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Franchising and the Entrepreneur
Multiple Choice Questions 1.
A franchise is a system of distribution in which semi-independent business owners pay ____________ and ____________ to a parent company in return for the right to become identified with its trademark, to sell its product or services, and often to use its business format and system. a. a percentage of sales; royalties b. upfront costs; incremental costs c. royalties; monthly consulting charges d. fees; royalties d. – Medium, Page 189
Franchises account for _____ percent of U.S. retail sales. a. 24 b. 34 c. 44 d. 54 c. – Difficult, Page 189
_______________ franchising involves providing the franchisee with a complete business system, with an established name, the building layout and design, accounting systems, and other elements while ______________ franchising allows the franchisee to use the franchiser’s trade name without distributing the products exclusively under the franchiser’s name. a. Product distribution; trade name b. Trade name; pure c. Pure; trade name d. Pure; product distribution c. – Easy, Pages 190-191
McDonald’s is an example of a ___________ franchise. a. conversion forms b. trade name c. product distribution d. pure d. – Easy, Pages 190-191
Benefits of involvement in a franchise experience include: a. management training and support. b. brand name appeal and standardization of goods and services. c. national advertising exposure and financial assistance. d. all of the above. d. – Easy, Pages 191-193
Which of the following is not a potential advantage of franchising for the franchisee? a. Management training and assistance b. National advertising program c. Centralized buying power d. Limited product line d. – Easy, Pages 197-198
Franchisers generally do which of the following regarding financial assistance to franchisees? a. Provide direct financing b. Assist in finding financing and occasionally provide direct assistance in a specific area c. Waive royalty fees for franchisees not making an adequate profit d. Generally do nothing, as having or finding financing is a requirement for qualifying for a franchise. b. – Medium, Pages 193-194
The failure rate for franchises is: a. higher than the rate for all new businesses. b. no different from the rate for all new businesses. c. lower than the rate for all new businesses. d. indeterminable because of the Right to Privacy Act. c. – Medium, Page 195
Franchise royalty fees typically range from _____ to _____ percent of a franchisee’s continuing sales. a. 1; 3 b. 5; 9 c. 3; 7 d. 7; 12 c. – Difficult, Page 196
After a 10-year period, the success rate of individual franchise business that survive is about ______________ than that of independent businesses. a. twice as great b. three times greater c. no different d. about half b. – Difficult, Page 196
When it comes to purchasing products, equipment, and incurring other expenses, the franchiser: a. cannot require the franchisees to buy from the franchise company. b. can set prices franchisees pay for the products but cannot set the retail price the franchisees charge. c. is permitted to set the retail price for the franchisee. d. cannot require franchisees to buy from an "approved" supplier. b. – Medium, Page 123
11. Which of the following is not a potential disadvantage of a franchise? a. Unsatisfactory training program b. Limited product line c. Less freedom d. Actually, all of the above are potential disadvantages of a franchise. d. – Easy, Pages 196-199 12.
The FTC’s philosophy regarding the UFOC focuses on: a. catching and prosecuting abusers of franchise laws. b. verifying the accuracy of UFOC information. c. providing information to prospective franchisees and helping them make wise decisions. d. licensing prospective franchisers. c. – Difficult, Page 202
Which of the following is an indication of a dishonest franchiser? a. A high-pressure sale b. A "get-rich-quick" scheme c. Attempts to discourage you from getting an attorney to review the contract d. All of the above d. – Easy, Page 205
Which of the following should make a potential franchisee suspicious about a franchiser’s honesty? a. Claims that the franchise contract is a standard agreement and that there is no need to read it or have an attorney look it over b. An offer of direct financing of a specific element of the franchise package c. Not providing detailed operational information until 10 days before signing the contract d. Requiring franchisees to spend a certain percentage of profits on advertising a. – Medium, Page 205
In addition to reading the franchiser’s UFOC, it would be wise for the potential franchisee to seek a franchise that offers which of the following? a. A unique concept or marketing approach b. A registered trademark c. A positive relationship with franchisees d. All of the above d. – Easy, Pages 206-209
The primary market for U.S. franchisers is __________, followed by __________. a. Japan; Mexico, Canada, and Europe b. Australia; Mexico, Canada, and Europe c. Mexico; Canada, Europe, and Australia d. Canada; Mexico, Japan, and Europe d. – Medium, Page 212
A method of franchising in which a franchise opens more than one unit in a broad territory within a specific time period is referred to as: a. multiple-unit franchising (MUF). b. master franchising. c. product distribution franchising. d. conversion franchising. a. – Medium, Page 211
Chris Jaffe, the owner of a small independent doughnut shop, is worried that a large doughnut franchise will open an outlet near her location and take away much of her business. Taking a proactive approach, Jaffe contacts the franchise, and after a few months of negotiations, becomes a franchisee. Jaffe is an example of which trend in franchising? a. Piggyback b. Conversion c. Master d. Subfranchising b. – Medium, Page 214
McDonald’s recently set up several small franchises in nontraditional locations such as a hospital, a college campus, an airport, a subway station, and a sports arena. These locations are based on the principle of: a. conversion franchising. b. intercept marketing. c. multi-unit franchising d. piggyback franchising. b. – Medium, Page 214
When the franchiser has the right to establish a semi-independent organization in a particular territory to recruit, sell, and support other franchises, it is known as a _____________ franchise. a. multi-unit b. piggyback c. conversion d. master d. – Easy, Page 215
Establishing a Baskin-Robbins franchise inside a Blimpee’s franchise is an example of _____________ franchising. a. multi-unit b. master c. piggyback d. diversionary c. – Easy, Page 215
True/False Questions 22.
