Where It All Began: The Evolution of Franchising
TASA ID: 11532
There are references in American history to early business relationships which, while possibly not meeting the current FTC definition, were without a doubt, franchise/licensing relationships. These relationships existed in the selling of wares from town-to-town by peddlers, licenses granted for general stores at military outposts, and certain livestock sales and other goods in which exclusive territorial rights were granted to the "franchisees" by the holder of the rights. Unfortunately, while the relationships are mentioned in the literature, the names of these early franchise founders and the structure of the business arrangement are not.
Throughout its long history, there have been four constants that have fueled the growth of franchising, the desire to expand, the lack of expansion capital, the need to overcome distance, and managing people from a distant location.
The use of franchising can be traced to the expansion of the church and as an early method of central government control, probably as far back as the Middle Ages. Some have written that it may indeed date back as far as the Roman Empire or earlier and given the necessity of large territorial controls, coupled with the lack of modern transportation and communication at the time, there is reasonable basis for this assumption.
Franchising was also used in England and Europe, where Royalty granted land rights to powerful individuals. In exchange for these land grants, the noblemen were required to protect the territory for the monarchs by establishing an army and were free to set tolls and establish and collect taxes, a portion of which was paid to the monarch. As it was an agrarian society, the control over the land represented enormous power and was the foundation for the feudal system. It occurred to me recently, that the movie Robin Hood, starring Errol Flynn, was simply the tale of a franchise relationship that went bad, with King Richard as the franchisor, Prince John as the master franchisee and the Lockslie family as the vociferous, disenchanted franchisee.
This system of governmental control existed in England until it was outlawed at the Council of Trent in 1562. With the economic opportunities presented by the discovery of the New World, colonialism of the period, and the emerging international trading opportunities, franchising was again used by government to expand and exercise control.
The Dutch East India Company was founded in 1602 by the Dutch Republic to conduct all trade between the Cape of Good Hope and the Straits of Magellan. The Company was capitalized by stock valued at 6.5 million guilders. The company, acting as a sovereign power, conquered territory from the Portuguese and established its headquarters in Jakarta in 1619. From that base, it created a monopoly of trade with Japan in 1641 and fought off British attempts to break into the spice trades. Turning west, the company engaged the services of Captain Henry Hudson in 1609, who was formerly in the employ of the English Muscovy Company, a franchisee of England, to find the Northeast Passage, giving the Dutch claims over the Hudson Valley in upstate New York as far as Albany. In 1799 the Dutch East India Company filed for bankruptcy and its possessions and rights were assumed by the Dutch Republic.
In 1607 the London Company was granted a charter for Virginia by England and hired Captain Christopher Newport to locate and settle the area. The story of Jamestown, the first permanent British settlement in North America, and Captain John Smith, who succeeded Captain Newport in managing Jamestown, is well known. Following the massacre of 347 settlers by the Powhatan Indian Confederacy on March 22, 1622, the British Crown, charging mismanagement of the area by the London Company, withdrew its charter in 1624 and the Colony of Virginia came under direct British control.
Much of the colonization and exploration by the British and European powers was conducted under similar "franchise-type" relationships.
Franchising, as a business concept, was transplanted into the United States from England and Europe where it was used "commercially" in the tavern and brewery industries. Tavern owners, in exchange for financial assistance from the breweries, agreed to sole purchase agreements with the breweries. The breweries did not exercise any controls over the operation of the local tavern except for the sole purchase arrangement.
It is important to understand in examining the birth of franchising in the United States that prior to franchising there was limited experience in chain operations. Chain operations would ultimately form the foundation for the franchise method of distribution.
Not surprisingly, transportation and the growing mobility of Americans were the impetus for the establishment of retail and restaurant chains and franchising in the manufacturing segments of the economy.
The earliest known restaurant chain in the United States was founded in the 1850's by Frederick Henry Harvey, an Englishman who opened his first restaurant in 1852. This initial restaurant failed during the Civil War. In 1876, Frederick Harvey opened the first of the Harvey House restaurants in a terminal of the Atchison, Topeka & Santa Fe Railroad. The railroad wanted to open depot restaurants for its passengers and provided Frederick Henry with locations and free transportation of restaurant supplies. By 1887, there was a Harvey House restaurant every hundred miles along the 12,000-mile-long Atchison, Topeka, & Santa Fe line. Frederick Harvey believed strongly in quality control and established regular field visits to his restaurants similar to those used today by franchisors.
