FRANCHISING IN RETAIL

Franchising

Franchising involves a contractual arrangement between a franchisor (a manufacturer, wholesaler,

or service sponsor) and a retail franchisee, which allows the franchisee to conduct business under
an established name and according to a given pattern of business.

The franchisee typically pays an initial fee and a monthly percentage of gross sales in exchange
for the exclusive rights to sell goods and services in an area. Small businesses benefit by being
part of a large, chain-type retail institution.

Types of franchising in retail

A. Product/trademark franchising
B. Business format franchising

In product/trademark franchising, a franchisee acquires the identity of a franchisor by agreeing

to sell the latter’s products and/or operate under the latter’s name. The franchisee operates rather
autonomously. There are some operating rules, but the franchisee sets hours, chooses a location,
and determines facilities and displays. Product/trademark franchising represents 60 percent of
retail franchising sales. Examples are auto dealers and many petrol service stations.

With business format franchising, there is a more interactive relationship between a franchisor
and a franchisee. The franchisee receives assistance on site location, quality control, accounting
systems, startup practices, management training, and responding to problems besides the right to
sell goods and services. Prototype stores, standardized product lines, and cooperative advertising
foster a level of coordination previously found only in chains. Business format franchising
arrangements are common for restaurants and other food outlets, real-estate, and service retailing.
Due to the small size of many franchisees, business formats account for about 80 percent of
franchised outlets, although just 40 percent of total sales (including auto dealers).
Structural arrangements of Franchising in retail

Three structural arrangements dominate retail franchising:

1. Manufacturer-retailer. A manufacturer gives independent franchisees the right to sell goods and
related services through a licensing agreement.

2. Wholesaler-retailer.

• Voluntary - A wholesaler sets up a franchise system and grants franchises to individual

retailers.
• Cooperative - A group of retailers sets up a franchise system and shares the ownership
and operations of a wholesaling organization.

3. Service sponsor-retailer. A service firm licenses individual retailers so they can offer specific
service packages to consumers.
COMPETITIVE ADVANTAGES AND DISADVANTAGES OF FRANCHISING

ADVANTAGES –

• They own a retail enterprise with a relatively small capital investment.

• They acquire well-known names and goods/service lines.
• Standard operating procedures and management skills may be taught to them.
• Cooperative marketing efforts (such as regional or national advertising) are facilitated.
• They obtain exclusive selling rights for specified geographical territories.
• Their purchases may be less costly per unit due to the volume of the overall franchise

DISADVANTAGE-

• Oversaturation could occur if too many franchisees are in one geographic area.
• Due to overzealous selling by some franchisors, franchisees’ income potential, required
managerial ability, and investment may be incorrectly stated.
• They may be locked into contracts requiring purchases from franchisors or certain vendors.
• Cancellation clauses may give franchisors the right to void agreements if provisions are
not satisfied.
• In some industries, franchise agreements are of short duration.
• Royalties are often a percentage of gross sales, regardless of franchisee profits

FRANCHISING LAW IN INDIA

India offers mainly four types of entry points for franchises, which includes:

• Direct franchising
• Master franchising
• Regional franchising
• Local incorporation.
Direct franchising is where a company creates a direct network of franchises. This works well for
local companies with pre-existing experience in India. However, it can prove to be challenging to
foreign companies entering India for the first time. In this case, the owner company directly
provides sales and support services to the franchisees. A common example of direct franchise is
the franchise opportunities offered by Monsoon Salon & Spa in metro cities like Delhi, Mumbai,
Pune, Chandigarh, Kolkata and more.

Master franchising is where a company awards exclusive rights to develop a foreign brand to a
local entity, often accompanied with a large investment made by the franchisor. The owner recruits
a specific person or a company to provide services to franchisees in a specified territory which can
typically be a major market or even one or more states. The master franchisee is then in charge of
developing the company’s brand either through cultivating a sub-franchised network or opening
outlets owned by the master franchisee (though the two are not mutually exclusive). A master
franchise can own a number of individual franchisees in a certain area, however, the same is not
applicable for a direct franchise. Generally master franchise model is adopted by fast food
restaurants, real estate agencies, and convenience food stores.

Regional franchising operates in the same way as master franchising but covers only a specific
regional area as opposed to the entire country. Given India’s diversity along with the complexity
of state-specific laws, many franchisors choose a regional franchising approach.

