The Evolution of Franchising

For many years--like the ancient bones of "Lucy" discovered by Donald Johanson in 1974 and long thought to be mankind's first ancestor--Albert Singer, who founded the Singer Sewing Machine Company in 1851, has been credited with being the first franchisor in the United States. The designation was likely given because his was the most recognized name of the early pioneers that people still remembered.

It was not until 2000, during IFA's Year of the Woman, that Martha Matilda Harper earned the title of first Business Format Franchisor by the IFA for developing the Harper Method shop franchise system. Starting in 1888 and developing into a franchise by 1891, Harper's shops grew into a chain of more than 500 salons and training schools at their peak. After years of decline following her retirement and subsequent death, a competitor acquired them in 1972 and closed the company and the remaining training centers. Some of the chain's clientele included Susan B. Anthony, Jacqueline Kennedy, Helen Hayes, and many other men and women of the times. What distinguished Harper from Singer was her approach to developing a support system and providing branding for the salons. Harper's franchise system incorporated many of the elements we have come to expect in a modern franchise system, including initial and continuing training, branded hair care products, field visits, advertising, group insurance, motivation, etc.

The truth is that the first franchisor in the United States was likely neither Singer nor Harper. While technically the country had not yet been born, the first franchisor in what was to become the United States appears to be one of our illustrious and innovative founding fathers. Almost every schoolchild can give you a list of his inventions: the lightning rod, the flexible catheter (I don't want to know what they used before), swim fins, bifocal glasses, the odometer, daylight savings time, the Franklin Stove, and a library chair that converted into a stepladder, among countless other inventions and improvements. He invented a musical instrument in 1761 called the armonica, for which Beethoven and Mozart both composed music. He gave us our first understanding of the properties of electricity, founded the nation's first hospital, charted the temperatures of the Atlantic Ocean, drafted the Albany Plan, co-wrote the Declaration of Independence, and found time to create the first franchise system on these shores. Back on September 13, 1731, in the city of Philadelphia, Franklin entered into a contract with Thomas Whitmarsh for a "Copartnership for the carrying on of the Business of Printing in Charlestown in South Carolina." The printing shop that Franklin formed with Whitmarsh also published the South-Carolina Gazette as well as being the local printer of many of Franklin's writings including his "Poor Richard's Almanack."

The agreement required that during its six-year term "the Business of printing and disposing of the Work printed shall be under the Care, Management, and Direction of the said Thomas Whitmarsh and the working Part performed by him or at his Expense." Further Whitmarsh was obligated to purchase his printing material from Franklin: "Thomas Whitmarsh shall not during the Term of the Copartnership aforesaid work with any other printing Materials than those belonging to the said Benjamin Franklin." Whitmarsh even agreed to an in-term covenant that he would not be in any other business but printing, "...nor follow any other Business but Printing during the said Term, occasional Merchandize excepted." The agreement did not impose any of these restrictions on Franklin, which was essential if Franklin were to enter into similar arrangements elsewhere.

Franklin during this period was the Postmaster General of the Colonies, enabling him to control, to a great degree, the distribution of news. From that position of power, Franklin entered into similar relationships with other printers throughout the Colonies. During his long stay in France, where he successfully negotiated the French participation in our War of Independence, a substantial portion of his income came from his franchised chains of printing stores. Without the French, there is little doubt that there would be no United States today; and without the income that Franklin earned from franchising, and which supported him for many years, the argument can be made that his enlistment of French support would not have been possible.

In addition to Franklin, there are references throughout U.S. business history about government monopolies and early business relationships that appear to be quite similar to modern-day franchising. These include Robert Fulton's licensing of his steamboats in the United States, England, Russia, and India and the licensing of general stores at military outposts and certain markets that sold livestock and other goods in which exclusive territorial or other rights were granted.

Back in the day

Throughout its long history, three constants have fueled the growth of franchising: 1) the desire to expand and control, 2) limitations on human and financial capital, and 3) the need to overcome great distances. The use of franchising can be traced to the expansion of the church and as an early method of central government control, probably before the Middle Ages. Some historians have written that franchising may 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, this is a reasonable assumption. Lloyd Tarbutton, in Franchising: the how-to book, dates the first business format franchise to China in 200 B.C.

