A Brief History of Franchising

By Mike Martuza

Franchising is a major contributor to the growth of the US economy. Most people are aware of franchising but are unaware that federal and some state governments play a role in regulating the US franchise industry. Franchising, as most people understand it today, began in the early 1950's when it was revolutionized by the systems implemented by the McDonald's restaurant chain. The McDonald brothers, Mac and Dick, created technologies and systems so efficient that they were able to service more customers, more quickly, than any restaurant had previously. Ray Kroc, who owned the first McDonald's franchise location outside of Southern California, was the visionary who created and implemented the systems responsible for the successful growth of the restaurant worldwide. The combination of systems at both the operations level and the corporate level introduced by McDonald's were so successful that they continue to be the foundation by which successful franchise companies operate.

During the 1950's and 1960's franchising grew very rapidly, primarily in the fast food industry. While most franchise companies were very open and honest about their sales efforts, wanting the prospective franchise owner to learn as much about the opportunity as possible, there were numerous instances of franchises employing very aggressive or deceptive sales tactics. These methods were much like what time-share vacation condo sales can be today, where a person meets with a representative for a number of hours, is bombarded with information and then is asked to make a decision and a payment before they leave the office. The requirement for an instantaneous decision does not usually allow the buyer the time to make a rational or well-informed decision and it is not uncommon for the buyer to have regrets shortly after the transaction when given further thought.

During this era franchise sales went along with only a few minor incidents. It was in the mid-1960s when a scandal would change forever the way in which franchises were sold. A promoter who was developing a competitive offering to the rapidly growing Kentucky Fried Chicken franchise created a concept that licensed the name and image of Minnie Pearl for "Minnie Pearl's Fried Chicken" restaurants. This promoter went around the country touting this new concept, and backed by favorable press, was able to convince several thousand people to invest in the right to open these establishments. After a period of time various authorities began to investigate the promoter, and his company, for financial irregularities. However, before the investigation could be completed the promoter left the country with all of the money. Many people lost a good portion of their life savings as the promoter was never found. Undaunted, several hundred of the potential franchise owners opened Minnie Pearl's Fried Chicken restaurants, but within a few years more than ninety percent of them had failed. Even though they had a common name, the owners lacked the proven systems needed to be successful (e.g., Marketing; Operations; Sales; Corporate Office Support). Further compounding the problem was that most of these owners had no experience in the food service industry, thus limiting their ability to create successful systems.

As a result of this and several other incidents, the state of California created in 1971 the first set of laws that companies were required to follow before they could offer a franchise to anyone living in the state. Over the next several years, more states developed their own sets of laws. For the most part the franchise industry did not oppose these laws, as they would act as a means to clear the unsavory element out of franchising. The concern of the franchise companies was that there could be 50 different sets of laws that they would have to follow. As the growth of franchise companies is based on the ability to use replicable systems nationwide, the outlook of many different sets of laws was worrisome.

As a result, in 1979, the Federal Trade Commission (FTC) created the first set of national franchise regulations. The FTC dictated that the franchise companies follow a certain set of rules when engaging prospects regarding possible franchise ownership. The first significant change required the franchise company to provide a Franchise Disclosure Document (FDD) to a prospect at, or before, their first significant discussion or in person meeting. The FDD is much like a prospectus that a person would get if they were considering investing in a stock or mutual fund. All pertinent legal information about the franchise company must be included in this document. The specific information that is provided in a FDD will be discussed in the next Exploring Franchising article "The Franchise Disclosure Document (FDD)". The second significant change set a timeline that must be followed before any money may be requested or paid. The law stipulates that for 14 days after the FDD is received by the prospect, the franchise company cannot ask for, or accept, any money from the prospect. The law was meant to remove the pressure sales tactic and to give the prospect some time to research and give more thought to the concept.

Since 1979 the laws regulating franchising in the US have been periodically modified to keep up with the times, but the biggest change to franchising has been the industries that franchising has entered. As our economy has become more service oriented, franchising has increasingly focused on providing services to both consumers and businesses. Many people are surprised to learn that so many of the services they utilize are franchised such as: dry cleaning, maid services, auto repair, computer services, pet care, education, etc.

Franchising is a viable and successful business model that only shows signs of strengthening. According to the International Franchise Association, there are over 3000 franchise opportunities available in the US, more than 900,000 franchise units currently operating, and more than one trillion dollars of revenue generated by franchised businesses each year. The franchise model creates entrepreneurs and small businesses that are significant drivers of jobs and productivity in our economy.