Local incorporation is when a foreign franchisor forms a subsidiary company and awards it
franchising rights in India. The American fast food chain Subway, for example, has established a
subsidiary in India, which handles their franchising network.

While franchising as an innovative way of expanding a business into new marketplaces has spread
all around the world, different countries have different laws which are applicable to franchising.

There is no specific legislation regulating franchise arrangement in India, reason being the
complexity of the relationship and the vast areas of law which such relationship involve.

The laws regulating franchising in India includes –law relating to contract, agency, distribution,
leasing, assignment, securities, financial investments, intellectual and industrial property,
competition, companies, immovable and movable properties, labor, foreign investment, insurance,
banking, import-export, technology transfer, and other legislations which may become applicable
in particular case. The applicability of laws depends precisely upon the modes of franchising which
may be domestic or crossborder.

Royalty Remittance

The FEMA and RBI regulate the terms of payment under Franchise Agreements(such as franchise
fees, management fees, development fees, administrative fees, royalty fees and technical fees)
where one party is a non-Indian entity including the amount to be paid and procedure for remittance
of these payments outside India. The RBI prescribes certain requirements such as furnishing of tax
clearances and chartered accountant certificate at the time of remittance of royalty payments by
the franchisee to franchisor outside India.

The Indian government permits foreign franchisors to charge royalties up to 1% for domestic sales
and 2% on exports for use of the foreign franchisor’s brand name or trademark, without transfer
of technology. The laws in India also permit lump sum and royalty payments to be made by Indian
franchisees to their foreign counterparts for use of foreign techno logy, which includes manuals,
systems etc. Lump sum payments up to US$ 2 million are permitted and royalties of 5% on
domestic sales and 8% on exports can be paid to the foreign franchisor. In addition, foreign
companies can enter into consulting agreements and receive up to US$ 1 million per project.
Amounts in excess of these can also be received but with the permission of the Indian Government.
These rules allow a foreign franchisor to structure its business in India in such a way so as to ensure
that it can repatriate the maximum amount from India.

The Government has specified formula for calculation of royalties which must be adhered to before
the foreign company can remit funds out of India. If the franchise agreement proposes royalties or
lump sum fees beyond the specified limits, the approval of the Foreign Investment Promotion
Board is required.

Taxation

Taxation is another issue which deserves due consideration. It is important to know the local sales
tax, property tax, and withholdings tax applicable in certain area. Further, how the franchise
arrangement is structured and the existence of treaties between the countries involved may have
considerable influence on the structure adopted.

Where the franchisor receives royalties, service or franchise fees, tax has to be paid under the
income tax Act (as income arising and accruing in India), whether the franchisor is an Indian or
foreign. In case where the foreign franchisor sends training personnel and supervisors to India, the
salaries payable to these persons may be subject to personal income tax, whether an arrangement
is made to deduct the tax at source or they are taxed as self-employed persons (professionals).

In calculating the amount of tax payable by the franchisor or the franchisee company, the deduction
available in tax laws of India can be important for tax planning purposes. Sometimes of these relate
to rent, repairs and insurance in respect to premises used for business; depreciation and expenditure
on research; and, expenditure of capital nature on acquisition of patent rights or copyrights.
However, the availability of tax advantages depends on the type of franchise, the product of the
franchise and unit locations.

EVOLUITON OF FRANCHISING

The word “franchise” is derived from the Anglo-French word meaning “liberty.” In Middle
French, it is “franchir”– to free. In Old French, it is “franc,” signifying free. The French term
“francis” means granting rights or power to a peasant or serf. The English term “enfranchise” is
defined as empowering those who have no rights. The term “Royal Tithes” is the predecessor of
royalties, and originated as the practice of certain English men (referred to as “freemen”) receiving
a percentage of the land fees paid by serfs to nobility. Throughout history, franchising has
promoted economic liberation, synergy, and opportunity, and has been true to its etymological
roots – “freeing” commerce from many of the traditional chains that had bound it. Naisbitt’s
famous comment in Megatrends is no exaggeration – “Franchising is the single most successful
marketing concept ever.”

THE HISTORY OF FRANCHISING

❖ Kings, Courts and Lord – Franchising Pre-1800

— During the Middle Ages, local governments granted high church officials and other personages
a license to maintain civil order and to assess taxes. Medieval courts or lords granted others the
right to operate ferries, hold markets, and perform professional business activities. The licensee
paid a royalty to the powers that be in exchange for, among other things, “protection.” This was
equivalent to a monopoly on commercial ventures. The practice was perpetuated throughout the
Middle Ages, and eventually became part of European common law.

