Mind Your Business - 17 November 2008

Answers

1. Explain the difference between a franchisee and a franchisor (4 marks)

A franchisee is an individual who puts up a sum of money to buy the right to trade under an existing trade mark or name. The franchisee buys a package which includes all the ingredients that will allow an inexperienced person to be able to set up in business. Once the franchise has been agreed the franchisee continues to receive the support of the franchisor to ensure the business runs smoothly.

A franchisor is an individual or company that grants a licence to another individual that gives them the right to use a trade name or trade mark for the purpose of carrying out business. The franchisor receives a fee from the franchisee for this right and agrees to provide pre-agreed support to the franchisee which may be in the form of fixtures and fittings, training, point-of-sale merchandise, etc.

2. Consider two possible reasons why an entrepreneur might choose to invest in a franchise rather than setting up their own business from scratch (8 marks)

Setting up any form of business enterprise involves risk; one of the basic principles any entrepreneur will take note of is the extent to which this risk can be managed and minimised. Setting up a business from scratch is very much a leap of faith. It means that a new product or service is being launched on an untried market. The risk of success can be increased by conducting market research, but there are plenty of examples where positive market research has not led to business success. The failure rate of new businesses is relatively high – as much as one in four, according to some figures – and so the risk involved in setting up a new business is significantly higher than that involved in setting up a franchise.

With a franchise, the business idea has already been tried and tested by someone else and found to have a formula capable of being successful. The entrepreneur is in a position to feel that they will be supported by the franchisor and that the market will have already got some faith and loyalty to the brand concerned. Many customers will not necessarily know that the enterprise is a franchise, believing it to be just another branch of a well-known business (in many cases) opening in their area, and this further helps get the business established quickly.

3. Discuss two possible problems facing an individual who is contemplating investing in a franchise such as McDonald's (10 marks)

One of the first problems with such a decision is raising the money required for the investment. The text points out that the average investment for a franchise is £166,000, and the average loan taken out is £40,000. The exact sum of money required will depend very much on the type of franchise being considered – some will require sums of money larger than the average, and some, obviously, will need less. Given that the sums of money being talked about here are relatively high, it is not something that any entrepreneur should take lightly. The main problem therefore for the entrepreneur is in planning where to raise the necessary finance. If loans are taken out with a bank, for example, then the individual would have to produce a convincing business plan and go through the usual process of making sure that they had done sufficient research on the franchise to convince a bank to take the risk of granting the loan. It may be that a bank would look more favourably at such an application given that it is a franchise and that the risk with franchises is less than with a brand-new start-up. It could also be that the sum of money required might be higher than might normally be the case with a new start-up, however.

Another problem might relate to the experience of the franchisee after the business has started up. One of the key reasons why many people wish to run their own business is to have some degree of independence. While running a franchise gives the owner the experience of running a business, there are restrictions associated with a franchise. The quality control systems, operational processes, methods of advertising, financial recording, etc., might all be subject to some degree of control or guidance by the franchisor and this can limit the freedom of the individual to run the business as if it were totally independent. For the owner, there will be a trade-off between the surrender of independence and the reduction in risk associated with running the business. As a result, the acceptance of the controlling hand of the franchisor in the running of the business is something that would have to be accepted prior to taking on the franchise. What would be important, therefore, is that the franchisee makes themselves fully aware of the extent of the control and the agreements they would have to enter into with the franchisee before they agreed to take on the franchise.

4. Using the passage and your business knowledge, evaluate the operation of a franchise system in professional sport (18 marks)

In the United States, franchises are widespread in sport: all the major sports played in the US, including soccer, baseball, football, ice hockey and basketball, are based on a franchise system. The text highlights some of the problems that this sort of system can bring as well as some of the benefits. The success of the sport as a whole seems to be the paramount concern of the owners of the overall franchise; in baseball, that is Major League Baseball, Inc. The work that is done on behalf of the sport as a whole might include such things as negotiating overall player employment rights and responsibilities, merchandising and TV contracts. The individual teams have control over many of their own affairs much as any other franchise would do but in the case of these types of sports the numbers are much greater.

Given the guiding principles of MLB, Inc. as the franchisor, the development of the sport as a whole is given a priority. In many US sports, the spread of championship titles between different teams is far greater than that in UK sport, where a relatively small number of very wealthy teams dominate. This spread is encouraged by initiatives like revenue sharing and the draft system, whereby poorer teams get to share in the wealth created by the sport as a whole and get first choice of new talent through the college system. The fact that many teams in the sport have a greater chance of winning titles helps to maintain interest in the sport for the fans and this in turn helps to generate revenue for the sport as a whole, as well as the individual franchises. The rise in attendance at MLB matches, accompanied by the rise in revenue for the sport (over £4 billion in 2007, which represents double the amount in 2000). It seems that this evidence would suggest that the role of overseeing the business as a whole by the franchisor has been of benefit not only to the business as a whole but also to the individual franchises.

Many teams still rely on local support for the franchise, however, not only in simple terms like attendance levels at the stadium but also the support of local authorities to invest in the success of the teams. This may be through the provision of land or planning rights for new stadia with some, if not all the money, coming from the local taxpayer. As such, the promise of hosting an MLB franchise may be seen as bait that is held out by the franchisor in return for concessions from the local authorities for the right to host that franchise. This is where the franchise system for such major sports differs from normal franchises.

With a normal franchise, the franchisor may be interested in expanding quickly through granting franchises to many willing franchisees. In the case of MLB, there are 30 teams and the prospect of any further expansion looks unlikely. When, as in the case of the Montreal Expos, the possibility of hosting a new franchise arises, the franchisor can set the entry bar at a relatively high level to maximise both immediate and future potential revenue. In this respect, the franchisor is in a relatively powerful monopoly position, which, it could be argued, might be exploited.

The text also suggests that fans are becoming disillusioned with the involvement of money in the sport; no longer do teams belong to the fans and the local community (if they ever did...) - the teams are owned by big business interests whose primary aim, it is argued, is generating profit rather than cultivating the wider stakeholder interests which include the fans. It could be argued that the involvement of major business figures in UK soccer is typical of this, but these are not franchises but individual clubs. Despite their independence, however, these clubs are members of the Premier League and it is the Premier League that does much of the negotiating of the brand itself much in the same way that MLB Inc does for baseball.

Given the success of the franchise system in US sport, it seems that interest in major sport is increasing rather than diminishing. The role of the franchisor could be said to be a key feature of this success. The individual franchises also know that their success is part of a collective operation and that their operation is inexplicably tied up with that of the franchisor. If fan alienation is occurring, as hinted at by the case of the Expos, then the rise in attendance figures and MLB revenues does not seem to provide much by way of support. From a business perspective, therefore, the rise in income generation would suggest that the franchise system is an appropriate and successful means of running sport in the US. Whether there would be the same degree of success in the UK with its different sporting roots and culture would be a different matter.