Franchising was used in England and Europe, where the Crown owned lands and other properties and granted land rights to powerful individuals. In exchange for these land grants, the noblemen were required to protect the territory by establishing armies and were free to set tolls and establish and collect taxes, a portion of which was paid to the Crown. As it was an agrarian society, control over the land represented an enormous power and was the foundation for the feudal system in which the nobles paid "royalties" to the Crown for the rights to own and work the land. In turn, the nobles divided the land among the local farmers or vassals who paid for that right, usually with a portion of the crops they grew. This system of governmental control existed in England until being outlawed at the Council of Trent in 1562.

The story of Robin Hood was simply the tale of such a franchise relationship, with King Richard as franchisor, Prince John as his master franchisee, Robin's family (the Lockslies) as the local nobles in Nottingham, and the local citizens working the land for the Lockslie family. The Sheriff was undoubtedly just a poorly trained field consultant. Among its other lessons, the story shows the danger to a franchisor of international expansion before your domestic operation is ready.

With the economic opportunities presented by the discovery of the "New World," the colonialism of the period, and the emerging international trading opportunities in Asia and Africa, governments and private companies used franchising to expand and exercise control over great distances.

The Dutch East India Company, founded in 1602 as a franchisee of the Dutch Republic, conducted trade between the Cape of Good Hope and the Straits of Magellan. The company's stock was valued at 6.5 million guilders at the time. Acting almost as a sovereign power, they conquered territory from the Portuguese and established a headquarters in Jakarta in 1619 as a base for trade with Japan. In 1641, the Dutch East India Company fought off British attempts to break into the spice trades and, turning west, engaged the services of Captain Henry Hudson to explore the New World. Up until 1609, Hudson had been an employee of the English Muscovy Company, a franchisee of the British government. His finding of the Northeast Passage gave the Dutch their claims over the Hudson Valley in upstate New York as far as Albany. By 1799, fortune turned against the Dutch East India Company, which filed for bankruptcy. All of the assets of the company were taken over by the Dutch Republic.

In 1607, the King of England granted a charter for Virginia to the London Company, which hired Captain Christopher Newport to settle the area. Captain John Smith succeeded Newport in managing the first permanent British settlement in the New World, which was named Jamestown. The story of Jamestown is well known, and following the massacre of 347 settlers by the Powhatan Indian Confederacy on March 22, 1622, the King of England, charging mismanagement of the area by the London Company, withdrew its charter. In 1624, the Colony of Virginia came under direct British control. Much of the colonization and exploration by the British and European powers in the New World were conducted under similar "franchise" relationships.

Franchising originated in Britain and Europe by the brewery industry to create a downstream distribution system for their products. Tavern owners, in exchange for financial assistance from the breweries, agreed to purchase all of their beer and ale from the sponsoring breweries. The breweries did not exercise any controls over the operation of the local tavern except for the sole purchase arrangement and were similar to Product and Trade Name franchising in the U.S. today.

Back in the USA: innovation

At the turn of the twentieth century, the growing mobility of Americans served as the impetus for the establishment of the country's retail and restaurant chains and manufacturing base. But it was an Englishman, Frederick Henry Harvey, who founded the first restaurant chain in the U.S. around 1850. Although his first restaurant failed during the Civil War, Harvey opened the first of the Harvey House restaurants in 1876 in a terminal of the Atchison, Topeka & Santa Fe Railroad. The railroad wanted to open depot restaurants for its passengers and provided Harvey with locations and free transportation of restaurant supplies. By 1887, there was a Harvey House restaurant every 100 miles along the 12,000?mile?long Atchison, Topeka & Santa Fe line. Harvey believed strongly in quality control, established regular field visits to his restaurants, and provided services similar to those used today by franchisors. The Harvey House chain was company-owned, but many of the lessons learned by Harvey became part of the structure of franchises later on.

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 his partner, Frank Wright, began to make A&W Root Beer. Needing capital to expand, Allen bought out Wright in 1924 and began to franchise the A&W concept. The A&W restaurant offered car-side service provided by "tray boys," and later added women servers, or "car hops," on roller skates to serve the customers.

