Franchising Model: A Brief Overview

Franchising Model: A Brief Overview

Franchising is one of the common business models that allows a company to expand its reach by granting the right to use its products, services and brand names to another party in exchange for a fee. It is a beneficial relationship for both the franchisor and the franchisee wherein the franchisor gets an efficient method to rapidly penetrate markets outside their usual jurisdiction without the typical costs associated with wide-scale expansion and, the franchisee gets the opportunity to own a business with a mitigated chance of failure because of the already established business and support system by the franchisor.

As per the Black Law’s Dictionary, ‘Franchise’ is license from the owner of a trademark or trade name (“Franchisor”) permitting another to sell a product or service under that name or mark (“Franchisee”). The International Franchise Association (IFA) defines franchising as a “continuing relationship in which the Franchisor provides licensed privilege to do business, plus assistance in organizing, training, merchandising and management in return for a consideration from the franchisee”. In India, there is no specific law for franchising in India, however the Finance Act, 1999 defined franchise as an agreement that grants the Franchisee the right to sell or manufacture, goods, provide services or undertake any process identified with the Franchisor, whether or not a trademark, service mark, trade mark.

A franchise agreement due to the nature of its business model is fundamentally a contractual relationship between the Franchisor and the Franchisee. A contract has to fulfil the essentials under Section 10 of the Indian Contract Act,1872 (Contract Act) to be considered “valid” or “enforceable” under the including valid offer and acceptance, lawful object and consideration etc.

Franchising Models operated in India

Franchising can be operated through different models such as: COCO, FOCO, FICO, COFO, and FOFO.

  • COCO (Company Owned Company Operated) – The Franchisor owns the franchise store unit and operates the business itself. Usually these franchise models are operated by the Franchisor in the initial stages of franchising wherein the company wants to enter into a new market or conduct a pilot testing before entering into brand building.
  • FOCO (Franchise Owned Company Operated) – The Franchisee bears the setup cost, while the Franchisor manages operations, providing the Franchisee with a minimum guarantee or a percentage of revenue as profit share. Since the company handles the daily business, it is preferred when customer handling/experience is essential. This model is typically used where the Franchisor wishes for brand and operations standardisation, market development and awareness. Also, this model helps the Franchisor to expand internationally and identify the best practises for operational procedures.
  • FICO (Franchise Invested Company Operated) – Franchisor raises funds from investors to open franchises, with investors only providing the investment while the company manages business operations and supply chain. Franchise investors are not involved in business operations.
  • COFO (Company Owned Franchise Operated) – This model involves the company making an investment in the franchise business, and the Franchisee operates it under the Franchisor’s guidance. However, this approach is uncommon in the industry since most companies prefer to directly manage their business operations rather than relying on Franchisees.
  • FOFO (Franchise Owned Franchise Operated) – The Franchisor grants its brand name to the Franchisee for a non-refundable franchise fee and a pre-agreed time period. The Franchisee owns the store, while operational costs and a percentage of revenue (royalty) are borne by the Franchisee, and prices and merchandise are determined by the Franchisor. This type of franchise model is usually preferred by brands whose brand name is already established and its objective is (i) Market expansion; (ii) Risk sharing; (iii) Requirement of local expertise, etc.

How is franchising governed in India?

Due to lack of any specific legislation governing franchises in India, there are no statutory pre-disclosure requirements for franchises. . It is governed by general laws relating to setting up of business, inter-alia, contract, competition, consumer protection and intellectual property related laws.

  • Restraint of Trade vs. Non-Compete Clause: The conflict between Section 27 of the Contract Act, which prohibits restraint of trade, and the use of non-compete clauses can create ambiguity in franchising agreements.
  • Doctrine of Privity: The doctrine of privity in contractual agreements can lead to issues for different parties involved in a franchising arrangement. The multi-layered agreements, including franchise, lease, and supplier agreements, can indirectly affect third parties, leaving them without legal recourse in case of breach.
  • Intellectual Property Protection: Intellectual property (IP) laws are crucial in franchising, as they safeguard the Franchisor’s trademarks and brand. However, challenges arise when Franchisees continue using Franchisor’s IP post-termination or there is ambiguity in IP provisions. This can impact exclusivity rights, geographical restrictions, and IP compliance.
  • Competition Law Implications: Franchise agreements can fall under vertical agreements regulated by the Competition Act, 2002. Vertical restraints like exclusive supply or distribution arrangements can lead to anti-competitive effects, reducing market competition and entry opportunities for new players and cause Adverse Appreciable Effect on Competition (AAEC) as per the Section 3(4) of the Competition Act, 2002.
  • Foreign Exchange Regulations: Foreign Franchisors operating in India face compliance challenges under the Foreign Exchange Management Act (FEMA). Issues arise concerning foreign investment, such as the treatment of lump-sum royalty payments and adherence to RBI’s regulations.
  • Labour Laws and Employee Relations: Navigating India’s complex labour laws, including hiring, termination, and compliance with employee rights, can add layers of legal and administrative complexities under franchising.
  • Dispute Resolution: Resolving disputes between Franchisors and Franchisees can at times be time-consuming and costly, particularly when legal proceedings are involved, further highlighting the need for clear contractual terms.

Conclusion

India has been considered a booming market for Franchises’ and has been expected to be a billion-dollar industry in the near future. Franchising is a multifaceted endeavour that demands a comprehensive understanding of legal, regulatory, operational, and market dynamics. Successfully navigating these challenges requires strategic planning, clear contractual frameworks, and a commitment to maintaining the interests of all stakeholders involved. Some points that we believe are more crucial than others and can aid a franchise business and the franchising parties are:

  • Capital Investment: For Franchisees, initial capital investment requirements, ongoing royalty payments, and operational costs can be substantial, and therefore necessitating careful financial planning and management of the investment needs is to be analysed prior to starting up any franchising business.
  • Technological Integration: Integrating technology solutions across a diverse network of franchise outlets can pose challenges in terms of standardization, training, and ensuring uniform customer experiences. However, the right usage of technology, and proper hiring, upskilling and training can add to the business’s advantage in a short period only.
  • Market Competition: The presence of numerous domestic and international franchise brands across various industries creates intense competition, requires Franchisors to differentiate themselves effectively and thus the Franchisors should study the market of its interest properly before entering such markets.
  • Government Regulations: Keeping up with evolving government regulations and policies, including changes in foreign direct investment (FDI) rules, licensing requirements, and business permits, can be demanding for both domestic and foreign Franchisors and Franchisees. Therefore, staying in touch with your legal advisors is highly recommended to keep you at bay from any legal trouble.

By implementing these solutions, India can create a more favourable and secure environment for franchising, encouraging domestic and international investment, and ultimately fostering the growth and success of the franchise industry in the country.

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