Franchising & Licensing: Two Powerful Ways to Grow Your Business in Any Economy
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Franchising & Licensing: Two Powerful Ways to Grow Your Business in Any Economy

by Andrew J. SHERMAN

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The definitive resource for corporations in myriad industries—now completely revised and updated. Filled with illuminating examples, stories from the field, and dozens of forms for drafting franchising agreements and licensing programs, the fourth edition of Franchising&Licensing covers all the strategic, legal, financial, and operational aspects of these


The definitive resource for corporations in myriad industries—now completely revised and updated. Filled with illuminating examples, stories from the field, and dozens of forms for drafting franchising agreements and licensing programs, the fourth edition of Franchising&Licensing covers all the strategic, legal, financial, and operational aspects of these complex but highly profitable business strategies. Incorporating up-to-the-minute information on regulations, best practices, Web 2.0 strategies, branding techniques and global trademark laws, the new FDD disclosure format, and the latest franchising trends, this indispensable reference reveals how to: Raise capital, structure agreements, and protect intellectual property • Create market-responsive sales, marketing, and globalization strategies • Establish quality control and compliance measures • Assess opportunities for mergers and acquisitions, joint ventures, and other alternatives to franchising • And much more Comprehensive and applicable to domestic and international franchising initiatives alike, this essential guide remains the industry standard.

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Franchising & Licensing



Copyright © 2011 Andrew J. Sherman
All right reserved.

ISBN: 978-0-8144-1569-6

Chapter One

Leveraging Intellectual Capital to Create Growth Opportunities and Profitable New Income Streams

Intellectual capital consists of human capital, intellectual property (IP), and relationship capital, and these are the key assets for driving growth and maximizing shareholder value in all types of economic conditions.

The biggest challenge that many companies face is how to keep growing in a slowing economy. The primary but not exclusive focus of this book is on two key strategies, franchising and licensing, as methods for leveraging the intellectual capital of a company into new revenue streams, market opportunities, and profit centers. For many years, companies of all sizes and in many different industries did not understand how to harvest their intangible assets; traditionally, they viewed these assets relatively passively as a way to defend market share instead of proactively as a source of new opportunity.

The strategic views toward the use of intellectual capital has evolved in the boardroom over the past three decades, as described in Figure 1-1.

CEOs and business leaders of companies of all sizes are often guilty of committing a very serious strategic sin: the failure to properly protect, mine, and harvest the company's intellectual property. This is especially true at many technology-driven and consumer-driven companies. From 1997 to 2001, billions of dollars went into the venture capital and private equity markets, and the primary use of these proceeds by entrepreneurs was the creation of intellectual property and other intangible assets. Eight years later, however, emerging growth and middle market companies, in many cases, have failed to leverage this intellectual capital into new revenue streams, profit centers, and market opportunities because of a singular focus on the company's core business or a lack of strategic vision or expertise to uncover or identify other applications or distribution channels.

Entrepreneurs and growing company leaders may also lack the proper tools to understand and analyze the value of the company's intellectual assets. In a recent study by Professor Baruch Lev at NYU, only 15 percent of the "true value" of the S&P 500 was found to be captured in their financial statements. Given the resources of an S&P 500 company, it is likely that smaller companies have their intangible assets even more deeply embedded and that the number for privately held companies may be as low as 5 percent. Imagine the consequences and opportunity cost if you were preparing to eventually sell your business (or even structure an investment with a venture capitalist or strategic investor) and 95 percent of your inherent value gets left on the table! This gap in capturing and reflecting this hidden value points out the critical need for a legal and strategic analysis of an emerging company's intellectual property portfolio.

Intellectual asset management (IAM) is a system intended to create, organize, prioritize, and extract value from a set of intellectual property assets. The intellectual capital and technical know-how of a growing company are among its most valuable assets, provide its greatest competitive advantages, and are the principal drivers of shareholder value. Yet rarely do companies have adequate personnel, resources, and systems in place to properly manage and leverage these assets. IAM helps growing companies ensure that strategic growth opportunities are recognized, captured, and harvested into new revenue streams and markets.

