I have seen the future – and it’s franchised!

On returning to the US in 1919 following a visit to the Soviet Union, Lincoln Steffens, an American journalist, boldly declared, “I have seen the future, and it works”. The massive political and economic changes in Eastern Europe seven decades later clearly prove that Steffen’s vision of the future ultimately did not prevail. The opening of a McDonald’s restaurant – perhaps the most ubiquitous and distinctive symbol of both western capitalism and global business – in Moscow in 1990 would no doubt have been particularly galling to Steffens had he lived to see it.

History does not record whether anyone after a visit to Southern California in the early 1950s noted the burgeoning franchising phenomenon and declared that “I have seen the future and its franchised – and it works”. This would have been a safer bet. Five decades later franchising is universally recognised as the “dominant force in the distribution of goods and services” and “the wave of the future”. From its modest beginnings franchising has expanded its influence in all regions of the world and most industry sectors. It has revolutionised the distribution of goods and services, and transformed the business landscapes of most countries. The sector worldwide comprises an estimated 16,000 franchise systems – its relentless growth driven by its inherent advantages as a method of business operation for both franchisor and franchisee.

Australia is of course characterised by an energetic, dynamic and viable small business sector that exists independently of the franchising sector. Much of the diversity and interest in an increasingly homogenised marketplace comes from the vitality and entrepreneurship of this small business sector. However, for the small business wanting to become a bigger business operating through a geographically dispersed network, or for the entrepreneurial employee who wishes to start his or her own business, franchising may provide the greatest opportunity for success.

The reasons for the relentless growth of franchising are not difficult to identify. Essentially, franchising is an intelligent way of doing business for both the franchisor and the franchisee. Its significance to the small business sector is readily apparent. For a successful small business with a proven concept and system, adopting a franchising strategy may provide the only viable opportunity for sustained expansion. For an aspiring business entrepreneur, acquiring a franchise may offer the only realistic opportunity to enter an industry.

The impressive record of franchising in promoting the viability of small business is of course not an accident. It is readily explained by the significant advantages franchising offers to both franchisor and franchisee. For the franchisor, franchising is a strategy for rapid and wide geographic expansion without having to provide additional capital to establish, or to directly manage, the outlets. For the franchisee, franchising delivers a proven concept and system, brand recognition, training, continuing support, economies of scale and lower risk. In the words of the US House of Representatives Committee on Small Business: “Franchising provides the means for merging the seemingly conflicting interests of existing businesses with those of aspiring entrepreneurs in a single process that promotes business expansion, entrepreneurial opportunity and shared cost and risk.” This equation has driven the substantial growth and development of franchising in Australia and overseas for the benefit of not only franchisors and franchisees, and their staff and consumers, but also the small business sector and the economy as a whole.

The most significant reason for the failure of independent small business is the transition from high-achieving technical expert/employee to small business proprietor. Red tape, the pervasive regulatory environment and lack of management skills conspire to complicate, and frequently threaten, the viability of the business. In a recent Federal Court decision, the judge commented on the purchasers of a successful small business, which quickly failed under their management in these terms:

… [the applicants] had little understanding of management aspects of the trade …. They were naïve to an astonishing extent … on aspects of actually managing the … business. Were it not for the breathtaking extent of their incapacity and naivety exhibited once they were in control of the business, I would have found it difficult to accept that they could be so ignorant of what must have been well-understood … practices in the trade.

These observations are a strong advertisement for franchising.

Franchising is of course not the only strategy that provides for management training and support. An item in a recent Sydney Morning Herald’s Friday Racing Form Guide (the research required to write this column is staggering!) noted the establishment of a trainers’ cooperative to supply trainers with accounting services and purchasing power to enable them to concentrate on what they are good at – i.e. train horses. Franchising delivers such support, but so do a number of other vehicles. The keys drivers of business today – brands, systems training, networks, management infrastructure, support, technology – are not exclusive to franchising and are indeed the key elements for any successful business. However, few business structures package these business drivers as well as franchising, which has become the preferred business formula for ensuring that all the ingredients of successful business are in place. Many franchise systems in Australia have indeed evolved from independent small business proprietors forming a buying group to achieve economies of scale, which develops into a marketing group to achieve branding and image and standards, which develops into a cooperative to achieve management infrastructure and support, which develops into a franchise system to better package the business drivers and deliver the entrepreneurial edge.

The focus of the discussion above has been franchising as a small business strategy. However, a significant but less widely appreciated trend is the increasing adoption by big business of a franchising strategy for entering an industry or expanding an existing business. Whereas the small business sector embraces franchising for sheer commercial necessity – because it offers perhaps the only form of business organisation available for business entry or expansion – big business embraces franchising because it is an intelligent way to organise a business. The unique advantages of franchising, which leverage the power of brands, the premium of proprietorship, the primacy of systems, and the utility of networks are increasingly attractive to big business.

Now, to return to Lincoln Steffens. It is perhaps ironic that the re-engineered transitional economies of Eastern Europe – in the predecessors of which Steffens saw the future – today provide exciting opportunities for franchising. Although franchising was born in the west, in the cradle of capitalism and entrepreneurship, it is now an important strategy to resuscitate enterprise and entrepreneurship in the former communist countries and assist the transition to market-driven economies. Steffens would presumably derive little comfort from those countries that have retained or, in the case of China, adopted the political system he so admired. Deng Xiaoping’s – the architect of China’s open door policy – concept of “socialism with Chinese characteristics” has transformed the Chinese economic system if not its political system. Franchising is, as documented in the last issue of Franchising magazine, already firmly established in China, where it has massive potential. In the developing economies in Asia, which are expected to generate 75 percent of world trade over the next two decades, franchising is an important strategy in the transition to a modern service economy.

As long as proven concepts, brands, systems, networks, training, infrastructure support, technology and management expertise drive successful businesses, franchising will be an inevitable part of the future. Franchising is a practical strategy rather than formula, and its success to date has been its continuing evolution to respond to practical challenges. However, the franchising sector of the future will not necessarily look the same as it does today. In the words of FCA chairman Stephen Giles: “It is likely that franchising as a business method will need to be dismantled and reconstructed. It will be franchising techniques, not franchising, that will be relevant. Old formats may no longer be relevant, or may not deliver the same competitive advantage.”

Franchising is a strong – perhaps the foremost – force in creating an entrepreneurial economy and encouraging enterprise. Ultimately, the only way I can be proved wrong in my prediction that the future is franchised, is if Lincoln Steffens is proved right. And that seems very unlikely.

Andrew Terry is professor and head of the School of Business Law and Taxation at the University of New South Wales and special counsel at Deacons . He can be contacted at a.terry@unsw.edu.au.