Franchising – Successful Form of Business Administration

Leila Kadagishvili Academic Doctor of Economics Assistant Professor, Iv. Javakhishvili Tbilisi State university

World economic practice proves that contemporary market economy is based on two main phenomena: large organizational economic structures and small business.

Prof. N. Chitanava says: “They seem to be based on contradictional and inconsistent principles, their goals, activities, size are formed on the base of different approaches, but this just seems to be so. If, on the one side, large structure is a “backbone” of contemporary market economy, on the other side small business promotes creation of competitive environment, guarantees flexibility and deepens the process of individualization. That’s why these two structures supplement each other”.1
This idea is based on the long world economy practice of integration relations between large and small businesses. These relations were formed in XVIII century in Great Britain and it was called “”Tied House system”. The essence of this system was that at that time British government restricted sales of alcoholic drinks and gave right to trade with alcohol only to the stalls which had licenses. “”Tied House System” was a kind of protection mechanism, which gave possibility to beer producers to make projections about production and sales of brewery and alcohol drinks. “”Tied House system” proved that it is an effective economic mechanism.2 Later this system developed and extended and it was called franchising. Franchising is connected with entrepreneurial activities and is considered to be a strategy for creating material wealth. “The term “franchising” comes from French “franc” – meaning privilege, advantage”.3 The system of franchising suggests a number of additional privileges and advantages, guarantees introduction of approved system of business-models and has long-run period of working.
Forming of franchising system was caused by economic necessity. A new method of business expansion began to occur in XIX century in the USA. This method included some elements of contemporary franchising. Zinger, a company producing sewing machines, was a pioneer. The company decided to increase sales in different countries by using distributors.4 Franchising “created” by Zinger became bases for developing this system in many different fields. In 1898 General Motors began to use independent organizations as distributors, in order to cut its sales costs. The company sold the right to trade with its products for a certain period of time and at certain territories to independent organizations. General Motors demanded from the distributors to make their capital investments in business and to maintain high standards of service. On its side, the company gave them guarantee that on “their territories” they would have no competitors trading with the goods of General Motors. It’s notable, that some car producer companies still use franchising for selling their cars. Franchising system is successfully used in the industry of non-alcoholic bottled beverages. Worldly known companies, such as Coca-Cola and Pepsi effectively use franchising for expanding the business. This system helped these companies to turn into international business grandees. Franchising system is widely spread in oil recycling companies, which sell oil products mainly via their franchisees.
As it is clear from the above-mentioned examples, since 30s of the XX century franchising has become less risky and more beneficial commercial system that was profitable for both franchisor (large company) and franchisee (small operating company). Franchisor takes responsibility to provide the operator company with its goods and technology, to make advertisements and to be guarantee when taking loans. On its side the operator is responsible for producing and selling only the franchisor’s product and run the business according to the franchisor’s directions. Thus, getting franchising doesn’t require setting up a new enterprise. Franchisee gets a functioning company; on the other hand, franchisor develops and expands business quickly, as this gives him the possibility to settle in new geographical regions.
Franchising belongs to payable business deals. Getting franchising agreement without paying for it is practically impossible, as one of the main characteristics of franchising agreement is that franchisee pays a certain amount of money to the franchisor. “To obtain the right of franchisor’s name and trade mark, the operator company always pays the franchisor definite one-time fee. The franchisors also set royalty rate paid by franchisees to the franchisor of the franchisees’ gross sales. As usual, the royalty rate varies between 2-3% of gross sales, but there are some cases, for example McDonald’s, when franchisees have to pay the franchisor 12% of their sales. The franchise agreement might also include other types of royalty fees (e.g. for using franchisor’s trade mark), which usually vary between 1-5%”.5 Judicial relations of franchising is described in Civil Code of Georgia, namely in the Law of Agreement.
There are different types of franchises: trademark franchising, production franchising, product distribution franchising. This form of cooperation between small and large companies is considered to be one of the ways that promotes development of small business. According to the data provided by USA Small Business Administration, over 60% of non franchise businesses went bankrupt during the last ten years, while only 14% of businesses functioning in franchise system did so. Large corporations act as “umbrellas” for small companies and this has a special importance for small businesses to survive in highly competitive environment.
