By Eric Parker
We believe that franchising has the capacity to put people into business, help them become successful and reduce unemployment. This is precisely what our country needs and for this reason alone, franchising deserves the widest possible support. To ensure that such support is directed at deserving initiatives we need to unmask some concepts that are often confused with franchises.
Not a source of start-up capital
Businesses that are unprofitable or unproven cannot be franchised. UK based franchise guru Martin Mendelsohn, a frequent visitor to South Africa in the late 1980s, was quite clear on this point. He believed that encouraging prospective franchisees to make an investment in an unproven concept and expecting them to help with its development, borders on committing fraud.
Not a pyramid scheme
It is common practice for franchise networks to charge upfront fees. This has caused some people to believe that franchises are akin to pyramid schemes, but this is not the case. The rationale for the existence of a franchised network and the payment of the upfront fee are totally different.
In a franchise, profits are generated through the sale of a viable product or service. In part, the upfront fee paid by franchisees upon joining the network reimburses the franchisor for the cost of training the franchisee and helping him or her to set up the business.
In a pyramid scheme, by contrast, fees are the main income source for its participants. If there is a product involved, it is either of poor quality or overvalued and barely saleable. Participants are encouraged to purchase the rights to a territory and allowed to on-sell rights to parts of this territory to a growing number of individuals who continue to divide the territory into even smaller slices.
As in most countries around the world, pyramid schemes are illegal in South Africa, but this does not stop criminals from targeting the gullible. Reporting on one such attempt, The Star quoted a government spokesperson as suggesting that this type of opportunity cannot go beyond 14 levels of recruitment before grinding to a halt. The original promoters of such schemes rake in large sums of money, while those who join late stand to lose everything
Writing in The Star, Jacob Kosoff, associate lecturer at Wits School of Economics, points out that only the pinnacle of the pyramid can gain rewards since a portion of all members’ investments flows directly up to him or her. Since such a scheme is unsustainable and exploits the uninformed, it is banned in most countries, including South Africa.
Not a business opportunity or a multi-level marketing scheme
Business opportunities and their cousins, multi-level marketing schemes, have a legitimate place in the economy. They occur at various investment levels and offer individuals with limited start-up capital entry into the world of business. This is acceptable, as long as their promoters are transparent about it.
A typical business opportunity is just that: an opportunity to purchase goods at a discount and sell them to others for the participant’s account. Such schemes do not offer the level of initial and ongoing support that is the hallmark of a franchise.
Roughly speaking, multi-level marketing schemes, also known as “network marketing ” schemes, fall into the same category. In most instances applicants receive a certain amount of stock and are given rudimentary sales training in exchange for a fixed initial payment. It is up to them to sell the product, usually in face-to-face situations or product parties.
They are expected to replenish stock at regular intervals. In some cases, they are granted a certain degree of area protection for as long as they maintain agreed sales levels. In addition, participants are encouraged to recruit others to sell the product. They receive an overriding commission based on their recruits’ sales, and on their recruits’ recruits’ sales, and so on, usually up to six.
The primary difference between a pyramid scheme and multi-level marketing is that, in the latter, participants’ income is mainly derived from product sales, not from granting territorial rights.
There is no pleasant way of making this point: to present a business opportunity or a multi-level marketing scheme as a franchise constitute misrepresentation and can only be classified as fraud. However, this does not apply to a hybrid scheme, as described below.
Not a get-rich-quick scheme
Developing a viable franchise takes time. Therefore, franchising cannot be seen as a get-rich-quick scheme. An aspiring franchisor, especially, needs to take a long-term view and accept that a franchise will typically take several years to generate worthwhile returns.
In the meantime, the franchisor needs to fund the creation of the franchise package and pay for the establishment and ongoing operation of the infrastructure needed to recruit, train and support franchisees.
Once the network is established and running properly, a franchise gathers momentum. Anyone who has attended the annual get-together of a leading franchise brand will agree that the energy fuelled by the co-operation of franchisor and franchisee generates a powerful force.
Some real-life examples provide proof of the resilience of franchised brands in the face of aggressive and, or occasion, extremely powerful competition.