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Monday, October 20, 2003

Like an iceberg, franchising is massive but only partly visible. In the United States alone, there are 600,000 outlets, or "stores" operating 4,500 franchise marquees. They account for a third of all retail sales in North America, reports Stephen Spinelli Jr., co-author of Franchising (Prentice-Hall, 2004) and one of the founders of oil-change franchise chain Jiffy Lube.

There are very successful franchises -- think of McDonald's, in spite of its recent problems -- and there are also-rans such as Arthur Treacher's Fish and Chips that got burned by failing to find a secure niche in the market. What makes one franchise succeed while others chew up their franchisees' lives and fortunes is the essence of wise franchise investing.

From a marketing point of view, the definition of a franchise lies in its nature. Some franchises sell a product widely available anywhere. What makes McDonald's unusual and important as a financial asset is not the almost generic burger but the format of the arches, certain toys for kids and the red-roof design of many stores.

Franchise agreements for selling Land Rovers, which are far rarer than cheeseburgers, control who can sell the product. The design of the store, whether the dealer also sells other brands of cars, and how the product is priced at retail in the local market are relatively unimportant, Spinelli notes.

From the point of view of investment, franchises are a kind of middle ground in which the investor contributes money and sweat equity, compared to a pure capital investment in which the investor just adds money and passively waits to see how his or her stock fares. But there are no sure things. Boston Chicken was launched in a fabulous initial public offering, then flopped when customers realized that the product was bland, the wait for the stuff was long and the price was high.

Sandy Shindelman has seen franchises come and go. The president of Winnipeg's Shindico Inc., a property development company, builds stores for franchise operations, and markets malls and free-standing locations. In his view, although location is crucial, all franchises live or die on the relationships they have with their customers.

"Location is important," Shindelman says. "But all that any location can do is to give a customer two chances to visit the business. After that, it's all up to how the business has established its relationship with the customer."

Franchise industry associations exist on the premise that a franchise is worth having, that is, that the organization or business plan of a franchised operation is worth the many fees the franchiser charges for participation in its system. But as Canadian franchise lawyer Ted LeValiant points out, those who sell franchises want to sell as many as they can, while most franchisees would like to have some exclusivity in the territory for the product they sell.

Saturation of a market with McDonald's stores, a strategy that the company said was used to try to drive out Burger King in selected markets, is no help to the franchisee who would like to dominate a neighbourhood. Saturation marketing is a test bed for what amounts to carpet bombing by marquee multiplication. And franchise agreements that make it easy for a franchiser to buy out a successful franchisee operation have the effect of shifting the risk almost entirely to the franchisee.

In spite of the proliferation of franchise-outlet signage on major thoroughfares, Canada is not overfranchised, Shindelman says. "A small business has become more glamorous than it was two decades ago. Especially for people who are not in a position to design their own enterprise, a franchise remains a good way to go."

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