Franchising refers to a contractual business arrangement where a company (franchisor) grants another firm or an individual (franchisee) the rights to do business in a prescribed manner within a specific territory over an agreed period. In return, the franchisee pays royalty contributions or other forms of fees to the franchisor. The franchisee combines resources from the franchisor such as brand name and operating procedures with its own financial resources and management experience. In most cases, companies use franchising as a strategy for geographical market entry, where the franchisee`s market knowledge as well as its human and financial capital supplements the business concept and the brand name of the franchisor. Consequently, the distribution of franchisor`s products and services through franchises is an integral component of the U.S. economy that continues to grow. The origins of franchising can be traced to the United States. Today, franchising has expanded globally. The need to have uniform products and services across different geographical regions of the U.S. necessitated franchising. Conceptually, the term franchising can be traced to the common law concept of “franchise,” which is a special granting of rights by the sovereign. The first part of the report examines the history of franchising; the second part provides a discussion on the types of franchises. Section three examines the distinctive characteristics that set franchises apart from agency agreements, distribution agreements, and licensing agreements. The last section addresses the economics of franchising by looking at the specific benefits that accrue to the U.S. economy both directly and indirectly from the franchised enterprises. The final section is the conclusion, which gives a summary of the findings from this research.
- Franchise History
2.1 Franchising as a State Institution
The origins of franchises can be traced to the public sector. Initially, the government used franchising as a tool for ensuring particular public services was delivered. For instance, in countries such as the United Kingdom, ferry owners were charged with the responsibility of providing and managing public transport. In exchange, they collected tolls. Other than being used as a tool for providing public services, was also a method that the government used to create monopoly corporations. Such companies were granted preferential treatment in the market, and hence they had an upper hand compared their rivals. Unlike in the United Kingdom, in the United States, franchises were originally a creation of the legislature at the state level. Given that the power to create a franchise was bestowed on the state, states used them to set up monopoly companies. Firms that were believed to offer useful public services in critical areas of the economy were granted monopolistic privileges. That notwithstanding, it was rare for a state to grant franchise to a firm purely on economic objectives.
Consequently, many of the firms that were granted franchise status before the 19th century benefited from a state privilege. Over time, however, especially in the 19th century, the special privileges that were at the disposal of the state were done away with, and their place was taken over by general incorporation laws. Even then, the state still had powers to grant monopoly privileges to a particular company to do business in lucrative sectors of the economy or areas that were regarded as strategic. The legal landscape of franchising was also developing. For instance, the courts of law started looking at property not an asset of a company, but as shareholders` resources invested in the firm. Therefore, there is a contract between the firm and third parties, which can be enforced in courts of law. This reasoning, provided the basis for delinking franchises from the state, and people started looking at them as private business property. 
2.2 The Rise and Growth of Private Franchising
As firms grew in terms of both size and their financial muscle, they started exerting greater control over their operations, especially their marketing function. This led to the birth of the franchisor-franchisee arrangement, which replaced the principal-agent relationship that existed before. As franchising developed, agents could get much of what they sold from a single supplier. As part of the arrangement, the manufacturer could dictate the amount of resources the agent had to allocate to equipment and the type of services offered to customers. This new arrangement attracted significant interest from agents because unlike before, the new arrangement granted them exclusive right to stocks and sell the products of a particular manufacturer in a given location. This benefited them in terms of reducing competition because once agent had been given the right to sell a particular product, no other agent could sell the same product in the same location. As these agents developed, they turned themselves into franchisees because they were connected to the manufacturers’ product and the brand name. a significant number of early franchises in the United States were agents who were granted exclusive area distributorships.”An example of early franchise in the U.S. market is the McCormick reaper manufactured by McCormick Harvesting Machine Company. Initially, the company used licensing agreements to manufacture and sell its McCormick reaper with the hope that it will capture a national market and benefit from low costs owing to the shipping challenges at the time. Additionally, to reduce costs, the company sold its patents and created manufacturing partnerships with agents in different regions the U.S. so that the reaper could be manufactured in the regions thereby eliminating shipping costs from the main manufacturing center. The company exercised tighter control over production and marketing. Other examples of early franchises in the U.S. are Singer Sewing Machine Co., oil refiners, and soft drink bottlers. Franchising continued to grow, even among small businesses because of its benefits that included the ability to join and penetrate new markets that were dominated by big distributors without huge capital and personnel requirements. It also allowed them to operate nationally and benefit from experienced management. By the turn of the 20th century, retailers, and wholesalers such as Rexall drugstore, Western Auto and Ben Franklin Stores had joined the franchising bandwagon.
