Start With A Win - What is Franchising with Dr. Ben Litalien Part 1 of 2

Starting point is 00:00:00 Have you ever wondered what the best way is to grow a business? Is it a franchise? Is it not a franchise? What do I do? I've got an expert on today, Dr. Ben Litalian. Let's check it out on Start With A Win. Welcome to Start With A Win, where we talk franchising, leadership, and business growth. Let's go. And coming to you from Start With A Win headquarters, it's Adam Contos here with Start With A Win. Have a great friend on today. We're going to talk franchising and business, Dr. Ben

Starting point is 00:00:32 Litalian, the founder and principal of Franchise Well, a consulting practice dedicated to the improvement and enhancement of franchising. He's also on the staff at Georgetown University in Washington, D.C., University of Denver Daniels College of Business. And also he's an adjunct associate professor at University of Maryland Global Campus, where he teaches entrepreneurship, small business management and venture planning in their online undergrad program. Ben's three-decade career in franchising includes building multiple franchise concepts to scale and running ExxonMobil's U.S. franchising program, where he developed a pipeline of a thousand locations in less than five years. Holy smokes, that's growth. He's involved in the development of social franchising across the globe, including Jibu, a network of retail water store franchises in eight East Africa countries where he serves as a founding board member. Ben's consulting clients, listen to these names, include Ikea, Remax, Snap-on Tools,

Starting point is 00:01:38 Brain Balance, and EXP Real Estate, and the new co-working concept at Success Space. Ben's a recognized speaker on franchise development and franchising for good. He's a contributor to Forbes on franchising. He's completed his doctoral program at the University of Maryland Global Campus and received a CFE, Certified Franchise Executive designation, from the International Franchise Association 20 years ago. Ben and his wife, Raeann, have been married for 37 years. She's awesome, by the way. I'm good friends with them.

Starting point is 00:02:15 And they live in Fredericksburg, Virginia, with their awesome long-haired German shepherd, Shadow. They have three grown children, a handful of grandsons, and Ben just got off a killer fly fishing trip in Wyoming. Ben, how you doing, friend? Awesome. Great to be here, man. Hey, this is a fun topic and something that you and I talk regularly about. For all the listeners, Ben and I are in business together in some franchise concepts. I met Ben a few years ago through Remax and the International Franchise Association. We've just been growing businesses together since then. I wanted to have him on the show for this special two-part episode because he is so knowledgeable in growing small business, big business, and also the franchise space. So, Ben, let's dive into franchising for everybody first.

Starting point is 00:02:59 You have an incredible definition of a franchise and kind of the history behind it that you share in your Georgetown University and DU curriculum. What's a franchise? Yeah, thanks. Franchising is a very powerful model, but it really started in the Middle Ages. And kings with large kingdoms used the franchise model to really manage their local communities. So they would go to a community and grant a local family the franchise to grow corn, let's say, or crops, so long as a portion of the crops they grew were given as a royalty to the king. But what the franchisee got was protection from the king. No one else could grow corn in that village except

Starting point is 00:03:47 them. And the king actually put his banner, a stake with the king's banner on it that said, hey, I'm under the protection of the king. And so the definition, if you will, of a franchise is the grant of independence or freedom. That's what the word franchise means. And so that villager was granted under the king's banner the freedom to have a business and to flourish and to sell to everyone else in the village, so long as he provided a royalty to the king. And when you think about franchising from that perspective, it's very empowering. Many people, unfortunately, many franchisors, unfortunately, you know, present franchising as this restriction that, you know, you've got to do everything we say and you can't cover outside

Starting point is 00:04:40 the lines. And it's all about, you know, I'm not in business for myself. I'm just basically working for this franchisor. And that's the farthest thing from the truth about how to build and grow big businesses using the franchise model. That freedom is what powers the franchise model. Right. Right. Yeah. I mean, it's like you're coming to the table with a partnership, you and the franchise or what is it we always say you're in business for yourself, not by yourself. Yeah, no. And I think that the key is to understand what is the independence and the freedom, right? If you're going to be a franchisee, you've got clear competitive advantages over the franchisor in two areas. One, human resources. Your ability to hire, train, and manage at the local level is a huge competitive advantage over

