FRANCHISINGIN GREECE

By: Themistoklis Kossidas,

Auditor, Hellenic Capital Market Commission,

Kolokotroni 1 & Stadiou str., 105 62, Athens, Greece.

Abstract

ThepaperisdealingwiththefranchisingmethodintheGreekmarket, giventhedynamicgrowthofthemethodduringthelastyearsthatresulted in the small and mediumsized enterprises to use it as a way of growth.

Franchisingisoneofthetwooptionsforsomeonetostartupanenterprise. Following the approach of our era that is based on knowledge, innovation, investment in new technologies, this method, supported by these characteristics, has been developed and established as one of the safest methods of enterprising growth.

Thepaperpresents the managerial aspects of franchising, such as: a) thebasiccharacteristicsoffranchisingandhowitfunctionsintheGreekmarket, b) thestepsforcreatingasuccessfulmaster franchise, c) the parameters that a franchisee should take into consideration in order to minimize the risk and create a successful venture and d) the elements of know-how in franchising.

The financial impact of franchising is being analyzed for the franchisor and the franchisee. ThefinancialinformationforlistedcompaniesintheAthensstock exchange, that use franchising as a way to increase their business, it is also presented and commented.

We also compare the present situation in Greece with the abroad, as well as the possible gains for the enterprises and the national economy, and the opportunities and future trends our country faces. The results of the three based-researches for franchising, made by ICAP, Logistika and FranchiseSuccess-Panorama 2006, are summarized and analyzed.

1. Introduction

In a business context, the terms “franchise” and “franchising” are often used interchangeably to mean a business, a type of business or an industry. Generally speaking, franchise is an agreement or license between two parties which gives a person or group of people (the franchisee) the rights tο market a product or service using the trademark of another business (the franchisor). The franchisee has the rights tο market the product or serνice using the operating methods of the franchisor. The franchisee has the obligation tο pay the franchisor certain fees and royalties in exchange for these rights. The franchisor has the obligation tο provide these rights and generally support the franchisee. Ιn this sense, franchising is neither a business nor an industry, but it is a method used by businesses for the marketing and distribution of their products or serνices.

-History of franchising

Franchising started in the United States as early as in the 18th century but the great expansion was in 1970s. In Greece, it appeared in mid-1970s but the real development started after 1997. During the 1990s, many small to medium sized businesses faced survival problems due to the market changes and the severe competition. Thus, franchising became the basic development tool for the small to medium sized businesses and it gets the credit for their revitalization and consistent growth.

Modern business format franchise really took-ff in Greece. There were many causes for the rapid adoption and use of franchising by many entrepreneurs and by many businesses, such as:

  • The recognition of franchising as one of the safest way for business development since the percentage of businesses that shut-down during the first 5 years of their life is 1%-2%, while a 50%-60% of independent stores shut-down during the first 5 years of their life.
  • The possibility to own a recognized brand-name that does not need a big capital investment, it is an opportunity for young ambitious entrepreneurs and experienced middle level employees.
  • The rise of mass marketing and the increasing mobility of the people fueled the growth of franchise businesses.
  • The consumer desire for convenience and consistency.
  • The shift in the Greek economy from production of goods to the providing of services, in particular services that fill the needs of life-styles.

Despite the late adoption of franchising in Greece, there are big steps forward thus the current situation is in a good track, as it is shown by the following figures. In 2001, there were approximately 230 franchisors and 4000 businesses whereas in 2005, there were 400 franchisors and 6000 businesses. For 2006, it is expected a bigger increase to franchise businesses compared to company-owned stores that will take place.

-Social impact of franchising

The pervasiveness of the franchise system has resulted in much discussion of its socio-economic impact on society. The overall consequences are positive, thus, it:

  • Creates new small to medium businesses and heightened competition in the economy.
  • Restricts the tax frauds, since franchisees have to keep proper accounting entries to calculate royalty fees.
  • Decreases the economic concentration in the economy.
  • Increases the employment.
  • Increases the life expectancy of the businesses.

The negative consequences, associated with franchising, are in the area of franchisor/franchisee relations and possible conflicts that might arise.

2. Managerial aspects

-The basic characteristics of franchising and how it functions in the Greek market

A franchising agreement involves two parties, the franchisor and the franchisee. On one hand, the franchisor owns the trademark, provides support (i.e. training, advertising, marketing, financing) and receives fees. On the other hand, the franchisee licenses the trademark, runs the business with the franchisor’s support and pays fees.