2.3 Franchising in the Post-World-War Era
Starting from 1945, franchising emerged as the best method for doing business in some industries, particularly the auto and petroleum industries. This business model was also used by automobile distributors and drug store chains. A number of enterprises were successful using the franchise business model. They include Dairy Queen that managed to use franchising to expand its business from just a single outlet to more than 2500 outlets within a period of four years. The remarkable growth of enterprises such as Dairy Queen attracted other businesses to try out the franchising business model to expand their reach. Some of the entrepreneurs that joined this bandwagon include Ray Kroc bought the rights to franchise McDonald’s restaurants. Other companies followed suit including Instaburger King and Harland Sanders (the manufacturer of recipes used in making Kentucky Fried Chicken. The attractiveness of franchising as a business model increased significantly in the 1950s and early 1960s, and franchisors were trying out different forms of franchising and subjecting their franchisees to different types of controls. Various contractual agreements were signed between franchisors and franchisees. A notable example during this era is Dairy Queen, which managed to open its stores in many geographical areas only to realize that it had lost control over its franchisees. Others such as Chicken Delight and Dunkin’ Donuts exerted significant restrictions on their franchisees thereby limiting their ability to procure supplies from different sources.
From a legal point of view, in the beginning of post-world War II era, franchise regulation was completely missing and many businesses and individuals had not understood franchising as a method of conducting business. For instance, in 1949 the U.S. Supreme Court branded the relationship between a petroleum company and its franchisees as “a sale on condition,” making it appear similar to any ordinary seller-buyer relationship. The majority decision completely overlooked the unique characteristic of the franchise relationship and the role played by vertical controls. However, in his dissenting opinion, Justice Jackson highlighted these unique characteristics. The case of Carvel Ice Cream Corporation vs. Noonan MD became the first case in which the U.S. courts recognized franchising as incorporating legal considerations that are quite different from a sale on condition or an agency relationship. The court came to the conclusion that a company`s trademark was the basis of franchise system and terminated an antitrust action that sought to charge illegal typing of product to the trademark.An additional significant development in after the war was the enactment of the Uniform Commercial Code in all the U.S. States except Louisiana. This brought standardized rules and uniform tools for securing debt. In turn, transactions across state borders became more accessible and it opened expansion opportunities for regional and national chains. Additionally, throughout the 1950s and 1960s, there was a significant growth in consumerism in the U.S. With increased demand for full disclosures by consumers, supporters of franchisees argued that franchisors had to disclose fully the nature of the franchises that they offered to potential franchisees. This led to the passage of disclosure legislation, starting with California in 1970, followed by other 14 states in 1980s. This has developed into the current FTC Rule.
- Types of Franchises
3.1 Business Format Franchise
Business format franchising can be defined as “the process of licensing the rights and obligation to copy a unique retail positioning that profitably serves a need for a viable customer segment.” The license may include products and/or services and may or may not be specific to a particular region. Typically, a business format franchise also entails access to sources of supply, specified equipment and comprehensive operating instructions. Generally, the business format comprises of several elements that exhibit four different components: service/product deliverable, system identifiers, benefit communicators, and format facilitators. Service/product deliverables (concept) are the distinct characteristics of the format franchise. For instance, for a restaurant franchise, its service/product deliverable also incorporates a differentiating characteristic such as the quality of food served or a unique menu. Benefit communicators imply that there are some intangible benefits to the customers such as elegance and quality. These attributes are important for consumer decision-making and image development, but it is difficult to measure them directly and objectively. System identifiers refer to auditory and visual elements that connect a particular retail outlet with a chain or system. Examples include logo or trademark. Finally, format facilitators refer to the procedures and policies that form the basis for the effective functioning of the format at the individual franchise or outlet level. It also refers to the integration of the franchise into the operations of the system as a whole. It incorporates store-level elements such as tore layout and design, equipment specification, in addition to system level requirements such as procedures for royalty payment and financial reporting requirements. Figure 3.1 below highlights the components of a business format franchise.
Not all the components of the business format franchise are equal in terms of their importance. The business name and trademark are important components. Therefore, they are core components that must be standardized across all the franchises because they are considered crucial for the system`s survival. The identification of core components under a business format franchise is important because it helps the franchisor to maintain standards throughout its network.
In the United States, business format franchising is the most popular form of franchising and has been in the nation since its introduction in the1950s. Examples of companies using this type of franchising include McDonalds, Burger King, Pizza Hut, and Domino’s Pizza. These companies have developed strict guidelines and standards that govern marketing and product development by their franchises. The franchises only sell a single product manufactured by only the franchisor. Using business format franchising companies such as McDonalds and Domino’s Pizza have managed to expand their business operations both domestically and internationally. Their franchisees are guaranteed of success because of the popularity of these brand names and the support and expertise provided by the franchisor. Because of high levels of standardization, companies like McDonalds are able to ensure quality and reliable customer service in all markets where they operate.
