MODULE -8 Managing Growth FRANCHISING

Franchising is as an arrangement whereby the manufacturer or sole distributor of a trademarked product or service gives exclusive rights of local distribution to independent retailers in return for their payment of royalties and conformance to standardized operating procedures. The person offering the franchise is known as the franchisor. The franchisee is the person who purchases the franchise and is given the opportunity to enter a new business with a better chance to succeed than if he or she were to start a new business from scratch.

Advantages
What you may buy in the Franchise 1. A product or service with established market and favorable image. 2. A patented formula or design. 3. Trade names or trademarks. 4. A financial management system for controlling the financial revenues. 5. Managerial advice from exports in the field. 6. Economies of scale for advertising and purchasing. 7. Head office services. 8. A tested business concept.

Advantages of Franchising to the Franchisor

The advantages a franchisor gains through franchising are related to expansion risk capital requirements, and cost advantages that result from extensive buying power. It is clear from the Subway example that Fred DeLuca world not have been able to achieve the size and scope of his business without franchising it. In order to use franchising as an expansion method, the franchisor must have established value and credibility that someone else is willing to buy. 1

Disadvantages of Franchising
Franchising is not always the best option for an entrepreneur. Anyone investing in a franchise should investigate the opportunity thoroughly. Problems between the franchisor and the franchisee are common and have recently begun to receive more attention from the government and trade associations. The disadvantages to the franchisee usually center on the inability of the franchisor to provide services, advertising, and location. When promised made in the franchise agreement are not kept, the franchisee may be left without any support in important areas. For example, Curtis Bean bought a dozen franchises in Checkers of America Inc., a firm that provides auto inspection services. After losing $ 2, 00,000, Bean and other franchisees field a lawsuit claiming that the franchisor had misrepresented advertising costs and has made false claims including that not experience was necessary to own a franchise. The Franchisee may also face the problem of a franchisors failing or being out by another company. No one knows this better than Vincent Niagara, an owner of three Window Work Franchises. Niagara had invested about $ 1 million in these franchises when the franchise was sold in 1988 to Apogee Enterprise and then resold in 1992 to a group of investors. This caused many franchises to fail, leaving a total of 50. The failure of these franchises has made it difficult for Niagra to continue because customers are apprehensive about doing business with him for fear that he will to out of business. No support services that had been promised were available. The franchisor also incurs certain risks and disadvantages in choosing this expansion alternative. In some cases, the franchisor may find it very difficult to find quality franchisees. Poor management, in spite of all the training and controls, can still cause individual franchise failures and therefore, can reflect negatively on the entire franchise system. As the number of franchises increases, the ability to maintain tight controls becomes more difficult.

Types of Franchises
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There are three available types of franchises. The first type is the dealership, a form commonly found in the automobile industry. Here, manufacturers use franchises to distribute their product lines. These dealerships act as the retail stores for the manufacturer. In some instances, they are required to meet quotas established by the manufacturers, but as is the case for any franchise, they benefit from the advertising and management support provided by the franchisor. The most common type of franchise is the type that offers a name, image, and method of doing business, such a McDonalds, Subway.KFC, Midas, dunkin, donuts.and Holidy Inn. There are many of these types of franchises, and their listings, with pertinent information, can be found in various sources. A third type of franchise offers services, these include personnel agencies, income tax preparation companies, and real estate agencies. These franchises have established names and reputations and methods of doing business. In some instances, such as real estate, the franchisee has actually been operating a business and then applies to become a member of the franchise.

INVESTING IN A FRANCHISE
Franchising involves many risks to an entrepreneur. Although we read about the success of McDonalds or Burger King, for every one of these successes there are many failures. Franchising, like any other venture, is not for the passive person. It requires effort and long hours, as any business does, since duties such as hiring, scheduling, buying, accounting, and so on, are still the franchisees responsibility. Not every franchise is right for every entrepreneur. He or she must evaluate the franchise alternatives to decide which h one is most appropriate. A number of factors should be assessed before making the final decision.