As demonstrated in Figure 1-2, the harvesting of intellectual capital is a strategic process that must begin with an inventory taken by the company's management team and by qualified outside advisors in order to get a comprehensive handle on the scope, breadth, and depth of the company's intangible assets. In these times of shareholder distrust of and disappointment in the management teams and boards of publicly held companies, corporate leaders owe it to shareholders to uncover hidden value and to make the most of the assets that have been developed with corporate resources. The leadership of the company will never know whether it has a "Picasso in the basement" unless it both (1) makes the time to take inventory of what's hiding in the basement and (2) has a qualified intellectual capital inventory team that is capable of distinguishing between a Picasso and a child's art project. Once these assets are properly identified, an intellectual asset management system should be developed to ensure open communication and strategic management of these assets. At that point, the company is ready to engage in the strategic planning process to determine how to convert these assets into profitable revenue streams and new opportunities, thereby enhancing and protecting shareholder value.

A review of your current IAM practices includes an analysis of the following:

What IAM systems, procedures, and teams are in place now? How and when were these systems developed? Who is responsible/accountable for managing these systems within the company? To what degree are adequate systems for internal and external communication and collaboration currently in place? What idea/technology harvesting filters are in place, as well as procedures for innovation decisional analysis (as to whether to move forward, prepare a budget, allocate resources, create a timetable, etc.)? Are the strategy and process for harvesting and leveraging intellectual assets reactive or proactive? What are the real or perceived internal hurdles (politics, red tape, budgeting processes, organizational structure) and/or external hurdles (market conditions, state of the art moving quickly, competitor's strategies, etc.) that stand in the way of improving IAM practices and procedures? What can be done to remove or lower those barriers?

The first step in developing an effective IAM system is to conduct an intellectual property audit. The IP audit is a multidisciplinary process to gather data and take inventory on all of the franchisor's intellectual property assets so that it can then be managed and leveraged properly and profitably. An IP audit can also include a competitive assessment of the strength and depth of the franchisor's inventory of intellectual assets relative to other franchisors and to competing nonfranchisors. This competitive assessment may be especially critical in anticipation of either a capital formation or merger/ acquisition transaction. It can also be a useful tool to determine where future research and development dollars or branding budgets should be directed, to the extent that the franchisor is losing competitive position to others or has noticeable holes or dangerous weaknesses in its IP portfolio. As the company matures, its inventory of intellectual assets should be getting stronger and deeper, not shallower, in order to protect its market position as well as to continue to deliver and maintain its value proposition in the management of its relationship with customers, suppliers, and channel partners.

A strategic planning process, coupled with IAM systems, will help you and your team uncover opportunities for growth. (See Figures 1-3 through 1-5.) Key questions include:

What patents, systems, and technologies have noncompeting applications that could be licensed to third parties to create new revenue streams, joint ventures, or partnering opportunities, distribution channels, or profit centers? What brands lend themselves to extension licensing or co-branding opportunities? What distribution channels or partnering opportunities can be strengthened if the company has greater control of them or provides additional support and services to them? What types of different growth and expansion strategies are being used by the company's competitors? Why? Where are the strategic/operational gaps in the company's current licensing and alliance relationships? As shown in Figure 1-6, the strategic planning process will help identify the different types of protectable intellectual property and the ways in which it can be leveraged into new opportunities.

The balance of this book is devoted to the various types of intellectual capital leveraging strategies, with a focus on business-format franchising in Chapters 2 through 17, licensing in Chapter 19, and joint ventures and strategic alliances in Chapter 20.

Chapter Two

The Foundation of Franchising

Over the last seven decades, franchising has emerged as a leading IP-leveraging strategy for a variety of product and service companies at different stages of development. Recent International Franchise Association (IFA) Educational Foundation statistics demonstrate that retail sales from franchised outlets comprise over 50 percent of all retail sales in the United States, with total economic output (including gross sales) estimated at over $2.3 trillion and employing over 21 million people at over 900,000 establishments in 2008. In an era when unemployment is running in excess of 10 percent and underemployment is nearly 20 percent, franchised businesses provided jobs to 21 million Americans, nearly one out of every seven citizens in the private sector.

Notwithstanding these impressive figures, franchising as a method of marketing and distributing products and services is really appropriate only for certain kinds of companies. Despite the favorable media attention that franchising has received over the past few years as a method of business growth, it is not for everyone. A host of legal and business prerequisites must be satisfied before any company can seriously consider franchising as an alternative for rapid expansion.