3.2 Product Franchise
Product franchising can be defined as the selling of a franchisor`s products. It is essentially a supplier-dealer relationship. Under this type of franchising, the franchisor grants its logo and trademark to its franchisees. However, unlike in a business format franchising, in a product franchise, the franchisor does not provide the franchisee with an entire system for running the business. In terms of sales volumes, product franchising is larger in the United States than business format franchising. However, many of the franchises that exist currently are business format franchises. Product-franchising focuses more on the products supplied or manufactured as opposed to the system of doing business. In many, but not all, cases, the manufactured products require a pre-sale and post-sale service, which is common in the car industry. In this form of franchising, may have the right of handling the franchisor’s product exclusively or on a semi-exclusive basis. This differentiates product franchising from a supplier-dealer relationship because in the latter, the dealer may handle numerous products including those of competitors. Unlike a dealer relationship, the franchisee in a product franchise is closely associated with the franchisor`s brand name and gets more services/support from the franchisor than a dealer would get from its supplier. To the franchisor, product franchising gives them the ability to influence how the retail stores distribute its products. With this arrangement, retailers are able to distribute the manufacturer`s products using the manufacturer`s brand name and product. In exchange for these rights, storeowners either purchase a minimum volume of products from the manufacturer or pay fees. Product franchising is common in industries such as automobiles, softy drinks, mobile homes, trucks, and gasoline and automobile accessories. For examples, firms such as Ford Motor Corporation, Coke, Goodyear Tires, and John Deere have for decades made use of distribution franchises in their operations.
3.3 Processing or Manufacturing Franchise
Under this type of franchising, the franchisee is granted the rights to manufacture the franchisor`s products under a license and sell the same product using the franchisor`s name and trademark. The franchisees equally benefit from national advertising of the product they have manufactured. The franchisee pays franchise fee to the company that owns the product. Sometimes, the franchisee has to pay a fee for each unit of product sold. Processing/manufacturing franchising is popular among food and beverage firms. Good examples are soft drink bottling companies that obtain franchising rights from soft drink manufacturers permitting them reproduce and distribute the products in different markets globally. Major soft drink manufacturers such as Coca-Cola and Pepsi equally sell supplies to their respective regional processing or manufacturing franchises. For example, Coca-Cola prepares its syrup concentrate before selling it to its bottling companies. The bottling companies in turn mix the ingredients with water and pack them in bottles before taking them to the market. Coke and Pepsi have franchised their manufacturing for more than twenty years. Additionally, modern corporations are increasingly using the manufacturing franchise method to grow their manufacturing capacities and reach out to customers in different markets.
- Distinctive Features of Franchise
Various architectural characteristics distinguish franchising from distribution, agency agreements, and licensing agreements.It is important to identify that the only characteristics that they have in common is the fact that all involve third parties, whereby there is an agent and a principal. For example, under franchising, the franchisor is the principal and the franchisee is the agent. The franchisee conducts business with third parties (customers) on behalf of the franchisor. Similarly, under agency agreements, there is a principal and an agent. The agent enters into contractual relationships with third parties on behalf of the principal. Beyond, this similarity, there are significant differences between the four. Franchising includes several components: a brand, business format (a unique retail positioning, for example, McDonalds menu are identical in all the states), economic interest, independence, and control and assistance by the franchisor. Even though independence, the use of a brand, some amount of control and even economic interest may be found in distribution, agency agreements, and licensing agreements, but the three lack a business format.
4.1 Franchising and Agency Agreements
Both agency agreements and franchising arrangements have a weaker party and a stronger party. The unequal position of the parties` position exists prior to, during, and even after the collaboration. This common imbalance in economic bargaining power can mislead people to think that agency agreements and franchising are the same thing. By definition, an agency is a self-appointed intermediary who has continuous authority to negotiate the purchase or sell of products on behalf of another party (the principal) or to negotiate and conclude the purchase or sale of products in the name and on behalf of the principal. The most important aspects of this definition are independence, and the power to negotiate purchase or sale on behalf of, for, or in the principal’s name.
