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United States Small Business Administration

RS Number 136

May 1993

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Purpose

Over the past two decades, the sale of goods and services through
franchises and the number of franchise establishments have grown
rapidly. This study documents the growth of franchising during
the1975-1990 period and the effect this growth has had on small
business, and makes some predictions for the year 2000.

"Business format franchising" is generally defined as
the conveyance to franchisees of an entire system for conducting
a business, while "product/trade name franchising,"
involves the right to distribute a manufacturer's products within
a specified territory or location. While the spread of business
format franchising to many parts of the service and retail trade
sectors has been observed, little hard data have been available
to understand whether small firms have benefited from this trend.
Further, no comprehensive evidence has been available to allow
a balanced review of both the costs and benefits to entrepreneurs
from the franchising relationship. Within the data limitations,
this contract presents a broad overview of the growth of small
firms in franchising, and examines regulations that affect both
the sale and transfer of franchises.

This study provides the most comprehensive data available on the
relationship between small firm franchisees and their franchisors.
Because franchise sales as a percentage of total retail sales
could reach 38 percent by the year 2000, it is vital to understand
whether small business owners are successful and satisfied using
the franchised form of business.

Scope and Methodology

This study used a combination of secondary data sources, a comprehensive
literature search, and personal interviews with franchisors, franchisees
and franchising experts to assess the benefits and costs to small
firms of operating a franchise business. Specifically, franchisors
and franchisees were interviewed in the following industries;
business services, food retailing, non-food retailing and convenience
stores.

Detailed case studies were developed using interview guides, and
in general, nine franchisees were interviewed in each franchised
sector. Questions covered sources of startup capital, background
of the owners (including previous business ownership experience)
the individual's process of evaluating a franchise opportunity,
and level of satisfactions between the franchisor and the franchisee.
These data were combined with income data from other sources to
provide a full, balanced portrait of small firm franchisees.

Highlights

About two-thirds of franchised firms are small businesses, generally
consisting of sole proprietors who own a single unit.

Franchising sales increased from 28 percent of total retail sales
in 1975 to 34 percent in 1990. The forecast is for franchised
sales to account for 38 percent of total retail sales in 2000.

Most of the growth in franchising has been in business format
franchising such as fast food establishments, quick printing shops,
janitorial services and the like. Product/trade name franchises,
such as gas stations, auto dealers and soft drink bottles, now
represent a quarter of franchised establishments.

Between 1975 and 1988, employment in franchising grew 162 percent,
compared with 34 percent in the non-farm economy. In addition,
the average number of employees per franchise increased by 80
percent during this period-from 8.1 to 14.6 employees per establishment.

Factors affecting the growth of franchising during the 1975-1990
period have included economic factors such as corporate downsizing
and contracting out; demographic factors such as increased labor
force participation of women and a more mobile society; and technological
factors-particularly changes in the technology of retailing.

Median costs to open a franchised small business range from $25,000
to $150,000. There are many opportunities to own a franchised
business for less than $50,000. Owning a franchised business involves
a series of ongoing royalty payments to franchisors. These payments
vary by industry, but are generally about 4 to 6 percent of sales.

About 10 percent of franchised units are owned solely by women.
An estimated 30 percent are owned solely or jointly by women.
About 5 percent of franchises are owned by minorities, which is
below the general minority business ownership level in the U.S.
business population.

Despite data limitations in this study, most franchisees seemed
generally satisfied with their levels of income and their relationship
with parent franchisors. However, some conflicts still remain
in the franchise relationship. Many franchise companies have franchisee
councils to resolve issues such as renewal rights, noncompete
clauses, transfer rights and other "sticky" aspects
of the franchising relationship.

Greater uniformity of franchisor disclosure rules across state
lines would reduce the costs of existing disclosure laws at both
federal and state levels.

It is recommended that the U.S. Department of Commerce and the
U.S. Small Business Administration jointly sponsor an annual survey
of franchising by firm size to more fully understand the effects
of franchising on small firms on a more current and comprehensive
basis.

Despite the success of many small business franchisees, the escalating
costs of some franchises make it increasingly difficult in some
industries for small business owners to become franchisees. Therefore,
increasingly innovative financing programs are needed to open
franchising to more female and minority business owners.

Ordering Information

The complete report is available from:

National Technical Information Service

U.S. Department of Commerce

5285 Port Royal Road

Springfield, VA 22161

(800) 553-6847

Ordering number: PB93-182574

Price Codes: A13 (Paper); A03 (Microfiche)
*Last Modified 6-11-01