Knowledge, experience, and funding are not always present in startup ventures; one element may be available while another is lacking.
People have found various solutions to overcome this obstacle, such as partnerships with others. However, this is not necessarily the ideal option, especially since it is often fraught with disagreements in partners’ viewpoints or with each partner’s personal ambitions, which could potentially destroy the project at its inception or later on.
As a practical example, let’s assume that (X) has funds he wants to invest in a business venture. Still, he is concerned about his lack of knowledge in technical and logistical aspects or the risk of launching a new product or service that no one is familiar with. Of course, the situation becomes even more challenging, with strong competitors already dominating the market.
As for (Y), he already has a successful and popular business and wants to expand horizontally. However, he doesn’t have enough funding to cover the expenses of an ambitious geographical expansion, which would require opening new branches accompanied by significant costs for rent, equipment, salaries, and promotional campaigns. He may also be reluctant to take an uncalculated risk in unfamiliar areas. Additionally, he faces another specific challenge—a cultural one. His limited connections in this new geographical environment and his lack of deep understanding of the local culture prevent him from achieving the same effectiveness he had in his original environment.
Here arises the need for a unique contractual relationship between (X) and (Y), known as a franchise agreement. The International Franchise Association (IFA) defines it as “a method of distributing products or services that includes the franchisor, who establishes a trademark or trade name and a business management system, and the franchisee, who pays a Loyalty fee and often an initial fee for the right to conduct business under the franchisor’s name and system. Technically, the contract linking the two parties is considered the ‘franchise,’ but the term is more commonly used to refer to the actual business operated by the franchisee. The practice of creating and distributing the brand and franchise system is often referred to as franchising.”
History of Franchising
Max Friedman, in an article for Business News Daily, writes that the Friedman says in an article on Business News Daily that the modern concept of franchising as a business idea dates best forms of franchise agreements can be traced to the mid-19th century when Isaac Sin, ger, the inventor of the sewing machine, signed franchise agreements to distribute his machines more effectively.
He added that the fast-food industry played a significant role in expanding the application of franchising in the 20th century. Companies like McDonald’s, founded in 1940, and KFC, founded in 1952, became pioneers in franchising by developing standardized systems for food preparation, service, and marketing that could be replicated across multiple locations. This allowed them to expand rapidly and dominate the fast-food industry.
McDonald’s is considered the largest franchisor in the world, with its annual revenue reaching over $23 billion in 2021.
Franchising in the Arab world
In most Arab countries, there are no specific laws regulating franchising; it is left to the documented agreement between the parties involved in the contract unless it conflicts with the country’s civil law.
Among the Gulf countries, Saudi Arabia has an explicit law regulating franchise agreements.
The Saudi Arabian Franchise Law – Royal Decree No. M/22 – October 8, 2019, considered the regulation of the relationship between the franchisor and the franchisee, enhancing transparency and protecting both parties’ rights while promoting the quality of goods and services in the Kingdom.
The law clarifies some terms, such as franchise, franchisor, franchisee, and franchise agreement. It defines a franchise as granting a natural or legal person the right to another natural or legal person to operate a business associated with a specific trademark in exchange for a financial or non-financial consideration.
The law also encourages franchising activities in the Kingdom by establishing a legal framework that protects the rights of both parties and ensures disclosure of the rights, obligations, and risks associated with franchise opportunities. This helps in making informed investment decisions.
The law applies to all franchise agreements executed within the Kingdom, with some exceptions, such as franchises issued under royal decrees or agreements subject to the commercial agency system.
One of the conditions of this law is that the franchise must have been actively operating for at least one year before granting the franchise. A disclosure document must be provided to the franchisee at least 14 days before signing the agreement.
The law includes obligations for the franchisor, such as providing technical support and training, defining the operational methods, and supplying goods or services throughout the agreement. Additionally, the franchisee must obtain the franchisor’s approval for specific changes, such as altering the business location or modifying the goods and services provided.
The law stipulates that the agreement must be written in Arabic and include all details related to the franchise operations, such as financial rights, training obligations, technical support, and trademarks.
The law sets conditions for renewing or extending the franchise agreement regarding the transfer of the franchise agreement or changes in the person controlling the franchisee. It specifies the circumstances under which the franchise agreement can be terminated, such as the breach of obligations by either party or the franchisee’s cessation of business operations.
