Company-owned expansion, that is, expansion of your outlets of distribution by company-owned units managed and operated by company employees, is a tried and true expansion method. It has several significant advantages, including retaining within the company the entire profit from each unit, control over all aspects of the business, including pricing, product mix, territories, etc., flexibility over operations, the ability to terminate managers and other employees who are not working out, etc. However, it is the rare company indeed that has sufficient capital resources and management depth to expand as quickly, and as broadly, as it desires to expand. Consequently, compromises have to be made and opportunities are postponed or lost as a result.

                As is true with most of life, nothing is perfect. This is true for the decision to expand solely through company-owned units. Company-owned expansion requires the capital resources of the company to be invested in such things as land and buildings, machinery and equipment, furniture and furnishings, inventory and personnel. If the company lacks sufficient internal working capital for these purposes, then the company's borrowing ability (plus interest) must be utilized or equity in the company must be given up to raise capital. There may be restrictions placed by third parties on the company's ability to expand, such as negative covenants in loan agreements limiting capital expenditures, limiting lease obligations, prohibiting the issuance of additional stock, etc.

                In addition, it is generally true that an employee/manager is not as dedicated as an owner/operator (e.g., franchisee). We refer to this as the "Cinderella Syndrome." By that we mean the feeling you get when you walk into a retail establishment shortly before closing time and the manager and employees make you feel uncomfortable for being in the store as if they are going to turn into mice at the stroke of nine. Owner/operators will see you as a "$" realizing that you are the last sale of the day and, inasmuch as all of the fixed costs have (hopefully) already been met, much of your sale goes directly to their bottom line. In addition, owner/operators generally are better at customer service, and are more involved in the community and local marketing activities, such as involvement in the local Chamber of Commerce, sponsoring a Little League team, etc. In addition, statistically there is a much greater turnover of company managers than of owner/operators.

                There are also a number of significant legal issues to consider in company-owned expansion. You are the owner or lessee of the premises of each unit and are liable for property damage and injury to employees, guests and invitees. Furthermore, your company manager and the other employees in the unit are all your employees. You are responsible for their actions rendered in the scope of their employment under various legal theories such as master/servant, respondeat superior and principal/agent. Furthermore, as your employees, you will be responsible not only for their base compensation but also their bonuses, vacation/sick days, health insurance, life insurance, profit-sharing plans and whatever else may be included in your employee benefit package. With today's insurance crisis, the costs of these benefits, particularly health insurance, are skyrocketing.

                In the typical franchise situation, the franchisee is an independent contractor and not your employee. In addition, the other employees in the unit are the franchisee's employees, not yours. You will not be responsible for salary payments to the franchisee and to his or her employees nor responsible for their fringe benefits. In addition, as a general rule, you will not be held responsible for the actions of the franchisee or of his or her employees for injuries occurring at the franchisee's premises. Also, a failure of any particular location will not have as direct an economic impact upon you if it is a franchised unit rather than a company-owned unit. You undoubtedly will lose a revenue source, but the capital invested at the location will be that of a franchisee rather than that of your own.

                The biggest trepidation for a company considering expansion by franchising is loss of control over the operation of the unit and over the unit operator. There are certain day-to-day matters over which you do lose control, which we will briefly discuss. However, through detailed and extensive control provisions in the franchise agreement and in the operations manual and other manuals (which manuals can be revised unilaterally by you to reflect changes in system-wide operations), a great deal of control can be exerted over a franchisee. Below is a "control" spectrum. As you can see, franchising is much closer to the company-owned situation than to other expansion formats.

                Some of the items over which you do not have as much control in franchising include the fact that you cannot control the prices to be charged by franchisees for products or services. The antitrust laws only allow you to recommend prices. That is why you see at the end of many commercials or in catalogues in which prices are advertised a disclaimer such as "at participating dealers only" or "prices may vary." A franchisee is an independent businessperson and needs to be treated more as a partner than as an employee. However, you usually have the final say and may operate much like a benevolent dictator. The terms of the franchise agreement and certain state franchise laws will restrict your ability to terminate franchisees. However, even in the employee situation, termination is sometimes not that easy with employment contracts, golden parachutes, and threats of claims of EEOC violations, wrongful termination, etc.

                You can, and must, exercise a great deal of control over the franchise operation and a franchisee when it comes to uniformity and quality control over products and services. This comes as part of "policing" your trademark. In a well-managed franchise system, but for a plaque in the premises, a customer has no idea whether the unit is company-owned or franchised. Franchising, if properly implemented, should make the customer's experience no different than if all the units were company-owned. Sometimes, the owner/operator (franchisee) makes it a superior experience.

                As you can see, there are numerous advantages and disadvantages to both company-owned expansion and franchising. Fortunately, company-owned expansion and franchising are not mutually exclusive. You can do both. Many franchising companies try to maintain a mix of company-owned units and franchised units such as 50/50 or 20/80. There's no reason why the mix can't be 90/10 where a company has historically expanded through company-owned units.