On the other hand, franchisees are independent and definitely they have the right to negotiate purchases and sales under the franchisor`s brand. However, they do not do so either for or on behalf of the principal. Inevitably, franchisees have an obligation under the terms of the franchise agreement to provide notice to the public that they are independently operated owned and operated businesses working under a license issued by the franchisor. Additionally, franchisees ordinarily sell products and services on their personal behalf under the franchisor`s brand, and not on behalf, or for the franchisor. Generally, the products that franchisees sell are owned by them. That said, it is possible that a franchisee can sell products or services supplied by the franchisor. Nonetheless, there are significant differences between franchise agreements and agency agreements. The running of a franchise is done in line with the business format. An agency agreement is not. Moreover, while a principal will offer some low level assistance and exercise a low level of control over his/her agent, a franchisor provides high level assistance to the franchisee and exerts significant level of control of the use of the business format and the brand. An agency agreement is a legal document through which the title of services or goods is transferred to the purchaser by the agent. On the other hand, franchising is primarily concerned with the way in which the products/services are sold (the business format).
4.2 Franchising and Distribution Agreements
Franchising is also distinct from distribution agreements. A distribution agreement can be defined as an arrangement where party A enters into an agreement with party B to supply particular products for resale within the entire or a specific area of the common market. It encompasses a broad range of commercial practices ranging from selective distribution to straight distribution. Straight distribution refers to the wholesale of products by the manufacturer to an independent third party, and the third party has to right to sell the products in whatever manner he deems fit. However, the selective distribution arrangement imposes qualitative restrictions on the environment in which the products are sold. The differences between franchising and straight distribution is substantial. Under straight distribution, there is no control, no assistance, no brand, and no business format. However, selective distribution has some similarities with franchising because it involves the use of a brand and there is control to some extent. Nonetheless, no assistance comes from the principal, and most significantly, business format is completely missing. Business format refers to the franchisor`s know-how on how to operate the business.
4.3 Franchising and Licensing Agreements
Franchising is different from licensing agreements and each of them has a unique business model. For a franchise, a specific business model is duplicated and the franchisor and the franchisee sign a franchise document, which directs how the franchise will be controlled and governed. Similarly, in franchising several important documents include the operations manual, the franchise agreement, and disclosure document. These documents stipulate the standard procedures that the franchise and its products must adhere to. Furthermore, support from the franchisor to the franchisees is standard ranging from marketing to training. Everything is conducted in a standardized fashion.
On the other hand, licensing agreements are primarily based on providing or selling a particular product or service. For example, an outlet can be licensed by Apple Inc. to sell its iPhones. Unlike a franchise that only sells products from the franchisor, licensees often stock and sell products not necessarily supplied by the licensor. Sometimes they even sell competitor products. Similarly; support provided to a licensee is confined to a particular product or service as opposed to the overall business. For instance, any training offered by the licensee will be limited to the product or service that the license agreement covers. A good example is Starbucks coffee. The company has entered into licensing agreements with different partners including airlines, hotels, hospitals, and businesses to sell its coffee.
- Economics of Franchising
Franchising plays a significant role in the U.S. economy and it affects thirteen lines of business including but not limited to automotive, quick service restaurants, full service restaurants, lodging, retail estate, beverage bottling, gasoline gas stations, commercial and residential services. As a whole in 2016, there are 801,000 franchise establishments in the U.S. This includes establishments owned by both franchisees and franchisors. These establishments account for 2.3% of the total non-farm business establishments in the U.S. In terms of their economic contribution, franchised firms directly employ 9 million Americans with a payroll of $351 billion. In terms of output, they generate $868 billion worth of output, and more than $541 billion in GDP contribution in 2016. Franchised businesses directly account for 5.6% of the total private nonfarm employment, 2.8% of the total private non-farm output, and 3.4% of total private non-farm GDP in 2016. This indicates that franchised businesses are a major source of employment in the U.S. economy. In fact, the number of jobs provided by franchised businesses in 2016 exceeds the number of jobs provided by manufacturers of durable products.
The economic benefits of franchised businesses transcends beyond the activities of these businesses because the franchises are themselves customers of various products and services from suppliers outside the franchise business. Additionally, the employees in the sector spend their incomes on various products and services in the economy. Consequently, the sector has a substantial spillover effect. In 2016, 16.1 million non-farm jobs are associated with franchising both directly and indirectly. This accounts for 10.1% of all non-farm jobs in the United States. It equally generates $2.1 trillion of private non-farm output, which represents 6.8% of total private non-farm output in the U.S. Evidently, business format franchising is the most popular in the U.S. market accounting for nearly 11 times as many establishments and 5 times as many employment opportunities as product distribution franchising in 2016. The majority of the franchises in the U.S. (about 88%) use business format franchising.  Although franchised establishments operate in all the 50 U.S. states, in addition to the District of Columbia, Texas, California, and Florida take the lead in terms of franchised business jobs, contribution to GDP, and output.
