Franchise arrangements are part of our day to day lives. From fuel stations to grocery stores and fast-food outlets, franchises can be seen all over the country and beyond. A common misconception with franchising is that it is limited to a specific industry.
It just depends on how the parties go about it. In this two-part series, I will look at what franchises are, how they work, their legal implications and I will share tips on how to implement them.
What is franchising
Franchising is the granting of a licence by one person (the franchisor) to another (the franchisee), which entitles the franchisee to trade as their own businesses under the brand of the franchisor, following a proven business model. The franchisee also receives a package, comprising all the elements necessary to establish a previously untrained person in the business and to run it with continual assistance on a predetermined basis (including a predetermined agreement length, with renewal options).
The term “franchising” however, has been used to describe many different forms of business relationships, including licensing, distributor agreements and agency arrangements.
A franchise in this sense will usually have the following key elements:
– The franchisor allows the franchisee to use a name, trade marks and other intellectual property, which is owned by or licensed to the franchisor.
– The franchisor exercises continuing quality control over the franchisee.
– The franchisor provides assistance to the franchisee.
– The franchisee periodically has to make payments to the franchisor.
‘First generation’ franchises
Commercial marketing agreements resembling modern franchise agreements first began to be used on a regular basis in the brewing and car industries. The brewing industry created tied-house agreements whereby brewers would only sell their product through selected pubs. The car industry created dealerships between vehicle manufacturers and dealers. Such franchise agreements are distinct from today’s franchise model in that, firstly, they did not oblige the franchisee to operate under the name or trademark of the franchisor. They were more like distribution agreements as opposed to outright franchise agreements. Secondly, these franchise agreements did not allow the franchisor to have significant influence and control on how the franchisee operates its business.
These supply dealership arrangements are sometimes referred to as “first generation” franchises because they lacked these two essential elements of modern “second generation” or “business format” franchises.
How distribution and franchise agreements differ
A manufacturer or supplier of goods may appoint an independent third-party distributor to market and resell its goods. Alternatively, a supplier of services may appoint a third-party company to provide retail services for the benefit of the customer. The latter arrangement is often found with Internet services, where the retailer re-brands a digital service under its own name, for “resale” to the end-user, like Internet service providers.
The key similarities and differences between a distributorship and a franchise include the following.
Usually, the distributor of goods buys the goods on its own account and resells to the customer, like how a consignment arrangement would work. Similarly, a service reseller may offer a retail service to its customer, but the actual service may be provided by a third party. An example is a company that advertises borehole drilling services but uses third parties to do the actual work. On the other hand, a franchisee may also purchase products from the franchisor, for example, burgers and buns for resale, or decorative features to be used to duplicate the distinctive appearance of a chain of pubs. So the process of sale and resale is not the key difference between distributorships and franchises.
However, a distributor will always buy products and services from its principal (otherwise there is no relationship), whereas a franchisor may impose no obligations on the franchisee about where to purchase its raw materials, provided the franchisee follows quality control procedures to enhance the brand name of the franchisor, and pays royalties for the use of the brand name and know-how. Chicken Inn chicken will ordinarily taste the same wherever you go because of the standards applied. It does not necessarily mean all franchises get chickens from the same source.
Exclusivity
A distributor may be appointed by one or any number of manufacturers or suppliers. So an electronics shop may deal with both Sony and Samsung in the same showroom. In developing markets, even car manufacturers may allow their distributors to deal in competing products, provided they do so from a showroom that is separate from the showroom dedicated to a competitor’s products, and there are procedures in place to protect confidentiality. But again, a supplier may require its distributor not to deal with any competing products.
With regard to franchises, an experienced hotel operating company may operate different franchises from different premises, particularly if the franchises relate to different market sectors. So exclusivity is not always key to a franchise relationship, provided that the franchised brand is not confused with other brands.
Trade name and branding
Distributors often trade under their own name. That name will usually have no connection with the name of the supplier of the goods. However, some large distributors are authorised to adopt the brand look of the supplier, perhaps in a retail outlet dedicated to the goods of that supplier. Thus, the premises of a car distributor may display the name of the car manufacturer very prominently, with all the associated branding. The name of the actual distributor or reseller may appear only on the sale contracts and other legal documents of the re-sale business.
Similarly, the reseller may provide an after sales service, in its own name, with second level support (spare parts, web-based diagnostics, telephone help desk) from the manufacturer. The key point here is that the franchisee will always use the name and branding of the franchisor, whereas a distributor may or may not use the branding of its supplier.
In part 2, I will explore more differences between franchises and distributorships and explore the legal aspects to consider when setting up a franchise. I will also look at how to implement a franchise operation.
Muza is a duly admitted lawyer with expertise in business law, labour law and commercial litigation. He writes in his personal capacity. For feedback, email him at hilarykmuza@gmail.com or call on +263719042628.