so and to “experience acquired to date” without saying in the preamble what that is. Since they have said they have had no franchise agreements notified to them since the existing block exemption regulation was brought into force in 1989 they certainly have no experience of franchising to justify that statement. The preamble does nothing to explain why it is that the Commission will not treat franchising differently from other methods of distribution.

When the European Court of Justice in the Pronuptia case specifically drew such distinctions and explained what they were, why indeed the Commission have doggedly refused to accept that franchising should be viewed as something different is difficult to understand. It appears that their approach is that if an agreement contains vertical restraints it is no different from any other agreement containing vertical restraints. Since this ignores the way in which the business is structured and the



way in which it operates in the market place it seems somewhat strange that a competition law enforcement agency should fail to draw these distinctions.

The regulation commences with a set of definitions. It is essential to understand these definitions before approaching the rest of the regulation in view of the impact they have, for example, the expression “non-compete obligation” would not normally be understood by most lawyers or business people to include tied buying provisions, but that is exactly what it does.

The definition of “selective distribution system” is quite interesting since for there to be a selective distribution system, a franchisor would need to undertake that “it will not sell goods to anyone other than distributors selected on the basis of specified criteria”. Given that the Commission in two of the cases individually notified to it decided that franchisees are not so selected and that it would be most unusual for any franchisor to give such an undertaking, franchisors would be well advised to spend some time considering the implications of this definition and how their contracts and business practices may be organised to ensure that what they have is not a selective distribution system. If that can be achieved, many of the hardcore clauses (see below) which have the potential to have the greatest adverse effect on franchise systems should be capable of being avoided.

The definition of know-how is based upon the definition of know-how contained in the existing regulation. The only problem is that the subsidiary definition of “substantial” does not give any recognition of the extent of know-how which is to be found in franchise systems.

Article 1(f) provides: “Substantial” means that the know-how includes information which is indispensable to the buyer for the use, sale or resale of the contract goods or services”.

The Commission, by adopting this definition made it questionable whether franchise systems will be able to show any “know-how” at all of which this definition would take note.

It is clearly arguable that it is not “indispensable” to any franchisee to have the franchisor’s know-how for the use, sale or resale of the contract, goods or services. On the other hand, it is also arguable that it is indispensable



for the franchisee to have the franchisor’s know how for the use, sale or resale of the contract goods or services in the way which the franchisor’s system requires.

It is worth therefore, looking at the Pronuptia decision of which the Commission were reminded and the way in which the Court approached the issue of know-how in the franchising context.

In paragraph 36 of the decision the Court stated the law as follows:

“1 (b) Clauses which are indispensable for the purpose of preventing the know-how provided and help given by the franchisor from benefiting competitors, do not constitute restrictions of competition within the meaning of Article 85(1)” (now 81(1)). (Note this reference is to an article in the EC Treaty not the regulation).

Furthermore, in paragraph 16 of its decision the Court stated:

“In the first place, the franchisor has to be able to communicate to franchisees his know-how and to provide them with the necessary help in implementing his methods, without running the risk that this know-how and this help benefit, however indirectly, his competitors. Consequently, the clauses which are indispensable to avoid this risk do not constitute restrictions on competition in the sense of Article 85(1) (now 81(1)). From this follows the prohibition on the franchisee on opening during the period of the contract or during a reasonable period after its expiration, a shop having a similar identical purpose in a region in which it could compete with members of the network. Similarly, from this flows the obligation imposed on the franchisee not to transfer his shop without the prior agreement of the franchisor; this clause helps to avoid the benefit of the know-how provided and the help given passing it indirectly to a competitor.”

The Court decision must be regarded as a statement of the law (indeed the Guidelines recognise this) and therefore it remains the case that clauses which are indispensable to the legitimate protection of know-how communicated to franchisees are in principle outside Article 81 (1) altogether.

Article 2(1) contains the basic exemption which applies broadly to agreements whose parties operate for the purposes of the agreement at a different level in the production or distribution chain. Exemption applies



where such agreements contain restrictions of competition which are caught by Article 81(1). If one can avoid Article 81(1) as can be the case with tied buying arrangements and perhaps with know-how, the question of whether or not the regulation needs to be relied upon becomes academic.

The words “for the purposes of the agreement” makes it plain that where a franchisor operates its own stores it will not be regarded for the purposes of agreements with franchisees as operating at the same level.

Article 2(2) dealing with associations of undertakings and its members seems to be directed at providing an exemption of a limited nature to buying co-operatives.

Article 2(3) extends the exemption to make it plain that the use of intellectual property rights which are directly related to the use, sale or re-sale of goods or services by the franchisee provided that the provisions do not constitute the primary objective of the agreement. This paragraph should not create problems for the overwhelming majority of franchise systems.

