An Introduction to Franchising and its Importance for Entrepreneurs and Small and

Medium-Sized Industries

by

Tan Tee Jim, S.C.Senior Partner,Head, IP & IT,

Lee & Lee

Kuala Lumpur, July 2008

Growth of Franchising

Singer Sewing Machine – first franchise (mid-19th century)

Automobile (e.g. Ford), petroleum products (e.g. Shell), soft drinks (e.g. Coca Cola)

Food and restaurants (e.g. McDonald’s, Starbucks)

Growth of Franchising

Home markets saturated – attractive opportunities overseas

Lack of/relaxation of regulations in most countries

Expansion of international trade Exposure to international media

Brief Outline

What is franchising? Types of franchising Why franchise? Why is franchising

important to SMEs? Considerations for franchisor/franchisee Pitfalls/Be careful Singapore Experience

What is franchising?

“A franchise operation is a contractual relationship between the franchisor and franchisee in which the franchisor offers or is obliged to maintain a continuing interest in the business of the franchisee in such areas as know-how and training; wherein the franchisee operates under a common trade name, format and/or procedure owned or controlled by the franchisor, and in which the franchisee has or will make a substantial capital investment in his business from his own resources.”

- Definition by International Franchise Association

What is franchising?

Legal and commercial arrangement concerning the successful business of a franchisor

Use of franchisor’s trade name, format, system and/or procedure under licence

Means to raise capital and expand quickly Assistance to franchisee

Marketing, management, advertising, store design, standards specifications

Payment by franchisee by way of royalty, licensee fee or other means

What is franchising?

Franchising is more than distributorship

Extends to an entire operation or method of business

Greater assistance, control and longer duration Distributor merely re-sells products to retailers

or customers

TYPES OF FRANCHISE

3 main types of franchise:

Product distribution franchise; Business format franchise; and Management franchise.

A product distribution franchise model is very much like a supplier-dealer relationship.

Typically, the franchisee merely sells the franchisor’s products. However, this type of franchise will also include some form of integration of the business activities.

PRODUCT DISTRIBUTION FRANCHISES

PRODUCT DISTRIBUTION FRANCHISES

Examples of famous product distribution franchise:

Produces the syrup concentrate

Sells the syrup concentrate

FRANCHISEE Produces the final drink

Retail Stores

Restaurants & F&B Outlets

Vending Machine

Operators

PRODUCT DISTRIBUTION FRANCHISES

BUSINESS FORMAT FRANCHISING

In a business format franchise, the integration of the business is more complete.

The franchisee not only distributes the franchisor’s products and services under the franchisor’s trade mark, but also implements the franchisor’s format and procedure of conducting the business.

Famous Examples

BUSINESS FORMAT FRANCHISING -

outlet in Sale, Australia

outlet in Marseille, France

MANAGEMENT FRANCHISE

A form of service agreement.

The franchisee provides the management expertise, format and/or procedure for conducting the business.

Famous Examples

Why is franchising important to SMEs?

Leveraging on a recognised brand name Enhancing business image Ensuring consistent quality Attaining higher productivity/better

motivated staff Access to good locations Economies of scale Reducing risks of failure

WHY FRANCHISE?

Franchises offer important pre-opening support: site selection design and construction financing (in some cases) training grand-opening program

WHY FRANCHISE?

Franchises offer ongoing support training national and regional advertising operating procedures and operational

assistance supervision and management support increased spending power, access to bulk

purchasing and economies of scale

Common considerations of franchisors

Developing franchise concept Market research Familiarity with local laws and

regulations Providing training and support to

franchisees

Common considerations of franchisors

Criteria for choosing franchisees Control over franchisees Supply of products/materials to

franchisees Intellectual property rights issues, e.g.

trade mark registration

Common considerations of franchisees

Demand Profitability of franchise, and length of

time required to recoup investment Track record of franchisor Support rendered to other franchisees

Common considerations of franchisees

Experience and profitability of other franchisees

Existence of competition Capital required Demands of franchisor, e.g. income

projections, deadline to open more franchise outlets

Franchisor–Franchisee relationship

Regulated by contract which usually covers: Initial fee Royalty fee/Management fee Capital required from franchisee Territory/Area of operation Duration of license and renewal IPRs Termination

BE CAREFUL

The franchisee is not completely independent.

In addition to the initial franchise fee, franchisee must pay ongoing royalties and advertising fees.

Franchisee must be able to balance restrictions and support provided by the franchisor with their own ability to manage the business

A damaged image or franchise system can result if other franchisees perform poorly or the franchisor has financial problems.

The duration of a franchise is usually limited and the franchisee may have little or no say concerning termination

BE CAREFUL

Not reading, understanding and/or asking questions about the franchisee agreement and other legal documents

Not understanding the responsibilities of a franchisee and the rights and obligations of a franchisor

Not seeking sound legal and financial advice Not verifying oral representations of franchisor

Common Mistakes of Prospective Franchisees

Not analyzing the local market in advance Not analyzing the competition Not making thorough due diligence of the

franchisor Not choosing the right location

Common Mistakes of Prospective Franchisees

Generally young and well educated 62% below 40 years old 57% had post-secondary education 32% own their own outlets 46% occupy the outlets as tenants

FRANCHISEES IN SINGAPORE

FRANCHISING IN SINGAPORE

Reason for Franchising

2/3 of franchisees felt that economies of scale in bulk purchasing encouraged them to consider franchising

FRANCHISING IN SINGAPORE

Feasibility of Franchising

Franchising is a more feasible option of business expansion than starting own outlets

FRANCHISING IN SINGAPORE

Success of the Franchise

FRANCHISING IN SINGAPORE

Success of Franchising

Franchisors’ Improvement in Average Monthly Sales since Franchising

FRANCHISING IN SINGAPORE

Success of Franchising

Franchisors’ Improvement in Average Monthly Net Profit since Franchising

FRANCHISING IN SINGAPORE

Success of Franchising

Franchisors’ Improvement in Average Monthly Sales since Franchising

FRANCHISING IN SINGAPORE

Franchising helps existing businesses do better.

Franchisees’Response to the Statement:“Joining a Franchise has Helped Me to Do Better than Before.”

FRANCHISING IN SINGAPORE

Business Performance

Percentage Increase in Average Monthly Sales for Franchisees who were Previously Running a Business in the Same Trade

FRANCHISING IN SINGAPORE

Business Performance

Percentage Increase in Average Monthly Net Profit for Franchisees Previously Running a Business in the Same Trade

Franchising – a great model for SMEs

Proven formula for success Due diligence Central role of IPRs Avoidance of dispute

Conclusion

Thank You

Tan Tee Jim, S.C.tanteejim@leenlee.com.sg

Kuala Lumpur, July 2008