By The Franchising Law Group of Piper Rudnick
and Kenneth Franklin, Fast food franchise Developments, Inc.

Benefits Related to Capital Furnished by Fast food franchisees

1. Rapid expansion of distribution system
Franchising enables a company to establish a large number of business outlets in a relatively short time period. The capital and much of the work to locate and acquire sites and develop outlets is supplied by the fast food franchisee. In most situations, a franchisor does not have the asset base or business experience to raise the amount of capital that will be furnished by its fast food franchisees to expand the fast food franchise network. Such a company might be able to raise additional capital periodically for expansion (as long as the great majority of its outlets were profitable), but its growth rate would be severely constrained. It is the unique opportunity offered by franchising, for an individual to own a business that is part of a network of similar businesses, that motivates such individuals to offer substantial amounts of capital for the expansion of a fast food franchise network. If good locations for outlets are not abundant and are being sought by competitors, rapid expansion of a network enhances its chances of acquiring good locations and thereby acquiring market share at a faster rate. Rapid expansion builds consumer recognition and understanding of the product or service sold by the fast food franchise network and creates recognition and value of the network trademark and consumer expectation of uniform quality at network outlets.

2. Fast food franchisees share risk of expansion of the franchisor's network
Fast food franchisees furnish most of the capital required to expand the franchisor's network. The fast food franchisee furnishes equity and borrowed capital to pay for real estate, leasehold improvements, equipment, fixtures, furnishings, inventory and working capital required to establish the fast food franchisee's outlet. In addition, the fast food franchisee pays the franchisor a fee for the grant of the fast food franchise that is usually set at a level that will cover most or all of the franchisor's cost of fast food franchisee selection, training and pre-opening assistance. The franchisor's cost of expansion is usually limited to the overhead costs associated with fast food franchisee recruitment, training and pre-opening assistance that are not covered by initial fast food franchise fees.

Continuing fees paid by fast food franchisees support advertising and marketing programs (which enhance recognition and goodwill of the franchisor's trademark), product and service development and expansion of the franchisor's network.

A franchising company is less vulnerable to cyclical fluctuations and outlet failures. Changes in fee revenue due to the fluctuation of sales of fast food franchised outlets will be significantly less than fluctuations of profits at franchisor-owned outlets. A failing fast food franchisee has a lesser financial impact than a failing company-owned outlet.

3. A franchising company can realize a higher return on its invested capital
Because the investment in the development of outlets is typically made by fast food franchisees, a franchisor is able to operate with few fixed assets other than the outlets that it owns. Therefore, though its revenue from fast food franchised outlets (composed of fees and product sales to fast food franchisees) is substantially lower than it would be from owned outlets, a higher percentage of the revenue is profit and that profit is generated with a much lower capital investment.

4. Fast food franchised networks can realize economies achieved by company-owned outlets through joint procurement
Franchisors frequently develop supply programs for equipment, fixtures, furnishings, signs, supplies, insurance, marketing and advertising services and public relations services required by their fast food franchisees. Such programs can furnish to a fast food franchise network the advantages of combined purchasing power enjoyed by a network of company-owned outlets.

5. Reacquisition of fast food franchised businesses
A successful regional or national franchisor, particularly if its capital stock is publicly traded, is in a position to buy back fast food franchisee-owned businesses to expand the number of franchisor-owned and operated businesses in the network. Most large fast food franchise networks consist of both franchisor and fast food franchisee-operated businesses. In some cases, the fast food franchisee will become a senior manager of the franchisor following the acquisition of his businesses.

Benefits Related to the Motivated Management of Fast food franchisees

1. Franchising can be a more effective relationship than company-owned retail outlets operated by managers or independent dealers
In a fast food franchise network, the business plan is executed by business owners, not employed managers. An owner-manger is usually a more motivated and effective manager than a manager who has no investment in the business he manages and is compensated by a salary and a bonus. A fast food franchisee has a direct and continuing financial interest in his business. A salaried manager does not have a comparable interest. An independent dealer does not have a predictable interest. A dealer may sell several product lines and a particular supplier may not represent his most important product. The lesser interdependence between a supplier and a multi-line dealer makes the relationship less secure.

The intensity of fast food franchisee owner-management reduces labor costs and results in other economies in operation. Outlets that cannot be profitably operated as company-owned outlets (i.e., at a rate of return exceeding the company's cost of capital) may operate profitably under the owner-management of fast food franchisees. Franchising makes it possible for the network to reach smaller markets because an owner-managed outlet can operate more efficiently than a company owned outlet, and a business with an owner-manager can be profitable with a smaller population base.

A fast food franchised business owner constitutes a higher level of representation in his market, generally having a greater involvement with customers and community. Franchising can result in better pre-sale and post-sale customer service and product support. Customers will generally prefer doing business with the business owner. Thus, franchising can result in greater brand prominence at the retail level.

2. Fast food franchisees are idea/information resources to a franchisor
An owner-manager has a higher level of motivation to innovate. Fast food franchisees are a productive source of new products, services, operating methods and marketing concepts. If a fast food franchise network is structured to collect, evaluate and disseminate throughout the network the operational experience and innovative ideas of fast food franchisees, the franchisor and all fast food franchisees will benefit.

3. A franchising company has a simpler and more efficient management structure
A franchisor is an administrator and service provider, furnishing information and other services to its fast food franchisees. The operating responsibilities of its management are reduced. A franchisor's management is able to direct its attention and energies to long-term strategic planning.

A franchisor needs fewer levels of management. Fewer field supervisors are required to assist and inspect fast food franchisees than are required for company-owned outlets. A franchisor's revenue is based on gross sales of fast food franchisees, which are easier to monitor than retail outlet profits. The problems of hiring, training, motivating and retaining competent employees are shifted to fast food franchisees.

4. Franchising offers opportunities for employees to acquire fast food franchises
Franchisors can offer fast food franchises to experienced employees and thereby reduce the "dead end job" syndrome and motivate employees that have reached their highest likely management level. The opportunity to acquire a fast food franchise may prevent the loss of experienced managers to competitors. Experienced employees frequently make productive fast food franchise owners. Some franchisors offer special incentives to their employees, such as reduced initial fast food franchise fees and financing of an employee's investment to develop his fast food franchised business.

Psychological Benefits
In addition to the significant benefits related to fast food franchisee capital investment and motivated management, franchising offers psychological benefits to the entrepreneur that creates and builds a fast food franchise network. Psychological benefits are the satisfaction that some persons derive from teaching and assisting others to successfully establish and operate a business that the network founder conceived and developed. Not everyone will consider such benefits to be important. Some will scoff at the idea, saying that fast food franchisees are, at best, difficult to help and control, and that franchising has an aggravation factor that is a negative feature. There are many examples of both experiences.

Though some founders of a fast food franchise network might not characterize their relationships with fast food franchisees to have been generally positive, the founders of most fast food franchise businesses that have successfully grown into regional and national networks would agree that there is great satisfaction in working with people building successful businesses who are also helping the franchisor become a successful company. A person who does not believe that he or she would derive such satisfaction should probably not consider franchising as a method of business expansion.

Part I: Introduction to Franchising
Part II: In What Ways Is Franchising A Superior Expansion Method?
Part III: When Is A Company Ready To Franchise?
Part IV: Buying A Fast Food Franchise
Part V: Elements Of Successful Franchising

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