One early A&W franchisee was J. Willard Marriott, who opened restaurants in Fort Wayne, Ind. and Washington, D.C. during the 1920s. Marriott and his partner, Hugh Colton, opened the first A&W restaurant in Washington, D.C., and grossed $16,000 in their first year in business. As with many early franchisess, they brought innovation to the A&W brand. Marriott thought he could increase unit sales if he could get permission to add food to the restaurant. Today A&W is one of the brands in the Yum! system.

Because of 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 created many modern innovations in the quick-service restaurant 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. Borrowing liberally from the White Castle format, R. B. Davenport in 1932 opened the first Krystal restaurant, which began franchising only in 1990.

During that same period, Howard Dearing Johnson acquired a pharmacy in Quincy, Mass. and began to sell three flavors of ice cream together with a limited menu of cooked items in his Howard Johnson restaurants. Howard Johnson awarded its first franchise to Reginald Sprague in 1935, and over the years expanded its menu to include 28 flavors of ice cream. Developing a distinctive roadside presence with its orange-roofed buildings, 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 the innovations of the early restaurant pioneers are still influencing franchising today, it was the automobile industry and the movement of a growing nation that created the opportunity and the need for these early restaurant chains to grow.

Many of the legendary franchised restaurant chains that began franchised operations over the next three decades include Kentucky Fried Chicken, established in 1930; Carvel, established in 1934; 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.

Hard lessons lead to growth

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 Singer Sewing Centers, McCormick Harvesting Machine Company, to a limited extent in the Harper salons (above), and later in the automotive and beverage franchises.

The Industrial Revolution in the U.S. started the mass production of consumer goods and created the opportunity for companies to produce manufactured goods at lower costs. This fueled consumer demand--and the need to sell and distribute products efficiently and cost-effectively over greater distances. Many methods of sale and distribution had been tried before franchising, including direct factory sales, sales through non-branded locations such as pharmacies, direct mail, and traveling salesmen. Ford Motor cars were originally sold through pharmacies. All of these methods were insufficient to achieve the downstream distribution needs of the manufacturers; the use of local sales representatives was most effective. General Motors sold its first franchise in 1898 to William E. Metzger of Detroit. By selecting franchisees and providing them with exclusive territories, hard goods manufacturers like GM and Ford were able to bring their products to market effectively and efficiently, and over longer distances.

As the auto manufacturers solved their distribution challenges and began the changeover from steam to internal combustion engines, the need to establish locations for these vehicles to obtain gasoline became critical. Lacking the capital required for purchasing real estate and establishing an adequate distribution system to meet the needs of the growing number of automobiles, the oil industry began to establish franchised dealerships across the country.

At the turn of the century, the high cost of transporting finished product in glass bottles kept soft drink bottling a localized industry. By shipping syrup concentrate to franchisees and requiring bottling under strict formulas and processes, soft drink manufacturers like Coca-Cola were able to control the quality of their product in distant markets, enabling rapid expansion without the need for the capital that company-owned development required. Franchisees obtained the rights use the Coca-Cola formula and valuable trade name, and the bottlers were able to overcome the transportation issues that had, until then, restricted their growth. In 1901, Coca-Cola issued its first franchise to the Georgia Coca-Cola Bottling Company.

Most of the early franchises were manufacturers, although some, like Martha Matilda Harper and Rexall were primarily service-based. In 1902, Louis Liggett formed a manufacturing cooperative among 40 independent drug stores, each investing $4,000 to start the manufacturing cooperative of the Rexall Drug Store chain. 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. The main service provided by the Rexall franchisor was its ability to efficiently buy and distribute products for the franchisees, not necessarily the ability to sell product they manufactured directly.

One of the greatest innovations in franchising came in 1909 with the establishment of the Western Auto franchise. Up to that time, product franchisors 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 markup on product sales to its franchisees (rather than royalties on sales), Western Auto, similarly to the Harper system, provided its franchisees with many of the same services 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 until the beginning of World War II, its truly explosive growth did not occur until after the war was over. Franchising emerged as a force in the post-war 1950s, taking advantage of pent-up consumer demand, available franchisees, ideas from returning veterans, and capital provided by separation pay and the GI Bill. The growth of franchising was further advanced by a change in trademark law that allowed franchisors to safely license their federally protected trademarks and service marks to their licensees. The Trademark Act of 1946, better known as the Lanham Act, provided trademark protection that became essential for modern franchising. Once potential entrepreneurs became confident of trademark and logotype integrity and protection, more and more individuals flowed into selling and buying franchises.