If the enterprises, that can’t meet constantly changing demands of the market, go bankrupt because of high competition, why do we put “umbrellas” over small enterprises? What characteristics do they have that are so important for economy to develop? Why are they considered to be the structures that promote economic development? The answer to these questions is rather simple: small enterprises have a number of advantages. These advantages are: flexibility, mobility, activity, ability to react quickly on the change in demand, team work, being oriented on the final outcomes, etc. Just because small enterprises are flexible and mobile (differently from large corporations) they can easily meet demands (move to markets where demand occurs), but they find it difficult to do so because of lack of resources. So, existence of small enterprises is very important, but they should operate not independently, but cooperate with large corporations which have both resources and image. Large corporations pave the way in market operations for small enterprises and by solving financial and organizational problems create good basis for them to adapt easily to the demands of the market. The advantage of small business development is also caused by their ability to create new jobs for people having different qualifications and in this way to solve the problem of middle-class formation. In 2008, 65.275 people were employed in small enterprises and 22.067 people acted as sole proprietors. To sum up, 87.343 people, 25.1% of all the employed (87.343 people) worked in small business sector in 2008. In this way, small business sector partly manages to reach social stabilization that is very important for the country having 16.5% of unemployment rate (with strict criteria).6
Some scientists think that “it would be better to divide over large organizations into separate, independent enterprise units instead of “building” larger and more complex concerns… Large enterprises, especially highly diversified ones have to think about it seriously. If they split into independent companies, they will be able to penetrate new markets”7. To our point of view this idea seems to be too brave. It would be advisable if small enterprises keep in touch with larger ones. This business model is widely spread in the whole world and it turned out to be quite viable. This is so, because large corporations don’t often find it profitable to open their own special services for selling. Besides, small subcontractors often produce separate parts that large corporations need for their production. Large corporations rely on them because they have narrow specialization and are focused on their competences. That’s why 90% of car parts that Japanese car producer companies use to make a car are produced by subcontractors, small enterprises.
Franchising has developed in Georgia as well. It appeared as direct foreign investments in Georgia at the end of the XX century. “The first and the most prominent example of industrial franchising in Georgia was opening a franchise of worldly famous franchise company Coca Cola. This company brought investments into the country, employed hundreds of people and is considered to be one of the large taxpayer. Besides Coca Cola, in Georgia there are franchisees of such transnational corporations as McDonald’s, Baskin Robbins, Toyota and supermarket chains: Babylon, Bata and others.”8 As it has already been mentioned franchises in Georgia are mainly granted by famous and successful foreign companies which have rich practice in making franchise agreements and great economic potential which enables them to maximally take their own interests into consideration and share risks with the future franchisees. It would be good if franchising developed between large and small corporations functioning in Georgia. The elements of this system appeared in companies Kazbegi and Nikora. Kazbegi opened over one hundred pubs and restaurants, where only Kazbegi Beer is served. A factory, owning Kazbegi’s license is functioning in Rustavi and it employees hundreds of people. Georgian entrepreneurs lack the experience of working in this field. Currently only 40% of the pubs and restaurants are functioning, the rest have gone bankrupt. What was the cause of such high rate of bankruptcy, if, as we have already noted organizations using franchising system have a lower risk of going bankrupt? Obviously, “Kazbegi did not take care of protecting partners’ interests by using territorial licensing method that resulted in high rate of bankruptcy. Franchising system is considered to be a new theory in Georgia and consequently at the first stages such results shouldn’t be strange for Georgian entrepreneurs.”9
Development of franchising system in Georgia will promote to identify competitive fields in the country and involvement of the country in global economy. Development of franchising will be followed by the development of production, bringing innovations, creating new jobs and improvement of social conditions of the society. In Georgia, there are some organizations which own buildings and storages and have relevant experience, but they don’t have new technologies or famous trademarks. Franchising system will greatly help such corporations to penetrate domestic as well as foreign competitive markets.
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