— During the Colonial Period, European monarchs bestowed franchises on daring entrepreneurs
who agreed to establish colonies and gain the protection of the “Crown” in exchange for taxes or
royalties.

❖ Drinks, Cars and Sewing Machines — Franchising From 1800 to 1900

— In 19th Century England and Germany, pub proprietors with financial difficulties became
exclusive distributors of beer purchased from specific brewers. The breweries did not exercise any
day-to-day control over the pubs.

— The first franchise in Australia under “royal privilege” was granted by Governor Macquarie in
1809. The franchisee was granted the right to import 45,000 gallons of rum over three years in
exchange for building the Sydney Hospital (the so-called “rum hospital”). — In the United States
during the mid-1800’s, trademark/product franchising developed when the Singer sewing machine
company formed a franchise in 1851. Due to the lack of necessary capital and the incipient stage
of the sewing industry, Singer had difficulty in marketing sewing machines, and turned to
franchising. Singer commissioned agents to sell and repair its line of machines. However, once the
machines were accepted by the public, Singer changed its marketing strategy and commenced
selling the machines through its company-owned outlets in the 1860’s.

— In the 1880’s, U.S. cities granted monopoly “franchises” to utility companies for water, sewage,
gas, and later electricity. — In 1898, William E. Metzger of Detroit, Michigan became the first
official dealer/franchisee of General Motors Corporation (GM). Under GM’s system, dealers
purchased the land and built the buildings for the dealership. In return, the dealers were allowed
to buy GM’s vehicles at a discount. — In 1899, Coca Cola sold its first franchise.

❖ A Period of Steady Growth – Franchising From 1901 to 1950

— In the early 1900’s, Henry Ford franchised dealers for his Model T. The oil companies followed
suit, franchising gas stations. — In 1902, Rexall Drugstores began franchising. — In 1909,
Western Auto established dealership programs. — In 1920, the “Ben Franklin” store systems
appeared with general merchandise stores. — In 1925, A&W established “walk up” root beer
stands, and Howard Johnson offered his three flavors of “superior” ice cream from his Wollaston,
Massachusetts drugstore. Howard Johnson’s franchised ice cream business expanded to a group
of East Coast restaurants, and in 1940, appeared on a state turnpike. — Between 1938 and 1955,
the following companies commenced franchise activities: Arthur Murray Dance Studios, Baskin-
Robbins ice cream stores, Duraclean carpet cleaning services, McDonald’s, Howard Johnson
Motor Lodge, and Harlan Sanders’s Kentucky Fried Chicken. — In 1948, Dairy Queen established
its 2500th unit.

❖ Build Along the Highway – Growth In Franchising from 1951-1969

— Franchising in the U.S. exploded in the 1950s. In 1950, less than 100 companies had employed
franchising in their marketing operations. By 1960, more than 900 companies had franchise
operations involving an estimated 200,000 franchised outlets. — In 1955, Tastee Freeze
established its 1500th unit. — In the 1950’s and 1960’s, the development of business format
franchising escalated, due in large part to the expansion of the service economy and President
Eisenhower’s decision to build the Interstate Highway System (with its concomitant increase in
automobile travel). Holiday Inn, Roto-Rooter, Dunkin Donuts, McDonald’s, Burger King, H&R
Block, Lee Myles, Midas, 7-Eleven, Dunhill Personnel, Wendy’s, Pearle Vision Center, Dairy
Queen, Orange Julius, Tastee Freeze, and Sheraton all began to franchise. — By the late 1960’s,
McDonald’s, Holiday Inn, and KFC were all approaching or had surpassed the one-thousand unit
mark. — Between 1964 and 1969, fueled by an ever expanding economy, an estimated 100,000
new franchise businesses commenced.

