A Brief History of Franchising
Franchising as a concept has a mystical history, but its roots have been traced as far back as the Roman Empire in the Middle Ages up through the rule of William the Conqueror in England. It was carried on by Louis Xlll in France, always associated with a granting of rights in exchange for something.
Today’s usage of the term as a business concept is widely accepted to be traced back to before the Civil War when two great US innovators designed systems to expand sales and service of their inventions. Either Cyrus Hall McCormick, with his mechanical reaping and harvesting systems, or Isaac Merritt Singer with his new sewing machines, are usually credited with its birth in about 1850.
Franchising is flourishing today. According to the IFA’s most recent Franchise Business Economic Outlook Report, franchise businesses will add 247,000 new direct jobs this year (a 2.9 percent increase to 8.8 million direct jobs over last year.) The number of franchise establishments will grow this year by 12,111, or 1.6 percent, to 781,794. Economic output from franchise businesses is estimated to increase by 5.4 percent over last year to $889 billion. The gross domestic product of the franchise sector is projected to rise by 5.1 percent this year, which is faster than the 4.9 percent GDP increase forecasted for the economy as a whole. The franchise sector will contribute about 3 percent of the entire U.S. GDP in 2015. I guess the Romans were on to something.
The Evolution of Modern Types of Franchising
Whether it be Singer, McCormick or even Ray Kroc, franchising has evolved to include many types of franchising development agreements; Single Unit Agreements, Multi-Unit Agreements, Area/Regional Development Agreements and Master Franchising are the most common. The one thing they all have in common would be a development schedule whereby the franchisee, in exchange for fees, is granted a license to develop one or more units within a defined period of time. Although with each of these agreements the franchisor is growing its franchise footprint and regional branding, typically the franchisee’s objectives as motivation to sign each type of development agreement will vary in many ways.
I would qualify Single Unit operators as investors mostly new to the industry and interested in “buying a job” or “testing the waters” of a new investment objective. Multi-Unit operators are more highly capitalized seasoned investors willing to accept a higher level of risk mitigated by more units and an asset rich exit plan. These are both operator driven models based on individual unit level economics whereby the owners are the operators of record.
Development Driven Models: The Best Kept Secret in Business Today.
Area or Regional Development models are popular and are used to quickly grow a brand footprint by selling large exclusive geographic development rights to sophisticated investors acting as sub-franchisors for their particular markets. These agreements are unique in the fact that they are sold only once. and the motivation for these agreements varies from operator driven models. As unit level success is paramount in both models, developers are more interested in creating cash flow from the sale of initial franchise fees to offset their development fee and in long term residual income driven by the royalty share from the franchises they sell.
The profile of successful developers is typically entrepreneurs with proven business experience and substantial capital resources. Often, they have operated one or more franchises within the franchisor’s system or another franchise company. They may also have organizational and financial resources sufficient to commit to a large-scale investment. Historically that model has been used by franchisors in more capital-intense industries such as lodging, restaurants, and automotive rental. Currently it is expanding into the senior/home care and even marketing industries.
The financial model works roughly like this in most cases. In exchange for a development fee based on a projected number of proposed units or on population demographics, the developer would be granted the licensing rights to the number of units agreed upon or, in some cases, a non-capped number of licenses. Normally, they would share in the franchise fees for each new license sold and in the royalty stream produced by each of the units sold for the life of the agreement. Typically, the Developer would be required to open and operate at least one unit to be used as a training hub. The hub would be required to provide pre-opening training and ongoing support for the franchisees in his/her market.
This model can provide the developer with a steady cash flow and a residual income for twenty years or more. The asset and income stream can have a huge terminal value as a valuable and sellable exit strategy.
Master Franchising: The Ultimate Best Kept Secret
Master Franchisees would negotiate for and ultimately buy the exclusive development rights for a brand in an entire business segment. Geographic area could be nationally or even internationally, and is used often to expand into new global markets. These agreements could be sold for captive markets where the franchisor has restricted access. They can also be used to leverage a franchisee’s practical knowledge of the competitive landscape and specific expertise within a market.
The best model would depend on the specific goals, business and market experience of the new franchisee.