What are Franchise Systems?

The term franchise comes from a French word which means "freedom." Politically, a franchise is the freedom to participate in government, generally through the right to vote. In business, franchise systems are business models in which a company with a successful product or business system allows other businesses the right, or freedom, to operate under their trade name for a fee. The original business which sells the right is called the franchisor: the person or company which purchases the right is called the franchisee.

It is difficult to find a consensus regarding the origin of franchise systems, though they seem to have evolved in the 1800’s from methods employed by German beer companies who charged a fee to businesses for the right to carry their beer. In 1850, Isaac Singer invented his treadle sewing machine, the first such machine suitable for use in the home. In order to raise the money for marketing and manufacturing, Singer sold territorial rights to individuals and businesses who would market the machines and teach purchasers how to use them. This early form of franchise system enabled his company to expand into the international market just five years later when it opened a plant in Paris, France.

Franchise systems expanded rapidly in the middle of the twentieth century. Inspired by the phenomenal success of Ray Kroc and the McDonald’s hamburger chain, franchise opportunities exploded. Fast food, car repairs, dry cleaning, carpet cleaners, family restaurants, and travel agencies were just a few of the options available. The growth was so rapid that in some cases, the franchisors became so involved with the sale of the franchise opportunity that they tended to neglect the franchisees once the contracts were signed. In 1979, the Federal Trade Commission (FTC) in the United States issued a Franchise Rule which established minimum disclosure requirements for franchise sales.

In most franchise systems, the franchisor maintains a great deal of control over the product and services offered by the franchisee in order to maintain brand consistency and the reputation of his trademark or product. For example, the franchisor generally has very strict terms governing marketing, product quality, building design and operating practices. An entrepreneur should carefully examine the restrictions of prospective franchise systems to make certain he is able to work comfortably within those constraints.

An investor needs to be aware that buying a franchise from a successful company does not necessarily guarantee his own success. The purchaser must make certain he has the managerial ability required to run a business, as well as the aptitude needed for the particular franchise he chooses. If he has no mechanical aptitude, for example, he may want to stay away from franchise systems that specialize in auto repair or maintenance. He should also make certain that the success of the parent company is not a result of regional issues, that the company has the resources to offer adequate support, and that his local area has not reached a saturation point for that type of business.

When investigating particular franchise systems, a prospective purchaser should consider a number of factors. He should know exactly what is included in the franchise fee; for example, training, operations manuals, guidance in site selection, and territorial rights. The franchisor should be able to provide projections of how much capital the investor needs, how long it should take for the new franchise to open, and when the investor can reasonable expect to recover his initial investment. It is also important to know how many other franchise offices will be sold in the same area, and if there are any on-going franchise fees.