FRANCHISE FILE
HOW DO FRANCHISORS FUND ESSENTIAL SERVICES, AND HOW MUCH SHOULD THEY TELL FRANCHISEES? SIMON LORD HAS SOME ANSWERS.
TO BE sustainable, a franchise network needs to be set up with a tried-and-tested model that allows for three things: 1. Sufficient income for franchisees to achieve an acceptable return on their investment; 2. Sufficient profit margin for the franchisor to retain their interest in managing the franchise; 3. Sufficient revenue to fund the support services that franchisees need on an ongoing basis. None of these is easy to get right, which is why new franchisors should always use an experienced and trustworthy consultant. Even if they get the income and profit margin right, getting the third one wrong can cause considerable grief further down the track.
Support services come in a variety of types. There’s research and development – keeping up with market trends, developing new products or services, or trialling new equipment or delivery methods. There’s negotiation – getting the best deals from suppliers or finding new suppliers. And there’s franchise support, which comes in a variety of types, from having office-based specialists in, for example, marketing or IT to field support – visiting individual franchisees to help them improve business profitability and compliance.
For an intending franchisor, it’s easy to underestimate the cost of providing each of these services. Take field support, for example. In the early days, with just a few franchisees to visit, it’s not hard for the franchisor or a senior staff member to ‘drop in’ on a few local franchisees – but once they have a national network of 25 or more, they’re going to need dedicated field staff, all of whom will need a travel and accommodation budget. How are they going to pay for this?
THERE’S MORE THAN ONE WAY TO SKIN A CAT
The truth is that, in many franchises, a franchise royalty of five percent or a flat weekly fee of $x doesn’t generate enough revenue to pay for all the services required, as well as a profit margin for the franchisor. In some cases, therefore, franchisors may charge additional fees for specific services such as training, IT or accounting services. However, in order to provide the overall service, many franchisors look to generate revenue from other sources too. These include: 1. A mark-up or margin on products provided. This means that franchisees pay only for what they actually buy. If the franchisor is manufacturing or wholesaling product, a markup is reasonable provided the product remains competitively (preferably advantageously) priced compared to similar products available on the open market. 2. A commission or rebate paid by suppliers. In some systems, the franchisees pay no fees and the franchisor manufactures no product, but the approved suppliers pay rebates to the franchisor on all products supplied to franchisees. This works as long as franchisees buy only through the approved suppliers, but franchisors need to audit carefully to prevent ‘alien’ products creeping in. 3. A fee, mark-up or margin on services provided. If the franchisor is providing, say, a central booking facility or debt collection services for the franchisees, these might be charged for separately. 4. A margin created by taking the head lease of a property and sub-leasing it to a franchisee. In some cases, this may be the only way a franchisee can get into a certain property, as some landlords prefer to deal with franchisors. McDonald’s have been using this system since the 1950s, when they discovered that the cost of providing franchisee support was greater than their royalty revenue.
KEEP IT HONEST
Many franchisors use a mix of the above methods in their fee processes, which is perfectly reasonable provided they result in fair prices to franchisees. But the concept of rebates, in particular, is currently causing a storm in Australia, where franchisees of certain chains are alleging to a Parliamentary Enquiry that they are paying well over market rates for certain items.
Buying power should be one of the biggest advantages of franchising, and the more a franchise group buys from a single supplier, the less it can expect to pay per item. Some of the discounts negotiated by a franchisor may well be activated only once a certain level of volume is reached, hence rebates beyond that point. But if a franchisor requires franchisees to pay more than they need to in order to increase the franchisor’s own profits, there’s trouble in store. Not only will franchisees’ profitability be hit – so will their level of trust in the franchisor. And that’s a very hard thing to restore.
It’s for this reason, then, that wise franchisors not only ensure good deals for their franchisees but are transparent about what they are receiving and what it is funding. Franchisees might not always like what they are told, but if they understand the reasons for any arrangements, it helps to build trust – not resentment.