A franchise is an arrangement in which semi-independent business owners pay fees and royalties to a parent company in return for the right to sell its products or services and often to use its business format and system. True – Easy, Page 189
Before entering a franchise contract, a potential investor should ask, "What can a franchise do for me that I cannot do for myself?" True – Easy, Page 189
Quality is so important in franchising that most franchisers retain the right to terminate the franchise contract and to repurchase the outlet if a franchisee fails to maintain quality standards. True – Medium, Page 189
When a franchisee buys a franchise, he or she is purchasing the expertise and the business of the franchiser. True – Easy, Page 189
Pure franchising involves the right to use all the elements of a fully integrated business operation. True – Easy, Page 191
Examples of some benefits franchise systems offer include management training, brand appeal, standardization of goods and services, national advertising, proven business formats, centralized buying power, and site selection assistance. True – Medium, Pages 191-195
Most franchisers provide extensive financial help such as loans and low-rate financing for their franchises. False – Medium, Pages 193-194
The failure rate for franchises is below that for other types of new businesses. True – Medium, Page 195
In addition to other fees, franchisees must also pay royalties but only on net profits; in other words, no profits, and no royalties. False – Medium, Page 196
A major advantage of a franchise contract is the national advertising campaign that most franchisers provide free of charge for their franchisees. False – Medium, Page 196
By signing the franchise contract, a franchisee typically surrenders some freedom and autonomy in operating his business. True – Easy, Page 197
It is illegal for a franchiser to require franchisees to purchase products only from "approved suppliers." False – Medium, Page 197
Having an attorney review and evaluate a franchise contract is unnecessary since the FTC requires all franchisers to offer a "standard" franchise contract. False – Medium, Page 198
The franchise contract defines the rights and the obligations of both parties and sets the guidelines that govern the franchise relationship. True – Easy, Page 198
A Uniform Franchise Offering Circular (UFOC) is a document that every franchiser is required by law to give prospective franchisees before any offer or date of a franchise. True – Medium, Page 202
If a franchiser encourages you to sign without reading the agreement, or discourages you from "spending the money on an attorney," this is a warning sign that the franchiser might be dishonest. True – Easy, Page 205
A good method for evaluating a franchiser’s reputation is to interview existing franchise owners about the operation. True – Easy, Page 208
A multi-unit franchise gives the franchisee the right to open more than one franchise outlet in a territory within a specific time frame. True – Easy, Page 211
The primary market for U.S. franchisers is Mexico, with Japan and Europe next. False – Medium, Page 212
A master franchise gives a franchisee the right to create a semi-independent organization in a particular territory to recruit, sell, and support other franchisees. True – Easy, Page 215
Essay Questions 42.