Article 2(4) provides exemption for non-reciprocal vertical agreements entered into between competing undertakings where the buyer has a total annual turnover not exceeding EUR100 million, or the supplier manufactures and distributes goods where the buyer is a distributor and not a manufacturer or where the supplier provides services at several levels of trade or the buyer does not provide competing services at its level of trade. The clause therefore extends the provisions of exemption to some agreements between actual competitors.

Article 2(5) makes it plain that if any vertical agreements are within the scope of any other block exemption regulation they cannot rely on this regulation.

Article 3 sets the market share threshold. The exemption applies provided the supplier’s market share does not exceed 30% of the relevant market. However, where the supplier has entered into an exclusive supply obligation with the buyer, the relevant market share threshold of30% is that of the buyer not the supplier.

Article 4 contains the hardcore clauses and excludes vertical agreements which directly or indirectly, in isolation or in combination of other factors



under the control of the parties, have as their object:

Paragraph (a) a minimum price fixing arrangement. Maximum and recommended sale prices will be permitted provided they are not disguised as a minimum price fixing arrangement resulting from pressure or incentives offered by any of the parties. This latter phrase means that care would need to be taken with any maximum or recommended price arrangements to ensure that such pressures do not exist.

Paragraph (b) is interesting in the sense that it prohibits the restriction of the territory into which, or of the customers to whom, the buyer may sell the contract goods or services, but it then contains four exceptions. The first is where there is a restriction on active sales into the exclusive territory or to an exclusive customer group, either where such territory or group is reserved to the franchisor or allocated by the franchisor to another franchisee, where such restriction does not limit sales by the customers of the franchisee. Second, a restriction of sales to end users by a wholesale purchaser. Third, a restriction on sales to unauthorised distributors by members of a selective distribution system. The fourth exception relates to components and spare parts which is not normally an issue in franchise system arrangements.

Paragraph (c) prohibits restrictions of active or passive sales to end users by members of a selective distribution system operating at the retail level of trade. It is worth referring to the discussion of the definition of “selective distribution system” (see above). It is to be noted that this provision does permit a franchisor to control where the trading premises of the franchisee will be based. The draft guidelines also indicated that the Commission are of the view that it would be possible for a franchisor to prevent a mobile franchise operator from taking his vehicle outside his allocated territory.

Paragraph (d), which only applies if there is a selective distribution system prevents a franchisor from restricting his franchisees from supplying each other. This is the same position as existed under the current block exemption regulation and has not proved to be a problem.

Paragraph (e) does not seem likely to affect any franchise systems.

Article 5 imposes further conditions which are relevant to franchises. The



exemption will not apply to the obligations set out in Article 5(a), (b) and (c). Unlike the hardcore listed clauses, this exemption will apply to the rest of the agreement it is just the offending clause which falls outside the BER and so must be considered on an individual basis on its merits (but see below the reference to a de minimis notice).

Article 5(a) prohibits direct or indirect non-compete obligations which are indefinite or which exceed 5 years. Remember, a non-compete obligation is defined as not only a conventional “non-compete” but also a tied buying arrangement requiring the franchisee to buy from the franchisor or a designated supplier more than 80% of the franchisee’s total purchases. A non-compete obligation which is tacitly renewable beyond a period of 5 years is deemed to have been concluded for a definite period. According to the dictionary, tacit means silent or not expressed. Presumably therefore this provision catches understandings or gentlemen’s agreements. A provision enabling a franchisee to renew should not offend against this provision provided it is the franchisee’s decision to renew and that a new agreement is entered into when such right is exercised. Curiously, if the franchisor is the franchisee’s landlord the period of 5 years can be extended for the term of the lease between them. In order to put this provision in perspective one has to look again at the Pronuptia decision referred to in the draft guidelines. However, the European Court of Justice was quite clear in its decision in which it stated “clauses which institute controls indispensable for the preservation of the identity and reputation of the network symbolised by the sign do not constitute restrictions of competition within the meaning of Article 85(1)” (now 81(1)).

The Court gave further guidance. It stated “thanks to the control exercised by the franchisor over the stock offered by the franchisee, the public can find in each franchisee’s establishment goods of the same quality”. Further, it stated “the clause providing that the franchisee should sell only those goods originating with the franchisor or the suppliers chosen by the franchisor may, in such conditions, be considered necessary by way of protection for the network’s reputation. It should not, however, lead to a situation in which the franchisee is prevented from acquiring those goods from other franchisees”. The effect of this is that if a franchisor can bring himself within principles enunciated in the Court’s judgment, a tied buying arrangement for 100% of the franchisee’s requirements for the goods would not be caught by the prohibition under Article 81 (1) and a franchisor need not be concerned with whether or not the regulation has



anything to say on the subject matter.