Following World War I, the advance of the automobile gave birth to another restaurant innovation, the drive in. In 1919, Roy Allen purchased the formula for his root beer recipe from a pharmacist and, together with Frank Wright, started A&W Root Beer. Needing capital to expand, Allen bought out his partner in 1924 and began franchising the A&W concept. A&W offered car-side service with "tray boys." Later A&W added female "car hops" on roller skates to service its customers.
One of A&W's early franchisees was Sherman and J. Willard Marriot who opened franchises in Fort Wayne, Indiana, and Washington, D.C. in the 1920's. The Marriots' first A&W in Washington was owned by J.W. Marriot and his partner Hugh Colton and grossed $16,000 in its first year. As with many of today's franchise systems, it was the Marriots as franchisees of A&W who brought innovation to A&W when they requested permission to add food to the restaurant to increase the unit sales.
Using the automobile, curb service, and an innovative hamburger cooked on onions, Billy Ingram and Walter Anderson opened their first White Castle restaurant in 1921 in Wichita, Kansas. White Castle is credited with many innovations in the fast food industry, particularly in their use of advertising and discount marketing, the first take-out packaging to keep the food warm and the folded paper napkin. While it is still a company-owned operation in the United States, White Caste has commenced international expansion via franchising. Copying the White Castle format, in 1932 R.B. Davenport opened the first Krystal restaurant and began franchising in 1990.
During that same period, Howard Dearing Johnson acquired a pharmacy in Quincy, Massachusetts, and began to sell three flavors of ice cream together with a limited menu of cooked items. In 1935 Howard Johnson awarded its first franchise to Reginal Sprague. Over the years the concept increased to an expanded menu and to 28 flavors of ice cream. Developing a distinctive roadside presence from orange roofed locations, and featuring one of the first pylon signs with its name and logo, the company secured the first turnpike contract on the Pennsylvania Turnpike.
While it was the innovation of the restaurant pioneers that established their menus, methods of operations and standards, it was the automobile and the movement of a growing nation that created the opportunity for these early restaurant chains to grow.
Many of the legendary franchised restaurant chains that began franchised operations over the next three decades included Carvel, established in 1934; Kentucky Fried Chicken, established in 1930; Dairy Queen, established in 1940; Dunkin Donuts, established in 1950; Burger King, established in 1954; McDonald's, established in 1955; and The International House of Pancakes, established in 1958. The stories of these early pioneering concepts have been the basis for many books over the years and the lessons learned are evident in the many food service chains that followed.
Tracing back to the late 1800's, the automobile and the growing mobility of Americans again become the basis for other early developments in franchising.
The earliest non-food franchises were relationships in which manufacturers established licensed selling and service locations for their manufactured goods through franchising. This can be seen in the establishment of Singer Sewing Centers and McCormack Harvesting Machine Company Dealerships in the 1850's and 1860's and the birth of the automotive franchises at the turn of the century by General Motors and Ford. The first franchise for General Motors was issued in 1898 to William E. Metzger of Detroit.
The American Industrial Revolution began the mass production of consumer goods. It was mass production which created the opportunity for these companies to produce manufactured goods at lower costs which fueled consumer demand and the need to sell and distribute the products efficiently and cost effectively. Many methods of sale and distribution were tried before franchising including direct factory sales, sales through non-branded locations such as pharmacies, direct mail and traveling salesmen. While all proved to be insufficient to satisfy the needs of the company, local salesmen were the most effective.
By selecting franchisees, and providing them with exclusive territories, hard goods manufacturers were able to effectively and efficiently bring their products to market.
As the automobile manufacturers solved their distribution problems through franchising and began the changeover from steam engines to internal combustion engines, there became a need to establish locations for these vehicles to obtain fuel. Lacking the capital required to purchase the real estate and establish an adequate distribution system to meet the needs of the growing number of automobiles, over the next 30 years the oil industry began to establish dealerships through franchising.
