How to identify a true business format franchise

Open the franchise section of any newspaper and you'll be presented with plenty of adverts for 'franchises'. How is one to distinguish the business opportunists chancing their arm from the serious franchise offerings? Stuart Anderson offers an overview of the types of opportunities sailing under the 'franchise' banner

The rather sticky image franchising garnered in the '70s through dubious individuals leaving their franchisees high and dry and schemes such as pyramid selling has all but disappeared thanks to the phenomenal success of the industry in the past 20 years. With the formation of the industry's trade association in the late '70s, franchising has weeded out corrupt business practices and gained recognition through all the major banks - including NatWest, Lloyds TSB, the Royal Bank of Scotland, HSBC and Bank of Scotland, all of which have created specialist franchise departments to advise clients who are seeking to invest in a franchise.

In fact, the annual turnover of franchised businesses in the UK has grown from £900 million in 1984 to £9.1 billion last year, and there are now over 700 business systems or 'franchisors' offering recognised franchise opportunities to the UK investor-entrepreneur.

In essence, a franchise is an agreement between the franchisor and the 'franchisee', whereby the franchisor grants the franchisee the rights to carry out specified commercial activities. You now often hear the word associated with movies and sports teams, where the original name or brand has been granted to a movie sequel or a relocated sports team. This term has been adopted in recognition of the fact that a franchise business offers the franchisee the use of the franchisor's brand, where the brand has an implied value in the marketplace.

While the term franchise is liberally attached to all kinds of business opportunities seeking investors, we can classify the types of franchises into four main categories:

Product Franchise

The manufacturer grants a store owner a distribution agreement and the right to trade under its brand in exchange for a fee or the purchase of a minimum inventory of stock. Many tyre stores and car dealerships use this approach.

Manufacturing Franchise

The franchisor provides the franchisee with the specifications to manufacture and sell its product in the franchisee's local market. An example of this is soft drink franchises, where the franchisee uses the soft drinks company's ingredients to produce, bottle and distribute its products.

Business Opportunity Franchise

Typically offering an exclusivity agreement for the franchisee, whereby the franchisor supplies the brand, products and customers or accounts in return for a fee. Vending machine routes and distributorships are typical business opportunity franchises.

Business Format Franchise

Sometimes referred to as the 'second generation' of the franchise concept, business format franchising acknowledges the franchise system as a distinct method of doing business from the outset, with the franchisor benefiting from rapid growth with limited risk and the franchisee buying into a proven business system. This form of franchise is characterised by franchises that have signed up to the charter of the British Franchise Association (BFA).

As well as providing a brand, product range and exclusive territory, the franchisor has developed and proven through pilot operations a business concept and format with tried and tested systems and procedures. The franchisee receives full initial training in the operation of the business and launch plus ongoing support from the franchisor and fellow franchisees in the operation of the business. The franchisor receives an initial investment from the franchisee to cover the value of the intellectual property being transferred and the costs involved, plus the payment of an ongoing management service fee (a percentage of the franchisee's turnover) to fund its continuing involvement.

The greatest attraction for franchisees is the limited risk. Starting up a new business carries a significant risk of losing the initial investment - for a new business start-up in the UK today the odds of survival for more than three years are less than seven out of 10, according to VAT registration and de-registration statistics released earlier this year by the Department of Trade and Industry. Meanwhile, according to the 2005 NatWest/BFA UK Franchise Survey just 1.4 per cent of franchises changed hands due to commercial failure last year, with an additional 0.3 per cent due to disputes.

The proven nature of the business ensures that franchisees are tapping into proven demand and profitability, and bypassing the often costly development stage of the business. The systems and procedures will be professionally constructed, supported by experienced management staff and the franchisee will benefit from realistic financial forecasts.

The UK Franchise Survey reports that only 14 per cent of franchisors require prior experience of the industry sector concerned. This is largely because the initial franchisee training is designed to cover everything the franchisee will need to know to operate the business. Comprehensive training opens up the availability of a franchise opportunity to a much wider population of potential franchisees, enabling the franchisor to select the best candidates in terms of commitment, drive and enthusiasm for the business rather than searching for relevant experience. Far more important to franchisors is a self-motivated individual (59 per cent), and sales and marketing experience (45 per cent), although a number of franchises are available in the UK targeting people who prefer not to take responsibility for winning sales and contracts for their business.

Franchising is a huge success story in the USA, where over half of all retail sales are generated through franchised outlets. The UK, as well as other European markets such as France and Spain, are following in this direction in recognising the tremendous head start the concept provides for small business owners in their initial start-up stages. For the aspiring business owner looking for the right concept in which to invest, franchising provides the answers - over 700 of them.