Second paragraph (b) of Article 5 deals with post term restraints against competition. There are four limbs to be satisfied to benefit from the regulation:

(1) the restraint must relate to goods or services which compete with the franchised goods or services;

(2) it is limited to the premises and land from which the franchisee has operated;

(3) it is indispensable to protect know-how transferred by the supplier to the buyer; and

(4) the non-compete obligation is limited to one year after termination.

This means that what is permitted is so narrow that one has to wonder to what extent it has any value at all. It is limited to preventing the franchisee from operating from the premises where he had operated the system. No protection from any surrounding area is permitted and it must be indispensable to protect know-how transferred. Know-how is, as explained above, so limited in its definition that it is scarcely likely to help.

The clause, however, does permit restrictions unlimited in time on the use and disclosure of know-how which has not entered the public domain. Franchisors may be well advised to look at strengthening the scope for protection which that offers.

Again, we need to look at the Pronuptia judgment to see what assistance may be obtained. There is some to be found in the following statement:

“The franchisor has to be able to communicate to franchisees his know-how and to provide them with the necessary help in implementing his methods without running the risk that this know-how and this help benefit whoever indirectly is his competitors. Consequently, the clauses which are indispensable to avoid this risk do not constitute restrictions on competition in the sense of Article 85 (l) (now Article 81 (l)). From this follows the prohibition on the franchisee on opening during the period of the contract or during a reasonable period after its expiration, a shop having a similar or identical purpose in a region in which it could compete with members of the network.”

Again, if a franchisor can bring his restraints within this statement from



the Court, an issue of whether or not the prohibition in Article 81 (1) would arise would have been dealt with and since the prohibition in the law would not have been offended against, the regulation would have no application.

Third, in paragraph (c) members of a selective distribution system cannot be required not to sell the brands of a particular competing supplier. Prohibition against all competing suppliers is apparently acceptable but to single individual suppliers out would not be.

Article 6 deals with the ability of the Commission to withdraw the benefit of the regulation where, in a particular case, it considers that the arrangements do not qualify for exemption under Article 81 (3) of the treaty.

Article 7 gives the power of a national competition authority to withdraw the benefit of the regulation in respect of its territory where the arrangements would not be compatible with the exempting provisions of Article 81(3).

Article 8 provides a mechanism by which the Commission may exclude the application of the regulation where parallel networks of similar restraints cover more than 50% of a relevant market. What is curious about this provision is that it pays no heed to what is the nature of the business which is being carried on - merely that the networks have similar vertical restraints.

Article 9 gives guidance on how market shares should be calculated with the time honoured phrase “that the market is the contract goods or services or other goods or services sold by the supplier which are regarded as interchangeable or substitutable by the buyer by reason of the products, characteristics, their prices and their intended use. The best thing that can be said about this form is that it seems to be capable of being interpreted in whatever way the Commission may choose to do so.

Article 10 deals with the calculation of turnover and provides for marginal relief for 2 years if the total turnover threshold which is permitted is exceeded by no more than 10%.

Article 11 contains a definition of connected undertakings.

Article 12 extends the existing regulation for franchising and the other distribution regulations until 31 st May 2000. During the period from



the 1st June 2000 to 31st December 2001, agreements entered into force before 31 st May which satisfy the existing regulation will continue to be valid, notwithstanding that they may not comply with the new regulation. The new regulation entered into force on 1 st June 2000 and expires on the 31 st May 2010.

The Commission has in the past published Notices setting out its policy in regard to what it regards as contracts or practice which are not significant enough to affect trade between member states appreciably and therefore would not infringe Article 81 (1) of the Treaty. This notice is commonly referred to as a de minimis notice.

The Commission recently published a draft of a proposed new de minimis notice which proposes a ceiling of 15% market share but still subject to the hardcore clauses referred to above. The notice is not subject to the conditions in Article 5 of the Regulation, ie. the tied buying and restraints against in term and post term competition. This means that franchise systems which do not have a market share of more than 15% only need concern themselves with the hardcore unless there are good reasons to expect the Commission or a Court to conclude that their market share (if less than 15% nevertheless), does appreciably affect trade between member states.

COMMISSION REGULATION (EC) NO 2790/1999 of 22 December 1999 on the application of Article 81 (3) of the Treaty to categories of vertical agreements and concerted practices. (Text with EEA relevance)

THE COMMISSION OF THE EUROPEAN COMMUNITIES, Having regard to the Treaty establishing the European Community, Having regard to Council Regulation No 19/65/EEC of 2 March 1965 on the application of Article 85(3) of the Treaty to certain categories of agreements and concerted practices, as last amended by Regulation (EC) No 1215/1999, and in particular Article 1 thereof, Having published a draft of this Regulation 3, Having consulted the Advisory Committee on Restrictive Practices and Dominant Positions,



Whereas:

(1) Regulation No 19/65/EEC empowers the Commission to apply Article 81 (3) of the Treaty (formerly Article 85(3)) by regulation to certain categories of vertical agreements and corresponding concerted practices falling within Article 81 (1).