The objective of this report was to examine franchising by looking into the various legal aspects. Specifically, the paper examined franchise history with a specific focus on the United States. The history reveals that franchises have evolved from their original form as instruments used by government in exchange for the performance of a public service to modem day franchising by private enterprises. The first franchises in the American market were companies such as McCormick Harvesting Machine Company and Singer Sewing Machine Co. Nonetheless, franchising gained significant popularity in the post-World War II period. It is during this period that franchising developed significantly leading to the birth of business format and product franchising. The franchising legal framework was also developed during this period including the Uniform Commercial Codeand disclosure legislations. The paper also examined the main types of franchises that include business format franchise (examples include McDonalds and Burger King), product franchise (examples include Ford Motor Company, Coca-Cola, John Deere distributors), and manufacturing/process franchising (examples include Pepsi and Coke). Of the three types, business format franchising was found to be the most prevalent type of franchising. In terms of the distinctive features of a franchise, the findings indicate that franchising is a distinct, specific, and uniform form of commercial activity that is significantly different from distribution agreements, agency agreements, and licensing agreements. Unlike the other three types of agreements, franchising is unique. Franchising is the only agreement that includes the essential elements of economic interest, independence, a brand, a business format, and full control and assistance. Although agency agreements, distribution agreements, and licensing agreements may have some of these elements, none of them has all these elements. Most importantly, none of them has the business format element. Finally, the paper examined the economics of franchising. The findings indicate that franchising contributes significantly to economy both at the national and state levels. The U.S. has approximately 801,000 franchise establishments in 2016. These establishments are not only major source of employment to the U.S. economy, but also contribute significantly to the nation`s GDP and national output. Estimates indicate that in 2016 franchised enterprises employ 9 million Americans. In terms of GDP, it has contributed 541 billion of gross domestic product in 2016 and an additional $868 billion in national output. Indirectly, franchised enterprises contribute to the U.S. economy in terms of purchases worth millions of dollars that they make from non-franchise suppliers, their employees also make various purchases in the economy contributing towards increasing the demand in the economy and creating jobs in other sectors of the economy. As a whole, franchising has registered dramatic growth in terms of both legal development and operational wise.
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. S. Vieux. “Case History of the American Business Franchise.” Oklahoma City University Law Review Spring-Summer, 1999 Franchising Law Symposium Articles. 24 Okla. City U. L. Rev. 37(1999), p. 1
. Vieux.Case History of the American Business Franchise, p.4
. Ibid. p.4
. Vieux.Case History of the American Business Franchise, p.4
. Ibid., p. 5.
. Ibid., p. 6.
. Thomas S Dicke, Franchising In America (Chapel Hill: University of North Carolina Press, 1992), p. 12.
. Vieux.Case History Of the American Business Franchise, p.6
. Ibid., p. 9.
. W. Michael Garner, Franchise And Distribution Law And Practice, September Update 2016, p. 1
. Michael, Franchise And Distribution Law, p. 2
. Ibid., p. 2.
. Ibid., p. 2
. Michael, Franchise And Distribution Law. p. 2
. Michael, Franchise And Distribution Law, p. 2
. 16 C.F.R. § 436.9(e); Franchise Rule 16 C.F.R. Part 436 Compliance Guide,(2008):21
. The Michigan Law Review Association. “Tying Arrangement With Trademark As The Tying Item Is Not A Per Se Violation Of The Antitrust Laws: Susser V. Carvel Corp.”, Michigan Law Review 63, no. 3 (1965):6.
. Patrick and Sevgin.Standardization And Adaptation, p. 71
. Ibid., p.71
. Ibid., p.72
. Brian Duckett, “Business Format Franchising: A Strategic Option For Business Growth – At Home And Abroad”, Strategic Direction 24, no. 2 (2008): 3-4.
. Patrick J. Kaufmann and Sevgin Eroglu, “Standardization And Adaptation In Business Format Franchising”, Journal of Business Venturing 14, no. 1 (1999): 69-85.
. Vieux. Case History Of the American Business Franchise, p. 10
. Vieux. Case History Of the American Business Franchise, p. 10
. Anne-Mette Elkjær Andersen. Distributorships and Agency Agreements in the United States – Fifteen Quick Tips.
. Anne-Mette Elkjær Andersen. Distributorships and Agency Agreements in the United States – Fifteen Quick Tips
. William M Pride, Robert James Hughes and Jack R Kapoor, Business (Mason, Ohio: South-Western Cengage Learning, 2014), p.562.
.PwC. The Economic Impact of Franchised Businesses: Volume IV, 2016. IFA Education and Research Foundation, 2016, p. 13
. Ibid., p.9
. Ibid., p. 11