1. Unproven versus proven franchise. There are some trade-offs in investing in a person or unproven franchise business. Whereas an unproven franchise will be a less expensive investment, the lower investment is offset by more risk. In an unproven franchise, the franchisor is likely to make mistakes as the business grows. These mistakes could inevitably lead to failure. Constant reorganization of a new franchise can result in confusion and mismanagement. Et, a new and unproven franchise can offer more excitement and challenge and can lead to significant opportunities for large profits should the business grow rapidly. A proven franchise offers lower risk but requires more financial investment. 2. Financial stability of franchise. The purchase of a franchise should entail an assessment of the financial stability of the franchisor. A potential franchise should develop answers to the following questions: How many franchises are in the organization? How successful is each of the members of the franchise organization? Are most of the profits of the franchise a function of fees from the sale of franchises or from royalties based on profits of franchisees? Does the franchisor have management expertise in production, finance, and marketing Some of the above information can be obtained from profit and loss statement of the franchise organization. Face to face contact with the franchisor can also indicate the success of the organization. It is also worthwhile to con tact some of the franchisees directly to determine their success and to identify any problems that have occurred. If financial information of the franchisors is unavailable, the entrepreneur may purchase a financial rating from a source such as Dun & Bradstreet. Generally, the following are good external sources of information: Franchise association. Other franchisees. Government. Accountants and lawyers. Libraries. Franchise directories and journals. Business exhibitions. 3. Potential market for the new franchise. It is important for the entrepreneur to evaluate the market that the franchise will attract. A

starting point t is evaluating the traffic flow and demographics of the residents from a map of the area. Traffic flow information may be observed by visiting the area. Direction of traffic flow, ease of entry to the business, and the amount of traffic (pedestrian and automobile) can be estimated by observation. The demographics of the area can be determi8nded from census data, which can be obtain ed from local libraries or the town hall. It can also be advantageous to locate competitors on the map to determine e their potential effect on the franchise business can be assessed in the market research. In some instances, the franchisor will conduct a market study as a selling point to the franchisee. 4. Profit potential for a new franchise . As in any start-up business, it is important to develop pro forma income and cash flow statements. The franchisor should provide projections in order to calculate the needed information. JOINT VENTURES What is a joint venture? A joint venture is a separate entity that involves a partnership between two or more active participants. Sometimes called strategic alliances, joint ventures involve a wide variety of partners that include universities, not for profit organizations, businesses, and the public sector, Joint ventures have occurred between such rivals as General Motors and Toyota as well as General Electric and Westinghouse. They have occurred between the United States and foreign concerns in order to penetrate an international market, and they have been a good conduit by which an entrepreneur can enter an international market. Whenever close relationships between two companies are being developed, concerns about the ethics and ethical behavior of the potential partner arise.

Types of Joint Ventures Although there are many different types of joint venture arrangements, the most common is still between two or more private-sector companies. For example, Boeing.Mitsubish/fuji/Kawasaki entered into a .joint venture for

the production of small aircraft in order to share technology and cut costs. To cut costs, arrangements were made between ford and Mesaurex in the area if factory automation and between General Motors and Toyota in the area of automobile production. Other private-sector joint ventures have had different objectives, such as entering new markets (Corning and CibaGiegy as well as Kodak and Ceuts), entering foreign markets (AT@T and Olivetti), and raising capital and expanding markets (U.S. steel and Phong Iron and Steel) Industry-university agreements created for the purpose of doing research are another type of joint venture that has been increasing usage. However, two major problems have kept these types of joint ventures form proliferating even faster. A profit corporation has the objective of obtaining tangible results, such as a patent, from its research investment; and wants all proprietary rights. Universities want to share in the possible financial returns from the patent, but the university researchers want to make the knowledge available through research papers. In spite of these problems, numerous industry-university teams have been established. In one joint venture agreement in robotics, for example, Westinghouse retains patent rights while Carnetic-Mellon receives a percentage of any license royalties. The university also has the right to publish the research results as long as it withholds from publication any critical information that might adversely affect the patent. International Joint ventures, discussed are rapidly increasing in number due to their relative advantages. Not only can both companies share in the earning and growth, but the joint venture can have a low cash requirement if the knowledge or patents are capitalized as a contribution to the venture. Also, the joint venture provides ready access to new international markets that otherwise may not be easily attained. Finally, since talent and financing come from all parties involved, an international joint venture causes less drain on a companys managerial and financial resources than a wholly owned subsidiary.

ACQUISITIONS

Another way the entrepreneur can expand the venture is by acquiring an existing business. Acquisitions provide an excellent means of expanding a business by entering new markets or new product areas. One entrepreneur acquired a chemical manufacturing company after becoming familiar with its problems and operations as a supplier of the entrepreneurs company. An acquisition is the purchase of an entire company, or part of a company by definition, the company is completely absorbed and no longer exits independently. An acquisition can take man y forms, depending on the goals and position of parties involved in the transaction, the amount of money involved, and the type of company. Although one of the key issues in buying a business is agreeing on a price, successful acquisition of a business actually involves much, much more. In fact, often the structure of the deal can be more important to the resultant success of the transaction than the actual price. One radio station was successful after being acquired by a company primarily because the previous owner loaned the money and took no principal payment (only interest) on the loan until the third year of operation. Advantages of Acquisition For an entrepreneur, there are many advantages to acquiring an existing business, as indicated below: 1. Established business. The most significant advantage is that the acquired firm has an established image and track record. If the firm has been profitable, the entrepreneur would need only to continue its current strategy to be successful with the existing customer base. 2. Location. New customers are already familiar with the location. 3. Established marketing structure. An acquired firm has its existing channel and sales structure. Known suppliers, wholesalers, and manufacturersreps are important assets to an entrepreneur. With this structure already in place, the entrepreneur on improving or expanding the acquired business. 4. Cost. The actual cost of acquiring a business can be lower than other methods of expansion. 5. Existing employees. The employees of an existing business can be an important asset to the acquisition process. They know how to run the business and can help ensure that the business will continue in its successful