                For the company that has expanded historically through company-owned units, a change to a dual distribution system may result in a number of advantages. Some of the advantages of combining franchising with continued company-owned expansion include:

                1.     Faster market penetration;

                2.     Reduced capital needs to finance expansion;

                3.     Increased advertising revenues, thereby being able to command a greater share of voice in a
                        market (e.g., Area of Dominant Influence (ADI)];

                4.     Increased economies of scale through larger group involvement such as purchasing, dealings
                        with vendors and suppliers, group insurance, etc.;

                5.     More efficient use of existing field personnel and existing resources to service not only the
                        company-owned locations but also the franchised locations;

                6.     Increased revenues from not only company-owned units but also initial franchise fees and
                        royalties paid by franchisees; and

                7.     Accelerating the achievement of profitability of company-owned units in new markets by
                        priming the market initially through franchised outlets.

                We will now discuss in greater detail these advantages:

                1.     Faster Market Penetration. If, as part of your long-term business plan, you desire to expand beyond your local market, or you want to expand as quickly as possible, or there are limited windows of opportunity which exist for your product or service which have to be exploited as quickly as possible such as changing technology, or you adopt a "first strike" expansion strategy, or for whatever reason you need or want to grow, combining franchising with your company-owned expansion plans can more quickly achieve these objectives. This is because you will be using the capital of others (that of your franchisees) in addition to your existing capital and borrowing ability to finance your expansion efforts. You can have far more units under site selection, construction, and opening at the same time using your staff and the franchisees working together.

                2.     Reduced Capital Needs. It takes far less capital to expand through franchising than it does by expansion solely with company-owned units. For the cost of perhaps one or two additional company-owned units, those funds can be invested in developing a franchise program and becoming a franchising company by creating a franchising division or subsidiary. These costs will be expended in franchise consultants (to develop business and marketing plans with franchising as a component and to refine training, operation and marketing manuals to change the focus from manager to franchisee); in attorneys' fees and costs (to prepare the necessary franchise documentation to implement your franchise system and to comply with Federal and state franchise laws); and in marketing expenditures for prospective franchisees, including possibly adding a director of franchise sales. However, when it comes to servicing franchisees, an existing multi-unit company operation has in place field management personnel who can also service these functions. If, for example, a company-owned location generates a pre-tax profit equal to 15% of gross revenues and a franchise location generates on-going royalties of 5% of the franchise's gross revenues, and if you can sell several franchises for every company-owned location, your return may be as great as merely opening a company-owned location. The faster you can franchise properly, the greater the return will exceed your historical company-owned expansion level. If your borrowing ability is limited (such as negative covenants in loan agreements) you can expand by using the capital of others (your franchisees) without paying interest. Also, you're not giving up equity in your company as in a stock offering.

                3.     Increased Advertising Revenues. In addition to receiving royalties, you will also be receiving advertising contributions from your franchisees (usually a percentage of their gross revenues) for you to utilize for regional and national advertising, productions of advertising and marketing materials, public relation activities, reimbursement to you for administrative overhead and expense in administering the advertising fund and, possibly, for advertising for prospective franchisees. While television advertising is effective, it is very expensive. Where you have been unable to advertise as much as you desire funded solely from your limited company-owned units, the additional funds from franchise locations may allow you to sustain the advertising level you need to remain competitive. This is particularly true where you cluster your company-owned units and franchise units in a given ADI to reach a critical mass of units as quickly as possible to command a larger share of voice in the market. Coupled with this is an additional obligation on franchisees to spend other funds on local marketing activities.

                4.     Increased Economies of Scale. As the number of units increase, your purchasing needs increase proportionately. The larger the purchaser you become, the greater your bargaining position with suppliers and vendors. You should be able to command the best price and have vendors and suppliers pass through any cost savings from these purchases such as truck load purchases. In addition, you should be able to command greater promotional allowances and your unit costs for transportation, warehousing, etc. should be reduced. In addition, there are companies who offer group insurance benefits to you and your franchisees. The larger the group, the lower the per individual and per unit cost will be. These types of economies of scale can be better achieved by employing dual distribution, which provides a vehicle for greater and faster expansion.

                6.     Increased Revenues. By greater expansion you not only continue to receive the profits from company-owned locations, but you will also receive on-going royalties from franchisees. While such royalties do not all go to your bottom line because of the services you continue to render to franchisees, a portion of the royalties should represent profit to you. Although in the initial stages your income may be reduced because you have diverted certain capital for continued company-owned expansion to invest in your franchising efforts, at some point in the not-too-distant future, your dual distribution revenue line should exceed the revenue line for company-owned expansion by virtue of the royalties received from a number of franchised units.

                7.     Accelerate New Company-Owned Location's Profitability. As you are undoubtedly aware, when you open your first unit in a new market, achievement of profitability usually takes longer than opening an additional unit in one of your existing markets for a number of reasons such as: your name is not as well known; you may have a greater distance to service and support the unit; you may have lost certain purchasing economies of scale, etc. If you penetrate a new market through franchise locations initially and, after the market has been primed, open a company-owned location, that new location should go up the profitability curve at an accelerated rate. That is not to say that you should steer franchisees to poor locations, but certain average potential locations in a market should be reserved for future company-owned expansion.

                While franchising is not for everyone, it is a time tested and viable expansion format. At the present time over 40% of retail sales ($640 billion) are made through franchised outlets. According to The Naisbitt Group, in its study for the International Franchise Association, this is expected to increase to 50% of retail sales ($1 trillion) by the year 2000. Those entrepreneurs who have a knee-jerk reaction against franchising in staunch support of solely company-owned expansion should at least explore the possibility of creating a dual distribution system. There may be synergies in combining franchising with continued company-owned expansion resulting in greater market penetration and profitability.

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