At the turn of the century, because of the high cost of transporting the finished product and the reusable glass bottles, American soft drink bottling was a localized industry. By shipping syrup concentrate to its franchisees, and requiring the local franchisees to bottle under strict formulas and processes, bottlers were able to control the quality of their product in distant markets, and expand rapidly without the need for the capital which company ownership would have required. Franchisees obtained the rights to exclusive markets and a valuable trade name and the bottlers were able to overcome the transportation issues that had to that time restricted their growth. In 1901 Coca Cola issued its first franchise to the Georgia Coca Cola Bottling Company.
Most of the early franchises were all based on a product line sold to its franchisees. During the 1850's and 1860's both Singer Sewing Machine and McCormack Harvesting Machine Company began franchising the sales and service of their equipment. In 1902 Louis Liggett formed a manufacturing cooperative with 40 independent drug stores, each investing $4,000 to start the manufacturing cooperative under the Rexall name. Following the end of World War I, the Rexall cooperative began to franchise independently owned retail outlets under the Rexall trade name, supplying franchisees with branded Rexall products.
One of the great innovations in franchising came in 1909 with the establishment of the Western Auto franchise. Up to that time, product franchisers sought franchisees with industry experience and, except for the supply of branded product, did not provide any significant business related services. While still relying on the mark-up on product sales to its franchisees rather than royalties on sales, Western Auto provided its franchisees with many of the same services which modern franchisors provide today. These included site selection and development, retail training, merchandising, marketing assistance and other continuing services. Western Auto also sought franchisees without industry experience as many franchisors do today.
While franchising continued to grow up until the beginning of World War II, the truly explosive growth in franchising began at the end of the war.
Franchising emerged as a force to be reckoned with in the post war 1950's, taking advantage of pent up consumer demand, available franchisees, ideas from the returning veterans and capital provided by separation pay and the GI bill. The growth of franchising in America was further advanced when prospective franchisees were assured of safety using federally protected trademarks and service marks, essential to the successful local operation of a nationally established franchise system.
Before Congress enacted the Trademark Act of 1946, better known as the Lanham Act, trademark protection was at best inconsistent and uncertain.
Once potential entrepreneurs became confident of trademark and logotype integrity and protection, more and more individuals flowed into the selling stream of franchising in the 1950s and 1960s.
The franchising boom in the 50's and 60's achieved almost mystical stature. Franchisors of convenience goods and services grew. Companies like McDonald's, Kentucky Fried Chicken, Laundry and Dry Cleaners, Hotels, Rental Cars, automotive aftermarket and temporary help companies proliferated in the marketplace. By 1965 McDonald's had grown to approximately 1000 units in only ten years and made their first public offering opening at $22.50. It closed the same day at $30 and closed the first month at $50. Nate Sherman's Midas Muffler during the same period had grown to 400 locations, Kemmons Wilson's Holiday Inn grew to 1000 locations and Jules Lederer's Budget Rent A Car opened their 500th franchise.
The growth in franchising did not come without problems. By the latter half of the 1960's the bloom was off the rose. Many franchisor companies focused more on the sale of franchises than on operating their franchise systems. Some franchisors made misrepresentation in attracting franchisees; some based their sales effort on the use of celebrity names and endorsements and failed. Some even sold franchises for concepts that didn't exist.
Due to the problems of the 50's and 60's, several states led by California began to enact laws governing the disclosure of information provided to potential franchisees. These states required the franchisor to deliver to a potential franchisee a disclosure document providing information explaining the opportunity. It was not until the summer of 1979 that the federal government promulgated Federal Trade Commission Rule 436 which established minimum uniform disclosure requirements throughout the United States.
Today, the format and content of the newer FDD disclosure documents have undergone change to strengthen disclosure at the federal and state level and to further regulate franchising. Some would say that the pendulum has swung too far and unduly burdens legitimate franchise companies from utilizing the franchise system to establish new channels of distribution.
Today, more than 4,000 franchisors and over six hundred thousand franchisees testify to the increasing growth of an industry that has burgeoned forth from roots dating back at least 2,000 years.
The evolution of modern franchising, created by the innovative companies and the pioneers that have led them, is an exciting tale in itself. The future, energized by still unimagined new concepts, new business techniques and international expansion, promises to add still more dynamic chapters to the continuing and growing adventure of franchising.
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