(2) Experience acquired to date makes it possible to define a category of vertical agreements which can be regarded as normally satisfying the conditions laid down in Article 81 (3).

(3) This category includes vertical agreements for the purchase or sale of goods or services where these agreements are concluded between noncompeting under-takings, between certain competitors or by certain associations of retailers of goods; it also includes vertical agreements containing ancillary provisions on the assign-ment or use of intellectual property rights; for the purposes of this Regulation, the term vertical agreements includes the corresponding concerted practices.

(4) For the application of Article 81 (3) by regulation, it is not necessary to define those vertical agreements which are capable of falling within Article 81 (1); in the individual assessment of agreements under Article 81 (1), account has to be taken of several factors, and in particular the market structure on the supply and purchase side.

(5) The benefit of the block exemption should be limited to vertical agreements for which it can be assumed with sufficient certainty that they satisfy the conditions of Article 81 (3).

(6) Vertical agreements of the category defined in this Regulation can improve economic efficiency within a chain of production or distribution by facilitating better coordination between the participating undertakings; in particular, they can lead to a reduction in the transaction and distribution costs of the parties and to an optimisation of their sales and investment levels.

(7) The likelihood that such efficiency-enhancing effects will outweigh any anticompetitive effects due to restrictions contained in vertical agreements depends on the degree of market power of the undertakings concerned and, therefore, on the extent to which those undertakings face competition from other suppliers of goods or services regarded by the buyer as interchangeable or substitutable for one another, by reason of the



products’ characteristics, their prices and their intended use.

(8) It can be presumed that, where the share of the relevant market accounted for by the supplier does not exceed 30%, vertical agreements which do not contain certain types of severely anti-competitive restraints generally lead to an improve-ment in production or distribution and allow consumers a fair share of the resulting benefits; in the case of vertical agreements containing exclusive supply obligations, it is the market share of the buyer which is relevant in determining the overall effects of such vertical agreements on the market.

(9) Above the market share threshold of 30%, there can be no presumption that vertical agreements falling within the scope of Article 81 (1) will usually give rise to objective advantages of such a character and size as to compensate for the disadvantages which they create for competition.

(10) This Regulation should not exempt vertical agreements containing restrictions which are not indispensable to the attainment of the positive effects mentioned above; in particular, vertical agreements containing certain types of severely anti-competitive restraints such as minimum and fixed resale-prices, as well as certain types of territorial protection, should be excluded from the benefit of the block exemption established by this Regulation irrespective of the market share of the undertakings concerned.

(11) In order to ensure access to or to prevent collusion on the relevant market, certain conditions are to be attached to the block exemption; to this end, the exemption of non-compete obligations should be limited to obligations which do not exceed a definite duration; for the same reasons, any direct or indirect obligation causing the members of a selective distribution system not to sell the brands of particular competing suppliers should be excluded from the benefit of this Regulation.

(12) The market-share limitation, the non-exemption of certain vertical agreements and the conditions provided for in this Regulation normally ensure that the agreements to which the block exemption applies do not enable the participating undertakings to eliminate competition in respect of a substantial part of the products in question.

(13) In particular cases in which the agreements falling under this Regulation nevertheless have effects incompatible with Article 81 (3), the Commission may withdraw the benefit of the block exemption; this may



occur in particular where the buyer has significant market power in the relevant market in which it resells the goods or provides the services or where parallel networks of vertical agreements have similar effects which significantly restrict access to a relevant market or competition therein; such cumulative effects may for example arise in the case of selective distribution or non-compete obligations.

(14) Regulation No 19/65/EEC empowers the competent authorities of Member States to withdraw the benefit of the block exemption in respect of vertical agreements having effects incompatible with the conditions laid down in Article 81 (3), where such effects are felt in their respective territory, or in a part thereof, and where such territory has the characteristics of a distinct geographic market; Member States should ensure that the exercise of this power of withdrawal does not prejudice the uniform application throughout the common market of the Community competition rules or the full effect of the measures adopted in implementation of those rules.

(15) In order to strengthen supervision of parallel networks of vertical agreements which have similar restrictive effects and which cover more than 50% of a given market, the Commission may declare this Regulation inapplicable to vertical agreements containing specific restraints relating to the market concerned, thereby restoring the full application of Article 81 to such agreements.

(16) This Regulation is without prejudice to the application of Article 82.

