Want Franchise With That?

No discourse on entrepreneurship past, present or future is complete without mentioning one of the most successful growth strategies going.

Devlin Smith

Magazine Contributor

May 1, 2002 10 min read

This story appears in the May 2002 . Subscribe »

Today, franchising's power is pretty hard to ignore. Filling strip malls and plazas, spreading over borders and oceans, franchising is making its way into every corner of the world and is servicing many needs in our lives. In the United States alone, nearly $1 trillion a year in sales are rung up at franchised outlets.

But only 25 years ago, franchising's place in the world was a lot less certain. While many of today's big players, like McDonald's and Holiday Inn, were enjoying franchising success back then, the franchising industry was still suffering from a bad reputation, dogged by lawsuits and horror stories about get-rich-quick schemes and fraudulent business opportunities.

"In the late 1960s, franchising and fraud became almost synonymous," says David J. Kaufmann, a franchise attorney with New York City-based Kaufmann, Feiner, Yamin, Gildin & Robbins Inc. "Those days, thank goodness, are long gone. The federal and state disclosure laws that some franchisors view as a burden were actually a savior for the franchising industry. Those laws have almost completely eradicated franchise fraud and criminal involvement in the franchise arena."

·Technology: First it leveled the playing field. Where's it headed now?
·Money: Capital was scarce 25 years ago. Here's its state today.
·Management: Trends are multiplying fast. What will stand the test of time?
·Marketing: Technology and personalization will rule this arena.
·Franchising:Get ready . . . the golden age of franchising is upon us.

25 Years of Entrepreneur: A timeline of the forces that have shaped entrepreneurship through the years

Getting It Right

Beginning in the early '70s, states began enacting franchise disclosure and registration laws. This action led to the Federal Trade Commission's Franchise Rule in 1979, which required all franchisors to furnish potential franchisees with information about the franchisor, the franchised business and the franchise relationship. The Uniform Franchise Offering Circular (see "Tell Me More") now satisfies the FTC's disclosure requirements. Twenty-one states regulate franchises with additional registration and disclosure requirements.

But some say regulation by the states and the federal government doesn't do much to give franchisees fair treatment. The new changes "created an enormous seller's market, and franchisors were able to drive tough bargains in terms of fairness of their franchise agreements," says Robert Purvin, chair of the American Association of Franchisees and Dealers, a San Diego, California-based franchisee advocacy group. "In 1977, the typical franchise agreement was beginning to change in that you no longer got substantial territories, didn't have the right to terminate your franchise if the franchise wasn't delivering you value and couldn't determine who you were going to buy your product sources from."

Reform on this front was slow. There was an industry-wide belief that 95 percent of franchises succeeded while 80 percent of independent businesses failed. No one was really interested in tampering with a system boasting those numbers.

But in the early '90s, two major studies debunked the myth that franchising guaranteed success. In 1996, Timothy Bates, then a professor at Wayne State University in Detroit, authored a study that revealed 61.9 percent of the franchised businesses studied succeeded, compared with 68.1 percent of the nonfranchised firms.

"The shock wave regarding the whole area of franchise success rates has caused a lot of us to stop [and re-examine it]," Purvin says. "We found a lot of franchises were being sold under the false premise-an industry-wide false premise-that you couldn't lose."

Around the same time Bates was conducting his study, Scott Shane, professor of entrepreneurship at the Robert H. Smith School of Business at the University of Maryland, began researching the survival rates of franchisors. In his study, Shane discovered that within 10 years, one quarter of all new franchisors fail, and that the failure rate is highest within the first four years.

As with the Bates study, there was a preconception that franchising meant successful expansion for businesses. "The popular notion was that franchisors are just well-established organizations like McDonald's," Shane says. In reality, he adds, "The typical [franchisor] is new because most of them fail in a short period of time."

TELL ME MORE

Since going into effect in 1993, the Uniform Franchise Offering Circular has provided prospective franchisees with the essential information they need when choosing the right franchise. "A franchisee that's more informed about the risks associated with the offering is an absolute benefit to the franchisor as well," says Dale Cantone, chair of the franchise and business opportunities project group of the North American Securities Administrators Association, developer of the UFOC guidelines.

"Any franchisor would admit that they want a franchisee to be fully informed about the risks associated with the offering before the franchisee decides to invest," adds Cantone.

The UFOC currently satisfies the Federal Trade Commission's Franchise Rule, but a new rule is being proposed that may make the UFOC obsolete. "The UFOC is going to be used by the FTC as the basis for a new disclosure document," Cantone says.

"Basically, the FTC's proposed format is the UFOC with a couple of slight revisions and a couple of additional requirements. In effect, it will replace the UFOC as the required disclosure document for franchising."