Starting point is 00:05:35 the franchisor. If they're based out of Cleveland and you're in Kansas City. What do they know about hiring, training and managing people in Kansas City? So you need to embrace that. Have the freedom to find great people, build a great culture, have the A-team, I call it. That's one. The second is your local sphere of influence. The franchisor isn't going to know what's going on in your community, what's valued in your community, the vibe, the culture. But you do, and you need to tap into that. You need to be known because you are the ambassador for that brand. If you're with Daddy's Chicken Shack, you are Daddy's Chicken Shack in your community. If franchisees embraced those two freedoms that they have, they can grow and scale a business much more rapidly than if they try to reinvent the franchisor's model and change the

Starting point is 00:06:36 operating system and change the marketing strategy and get involved. Those are all on the franchisor side of the partnership that you mentioned. So when I talk with franchisees and I speak at a number of franchise conventions every year, I just got back from Celebrity Annual Convention talking with their franchisees about this very topic. Take advantage of these two freedoms that you're granted in this relationship under the King's banner, and you can build and grow a very successful business. Let the franchisor focus on policy procedures and guidelines and systems. That's what you're partnering for. Right. It's, it's interesting because when you, you know, when you talk to, and you know, I want to define some terms here in a moment, but when you talk to the franchisees and franchisors, people that own the franchises and the parent company, it's fascinating because sometimes the people that run the local locations want to spend their time doing the things that the parent company should be doing or is doing.

Starting point is 00:07:38 If they didn't spend their time doing that, they could be out adding business, which is money in their wallet. Exactly right. So exactly right. You know, it's fascinating. Don't get out of your lane, I guess, is the thing we need to say here. But I want to take a step back and define some of these terms that we use a lot of. Ben, can you, first of all, we hear the term FDD a lot. Explain to us what an FDD is and why that's important. Yeah. So the franchise disclosure document is required by the Federal Trade Commission, who has the governmental authority over the franchise sector. Sometimes people will say

Starting point is 00:08:18 franchise industry, which is not really a good way to describe what franchising is. It's not really an industry, although there are over 150 industries using the franchise model. But the Federal Trade Commission is responsible for governing franchising in the United States. And there are similar organizations in other countries around the world. But it's important to note that their governance over franchising is really unique. It's only on the offer and sale of a franchise. So they don't govern the ongoing relationship. Once somebody becomes a franchisee, it's between the franchisor and the franchisee. The FTC is not involved. So the FDD is the document that they require any qualified candidate to receive from the franchisor, and it has 23 items in it. So whether

Starting point is 00:09:13 you're applying to be a McDonald's franchisee, a Dell Dinker franchisee, a REMAX franchisee, every franchisor has to provide the same 23 items of disclosure to a candidate. It's interesting when you take a look at that because they have to have that for 14 days. Is that correct? What's the exemption process? There's a financial exemption process. a sophisticated investor exemption, individuals with a net worth over 6.125 million. States beyond the FTC rule, certain states have passed laws that in addition to complying with the federal, in their state like Washington, California, Illinois, New York, Hawaii, these states have enacted additional laws,

Starting point is 00:10:08 in which case you prepare your FDD and you submit it to the state. The state reviews it and may require you to make modifications, typically around notice of termination and things like that. And so there is this second tier of regulation that's out there, depending on what state you live in. Right. And there are some different requirements. And we're still on this document because this is important. This is where you get disclosure about a franchise. The disclosure is in a – the document's pretty big.

Starting point is 00:10:47 It includes a copy of the franchise agreement itself, which is truly the contract within there. But the rest of this document is a disclosure and a receipt for the disclosure. And you hear what's called the item 23, which is the receipt for the disclosure. But there are some certain things that are required in order to actually file this, Ben. We don't need to be all inclusive here, but, you know, like audited financials. What are some of the things that are required to be submitted in the FDD that really creates this kind of as an onerous process for a new startup business to come into franchising? What do you see challenges are with gathering those things? It's a very important document for candidates.

