franchising aspects Jan, 04 2014

Fab five success strategies for retail franchising

Retail franchising in India is relatively new and in its infancy. There is no statutory definition of 'franchise' available in India as there is still no specific legislation in the country dealing with franchising.

By Dr S P Parashar
Fab five success strategies for retail franchising

The Chapter five of the Finance Act 1999 defines a ‘franchise’ as an agreement by which the franchisee is granted representational right to sell or manufacture goods or to provide service or undertake any process identified with the franchisor, whether or not a trademark, service mark, trade name or logo or any such symbol, as the case may be, is involved. 

India is said to be a country of shopkeepers. There are millions of mom and pop shops. Most of these are single stores. A single store is nothing but buying a job. The real magic of business is in up-scaling and multiple units. In the face of limited financial and other resources, up-scaling and multiple units remain a dream for many mom and pop stores. Franchising offers a great option in the face of limited owner resources. India, indeed, has vast potential for franchising. The recent demographic shift, higher education and income levels, extensive network of banking and non-banking financial institutions, expansion of markets for capital, ownership and control and contraction of job market are all positives in the environment for franchising in India.

What do we need to do to make a success out of vast franchising potential in India? Five essential success strategies, as follows:

Provide a FDD to Potential Franchisees

The first thing is to resolve to follow the best franchising practices from around the globe. USA has a long history of franchising and we can learn a lot from them. The absence of a specific code or regulation in India so far offers the best time and opportunity to distinguish your franchise by voluntarily following best franchise practices comparable to advanced countries like USA.

The Federal Trade Commission (FTC) requires every franchisor to provide a franchise disclosure document (FDD) to potential franchisee at least 14 days before signing the franchise agreement.  A standard FDD in USA includes many topics like litigation, bankruptcy, initial fee, estimated initial investment etc. 

India is a common law country and under the Doctrine of Law of Equity, disclosure of relevant information is warranted between parties to a contract including franchise agreement. It will thus be a good strategy for every franchisor in India to develop and provide a FDD to potential franchisees. It will certainly facilitate bringing lot of goodwill and business to them. Information asymmetry and lack of trust tend to be the two biggest hurdles in deal making. Transparency could be the real answer to this problem.

Build Seller’s Discretionary Earnings (SDE) and Value
The key to building and expanding franchise is Seller’s Discretionary Earnings (SDE). Franchisees will not invest unless they see value in the franchise proposition. The number one key to franchise value is SDE. 
Earnings before Interest, Tax, Amortization and Depreciation (EBITAD) 
+ Interest
+ Depreciation
+ Owner’s compensation
+ Non-essential business expenses (Discretionary Expenses)
+/- Market Adjustments
+/- One- time revenue / expenses

Invariably, SDE is much higher than net income because mom and pop businesses serve as pass through and tax shield.

Standardize Operating Procedures and Document It

The standardised operating processes and procedures are the foundation of brand and franchise value. For a restaurant, for example, standardised recipe is the prime asset and source of competitive advantage. For building and expanding retail franchise, the franchisor should first and foremost standardise operating processes and procedures and document them into an operations manual, to be handed over to franchisees at the appropriate time.

Help franchisees with training, set up and operational guidance and support

The franchisees are attracted to franchise businesses instead of building businesses from scratch essentially to save time, money and energy in ideation and setting up, mitigating business risks and avoiding surprises and losses. After all, they have chosen to go for a tested model rather than toying with untested ideas. To keep them attracted and motivated, franchisors should assist franchisees with training, set up and operational guidance and support, specially marketing of products and services. There may be a reasonable charge for the same as no one expects free lunches. But never underestimate the power of ‘Free of Cost’ sweeteners or ‘Affordable Cost’ pitches.

Charge Fee and Royalty but Leave Value at the Table

A franchise is essentially a grant of right to use franchisor’s brand and business model by the franchisee for a fee. But while charging one-time fee and determining earn out royalty, as a good principal and practice, value should be left on the table for the franchisee to attract and keep him/her motivated. 

In USA, 33 per cent to 70 per cent annual return on investment (including owner compensation) is considered a reasonable expectation in main street businesses. This signifies a multiple of 1.5 to 3 to SDE for business valuation.

(The author is currently Managing Partner and Principal Consultant with TACM Management Education Consulting, LLP, New Delhi. He is former Director, IIM Indore. He provides advice / consulting in areas of business diagnostics, business valuation, franchise search and selection, franchise building, buying and selling of franchises and businesses in USA and India.)

Franchising in the United States

In USA, under the Federal Trade Commission (FTC) Franchise Rule, there are three elements of a franchise, namely, trademark, significant control or assistance and required payment.

Trademark: The franchisee is given the right to distribute goods and services that bear the franchisor's trademark, service mark, trade name, logo, or other commercial symbol.

Significant Control or Assistance: The franchisor has significant control of, or provides significance to the franchisee’s method of operation.

Required Payment: The franchisee is required to pay the franchisor at least US$500 either before or within 6 months of opening for business. These include franchise fees, royalties, training fees, payments for services etc.

If all three elements are present, then the relationship will be a "franchise" for purposes of the FTC Franchise Rule.
In USA, in addition to federal law, there are state laws relating to franchising and they differ state to state.

Related: Franchisor Leads The Path To Success

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