There are numerous tools a business may use to grow and expand, not just locally but also globally. Franchising is one of the many ways through which brand owners can rapidly grow their businesses and expand profits while delegating much of the cost and risk to a third party.
Franchising is commonly used in a wide variety of service oriented businesses, such as restaurants, hotels, health care, real estate and others, and is also used production and distribution of products. In Mongolia for example, over the last few years many global brands entered Mongolia via a franchise arraignment. Major brands to do so include Coca-Cola, Pepsi, Ramada Hotels, Shangri-La Hotels, Cosmopolitan, Re/max real estate, KFC, Burger King, Coffee Bean and Tea Leaf, Pizza Hut, Emart to name only a few. This strategy is chosen very deliberately due to the low risk of bankruptcy, and a higher chance of success for business to enter a franchising agreement. Research shows that an average consumer in the world spends one of every three dollars on product or service provided via a franchise model, demonstrating the economic significance of franchising.
In a franchise arrangement, the franchising party or Franchisor gives the Franchisee permission to not only use the Franchisor’s intellectual properties (trademarks, brand name, know how, goodwill, copyright, etc.) but also the Franchisor’s business operations system. In addition, Franchisees often benefit from the Franchisor’s distribution systems and marketing campaigns to sell the Franchisee’s products or services. In return, the Franchisee pays the Franchisor consistent fees and royalties, providing a steady stream of income for the Franchisor.
The franchise model provides several benefits for both the Franchisor and the Franchisee. Along with other benefits franchise agreements allow Franchisor companies to expand much more quickly than they could otherwise. A lack of funds and workers can cause a company to grow slowly. Through Franchising, a company invests very little capital or labor because the Franchisee supplies both. The Franchisor company experiences rapid growth with little financial risk.
The Franchisee also has numerous advantages that come from entering a franchising agreement. There is a low risk for the Franchisee due to the tried and tested formula. Franchisee gets the benefit of owning a proven business formula that has been tested and shown to work well in other locations. In addition, the Franchisee gets training and head office support from the Franchisor; this may be essential if the Franchisee is new to running a business and has no experience or business knowledge. And in a broader sense, global franchising is beneficial for the local government and economy as well, because jobs are created, and ownership remains local.
There are three major types of franchises – business format, product, and manufacturing – and each operates in a different way.
In business format franchises (which are the most common type), a company expands by supplying independent business owners with an established business, including use of its name and trademark. The Franchisor company generally assists the independent owners considerably in launching and running their businesses. In return, the business owners pay fees and royalties. In most cases, the Franchisee also buys supplies from the Franchisor. Fast food restaurants are good examples of this type of franchise. Prominent examples include KFC, Burger King, and Pizza Hut.
With product franchises, manufactures control how retail stores distribute their products. Through this kind of agreement, manufacturers allow retailers to distribute their products and to use the manufacturer’s name and trademarks. To obtain these rights, store owners must pay fees or buy a minimum amount of product for sale. In Mongolia there are several clothing retail stores that utilize this type of franchise, for example, United colors of Benetton stores, and Mango stores.
Through manufacturing franchises, a Franchisor grants a manufacturer the right to produce and sell products using its name and trademark. This type of franchise is common among food and beverage companies. For example, soft drink bottlers often obtain Franchise rights from soft drink companies to produce, bottle, and distribute soft drinks. For example, MCS Coca-Cola LLC obtained Franchise rights to produce, bottle and distribute soft drinks of the Coca-Cola company in Mongolia.
There are four basic types of franchise agreements: single-unit, multi-unit, area development and master franchising agreements.
A single-unit franchise agreement is the most common and is simply where a Franchisor grants a Franchisee rights to open and operate one single Franchise unit. In Mongolia, explicit examples are Caffé Bene, a coffeehouse chain, or Re/max, a real estate agency. All single units of these chains use the same trademark and same utilize the business operations system of the Franchisor. However, every single unit in Mongolia is owned by a different local company.
A multi-unit franchise agreement is where a Franchisor grants a Franchisee rights to open more than one franchise unit. For example, Tavan Bogd Foods LLC has multi-unit franchise rights to operate KFC restaurants in Mongolia, and Max Center LLC has multi-unit franchise rights to operate Burger King restaurants.
An area development agreement allows a Franchisee the right to open multiple units over an agreed amount of time within a specified geographic location and/or to own rights to their specific territory and earn money on each franchise sold in their territory through sharing of the franchise fee and ongoing royalties.
A master franchise agreement, also referred to as sub-franchising, gives a Franchisee the same rights as an area development agreement but also gives that Franchisee rights to establish franchises arrangements with other individuals or entities within the specified territory. A Master Franchisee assumes many of the tasks and obligations of the Franchisor such as training and support and receives a portion of the franchise fee and royalties. While technically there are significant differences there are times that master franchising and area development are used interchangeably.
The regulation of franchising varies country to country. While some countries have adopted separate franchising laws, many countries do not have a separate law that regulates franchising in its entirety. In most countries franchising is regulated in their commercial laws, commercial codes or civil codes, and in some countries it falls under regulation of several laws. In Mongolia franchise arrangements are regulated via Articles 333 – 338 of the Civil Code. The Civil Code provides the definition of a Franchise Agreement, and outlines the legal obligations and liabilities of the parties, terms of agreement, and non-competition terms. Intellectual property related aspects of a franchise agreement shall be regulated by relevant intellectual property laws.
It seems clear that franchising model in Mongolia is poised to continue to grow, as several global brands have announced their opening in Mongolia in the near future. Of course, prior to any franchise arrangement in Mongolia, a foreign business should seek out qualified advice from their Mongolian lawyer.