Starting point is 00:11:24 So keep in mind a couple of things. One, the FTC is a consumer protection agency. So their effort is to protect the average consumer from being taken advantage of, if you will, by a franchisor, meaning the FTC assumes the franchisor has more knowledge than the consumer does about whatever it is they're trying to sell the franchise. And so this FDD says, hey, I need you to level the playing field for the consumer by sharing with them who owns the business. What is the legal entity? Are there any affiliates associated with this? Is there any other business going on related to this? Information about how much is my initial cost if I were to buy this franchise? What are my ongoing costs associated with buying it? What are the requirements relative to the

Starting point is 00:12:20 equipment or the supply chain or the vendors? And so it really, for the average consumer, gives them purview into the full business the franchisor is offering for them to associate with. Now, I would highlight that and say that back when the FTC enacted this in the 70s, the average consumer buying a franchise was very disadvantaged in the information that was being provided. Today, you can do a Google search of any franchisor and access scads of information. So I believe it's really lost some of its relevance over time because of technology and the flow of information. Secondly, someone buying a franchise today, in many cases, is a very sophisticated, potentially wealthy individual or business owner who may be exempt, as we talked about. But even if they're not, they're not really benefiting substantially by this information. So, again, the FDD is really valuable if you're an individual looking to buy a franchise, which is a great way to start building a business that can grow to be thousands.

Starting point is 00:13:39 The largest franchisee in the United States owns 3,000 franchises in six brands, right? That's not the consumer that the FTC is trying to protect, right? And there's everything in between, right? I've been a franchisee many times in my career. My wife has now forbidden me from buying any more franchises to stay focused. But being a franchisee is a phenomenal way to own your own business, but have the support of a brand and a system from a franchisor. Okay. So, and we talked the words franchisee, Z, and franchisor, Zor here. Explain the difference between a Z and a Zor. Yeah. So the franch Zor is the king, right, in the middle ages story. It's the owner, technically, of the marks.

Starting point is 00:14:33 Who owns the marks that you're going to be getting a license to? Because if you're not getting a license to a trademark, you're not buying a franchise. So that's one. And then two, the business system. So in franchising, there are manufacturer franchises, product franchises and business format franchises. And what we're talking about are business format franchises where you're actually getting the business operating system to run a manual process, etc. It's very, very well defined. And that's what entrepreneurs can benefit from. You don't have to reinvent the wheel. If you want to be in the real estate business, I mean, why would you want to start from scratch when you can

Starting point is 00:15:17 access Remax? I mean, what an incredible system. And so that's really the premise of the franchisor. They're the one that owns the trademarks and licenses them and provides the business model. The franchisee is simply an individual or entity that is signing the contract, if you will, to acquire the license to the brand and the operating system. Right. And you mentioned trademark, registered trademark. Tell us about, you have to have a federally registered trademark here, correct? You actually don't. Yeah, the FTC does not require a franchisor to have a federally registered trademark in order to offer and sell franchises. But you do have to disclose as one of the items in the FDD, your trademark and the status of it. Right. And so if you're an individual looking to buy a

Starting point is 00:16:11 franchise, you want to read the FDD carefully because it's a risk if you buy a franchise and the franchisor doesn't have a federally registered trademark. What's going to happen if somebody else gets that registration? You might have to change your signs, change your brand. So it's certainly something to be aware of. Yeah. Why would you franchise without a federally registered trademark, right? It could be in registration, right? Which as everybody knows, takes a period of time. And that's a good question to ask. If a franchisor is offering and their registration is in process, it's a good question to ask. Have you had any issues with it? Is it under review? Is there anybody that has raised any concerns with it? You can do your're going to register that other people might have been using in a isolated, you know, one location here or there. You can't make them change it after your registration has been given, but you stop them from expanding using it once you get that registration. So let's talk about the systems and processes in the business because you know we know that a a