Regardless of whether the UFOC will be replaced sometime in the future, Cantone is proud of the document. "The UFOC," he says, "has held up fairly well for 10 years."

Power Plays

Once people realized franchising wasn't a sure thing, interest in franchisee advocacy grew. The International Franchise Association has been representing the franchising community since 1960 but had limited its membership to franchisors and suppliers until 1992.

"The association's leadership had sufficient vision to realize that if franchising was truly going to operate with a sense of unity, and we were truly going to be the voice of franchising, franchisees had to play a very significant part in this organization," explains IFA president Don DeBolt.

Franchising 101

Learn more about franchising by visiting our Franchise Zone.

In the early '90s, Purvin helped create the AAFD to represent franchisees. The American Franchisee Association was also founded about this time, and today nearly 50 percent of franchises possess either company-sponsored franchise advisory counsels or independent franchisee associations, all giving voice to franchisees within their systems and the government.

While franchisees found a voice in the franchising community, franchisors began thinking globally. "Now there isn't a major franchise brand out there that doesn't have global reach, a presence in virtually every country," Kaufmann says. "Franchisors were the first to enter what used to be the Communist bloc of Europe to set up franchise networks in countries whose economies were only beginning to resemble free market operations. In many ways, American franchisors have developed the business marketplace in Eastern Europe and in many parts of the third world."

Back on the home front, franchisors were exploring new ways to educate franchisees. In 1990, Cheryl Babcock, who was once the executive director of the International Center for Franchise Studies at the University of Nebraska, was recruited by the University of St. Thomas in Minneapolis to start a franchising program.

Under Babcock's direction, the Institute for Franchise Management offers a wide range of courses to undergraduate and graduate students, franchisees and franchise executives. "I served on the education committee of the IFA for a number of years, and I would listen to people from different franchise companies talk about what they needed," says Babcock. "I didn't see anybody [trying to meet those needs], so I worked with people in the franchise community to develop a program."

The Golden Age to Come

As organizations and programs for franchisees and franchisors began springing up, the franchises themselves became a greater part of the collective consciousness, further dispelling franchising's negative connotations. "In those days, there was a lot more skepticism, both from the public and prospective franchisees," says Tony DeSio, founder of Mail Boxes Etc. and Image Arts Etc. "As time has gone by, the public has come to embrace franchising because they're familiar with the successful franchises and brands. They know that, from one location to another, they can rely on product consistency."

While expanding nationally and internationally, franchises have continued to work on improving their business systems. "It's easier [for new franchisees to enter the system] now. They give you handbooks that tell you how to run your business so you don't have to come up with the context for construction and development on your own," explains Paul Sweeney, a Cranberry Township, Pennsylvania, McDonald's franchisee who opened his first restaurant in 1973. "As an entrepreneur back in the '70s, most of that didn't exist. We needed to do all that developing."

Just as franchisees and franchisors worked together over past years to build their systems, these same people will continue to collaborate in order to strengthen franchising without outside involvement in the 21st century. "I see franchisees veering away from a dangerous path that was unnecessary," says Kaufmann. "I think the death of the 2oth century also led to the death of more radical calls for the federal regulation of franchising on a substantive basis."

Even with all the changing and growing that franchising has done over the past 25 years, many believe we've only just scratched the surface of what franchising can potentially achieve. "If you look in the rearview mirror at the past 25 years and see the tremendous success of franchising, that's just a glimpse of what the future will be," DeBolt says. "I truly believe that, as we see more and more globalization, franchising will play an even more significant role with its ability to create jobs and personal wealth."

DeBolt also predicts that franchising's powerful influence will ultimately stretch far beyond just the way the world eats and shops. "Franchising will probably make a larger contribution to world peace," he says, "than any diplomatic mission or military action."

MINORITY LEAGUE

While franchisors plot their expansion, they have recently set their sights abroad. C. Everett Wallace, however, is urging them to reconsider their plans and not to underestimate the power of burgeoning domestic markets.
Wallace, co-director of the National Minority Franchise Initiative, believes that over the next 25 years, franchising can play an important role in revitalizing and reshaping urban communities and minority neighborhoods. "The advantage of franchising, without question, is not only do you have a proven brand and proven system, but you also have the opportunity for that [system] to be owned by somebody who is locally based," he explains. "That's critically important in rebuilding the community overall because you're really building from within."
And as minority populations change, it becomes essential not only for the franchise communities, but also for the franchises themselves to promote an increase in minority ownership. "Minority franchising is going to have to expand just by the sheer demographics," Wallace says. "In all probability, your customer base is going to be a minority customer base, and logic dictates that you should have someone who looks like your customer owning that business."

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