Page 71 - DMGT551_RETAIL_BUSINESS_ENVIRONMENT

Retail Business Environment

Notes The franchisor typically earns royalties on the gross sales of the franchisee. In such cases,
franchisees must pay royalties whether or not they are realizing profits from their franchised
business.
Cancellations or terminations of franchise agreements before the completion of the contract
have serious consequences for franchisees. Franchise agreement terms typically result in a loss
of the sunk costs of the first-owner franchisees who build out the branded physical units and
who lease the branded name, marks, and business plan from the franchisors if the franchise is
cancelled or terminated for any reason before the expiration of the entire term of the contract.
Franchising dates back to at least the 1850s; Isaac Singer, who made improvements to an existing
model of a sewing machine, wanted to increase the distribution of his sewing machines. His
effort, though unsuccessful in the long run, was among the first franchising efforts in the United
States. A later example of franchising was John S. Pemberton’s successful franchising of Coca-
Cola. Early American examples include the telegraph system, which was operated by various
railroad companies but controlled by Western Union, and exclusive agreements between
automobile manufacturers and operators of local dealerships. Earlier models of product
franchising collected royalties or fees on a product basis and not on the gross sales of the
business operations of the franchisees.
Modern franchising came to prominence with the rise of franchise-based food service
establishments. This trend started before 1933 with quick service restaurants such as A&W Root
Beer. In 1935, Howard Deering Johnson teamed up with Reginald Sprague to establish the first
modern restaurant franchise. The idea was to let independent operators use the same name,
food, supplies, logo and even building design in exchange for a fee.

The growth in franchises picked up steam in the 1930s when such chains as Howard Johnson’s
started franchising motels. The 1950s saw a boom of franchise chains in conjunction with the
development of the U.S. interstate highway system. Fast food restaurants, diners and motel
chains exploded. In regard to contemporary franchise chains, McDonald’s is unarguably the
most successful worldwide with more restaurant units than any other franchise network.
According to Franchising in the Economy, 1991-1993, a study done by the University of Louisville,
franchising helped to lead America out of its economic downturn at the time. Franchising is a
unique business model that has encouraged the growth of franchised chain formula units because
the franchisors collect royalties on the gross sales of these units and not on the profits. Conversely,
when good jobs are lost in the economy, franchising picks up because potential franchisees are
looking to buy jobs and to earn profits from the purchase of franchise rights. The manager of the
United States Small Business Administration’s Franchise Registry concludes that franchising
there is continuing to grow and that franchising is growing in the national economy.

Notes Franchising is a business model used in more than 70 industries and that generates
more than $1 trillion in U.S. sales annually.
Appropriateness of Franchising with Business:
Businesses for which franchises are said to work should have the following characteristics:

 Businesses with a good track record of profitability.
 Businesses built around a unique or unusual concept.
 Businesses with broad geographic appeal.
 Businesses which are relatively easy to operate.

66 LOVELY PROFESSIONAL UNIVERSITY