Define franchising. Explain the three types of franchising. Which is the fastestgrowing segment? A system of distribution in which semi-independent business owners (franchisees) pay fees and royalties to a parent company (franchiser) in return for the right to become identified with its trademark, to sell its products or services, and often use its business format and system. The three types of franchising are: 1. Tradename 2. Product distribution 3. Pure (business format) Pure franchising outlets’ sales are growing at a faster rate. Page 189
Outline the benefits and drawbacks of buying a franchise. Some of the primary benefits of franchising include: Management and training support • Brand name appeal Standardized quality of goods and services • National advertising programs • Financial assistance • Proven products and business formats • Centralized buying power • Site selection and territorial protection • Greater chance for success The drawbacks of franchising include: Franchise fees and profit sharing • Strict adherence to standardized operations • Restrictions on purchasing • Limited product line • Unsatisfactory training programs • Market saturation • Less freedom Pages 191-199
What is a Uniform Franchise Offering Circular? How can it help a potential franchisee? The law requires franchisers to register and deliver a copy to perspective franchisees before any offer or sale of a franchise. The Uniform Franchise Offering Circular, or UFOC, establishes full disclosure guidelines for any company selling franchises. It can help potential franchisees avoid being defrauded by requiring that the franchiser disclose detailed information on their operation at the first personal meeting, or at least ten days before a franchise contract is signed, or before any money is paid. Page 202
Outline the recommended procedure for buying a franchise. The most effective step to buying a franchise are: • Evaluate yourself • Research your market • Consider your franchise options • Get a copy of the franchiser’s UFOC • Talk to existing franchisees • Ask the franchiser some tough questions • Make your choice Pages 205-209
What are some indicators that a potential franchisee might be dealing with a dishonest franchise? What steps can a potential franchisee take to avoid becoming a victim of a dishonest franchise? Indicators of a potentially dishonest franchise may include: • Claims that contract is standard and “you don’t need to read it” • Failure to provide disclosure information • Marginally successful or no prototype • Oral promises of future earnings with no documentation • High turnover rate • Poor manual or none at all • Unusual amount of litigation • Attempt to discourage attorney advice • High pressure sales • Claiming to be exempt from federal laws
• • •
Get-rich-quick schemes Reluctance to provide references Evasive or vague answers
Steps to take may be to: • Do your research • Ask for UFOC • Investigate thoroughly • Preparation, common sense, and patience Pages 205-209 47.
Explain the following franchise concepts and give an example of each: intercept marketing, conversion franchising, multi-unit franchising, and master franchising. Intercept marketing is the principle of putting a franchise’s products or services directly in the paths of potential customers, wherever they may be. Example: Putting a scaled-down version of a Subway sandwich shop in a gas station convenience store. Conversion franchising is a trend in which owners of independent businesses become franchisees to gain the advantage of name recognition. Example: An Italian restaurant owner buys a franchise like the Olive Garden restaurant. Multi-unit franchising is a method whereby a franchisee opens more than one unit within a specific time frame. Example: An individual or family owning all the local McDonald’s. Master franchising is a method of franchising that gives the franchisee the right to create a semi-independent organization in a particular territory to recruit, sell, and support other franchisees. Example: An individual fluent in Spanish works to recruit as many franchisees as possible in Spain. Page 132
Explain three trends currently shaping the franchising industry. Three current trends can be included from the following list: • Franchisees are better educated and more financially secure • Internationalism of American franchise system • Smaller, nontraditional locations • Conversion franchising • Multiple-unit franchising • Master franchising • Serving aging baby boomers Pages 211-215
Franchising and the Entrepreneur Mini-Case 6-1: Pipe Dreams Ralph Emerson thought he’d been a librarian long enough, and when the opportunity arose to open a small tobacco, pipe, and cigar shop in the newly renovated downtown business district, he was ready to act. Pipe Dreams is a franchiser of smoke shops, and was founded eight years ago by a noted tobacconist in New York City. The concept for the shops is simple, yet sophisticated. It is simple in the sense that the shops sell only tobacco-related products, but sophisticated in the breadth and quality of the inventory they carry. Each franchise, depending on size, is stocked with inventory selected by the company’s founder. The franchiser finances the shop’s initial inventory. The franchisee is expected to create a decor within predetermined standards that Pipe Dreams establishes. Each franchisee must attend a three-day workshop, outlining the fundamentals of tobacco blending, the merchandising of pipes and cigars, and the techniques of successful business operation. The franchise contract requires the franchisee to contribute 1.5 percent of gross revenue to a national advertising campaign. According to the contract, Pipe Dreams will finance the required fixtures for the store for ten years. In addition, the franchiser supplies all inventory at very favorable prices because it purchases in large quantities. Ralph knows he can buy tobacco products from a variety of wholesalers. He also has some ideas on what would make a tobacco shop successful in this town. Ralph knows that Pipe Dreams franchisees have had a high success rate in the past. Questions 49.
Help Ralph make a decision by outlining the advantages and the disadvantages of a franchise arrangement. Chapter 6 outlines the advantages and disadvantages of franchise arrangements. The case suggests that the Pipe Dreams franchise (like many franchises) offers the entrepreneur a greater chance of success than "starting from scratch."
Assuming that Ralph has adequate capital, would you recommend that he invest in the franchise or open his own tobacco shop? Why? Given Ralph’s lack of experience in business, generally, and in managing a tobacco shop, specifically, it probably is wise for him to take the franchise option. Once he learns the business and gets established, he could explore the possibility of terminating the franchise relationship.