Franchising ch. 2 "The Advantages of Franchising"

Selecting And Offering Incentives To Outlet Operators #1

Effective selection of operators: "Adverse selection" - the tendency of people with lesser abilities to put themselves forward as candidates for jobs more often than the overall population. Expensive and time-consuming for firms to find who actually has the needed skills and abilities.

Using Franchising Improves Environmental Scanning

Franchisees communicate directly with headquarters, not through layers of hierarchy. -Speed -Distortion Franchisees more likely to tell the truth than managers of company-owned outlets. -Politics

Obtaining Resources for Rapid Growth #1

Why seek growth? -Build brand name -Obtain supplies through bulk purchasing. -Recover fixed costs, such as new recipes. -Fill good locations before the competition does.

Obtaining Resources for Rapid Growth #3

"Passive investors" often view young firms as too risky: -"Information asymmetry" - passive investors have less information about the entrepreneur's abilities and ethics than does the entrepreneur. -"Moral hazard" - risk that the entrepreneur will act in ways that harm the passive investor without the investor realizing it. -Franchisees have much more information about a business and thus face less risk than do passive investors.

Overall Lessons Related to the Business Model

-Rely on franchising rather than company-owned outlets when you want to MINIMIZE RISK. -Rely on franchising rather than company-owned outlets when you want to GENERATE HIGH ROI. By cutting investment and operating costs, franchising generates a high ROI.

Three categories of advantages

1. Franchising provides a better mechanism for selecting and offering incentives to outlet operators than salaried employees. 2. Franchising offers an efficient mechanism for obtaining human and financial resources for rapid firm growth. 3. Franchising offers a lucrative business model, generating financial returns at relatively low risk.

Qualifying to be a Panera Bread Franchisee

Applicants must meet the criteria identified below to gain consideration for a Panera Bread franchise.• Experience as a multi-unit restaurant operator• Recognition as a top restaurant operator• Net worth of $7.5 million• Liquid assets of $3 million• Infrastructure and resources to meet our development schedule• Real estate experience in the market to be developed• Total commitment to the development of the Panera Bread brand• Cultural fit and a passion for fresh bread

What About Bonuses And Stock Options?

Beneficial, but not as good as franchising. Stock options encourage outlet managers to make very risky decisions. Bonuses encourage outlet managers to focus on the short-term only.

Selecting And Offering Incentives To Outlet Operators #2

Better incentives for operators: "Shirking" - where a person does not put forth maximal effort because his/her compensation will be the same regardless of how hard s/he works If a franchisee shirks, the franchisee's sales and profits fall. Franchisees have stronger incentives to innovate than a salaried employee - Big Mac, Egg McMuffin. Franchisees have an incentive to set a high pace for work among their employees. Franchisees have an incentive to keep materials and labor costs down.

Selecting And Offering Incentives To Outlet Operators #3

Better incentives for operators: In one study, average sales in franchised restaurants was 82% higher than in nonfranchised restaurants. In another study, shift managers in company-owned outlets made 9% more than shift managers in franchised outlets.

Obtaining Resources for Rapid Growth #2

Capital acquisition: -Franchisees pay a franchise fee and a royalty. -Franchisees pay start-up costs such as setting up a store and buying inventory. -Allows franchisor to avoid taking on a lot of debt.

Summary

Franchising offers three main categories of advantages. Relative to opening company-owned outlets: --Franchising provides a better mechanism for selecting and offering incentives to outlet operators --Franchising offers an efficient mechanism for obtaining human and financial resources for rapid firm growth --Franchising offers a lucrative business model, generating financial returns at relatively low risk Firms must weigh these advantages relative to franchising's disadvantages when making decisions about how to grow the business

Obtaining Resources for Rapid Growth #5

Human resource acquisition: -Establishing and operating outlets is time consuming. -Franchising allows a firm's management to specialize in identifying, selecting, and training franchisees. --Franchisees have the responsibility of hiring and supervising employees.

Obtaining Resources for Rapid Growth #4

Other considerations about capital -Many firms are hard to finance because they have limited tangible assets. -More efficient to sell franchises than to go public to raise funds, also keep control. -Lose control when using venture capital. ---91% of franchisors chose to franchise at least in part because it allowed them to maintain control of their firms.

How Do Firms Pick Franchisees?

Punnet Square example.

Overall Lessons Related to Incentives

Rely on franchising rather than company-owned outlets when it is difficult and expensive to select people to operate outlets; franchising provides an inexpensive and effective solution to selection problems. Rely on franchising rather than company-owned outlets when outlet managers have an incentive to shirk or when you want local market adaptation; franchising is very effective in these situations.

Overall Lessons Related to Resources

Rely on franchising rather than company-owned outlets when you want to grow your business quickly. Rely on franchising rather than company-owned outlets when you want to overcome financial and human resource constraints on the growth of your firm.

A Lucrative Business Model #2

Return on investment (ROI): -3 components: Revenues/Amount capital invested+costs of generating revenues -Revenues are lower, but capital and costs are much lower. -Net effect is higher ROI.

A Lucrative Business Model #1

Risk sharing: -Franchisee capital is at risk. -Franchisors often buy back successful outlets and leave lesser outlets as franchises. -Earn royalty on sales rather than profits. -Geographic expansion provides diversification. -Limit legal liability and insurance costs.