To protect the rights of both parties, the law grants the affected party the right to seek compensation if the other party breaches its obligations or terminates the agreement unlawfully, and it specifies a time frame for hearing compensation claims.
The law also clarifies the impact of transferring or terminating the agreement on the use of trademarks. Any agreement in which the franchisee relinquishes their rights as stipulated by the law is considered invalid unless it is part of a final settlement.
Political Challenges on Franchise Agreements
Political storms can impact franchise agreements, as seen directly after the outbreak of the Russia-Ukraine war when many American, European, Japanese, and Korean companies exited the Russian market.
For example, McDonald’s sold all its branches below market value to Russian businessman Alexander Govor, and its restaurants now bear a completely different brand name, Vkusno i tochka, which means “Tasty and that’s it.” Instead of Coca-Cola, the brand Cool-Cola appeared, Starbucks withdrew and was replaced by Star Coffee, Donutto replaced Dunkin’ Donuts, IKEA was replaced by a Belarusian furniture company named Swede House, and Turkish clothing replaced the items on Zara’s shelves.
This sudden Western exit from the Russian market represented a significant investment opportunity, allowing many local and Turkish companies to establish a foothold for their products. Some even used the same visual identity as the departing brands.
Ethical Challenges on Franchise Agreements
Calls for boycotting brands that economically support the Israeli occupation in Palestine have emerged across the Islamic world following the Al-Aqsa Flood battle against settlements in the Gaza Strip on October 7, 2023. This was followed by a wide-scale Israeli war on Gaza, resulting in massive destruction of infrastructure, schools, hospitals, residential areas, and tens of thousands of civilian casualties, including women and children.
Social media platforms have erupted with debate between those who support the boycott as a moral obligation and those who oppose it. Both sides question the boycott’s effectiveness and emphasize its negative impact on local workers employed by franchised companies.
Sales of several Western brands in the Islamic world have declined, placing franchisees of these brands in an unexpected financial challenge.
In contrast, local industries that previously could not have dreamed of capturing even a small share of the market against giant multinational companies have seen a surge in growth.
Advantages of Franchising
One of the biggest advantages of franchising is the opportunity to benefit from a brand’s established reputation. Operating under a well-known brand name can immediately attract customers and reduce the marketing efforts needed to build brand awareness.
Franchising often comes with a proven business model and standardized operating procedures, which helps reduce the risks associated with starting a new business. The franchisee can benefit from the franchisor’s experience and established strategies.
Franchisors often provide comprehensive training and ongoing support to franchisees in daily operations, marketing, customer service, and financial management.
Since franchise businesses typically operate under well-known names and have proven track records, they may be more acceptable to financial institutions, making it easier for franchisees to obtain the necessary funding to start and operate the business.
Being part of a network of franchisees provides support and shared knowledge, allowing them to exchange experiences and resources, which enhances their chances of success.
Disadvantages of Franchising
While franchising can offer a substantial business opportunity, it comes with relatively high startup costs. These costs include initial franchise fees and ongoing fees such as sales percentages.
Operating within a franchise framework means adhering to the procedures and policies set by the franchisor, which can be a challenge for those who wish to innovate and be creative.
The success of a franchise depends heavily on the franchisor’s reputation and performance. The franchisee may also be affected if the franchisor encounters financial problems or negative publicity.
Sometimes, disputes can arise between the franchisor and the franchisee over fees, territorial rights, or business practices. Managing these relationships can be challenging.
Most Popular Clauses Commonly Found in Franchise Agreements
The Franchise Disclosure Document (FDD) is a legal document that provides detailed information about the franchisor and the franchise system. It is usually offered within a specific period before signing the franchise agreement or paying any fees. The FDD includes several pieces of information, such as the franchisor’s background, company history, business record, details about the initial franchise fees, percentages of sales, and other costs the franchisee must pay.
The Franchise Disclosure Document (FDD) also includes the operational duties and responsibilities of the franchisee, including territorial rights and operational requirements. Prospective franchisees should carefully review the FDD and consult with a franchise attorney to ensure a complete understanding of the terms of the franchise agreement.
Franchising offers a substantial opportunity for individuals looking to enter the business world and benefit from a proven business model and a well-known brand. However, it requires a significant financial and operational commitment. Prospective franchisees should conduct thorough research and financial planning and seek legal advice before taking this step.
In general, there is no business venture that is guaranteed to succeed with absolute certainty; otherwise, everyone would invest their money in it, regardless of the amount.