Starting point is 00:17:25 franchise system has you know some sort of a brand like you mentioned you're licensing this brand for use but there's also a system attached to it which is kind of the second component here you know the control of the business the third component is paying a fee for this so maybe we get that one out of the way first so tell tell me about, you know, the fee. The fee is one of those necessary components of a franchise model, the three legs of the stool that we had Andrew Sherman on, on another podcast, and he explained kind of the three parts of franchising with respect to that. Tell us what are the different fees that people see in this? And I don't mean, I mean, you know, everybody's like fees bad, you know, I hate that mean, you know, everybody's like fees bad.

Starting point is 00:18:05 You know, I hate that term. You know, a lot of people call it investment, things like that. Ultimately, what you're doing is you're buying time with this fee. I mean, essentially, this is a time purchase because it means you're not inventing the wheel yourself. You're not, you know, spreading the wheel out yourself, you're paying a portion or a portion of your business here to start up and a portion of your business to operate so you don't have to go do all this other garbage that somebody else is taking care of for you. So talk to us about the fees real quick. As Andrew, I'm sure, talked about a license to a trademark, payment of a fee, and an operating

Starting point is 00:18:41 system. If those things are in what you're selling to someone, it's called a franchise. The fee part of it, the FTC does not designate what fees are called, how much they are. So as a franchisor, as a business owner who wants to franchise their concept, you have to make a myriad of decisions. How much are you going to charge? Typically, there's an upfront fee called a franchise fee or an initial franchise fee. Think of that as like the ticket to the ballgame. It gets you into the stadium, but you're going to buy all your concessions separately. So that ticket to the ballgame gives you the right to the license, right to the systems. And it is often set based on what others are selling franchises for in that same sector. Beyond that, there's an ongoing called a royalty. Again, going right back to the Middle Ages, that's where it came from. So this royalty can be calculated any way the

Starting point is 00:19:40 franchisor wants. It's most typically a percentage of gross sales. To be fair, keep in mind, that means even if you're not making money, the franchisor will be, right? If you have $400,000 in sales and you're just at break even, you're still paying that royalty to the franchisor. So there's a curve when you buy a franchise. You want to get up and over the natural in mind, the one that's the largest and growing the most is technology fee. Franchisors work in a very data-rich environment. Every transaction from every customer across the system, all that data is flowing into the franchisor. So franchisors use very powerful technology platforms so that they grasp that information. I often share with folks the only clear competitive advantage typically a franch with one arm tied behind your back. What that means is franchisors have technology fees. They'll take their platform of technology assets, and then instead of the franchisee having to go sign up

Starting point is 00:21:16 with five different vendors and have five different bills coming in, the franchisor does an enterprise platform and then just collects one technology fee. So when you're looking at FDDs, you're going to see in some cases it might be $500 a month. Others, it might be $1,500 a month. You have to look at the underlying technology platforms. What does it give you access to? In the case of some of the companies that, you know, Adam, we work with, we've got a restaurant in our hand. I mean, literally the franchisee on their phone, real time, sees all the data flow of every sandwich they sold, their inventory control, their labor control. So very powerful.

Starting point is 00:21:58 If a franchisee had to go try and put that in place and have those relationships. Very cumbersome, very distracting, but the franchisor puts it in place under one technology. Right. Ben, that's some fascinating information there. And this is a good break point for the first part of our two-part series here. When we come back, we're going to dig deeper into the franchise system, the business system. How does the business work? What are some of the challenges they face? And how do franchisees and franchisors overcome those challenges? So everybody, make sure you check back for episode two of two here with Dr. Ben Litalian.

Starting point is 00:22:37 We'll see you next time on Start With A Win. Thanks for joining us on Start With A Win. Be sure to like and subscribe to this episode and share it with your friends. Also, be sure to check out Adam on YouTube and Adam Canto, CEO, as well as on all the social media platforms. And don't forget, start with a win.

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Start With A Win - What is Franchising with Dr. Ben Litalien Part 1 of 2

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