(17) In accordance with the principle of the primacy of Community law, no measure taken pursuant to national laws on competition should prejudice the uniform application throughout the common market of the Community competition rules or the full effect of any measures adopted in implementation of those rules, including this Regulation,

HAS ADOPTED THIS REGULATION:

Article 1

For the purposes of this Regulation:

(a) ‘competing undertakings’ means actual or potential suppliers in the same product market; the, product market includes goods or services which are regarded by the buyer as interchangeable with or substitutable for the contract goods or services, by reason of the products’



characteristics, their prices and their intended use;

(b) ‘non-compete obligation’ means any direct or indirect obligation causing the buyer not to manufacture, purchase, sell or resell goods or services which compete with the contract goods or services, or any direct or indirect obligation on the buyer to purchase from the supplier or from another undertaking designated by the supplier more than 80% of the buyer’s total purchases of the contract goods or services and their substitutes on the relevant market, calculated on the basis of the value of its purchases in the preceding calendar year;

(c) ‘exclusive supply obligation’ means any direct or indirect obligation causing the supplier to sell the goods or services specified in the agreement only to one buyer inside the Community for the purposes of a specific use or for resale;

(d) ‘Selective distribution system’ means a distribution system where the supplier undertakes to sell the contract goods or services, either directly or indirectly, only to distributors selected on the basis of specified criteria and where these distributors undertake not to sell such goods or services to unauthorised distributors;

(e) ‘intellectual property rights’ includes industrial property rights, copyright and neighbouring rights;

(f) ‘know-how’ means a package of non-patented practical information, resulting from experience and testing by the supplier, which is secret, substantial and identified: in this context, ‘secret’ means that the know-how, as a body or in the precise configuration and assembly of its components, is not generally known or easily accessible; ‘substantial’ means that the knowhow includes information which is indispensable to the buyer for the use, sale or resale of the contract goods or services; ‘identified’ means that the know-how must be described in a sufficiently comprehensive manner so as to make it possible to verify that it fulfils the criteria of secrecy and substantiality;

(g) ‘buyer’ includes an undertaking which, under an agreement falling within Article 81 (1) of the Treaty, sells goods or services on behalf of another undertaking.



Article 2

1 . Pursuant to Article 81 (3) of the Treaty and subject to the provisions of this Regulation, it is hereby declared that Article 81 (1) shall not apply to agreements or concerted practices entered into between two or more undertakings each of which operates, for the purposes of the agreement, at a different level of the production or distribution chain, and relating to the conditions under which the parties may purchase, sell or resell certain goods or services (‘vertical agreements’). This exemption shall apply to the extent that such agreements contain restrictions of competition falling within the scope of Article 81 (1) (‘vertical restraints’).

2. The exemption provided for in paragraph 1 shall apply to vertical agreements entered into between an association of undertakings and its members, or between such an association and its suppliers, only if all its members are retailers of goods and if no individual member of the association, together with its connected under-takings, has a total annual turnover exceeding EUR 50 million; vertical agreements entered into by such associations shall be covered by this Regulation without prejudice to the application of Article 81 to horizontal agreements concluded between the members of the association or decisions adopted by the association.

3. The exemption provided for in paragraph 1 shall apply to vertical agreements containing provisions which relate to the assignment to the buyer or use by the buyer of intellectual property rights, provided that those provisions do not constitute the primary object of such agreements and are directly related to the use, sale or resale of goods or services by the buyer or its customers. The exemption applies on condition that, in relation to the contract goods or services, those provisions do not contain restrictions of competition having the same object or effect as vertical restraints which are not exempted under this Regulation.

4. The exemption provided for in paragraph 1 shall not apply to vertical agreements entered into between competing undertakings; however, it shall apply where competing undertakings enter into a non-reciprocal vertical agreement and:

(a) the buyer has a total annual turnover not exceeding EUR 100 million, or

(b) the supplier is a manufacturer and a distributor of goods, while the buyer is a distributor not manufacturing goods competing with the contract goods, or



(c) the supplier is a provider of services at several levels of trade, while the buyer does not provide competing services at the level of trade where it purchases the contract services. 5. This Regulation shall not apply to vertical agreements the subject matter of which falls within the scope of any other block exemption regulation.

Article 3

1. Subject to paragraph 2 of this Article, the exemption provided for in Article 2 shall apply on condition that the market share held by the supplier does not exceed 30% of the relevant market on which it sells the contract goods or services.

2. In the case of vertical agreements containing exclusive supply obligations, the exemption provided for in Article 2 shall apply on condition that the market share held by the buyer does not exceed 30% of the relevant market on which it purchases the contract goods or services.