Many companies prematurely select franchising as a growth alternative and then haphazardly assemble and launch the program with an approach toward franchise development that parallels the sale of used cars. Other companies are urged to franchise by unqualified consultants or advisors who may be more interested in professional fees than in the long-term success of the franchising program. And still others move too quickly in the development of their franchising program without devoting the time and resources needed for the development of an effective and viable business and economic model. This oversight has caused financial distress and failure at both the franchisor and franchisee level and usually results in litigation. Current and future members of the franchising community have a duty to take a responsible view toward the creation and development of their franchising programs and to embrace the notion that this is a get-what-you-give, relationship-driven business model and expansion industry.

Responsible franchising starts with an understanding of the strategic essence of the business structure. As Bob Gappa of M2000 has been preaching for many years, the franchise system has three critical components: the brand, the operating system, and the ongoing support provided by the franchisor to the franchisee.

The brand creates the demand, allowing the franchisee to obtain customers. The brand includes the franchisor's trademarks and service marks, its trade dress and décor, and all the intangible factors that create customer loyalty and build brand equity. The operating system essentially delivers the promise, thereby allowing the franchisee to maintain customer relationships and build loyalty. The ongoing support and training provide the impetus for growth, providing the franchisee with the tools and tips to expand its customer base and build its market share. The responsibly built franchise system provides value to its franchisees by teaching them how to get and keep as many customers as possible, who consume as many products and services as possible and as often as possible. Early-stage and emerging franchisors must embrace the notion that there is no greater calling than helping others get into business for themselves and supporting the transformation of their lives and the wealth of their families.

In fact, most litigation in franchising revolves around the gap between the actual needs of the franchisees to remain competitive in the marketplace and the reality of what kind of support the franchisor is capable of providing. The seed of the disappointment is in the recruitment phase of the relationship, and it continues beyond the start-up, as the franchisee struggles to remain competitive unless the franchisor delivers on its promises and is committed to providing excellent initial and ongoing training and support. Franchisors can significantly reduce the risk of these disputes by emphasizing ethics and integrity as the strategic essence of the franchising program, by insisting on these standards, and by following a code of conduct that ensures the adoption of these norms at all levels of the organization.

Reasons for Franchising

A wide variety of reasons are cited by successful franchisors as to why franchising has been selected as a method of growth and distribution. Through franchising, they are able to:

Obtain operating efficiencies and economies of scale.

Increase market share and build brand equity.

Use the power of franchising as a system to get and keep more and more customers—building customer loyalty.

Achieve more rapid market penetration at a relatively low capital cost. Reach the targeted consumer more effectively through cooperative advertising and promotion. Sell products and services through a dedicated distributor network. Replace the need for internal personnel with motivated owner/operators. Shift the primary responsibility for site selection, employee training and personnel management, local advertising, and other administrative concerns to the franchisee, licensee, or joint venture partner with the guidance or assistance of the franchisor.

In the typical franchising relationship (see the different types in Figure 2-1), the franchisee shares the risk of expanding the market share of the franchisor by committing its capital and resources to the development of satellite locations modeled after the proprietary business format of the franchisor. The risk of business failure of the franchisor is further reduced by the improvement in competitive position, reduced vulnerability to cyclical fluctuations, the existence of a captive market for the franchisor's proprietary products and services (due to the network of franchisees), and the reduced administrative and overhead costs enjoyed by a franchisor.


Excerpted from Franchising & Licensing by ANDREW J. SHERMAN Copyright © 2011 by Andrew J. Sherman. Excerpted by permission of AMACOM. All rights reserved. No part of this excerpt may be reproduced or reprinted without permission in writing from the publisher.
Excerpts are provided by Dial-A-Book Inc. solely for the personal use of visitors to this web site.

Meet the Author

ANDREW J. SHERMAN is a partner in the Washington, D.C., office of Jones Day and an internationally recognized authority on the legal and strategic issues of emerging and established companies. He has been interviewed by The Wall Street Journal, USA Today, Forbes, Time, and other publications, and is the author of Raising Capital (978-0-8144-0856-8).

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