A franchise is an agreement or arrangement to conduct a particular business in accordance with an established format, brand, technique, or model. In return, the franchisee usually pays a fee and a percentage of the sales revenue to the franchisor. Examples of franchises include MacDonalds, Prontoprint, Dynorod and Coffee Republic.
In a franchise agreement, the franchisor permits the franchisee to use its name in return for payments. The franchisor places restrictions on and exercises a measure of control over how franchisee operates the business. It will provide the franchisee with initial and continuing assistance. The franchisor may exercise continuing control over the franchisee in some cases. The franchisee operates his business under the franchisor’s trade name, so that it appears to the outside world, to be the franchisor.
The franchisor sells his products and services to the franchisee. The franchisee trades under the franchisor’s trademarks and trade names and benefits from the franchisor’s help and support. Franchise agreements will typically provide rights for a particular term (period) and a particular territory.
A franchise arrangement may be put in place where an existing successful business wishes to expand, and another business, with little or no experience, wishes to enter that business. A Franchise Arrangement will commonly commence with a pilot operation. This is necessary to enable the partes to appraise the feasibility of the project.
Franchising offers the opportunity to secure distribution for products and services faster than would otherwise be the case. The franchisor may be able to increase purchasing power and reduce overheads. The disadvantage of franchising for the franchisor, is a loss of control. Although a franchise agreement may impose restrictions, the franchisees are independent third parties who maximise profits on their own account.
Businesses may expand overseas using franchises. The franchisor may grant franchises directly to franchisees in the other country. It may establish a subsidiary or branch operation, and use that as its franchisee. A joint venture may be established between the franchisor and the resident of the third country.
A franchisor may develop a franchise business by way of a pilot operation. A pilot franchise may be put in place on preferential terms in order to test the franchise in the relevant market. This is less likely to be necessary, where the franchise agreement is made in relation to established proven product.
Commonly, the franchisor enters a master franchise or development agreement, which obliges the franchisee to establish sub-franchises. The franchisor may grant a master franchise agreement. This master franchisor is given the exclusive right to operate and grant franchises within the territory. It undertakes to appoint sub-franchisees franchisee on the basis of franchise agreements stipulated by the franchisor.
An Operations Manual typically operates in conjunction with the franchise contract.It may regulate the terms under which the franchisee operates the business. It typically sets out the day to day operational instructions.
It is not unusual for the franchisor to take a lease of premises and grant a sub-licence to the franchisee in order to satisfy a landlord’s requirements. The franchisor might alternatively grant a licence to occupy the premises to the franchisee.
Some distributorships have elements of a franchise. For example, a motor vehicles distribution agreement may be undertaken under the franchisor’s name. There tends to be more freedom with distributorships than with a pure franchise arrangement.
The earliest franchises were found in the motor trade with dealerships between vehicle manufacturers and dealers. In England, (but not to the same extent in Ireland), the brewing industry developed tied house arrangements between brewers and publicans.
The more modern franchise agreements involve the franchisee operating his business under the franchisor’s trademarks, style and modus operandi so that it appears to the outside world that the franchisee is the. franchisor. The franchisor exerts substantial influence on the way the franchisee operates the business under this type of arrangement.
In some cases, the franchisor seeks greater control and uniformity in order to safeguard its brand. For example, Spar and Texaco have undertaken franchise arrangements of this nature, replacing earlier less prescriptive arrangements.
Contrast with Other Arrangements
Franchise agreements may be contrasted between other marketing arrangements. Distributorship agreements involve the appointment of an independent distributor to market goods. This will not usually be done under the supplier’s name or under the supplier’s trademark.
The distributor is an independent business. While it may have many obligations that are similar to those of a franchisor, the restrictions will not be as extensive. Royalty fees are not payable. The distributor’s profit is based on the margin between its purchase and sales.
Intellectual property or know-how may be licensed to allow another to manufacture or sell goods. The license agreement will generally contain restrictions similar to those in franchise agreements, but they will not be as extensive in relation to the manner in which the business operates.
Franchise agreements are not generally used in this context. Their main emphasis is on the brand, principally at the retail level.
Franchising allows the establishment of distribution channels for new products and services. It might not be technically or economically possible for the franchisor to establish his own distribution chain and his own branches. There may be regulatory restrictions on a non-national establishing a business within the jurisdiction.