Article 4

The exemption provided for in Article 2 shall not apply to vertical agreements which, directly or indirectly, in isolation or in combination with other factors under the control of the parties, have as their object:

(a) the restriction of the buyer’s ability to determine its sale price, without prejudice to the possibility of the supplier’s imposing a maximum sale price or recommending a sale price, provided that they do not amount to a fixed or minimum sale price as a result of pressure from, or incentives offered by, any of the parties;

(b) the restriction of the territory into which, or of the customers to whom, the buyer may sell the contract goods or services, except:

- the restriction of active sales into the exclusive territory or to an exclusive customer group reserved to the supplier or allocated by the supplier to another buyer, where such a restriction does not limit sales by the customers of the buyer,

- the restriction of sales to end users by a buyer operating at the wholesale level of trade,

- the restriction of sales to unauthorised distributors by the members of a selective distribution system, and



- the restriction of the buyer’s ability to sell components, supplied for the purposes of incorporation, to customers who would use them to manufacture the same type of goods as those produced by the supplier;

(c) the restriction of active or passive sales to end users by members of a selective distribution system operating at the retail level of trade, without prejudice to the possibility of prohibiting a member of the system from operating out of an unauthorised place of establishment;

(d) the restriction of cross-supplies between distributors within a selective distribution system, including between distributors operating at different level of trade;

(e) the restriction agreed between a supplier of components and a buyer who incorporates those components, which limits the supplier to selling the components as spare parts to end-users or to repairers or other service providers not entrusted by the buyer with the repair or servicing of its goods.

Article 5

The exemption provided for in Article 2 shall not apply to any of the following obligations contained in vertical agreements:

(a) any direct or indirect non-compete obligation, the duration of which is indefinite or exceeds five years. A non-compete obligation which is tacitly renewable beyond a period of five years is to be deemed to have been concluded for an indefinite duration. However, the time limitation office years shall not apply where the contract goods or services are sold by the buyer from premises and land owned by the supplier or leased by the supplier from third parties not connected with the buyer, provided that the duration of the non-compete obligation does not exceed the period of occupancy of the premises and land by the buyer;

(b) any direct or indirect obligation causing the buyer, after termination of the agreement, not to manufacture, purchase, sell or resell goods or services, unless such obligation:

- relates to goods or services which compete with the contract goods or services, and



- is limited to the premises and land from which the buyer has operated during he contract period, and

- indispensable to protect know-how transferred by the supplier to the buyer, and provided that the duration of such non-compete obligation is limited to a period of one year after termination of the agreement; this obligation is without prejudice to the possibility of imposing a restriction which is unlimited in time on the use and disclosure of know-how which has not entered the public domain;

(c) any direct or indirect obligation causing the members of a selective distribution system not to sell the brands of particular competing suppliers.

Article 6

The Commission may withdraw the benefit of this Regulation, pursuant to Article 7(1) of Regulation No 19/65/EEC, where it finds in any particular case that vertical agreements to which this Regulation applies nevertheless have effects which are incompatible with the conditions laid down in Article 81 (3) of the Treaty, and in particular where access to the relevant market or competition therein is significantly restricted by the cumulative effect of parallel networks of similar vertical restraints implemented by competing suppliers or buyers.

Article 7

Where in any particular case vertical agreements to which the exemption provided for in Article 2 applies have effects incompatible with the conditions laid down in Article 81 (3) of the Treaty in the territory of a Member State, or in a part thereof, which has all the characteristics of a distinct geographic market, the competent authority of that Member State may withdraw the benefit of application of this Regulation in respect of that territory, under the same conditions as provided in Article 6.

Article 8

1. Pursuant to Article 1 a of Regulation No 19/65/EEC, the Commission may by regulation declare that, where parallel networks of similar vertical restraints cover more than 50% of a relevant market, this Regulation shall not apply to vertical agreements containing specific restraints relating to that market.

2. A regulation pursuant to paragraph 1 shall not become applicable



earlier than six months following its adoption.

Article 9

1. The market share of 30% provided for in Article 3(1) shall be calculated on the basis of the market sales value of the contract goods or services and other goods or services sold by the supplier, which are regarded as interchangeable or substitutable by the buyer, by reason of the products’ characteristics, their prices and their intended use; if market sales value data are not available, estimates based on other reliable market information, including market sales volumes, may be used to establish the market share of the undertaking concerned. For the purposes of Article 3(2), it is either the market purchase value or estimates thereof which shall be used to calculate the market share.

2. For the purposes of applying the market share, threshold provided for in Article 3 the following rules shall apply:

(a) the market share shall be calculated on the basis of data relating to the preceding calendar year;

(b) the market share shall include any goods or services supplied to integrated distributors for the purposes of sale;

(c) if the market share is initially not more than 30% but subsequently rises above that level without exceeding 35%, the exemption provided for in Article 2 shall continue to apply for a period of two consecutive calendar years following the year in which the 30% market share threshold was first exceeded;

(d) if the market share is initially not more than 30% but subsequently rises above 35%, the exemption provided for in Article 2 shall continue to apply for one calendar year following the year in which the level of 35% was first exceeded;

(e) the benefit of points (c) and (d) may not be combined so as to exceed a period of two calendar years.