mode. They already have established relationships with customers, suppliers, and channel members and can reassure these groups when a new owner takes over the business. 6. More opportunity to be creative. Since the entrepreneur does not have to be Concerned with finding suppliers, channel members, hiring new employees, or creating customer awareness, more time can be spent assessing opportunities to expand or strengthen the existing business and tap into potential synergies between the business.

Disadvantages of an Acquisition
Although we can see that there are many advantages to acquiring an existing business, there are also disadvantages. The importance of each of the advantages and disadvantages should be weighed carefully the other expansion options. 1. Marginal success record. Most ventures are for sales have an erratic, marginally Successful or even unprofitable track record. It is important to review the records and meet with important constituents to asses that record in terms of the businesss future potential. For example, if the store layout is poor, this factor can be rectified; but if the location is poor, the entrepreneur might do better using some other expansion method 2. Overconfidence in ability: sometimes an entrepreneur may assume that he or she can succeed others have failed. This is why a self-evaluation is so important before entering into any purchase agreement. Even though the entrepreneur brings new ideas and management qualities, the venture may never be successful for reasons that are not possible to correct. Often managers are overconfident in their ability to overcome

cultural differences between their current business and the one being acquired. 3. Key employee loss. Often when a business changes hands, key employees also leave. Key employee loss can be devastating to an entrepreneur who is acquiring a business since the value of the business is often a reflection of the efforts of the employees. This is particularly evident in a service business, where it is difficult to separate the actual service from the person who performs it. In the acquisition negotiations, it is helpful for the entrepreneur to speak to all employees individually to get some assurance negotiations; it is helpful for the entrepreneur to speak to all employees individually to get some assurance of their intentions as well as to inform them to how important they will be to the future the business. Incentives can sometimes be used to ensure that key employees will remain with the business. 4. Overvaluated. It is possible that the actual purchase price is inflated due to the established image, customer base, channel members, or suppliers. If the entrepreneur has to pay too much for a business, it is possible that the return on investment will be acceptable. It is important to look at the investment required in purchasing a business and at the potential profit and establish a reasonable payback to justify the investment. MERGERS A merger-or a transaction involving two, or possibly more, companies in which only one company survives- is another method of expanding a venture. Acquisitions are so similar to mergers that at times the two terms are used interchangeably. A key concern in any merger ( or acquisition ) is the legality of the purchase. The department of Justice frequently issues guidelines for horizontal, vertical and conglomerate mergers which further define the interpretation that will be made in enforcing the Sherman Act and Clayton Act. Since the guidelines are extensive and technical, the entrepreneur should secure adequate legal advice when any issues arise. Why should an entrepreneur merge? There are both defensive and offensive strategies for a merger, Merger motivations range from survival to protection to diversification to growth. When some technical

obsolescence, market or raw material loss, or deterioration of the capital structure has occurred in the entrepreneurs venture, a merger may be the only means for survival. The merger can also protect against market encroachment, product innovation, or an unwarranted takeover. A merger can provide a great deal of diversification as well as growth in market, technology, and financial and managerial strength. How does a merger take place? It requires sound planning by the entrepreneur. The merger objectives, particularly those dealing with earnings, must be spelled out with the resulting gains for the owners of both companies delineated. Also, the entrepreneur must carefully evaluate the other companys management to ensure than, if retained, it would be competent in developing the growth and future of the combined entity. The value and appropriateness of the existing resources should also be determined. In essence, this involves a careful analysis of both companies to ensure that the weaknesses of one do not compound those of the other. Finally, the entrepreneur should work toward establishing a climate of mutual trust to help minimize any possible management threat or turbulence.

FIGURE 15.1 Merger Motivations

DEFENSIVE (Passive)
Survival requiremen t Capital structure deterioratio n Technologi cal Obsolescen ce Loss of raw Protection against. Market infringement Lower cost position of a competitor Product innovations by others An unwanted takeover Diversification Countercyclical Conunterseasonal International operations Multiple Strategic Plans

OFFENSIVE (Active)
Gains in. Market position Technological Edge Financial strength Managerial talent

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