The franchisor may be able to exercise greater market power for the benefit of all franchisees. The use of a franchisee might help expand the network, more quickly, than might otherwise be the case. There is an alignment of incentives between the franchisee and the franchisor, in that both have a stake in the success of the business.
The principal disadvantage of a franchise is the loss of control. Ultimately, despite the restrictions and conditions, franchisees are independent third parties who seek to maximise their profits. This may occur at the expense of the franchisor’s reputation.
The franchisor will incur costs in supporting and maintaining the franchisee. He will have to disclose confidential know-how and information. Notwithstanding the legal protections in the agreement, there is a greater risk that the information may leak out or be abused. It may be difficult to pursue enforcement in foreign countries.
The franchise arrangement carries advantages for the franchisee. It may allow him to enter a business with relatively little experience. Franchisees may be new traders with little track record in the business. The specialist knowledge and business model is supplied by the franchisor. The franchisee may be able to take advantage of the established name and reputation. The lead time in business development is reduced.
Capital is more likely to be readily available in respect of an established brand, than for a new business venture. The franchisee may be able to take advantage of the franchisor’s purchasing power. He may take advantage of the advertising and the brand development and maintenance undertaken by the franchisor. Support and training are usually supplied throughout the franchise period.
The franchisee is subject to substantial constraints. He will be obliged to pay royalties or a markup on the goods and services. There may be restrictions on his ability to sell the business or pass it to others. If the franchisor goes insolvent or if his reputation is adversely affected, then the franchisee will also be affected.
Branding and Promotion
The franchisor will keep control of how the franchise brands and trademarks are marketed and used. There will often be an upfront fee payable to the franchisor to enter the franchise agreement. A franchisee’s business is an independent business entity, which will have all the usual obligations such as registration for tax, VAT, etc.
There will usually be a requirement to pay a percentage of sales and/or a management fee to the franchisor. The franchisee will typically have to buy stock / product from the franchisors. It may also be necessary to purchase training and contribute to the costs of any advertising campaigns. There may be competition law issues which need to be considered in this context.
Advertising and promotion is an important element in franchising. The franchisor’s brand, products and services are advertised by it. The franchise agreement requires the franchisee to pay an advertising levy to enable advertising to be undertaken.
The right to use intellectual property rights will typically be included as part of the franchising package. The franchisor will typically have built up substantial know-how and brands. Copyright may exist for advertising slogans. Trademarks and unregistered designs are usually significant. Franchisors require franchisees to enter into a Licence Agreement in relation to the use of the licensed trademarks.
Intellectual property rights are central to franchises. The franchisor will have built up know-how and business techniques, supported by trademarks copyright material (particularly in marketing) and possibly patents.
The franchisor will grant a licence and consent to use these intellectual property rights in the course of the franchise operation. The agreement will contain, or there will be separate licence agreements regulating, the terms under which the intellectual property of the franchisor may be used.
Competition Law Issues
Competition law is significant in the context of franchising. Both European and Irish competition law, restrict anti-competitive actions and behaviours. Certain elements franchising agreements may come into conflict with competition law. See the separate section in relation to the competition law aspects of franchise and vertical agreements.
Franchise agreements will not generally give rise to competition law concerns unless one party enjoys considerable market power and the agreement is part of a larger network of similar agreements. Competition between brands may not be restricted if the effect is to create stronger, vibrant competition between brands.
Competition laws are broadly favourable to franchising. Although some clauses in franchise agreements may breach the Competition Act, a number of exceptions are potentially available.
Competition concerns may arise in relation to franchise agreements, if there is insufficient inter-brand competition. The European Union Vertical Agreement Block Exemption will commonly apply. It may be possible to justify the arrangement on the basis that it benefits outweigh its anti-competitive effects.
An abuse of a dominant position may include discriminatory pricing, predatory pricing or refusal to supply without justification. In practice, few franchisors have a dominant position.
Franchising is not directly regulated in Ireland. The Irish Franchise Association is a self-regulatory body within the Irish franchise sector, with a standards-based approach to its membership. It accredits its members when it is satisfied that the minimum best practice standards have been achieved. Their members subscribe to the European Code of Ethics on franchising.
Under the Code, franchisors are required to
- have a pilot operation before launching a franchise,
- own all brands and trademarks,
- provide continual training
- deal fairly with the franchisee.
References and Sources
The Encyclopedia of Forms and Precedents Vol 16(4)