Article 10

1 . For the purpose of calculating total annual turnover within the meaning of Article 2(2) and (4), the turnover achieved during the previous financial year by the relevant party to the vertical agreement and the turnover achieved by its connected undertakings in respect of all goods



and services, excluding all taxes and other duties, shall be added together. For this purpose, no account shall be taken of dealings between the party to the vertical agreement and its connected undertakings or between its connected undertakings.

2. The exemption provided for in Article 2 shall remain applicable where, for any period of two consecutive financial years, the total annual turnover threshold is exceeded by no more than 10%.

Article 11

1. For the purposes of this Regulation, the terms ‘undertaking’, ‘supplier’ and ‘buyer’ shall include their respective connected undertakings.

2. ‘Connected undertakings’ are:

(a) undertakings in which a party to the agreement, directly or indirectly:

- has the power to exercise more than half the voting rights, or

- has the power to appoint more than half the members of the supervisory board, board of management or bodies legally representing the under-taking, or

- has the right to manage the undertaking’s affairs;

(b) undertakings which directly or indirectly have, over a party to the agreement, the rights or powers listed in (a);

(c) undertakings in which an undertaking referred to in (b) has, directly or indirectly, the rights or powers listed in (a);

(d) undertakings in which a party to the agreement together with one or more of the undertakings referred to in (a), (b) or (c), or in which two or more of the latter undertakings, jointly have the rights or powers listed in (a);

(e) undertakings in which the rights or the powers listed in (a) are jointly held by:

- parties to the agreement or their respective connected undertakings referred to in (a) to (d), or

- one or more of the parties to the agreement or one or more of their connected undertakings referred to in (a) to (d) and one or more third parties.

3. For the purposes of Article 3, the market share held by the



undertakings referred to in paragraph 2(e) of this Article shall be apportioned equally to each undertaking having the rights or the powers listed in paragraph 2(a).

Article 12

1 . The exemptions provided for in Commission Regulations (EEC) No 1983/83 (EEC) No 1984/83 and (EEC) No 4087/88 shall continue to apply until 31 May 2000.

2. The prohibition laid down in Article 81 (1) of the EC Treaty shall not apply during the period from 1 June 2000 to 31 December 2001 in respect of agreements already in force on 31 May 2000 which do not satisfy the conditions for exemption provided for in this Regulation but which satisfy the conditions for exemption provided for in Regulations (EEC) No 1983/83, (EEC) No 1984/83 or (EEC) No 4087/88.

Article 13

This Regulation shall enter into force on 1 January 2000. It shall apply from 1 June 2000, except for Article 12(1) which shall apply from 1 January 2000.

This Regulation shall expire on 31 May 2010.

This Regulation shall be binding in its entirety and directly applicable in all Member States.

Done at Brussels, 22 December 1999. For the Commission Mario MONTI Member of the Commission This European Code of Ethics is the up-to-date version of the Code First.





Appendix B

World Franchise Council Franchise Association MembersArgentinaArgentine Association of Franchising Av. Libertardor 222, 70-A Buenos Aires 1001, Argentina Tel: (54-11)4-394-3318 Fax: (54-11) 4-394-8107 Web: www.aafranchising.com

AustraliaFranchise Council of Australia GPO Box 1498N, Melbourne Victoria, 3001, AustraliaTel: 1300 669030 Fax: 03 9822 7752

AustriaAustrian Franchise AssociationBayerhamerstrafle 12, 5020 Salzburg, AustriaTel:+43-662-87 42 360 Fax:+43-662-87 42 365Web: www.franchise.at

BelgiumBelgian Franchise AssociationBoulevard de L’Humanite, 116/2, B-1070 Brussels, BelgiumTel: +32 2 523 97 07 Fax: +32 2 523 35 10Web: www.partnership-fair.be

BrazilBrazilian Association of FranchisingAv. Brigaderio Faria Lima, 1739-3 Andar CEP 01452-001 Jd. Paulistano - Sao Paulo - SP - BrazilTel: +55.11.3814.4200 Fax: +55.11.3817.5986Web: www.abf.com.br



BritishBritish Franchise AssociationThames View, Newtown Road, Henley-on-Thames, Oxfordshire, RG9 1HG, EnglandTel: 01491578050 Fax: 01491573517Web:www.british-franchise.org

CanadaCanadian Franchise Association2585 Skymark Ave. Suite 300 Mississauga, Ontario L4W WY5Tel: 905-625- 2896 Fax: 905-625-9076Web: www.cfa.ca

ChinaChina Chain Store & Franchise Association25 Yuetan North Street Beijing 100834, ChinaTel: + 8610-6839-1464 / 1440 Fax: + 8610-6839-1434/1444Web: www.ccfa.org.cn