Franchising boomed in the 1950s and '60s and achieved almost mystical stature. Franchisors of convenience goods and services grew. Companies like McDonald's, Burger King, Wendy's, Kentucky Fried Chicken, laundry and dry cleaners, hotels, rental cars, automotive aftermarket, and temporary help companies proliferated throughout the U.S. By 1965, McDonald's had grown to about 1,000 units in only ten years and made its first public offering, which opened at 22, closed the day at 30, and closed its first month at 50. Nate Sherman's Midas Muffler during the same period had grown to 400 locations, while Kemmons Wilson's Holiday Inn grew to 1,000 locations and Jules Lederer's Budget Rent A Car opened its 500th franchise.

Time for some rules

The growth in franchising did not come without problems. By the latter half of the 1960s, the bloom had left the rose. Many franchisors focused more on the sale of franchises than on operating their systems and providing services to their franchisees. Many franchisors during that period made misrepresentations in the promises they used to attract franchisees, some based their sales effort on the use of celebrity names and endorsements, and many of those franchise systems failed. Some even sold franchises for concepts that didn't exist.

Out of these problems, franchise regulations began to emerge. Since 1968, beginning with the enactment of disclosure laws in California, various states have enacted laws regulating the offer and sale of franchises. Generally, these laws required franchisors to deliver to a potential franchisee, in advance of a sale, a disclosure document providing specified information on the opportunity. But it was not until the summer of 1979 that the Federal Trade Commission issued its Trade Regulation Rule on Franchises and Business Opportunity Ventures (the "FTC Rule"), which required franchisors in the U.S. to prepare a pre-sale Offering Circular and established minimum disclosure requirements nationwide. The FTC has proposed several changes to the format and content of the disclosure documents, and these new disclosure requirements will soon be in effect.

The emergence of sensible franchise disclosure regulation has been one of the most significant reasons for the success of franchising in this country. While most franchisors have always operated their businesses with integrity, the stain on franchising from the activities of the con artists of the post-World War II era made franchising seem more similar to multi-level marketing and other less reputable investment opportunities than to a reliable and generally safe investment. Today, it is because of franchise regulations that most investors, including Wall Street, view franchising favorably. While there are still tensions in the franchise relationship (and likely always will be), for the most part the issues between franchisors and franchisees are no longer based on how the franchise was originally sold, but on more substantive issues dealing with the management of the relationship.

According to the 2003 International Franchise Association Education Foundation study on franchising in the U.S., franchising accounts for approximately 760,000 businesses producing approximately $1.53 trillion, or 10 percent of our national output. Fully 9.7 million people work directly for franchisors and franchisees, and when you factor in the suppliers to franchising, more than 14 percent of all U.S. private-sector jobs have been created because of franchising. While there have been no documented studies in decades about the safety of franchise investments, the perception in franchising is that investing in franchising has significant benefits over non-franchised independent small-business ownership.

It is interesting to note that tracing the course of franchising demonstrates the difference between history and evolution. History is a documentation of what has happened in the past and is no more. Evolution is the tracking of an ongoing phenomenon that has continuously changed over the years and keeps altering its present form and future course. No one can doubt that the evolution of franchising has also been a genuine revolution of ideas, business concepts, and the entire economic process.

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.

One closing note on the future. In "The Demolition Man," a movie released in 1993, Sylvester Stallone awakens in the middle of the 21st century from a cryogenic sleep and is taken to a "fine restaurant" for dinner. As the car he is riding in pulls up to the restaurant you see a Taco Bell sign. Stallone's character, a product of the 1980s, is surprised and asks, "Taco Bell? I thought we were going to a great restaurant. Is this a mistake?" To which his driver replies, "Not at all. Since the great franchise wars, all restaurants are now Taco Bell."

Michael Seid is founder and managing director of MSA, the nation's leading franchise advisory firm (www.msaworldwide.com).