The typical franchisor will have establishments that are operated by franchisees as well as establishments that are operated by corporate employees. There are many types of franchise arrangements, the two generic are:

  • Product distribution franchises sell the franchisor's products and are supplier-dealer relationships. Ιn general, the franchisor licenses the use of its trademark tο the franchisee but may not in all cases provide the franchisee with a system for running its business. Examples of product distribution franchises are soft drink distributors, automobile dealerships, and gas stations.
  • Business format franchises not only sell the franchisor's product or serνice, with the franchisor's trademark, but operate the business according to a system provided by the franchisor. The franchisor provides training, marketing materials, and an operations manual to the franchisee. There are many examples of business format franchises, such as quick serνice restaurants, automotive services, lodging, real estate agents, convenience stores, and tax preparation services.

It might be helpful in understanding how business format franchising works to examine the role of both the franchisor and the franchisee for a typical franchised fast food restaurant (it is a highly franchised industry).

Thus, the franchisor gives general guidelines for the site selection, provides prototype design (similar to other restaurants), makes generalized recommendations for the employees, sets the menu, recommends the pricing policy, provides advertising, sets quality standards, trains and inspects franchisees and offers bulk purchasing program.

The franchisee chooses the site with the necessary approval, implements the restaurant design, runs the human resources department, might change the menu upon approval, decides the actual prices, carries out the quality control system and complies with the program.

-Advantages and disadvantages of franchising

In general, the advantages of franchising are:

  • Lower cost of establishment - the cost to acquire a well-know brand-name is considerably lower than to set-up a business and try to dominate the market.
  • Less exposure to risk - the experience and know-how of the franchisor reduces the risks.
  • Increase motivation – the franchisee as an independent businessman is more motivated than a salary employee because of profit incentives and growth opportunities.
  • Some control of operations – the franchisor keeps some control over the undertaking, whereas the franchisee can develop, to a certain degree, its entrepreneurial skills.
  • Economies of scale – franchising contributes to economies of scale due to the size of expenses i.e. the expenses are divided to all members of the network.
  • Knowledge of the local market – the knowledge of the local market is a competitive advantage for the franchisee that is used by the franchisor for the business expansion.
  • Source of capital – the franchisor, through fee and royalty arrangement, receives capital from the franchisee for channel developments and thus has lower capital requirements than the wholly owned chain.

The disadvantages of franchising are:

  • Profit participation – there is a franchising fee to be paid.
  • Some control of operations – this point is also a disadvantage because the franchisor does not exercise full control over the undertaking and the franchisee can not act freely.
  • Possible disagreements and conflicts – the franchising relationship involves two independent parties bound together by contract. The possibility for disagreement or conflict is much greater than among wholly owned chains.

-The steps for creating a successful master franchise

Historically, franchisors first complete their development at a national level before they decide to look for international investors. However, in today's global economy, there is no longer a need to stall international expansion. Each concept can be considered as ready to penetrate new markets, if it has developed a stable national base with strong financials, it is governed by a strong and completely devoted team and it has the necessary facilities to train and support international investors. Most candidates, who are serious about acquiring and operating a master franchise, have healthy balance sheets, thus an analytical report of the finances should be prepared. Also, the franchisors, should be prepared to give details regarding all the existing franchisees, who will give reference regarding the company.

The franchisor’s aim during the first 12-18 months is to find and establish a master franchise in the primary target-market. The decision to expand the business abroad must be taken beforehand and a strategy plan to be drawn for the expansion. Many franchisors make the mistake of responding to an "opportunity" for development in unknown markets.

The franchisor should come in contact with experienced franchise advisors and entrust them with the conduct of a pre-entry study, aimed at defining the basic sectors that must be looked into before deciding to expand the business internationally. Such a study is extremely important as it will give useful information for the target-markets and will allow to better negotiate with candidate franchisees. This study will give indications on the i) needed time and budget, ii) legal direction for the entrance in the new market and iii) direct competition, regarding the product, or service, or other franchisors.

Before the assignment of the legal franchise rights in any other country, the franchisor must ensure the copyright of the brand and the trade marks and must not allow a master franchisee to secure the copyright, because then control might be lost. All the elements of the system, the training program for franchisees and the support package offered, must be reorganized so that it suits the needs of each new market.

When the necessary study has been completed, the franchisor should prepare an advertising and promotional campaign for the selected market to attract suitable candidates, who could buy and operate a master franchise.

Searching candidates must be thorough and before the final choice of a master franchisee a collection and a verification of all the candidate's data (i.e. precise identity, residence and other business activities) is required.