ColombiaColombian Association of FranchsingHolguines Trade Center Torre Lili OF 606 Cali, ColombiaEmail: [email protected]

DenmarkDanish Association of FranchisingLyngbyvej 20 DK-2100 Copenhagen - DenmarkTel: +45.39.15.82.82 Fax: +45.39.15.80.10Web: www.dk-franchise.dk

FinlandFinnish Franchise AssociationSuomen Franchising-Yhdistys sY (SFY) PL 868 08680 Lohja asTel: +358.19.331.195 Fax: +358.19.331.075Web: www.franchising.fi

FranceFèdèration francáise de la franchise60 rue La Boètie 75008 Paris, FranceTel: 00 33 1 53 75 2225 Fax: 00 33 1 53 75 2220Web: www.franchise-fff.comGermany



German Franchise AssociationLuisentrasse, 41 10117 Berlin, GermanyTel: +49.0.30.278.9020 Fax: +49.0.30.278.90.215Web: www.dfv-franchise.de

GreeceGreek Association of FranchisingSkoufou 10 105 57 Athens, GreeceTel: +30.210.32.34.620 Fax: +30.210.32.38.865Web: www.franchising.gr

HongKongHong-kong Franchise Association22/F Unit A, United Centre, 95 Queensway, Hong Kong Tel: +852.2529.9229 Fax: +852.2527.9843Web: www.franchise.org.hk

HungaryHungarian Franchise AssociationPOB. 446 Budapest H-1537, HungaryTel: +361.212.41.24 Fax: +361.212.57.12Web: www.franchise.hu

IndiaIndian Association of Franchising54-A, Eite Auto House, Sir. M. Vasanji Road, Chakala, Andheri (East), Mumbai 400093 IndiaTel: (91-22) 692 1258 Fax: (91-22) 692 1258Email: [email protected]

ItalyItalian Franchsie AssociationCorso di Porta Nuova, 3 Milan 20121, ItalyTel: (39-02) 2900-3779 Fax: (39-02) 655-5919Web: www.assofranchising.it



JapanJapan Franchise Association2nd Akiyama Building Toranomon 3-6-2, Minato-ku, Tokyo 105-0001, JapanTel: +81.3.5777.8701 Fax: +81.3.5777.8711Email: [email protected]

KazakhstanKazakhstan Franchise Association1 Abai Ave. ALMATY 480100 Republick of KazakhstanTel: 7 (3272) 63 78 13 Fax: 7 (3272) 63 68 21Email: [email protected]

LatviaLatvian Franchise AssociationLachpliesha 81/2 Daugavpils LV - 5403 LatviaTel: +371.54.26.349 Fax: +371.54.27.374Web: www.franch.lv

MalaysiaMalaysian Franchise AssociationSuite 1045, Level 10, Block A2 Leisure Commerce Square No 9, Jalan PJS 8/9 46150 Petaling Jaya Selangor Dural Ehsan, MalaysiaTel: (60 3) 7877 1557 Fax: (60 3) 7877 1559Web: www.mfa.org.my

MexicoMexican Franchise AssociationInsurgentes Sur #1783-202 Guadalupe Inn Mexico 01020, D.F. Tel: (52 55) 5661-2040 Fax: (52 55) 5661-2800Web: www.franquiciasdemexico.org

NetherlandsNetherlands Franchise AssociationBoomberglaan 12, NL-1217 RR Hilversum - NetherlandsTel: +31.35.624.23.00 Fax: +31.35.624.91.94Web: www.nfv.nl



New ZealandFranchise Association of New ZealandP O Box 23 364, Hunters Corner, Papatoetoe, Auckland, New ZealandTel: + 64 9 278 9012 Fax: + 64 9 278 9013Web: www.www.franchise.org.nz

PhilippinesPhilippine Franchise Association701 OMM-Cittra Bldg. San Miguel Ave. Ortigas Center, Pasig CityTel: +632.687.0365-67 Fax: +632.687.0635Web: www.philippinefranchiseassociation.com

PortugalPortuguese Association of FranchisingRua Viriato, 1050-234 Lisboa, PortugalTel: +351.21.319.29.38 Fax: +351.21.319.29.39Web: www.apfranchise.org

TaiwanTaiwan Chain Store and Franchise Association7 F, NO 197 Nanking E Rd. Sec. 4 Taipe, TaiwanTel: (8862) 2712 1250 Fax: (8862) 2712 7997Web: www.tfca.org.tw

USAInternational Franchise Association1350 New York Ave. NW Suite 900 Washington DC 20005-4709 Tel: +202.628.8000 Fax: +202.628.0812Web: www.franchise.org

Documents

How To Franchise · Franchising - what is it? Franchising is a method of marketing goods and services but the term “franchising” has become more widespread with use by business