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TOP CONTRIBUTORS

Franchising is a business model in which many different owners share a single brand name. A parent company allows entrepreneurs to use the company's strategies and trademarks; in exchange, the franchisee pays an initial fee and royalties based on revenues. The parent company also provides the franchisee with support, including advertising and training, as part of the franchising agreement.

Franchising is a faster, cheaper form of expansion than adding company-owned stores, because it costs the parent company much less when new stores are owned and operated by a third party. On the flip side, potential for revenue growth is more limited because the parent company will only earn a percentage of the earnings from each new store. 70 different industries use the franchising business model, and according to the International Franchising Association the sector earns more than $1.5 trillion in revenues each year.[1]

Companies Involved

The franchising business model is used across many industries, but it is most popular in the fast food restaurants, hotel, and casual & upscale restaurants industries. According to an International Franchise Association study, franchisee-owned locations accounted for 56.3%, 18.2%, and 13.1% of each respective industry's total locations in 2001.[1]

Fast Food Restaurants

  • McDonald's (MCD) operates the world's largest fast food chain, and earns 37% of its revenue from franchising[2] across its approximate 31,400 restaurant locations. [3] Franchisees operate 65% of McDonald's restaurants worldwide.[3]
  • Yum! Brands (YUM) runs over 35,000 locations of its A&W, KFC, Pizza Hut, Taco Bell, and Long John Silvers restaurant chains worldwide.[4] The company franchises 72% of its restaurants[5] which accounted for 12.6% of the company's revenue in 2007.[5]
  • Burger King Holdings (BKC) operates 11,000 restaurants of its fast food Burger King chain worldwide[6] and earned $2.3 billion in revenue in 2007.[7] Franchisees operate 88.5% of Burger King locations, which account for 22% of the company's revenue.[7]
  • Carrols Restaurant Group (TAST) is a franchisee conglomerate that operates over 560 restaurants under the Burger King, Pollo Tropical, and Taco Cabana brand names. In 2007, the company earned $645 million in revenue.[8]

Hotel

  • Intercontinental Hotels Group (IHG) operates hotels and resorts under the InterContinental, Crowne Plaza, Hotel Indigo, Holiday Inn, Holiday Inn Express, Candlewood Suites, and Staybridge Suites brand names. The company franchises 76% of its hotels[9], which accounted for 33% of the company's revenue in 2007 .[10]
  • Starwood Hotels & Resorts Worldwide (HOT) operates luxury hotels under the St. Regis, Luxury Collection, W, Westin, Le Meridien, Sheraton, Four Points, Aloft, and Element brand names. Approximately 44% of the company's hotels are operated by franchisees[11]. Approximately 44% of the company's 2007 revenue was earned through franchising operations.[12]

Casual & Upscale Restaurants

  • Denny's (DENN) operates 1,546 restaurants nationwide[13], 75% of which are franchisee-owned.[13]. The company's franchise operations accounted for 10.1% of Denny's revenue in 2007.[14]
  • DineEquity, Inc.(DIN) runs 1,344 IHOP restaurants and 1,976 Applebee's restaurants, two casual dining chains.[15] Franchisees operate about 84% of DIN's restaurants[16], which together accounted for 42.5% of the company's revenue in 2007.[17]

Retail

  • Blockbuster (BBI) is a leading provider of in-home movie and game entertainment that focuses on movie and video game rentals. Franchisees operate 22.4% of the company's stores[18], which account for 12.3% of Blockbuster's revenue in 2007.[19]

Rental & Leasing Services

  • Avis Budget Group (CAR) operates two car rental companies, Avis, and Budget and is the largest publicly-traded car rental company in the United States. The company franchised 39% of its Avis locations and 57% of its Budget locations nationiwide, which together contributed to 9% of company's 2007 revenue.[20]
  • Dollar Thrifty Automotive Group (DTG) operates in the rental car industry, specializing in airport car rentals. Franchisees operate 44% of the company's locations, but only account for 3.8% of DTG's 2007 revenue.[21]

How Franchising Works

The franchising business model consists of two operating partners: the franchisor, or parent company, and the franchisee, the proprietor that operates one or multiple store locations. Franchising agreements usually require the franchisee to pay an initial fee plus royalties equal to a certain percentage of the store's monthly or yearly sales. Initial fees vary significantly across each industry, ranging from $35,000 for an Applebee's restaurant to over $85,000 to open a Hilton hotel.[22] Royalty fees are also variable - for example, Intercontinental Hotels Group (IHG) franchisees are required to pay the company 5% of their yearly sales[22], while Applebee's franchisees pay 4% of monthly sales and IHOP franchisees pay a 4.5% royalty fee of weekly sales.[23] The franchisee also covers the costs of actually starting and operating the store, including legal fees, occupancy or construction costs, inventory costs, and labor. Franchise agreements usually have a term of between 10 and 20 years, depending on the company.

The parent company authorizes the franchisee's use of the company's trademarks (for example, selling Big Mac's at McDonald's) as part of the franchising agreement. Additionally, the franchisor provides training and support as well as regional and/or national advertising.