❖ New Regulation and an Oil Embargo – Franchising 1970 to 1985

— In 1970, annual retail sales for franchises were estimated at over $95 billion. — In 1970, the
U.S.’s 181,000 franchised gasoline stations accounted for 82% of product/trade name franchises
and nearly 55% of all franchises. — Also in 1970, California became the first state to regulate the
sale of franchises when it enacted the California Franchise Investment Law (CFIL). — In 1971,
annual retail sales of franchised businesses were estimated at over $114 billion. — Between 1969
and 1973, an additional 50,000 franchised units took form, and by 1973, franchised businesses
exceeded 374,000 units.
— Between 1973 and 1976, due to the Arab oil embargo, national shortages of gasoline
precipitated the closure of nearly 32,000 franchised gasoline service stations. — In 1975, retail
sales of franchises exceeded $161 billion. — By 1976, gasoline’s share of total franchising fell to
41%, and, by 1980, to 36%. — Between 1976 and 1980, more than 19,000 new franchises were
established; however, the increase did not offset the loss of gasoline franchises during the decade.
— In 1978, the Federal Trade Commission (FTC) adopted the FTC Rule involving pre-sale
disclosures, which became effective in 1979. — In 1979, retail sales of franchises exceeded $274
billion, an increase of 140% from 1971. — By 1980, there were more than 356,000 franchised
businesses, 18,000 less than the peak level achieved in 1973. Product/trade name franchise sales
reached $231 billion, an increase of 129% from 1971. Sales by business format franchises tripled
from $16 billion in 1971 to $48 billion in 1979. — In 1985, retail sales of franchises exceeded
$474 billion.

❖ Big Overall Growth Returns – 1986 to 1995

— In 1986, the U.S. Department of Commerce estimated that retail sales by franchised
establishments represented 34% of all retail sales. Sales of products and services by all franchises
grew by $198 billion during the period of 1980-1986. — During 1987 and 1988, an additional
50,000 new business format franchises were established, nearly double the number added during
1985-1986.

— In 1988, there were more than 416,000 franchise businesses, employing approximately 7
million workers, with estimated sales of $543 billion. The mix was approximately 70% business
format, and 30% product franchise. The estimated 27,273 new franchise units that opened in 1988
represented the addition of one new franchise unit every twenty minutes throughout the year.

— Between 1987 and 1989, franchises added over 400,000 new jobs to the United States economy,
while the Fortune 500 companies added only 10,000 (i.e., franchising accounted for 40 times as
many new jobs). — In 1990, retail sales of franchises exceeded $607 billion, with more than
460,000 units in existence. — In 1993, NASAA unanimously adopted the UFOC Guidelines as
the recommended format for franchise disclosure documents at the state level. The FTC approved
the use of the UFOC as an alternative to the FTC’s disclosure requirements later that year. — By
1995, the new UFOC Guidelines were adopted by each of the state franchise regulatory authorities
that require registration of franchise offerings.
 ❖ The Current Status and Reasons for New Growth – 1996 to the Present

Advances in technology, orientation towards a service economy, a relative decrease in the

importance of product franchising, an expansive interstate road system, active baby boom retirees
looking to “be their own boss,” and women in the work force, have all contributed to the
burgeoning rise in business format franchising. According to a survey conducted for the
International Franchise Association’s Educational Foundation, as of 2001, there were more than
767,483 franchise-related businesses (including franchisor owned), generating 9,797,117 jobs
(equivalent employment of all manufacturers of durable goods, such as computers, cars, trucks,
planes, communications equipment, primary metals, wood products, and instruments), meeting a
$229.1 billion payroll, and producing $624.6 billion of output. The same survey found that
franchised businesses in 2001 accounted for 7.4 percent of all private-sector jobs, 5.0 percent of
all private sector payrolls, and 3.9 percent of all private sector output. Business format franchising
accounted for 4.3 times as many business establishments as product franchising, and four times as
many jobs, and operated more establishments, met a greater payroll, and generated more output in
business services than in any other single line of business. The quick service restaurants hired more
people than any other business format segment, and automotive and truck dealers employed more
workers and had the greatest payroll of any other product distribution franchise. Jobs and payrolls
in franchised businesses were greatest in California, Texas, Florida, and Illinois in 2001. Relative
to the size of the statewide economy, franchising had the greatest impact on jobs and payrolls in
Nevada, Arizona, New Mexico, Florida, and Mississippi.

Studies indicate that a new franchise business opens approximately every five to eight minutes of
each business day, and that franchises are, on average, more profitable than company owned
locations. This holds especially true for franchisors in the fast food industry. 50% of all franchise
companies in existence started in the last 33 years, 70% of them in the last 45 years, and 97% of
them in the last 55 years.