The franchisor must cooperate with the franchisee in order to create the regional business development plan. The master franchise deal must include reference to the minimum demands the franchisor has from the master franchisee of each country.

-The basic parameters that a franchisee should take into consideration in order to minimize the risk and create a successful venture

The best way, for a franchisee, to minimize any possible risk, it is to be aware of the risks and to have prepared an alternative plan. The following parameters should be born in mind at an early stage, much before the kick-off of the venture in order to have enough time to think of possible benchmark treatments.

  • Assess the available capital – assure that the available capital covers the franchise expenses. Rely on financing up to 40% of the total investment.
  • Carry-out a market research – read, search and learn anything that has to do with the concept. The viability and the duration of the concept should be prime selection criteria, not the market trend. The prospective franchisee should talk with established franchisees to benefit from their experience.
  • Visit exhibitions – the franchisee has to collect all available information i) for the franchisor and ii) the attractiveness of the concept to others. A well organized franchisor that supports its network by providing any requested information, by educating the employees and by helping-out during difficulties should be highly appreciated.
  • Verify your suitability as franchisee – a successful franchisee has to have certain characteristics that might differ depending the franchise. Build on the strengths and try to improve the weaknesses.
  • Valuate the brand-name – try to estimate the fair value for the concept. Franchisors tend to over-estimate the brand-name.
  • Check the franchise agreement – franchise agreement is a contract and every word has to be understood and explained so that there will not be misunderstandings and confusions.

-Know-how in franchising

The distribution system is where the know-how holds an important position and franchise is not only a distribution system. So, one of the basic elements of franchise is the know-how. In particular, there can be no franchise without know-how. Thus, the definition of know-how in franchising includes the following:

Confidential - the best way to define the confidential character of know-how is the following; know-how is confidential as it is not directly accessible to a franchisee, in other words the franchisee will have to go through the franchisor in order to obtain this know-how.

Original - the term refers mainly to the fact that know-how is not known in a particular business.

Substantial - the know-how must consist of information and facts that are important enough as to give franchisees a competitive advantage. Moreover, if a franchisee does not have access to this information, it would be hard to succeed in business as fast and as well as desired.

Tested - the franchisor must have already tried this know-how in as many areas as possible (or at least in one area) and for as long as possible. This is the significance of the so-called "test areas". The legal form of these areas (branch office, subsidiary, etc) is of no importance. It is also obvious that these tests must be successful.

Defined - given the complexity of know-how, it is best, and logical, for it to be written on a manual. Of course, manuals should not be handed over before signing a contract. However, some elements of this know-how can be passed on even before signing the contract. For example, definitions of a certain geographical area, its characteristics and the criteria for choosing this area can be disclosed.

Sophisticated - it is clear that an outdated know-how has absolutely no value. In order to avoid downgrading it, the franchisor must constantly update his know-how. This tactic will ensure that the franchisor's system will not be copied or counterfeited by his competitors and that the franchisees will continue to be part of the system, since this system is truly effective. This is one of the main reasons why franchisees continue to pay legal rights, without complaint.

Communicable – in order for this know-how to be commuted to franchisees, franchisors must create and maintain ways of transferring it. This transfer may be initially training and handing the manual, but it can also be continuous,by organizing educational programs and updating the manual. In terms of time, these stages of transferring know-how coincide with the signing of franchise contracts for the initial transfer, and during the period this contract is valid, for the continuous transfer of know-how.

In conclusion, know-how is not real and has nο value for a franchise, if it does not allow franchisees of the system to reproduce the franchisor's success.

3. Financial aspects

The selection of a distribution channel is usually considered to be a marketing decision, but the factors influencing the decision of which marketing channel to use include financial consideration. Indeed, the decision to franchise is often based heavily on financial than marketing considerations.

As mentioned earlier, an important reason for franchising is the lack of capital to build a wholly owned system and much of the expansion effort of franchising systems is financed by the franchisees.

-Financial impact of franchising for the franchisor and the franchisee

There are some financial factors that the prospective franchisor should take into consideration during the development of a franchise system. These factors can be categorized in three main stages named, the initial, the pilot and the development.

The initial stage includes possible sources of revenue for the franchisor such as initial franchise fee, on-going fee, supplementary revenue. The initial franchise fee should include the design and development cost of the concept. The cost should be allocated proportionally to all possible franchisees for a period that depends on the initial life expectancy of the concept. The on-going fee (or royalty fee) is a percentage of sales made by the franchisee paid to the franchisor. The supplementary revenue is the revenue that derives from extraordinary activities such as lease or rental of equipments i.e. activities outside the contract agreement but provided to the franchisee upon request.