Advantages of the Franchising Model

  • Franchisees require less initial capital than independently starting a company and can use proven successful strategies and trademarks.
  • Franchisees are provided with significant amounts of training, not common to most entrepreneurs.
  • The franchisor benefits because it can expand rapidly without having to increase its labor force and operating costs, using much less capital.
  • Franchised stores have a higher margin for the parent company than company-owned stores because of minimal operating expenses in maintaining franchised stores. For example, DineEquity, Inc.(DIN) earned a 52.7% profit margin from franchisee-owned restaurants in 2007 while company-owned restaurants operated at a mere 6.7% profit margin.[24]

Drawbacks of the Franchising Model

  • Franchising stores reduces the amount of control that the parent company has over its products and service, which may lead store quality to vary greatly from store to store.
  • Franchisees must pay a percentage of their revenues to the parent company, reducing their overall earnings.

Market Forces Affecting Franchising Companies

Weakened Economy Hurts Sales and Slows Franchise Expansion

Franchising becomes a much less desirable business model during rough economic times. First, franchisees must pay royalty fees based upon their revenue, regardless of whether or not they are earning profits, which adds to the franchisee's financial struggles in an economic downturn. Furthermore, slower sales cause parent companies to reduce expansion plans. For example, the 2007 Technomic Restaurant Industry Study blamed the poor U.S. economy as the reason why restaurants reduced funding for expansion by an average 1.4% during 2007.[25]

Economic issues related to the 2007 Credit Crunch and subprime lending crisis drastically weakened the U.S. economy, which has led to lower levels of consumer spending, particularly in the restaurant dining industry. For example, many restaurants suffered from a decline in traffic and comparable store sales during 2007, like Applebee's, which attributes a 4% decrease in guest traffic and 2.1% decline in comparable store sales to weakened consumer spending.[26] Additionally, a 2007 RBC Capital Markets Survey indicated that 39% of respondents reduced their frequency of restaurant dining because of lower levels of dispensable income in 2007.[27]

High Potential for Growth Through International Franchising in Emerging Markets

Unlike the United States and many other Western countries, emerging markets are commercially underdeveloped and have significant growth opportunities. For example, the U.S. Department of Commerce estimated that over 75% of the expected growth in world trade over the next 20 years will come from developing countries, primarily large emerging markets like China.[28] Furthermore, the rise of China's middle class, as well as India's booming per capita income provide significant new markets for franchises to operate. China's middle class is expected to almost double in the next two years, reaching 25% of the Chinese population in 2010, which is spurred by China's 700% growth in per capita income since the late 1980s.[29] Furthermore, the Indian per capita income is expected to increase more than 300% by 2025.[30]

As the wealth of consumers in emerging markets grows, so too will their appetites for consumer goods, as evidenced by India's 1,440% growth in its retail industry between 1991 and 2007.[31] Also, as of 2007, India's franchising industry is expected to grow 30% annually as mega-franchising chains like Yum! Brands (YUM) have already established a presence in India.[32] High levels of consumer demand, coupled with relatively low levels of competition, offer a lucrative opportunity for many franchisors to expand into emerging markets. Expansion via franchising is an attractive option for companies looking to expand abroad without incurring high costs. Additionally, international franchisees already possess many inherent qualities needed to succeed abroad, like the ability to speak the native language.

References

  1. 1.0 1.1 IFA 2001 Study pg. 24
  2. MCD 2007 10-K, Item 7, pg. 15
  3. 3.0 3.1 MCD 2007 10-K, Item 7, pg. 11
  4. YUM 2007 10-K, Item 1, pg. 1
  5. 5.0 5.1 YUM 2007 10-K, Item 6, pg. 19
  6. BKC 2007 10-K, Item 1, pg. 1
  7. 7.0 7.1 BKC 2007 10-K, "Item 6, pg. 36
  8. TAST 2007 Annual Report Item 6, pg. 43
  9. IHG 2007 Annual Report, pg. 23
  10. IHG 2007 Annual Report, pg. 27
  11. HOT 2007 10-K, Item 1, pg. 4
  12. HOT 2007 10-K, Figure 4
  13. 13.0 13.1 DENN 2007 10-K, Item 1, pg. 1
  14. DENN 2007 10-K, Item 7, pg. 13
  15. DIN 2007 10-K, Item 1, pg. 1
  16. DIN 2007 10-K, Item 2, pg. 27-29
  17. DIN 2007 10-K, Item 7, pg. 48
  18. BBI 2007 10-K, Item 1, pg. 12
  19. BBI 2007 10-K, Item 6, pg. 49
  20. Avis 2007 10-K, pg. 7
  21. DTG 2007 10-K, Item 1, pg. 4-5
  22. 22.0 22.1 Entrepreneur.com Franchise 500 List
  23. DIN 2007 10-K, Item 1, pg. 5 & 9
  24. DIN, Inc. 2007 10-K, Item 6, pg. 35
  25. Technomic, Inc. 2007 Restaurant Industry Study
  26. DIN 2007 10-K, Item 7, pg.56
  27. Nation's Restaurant News 10/1/2007
  28. "Economic Potential of International Franchising in Emerging Markets"
  29. China Daily- "Dissecting China's Middle Class"
  30. Penny Sleuth- "Investing in India"
  31. IBEF.org, Retail
  32. www.franchisedirect.com- "India and Franchising"
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