Franchising Your Business: How to Keep the Franchise Relationship in Balance
PrintA franchising relationship works when it is in “business balance”-- that is, when both sides are receiving the value they need from the relationship, value they can get nowhere else. Underlying every balanced franchise relationship is a fundamental business exchange of intellectual property, services, cooperation, and money. Understanding that exchange and maintaining the business balance of the franchise relationship is the key to franchise success.
The Basic Exchange. At the most basic level, the franchisor provides its intellectual property (trademark, knowhow, trade dress) in exchange for the franchisee’s investment dollars and willingness to both receive training and follow the business system provided by the franchisor. What the observer sees of this exchange is a payment of money and an initial training program, the first phase of the process by which the franchisor delivers its all-important knowhow to the new franchisee.
Virtually all franchise programs require a substantial initial investment by the new franchisee. The initial franchise fee can run up to $50,000, and typically covers the franchisor’s initial expenses – recruiting, training, site evaluation, opening assistance. I advise new franchisors considering how to arrive at their initial franchise fee that it should cover initial expenses and not far exceed them or it will weigh down the finances of the new franchisee. A well-balanced fee structure charges the franchisee fairly for value received, and roughly approximates what it might cost the franchisee to purchase those services in the marketplace.
Building Blocks. The franchise relationship builds on the basic business exchange. The details of the business operation are conveyed by an operations manual, which is increasingly provided online, behind passwords. The manual provides the detailed requirements and guidelines of the system, is highly confidential, and is usually incorporated into the franchise agreement itself. It is the single most important expression of the knowhow conveyed to franchisees, and is often used in the training process.
The franchisee brings to the table a willingness to take the lead in developing and operating the new business according to plan, a commitment to the mutual efforts to promote the brand, cooperation in the effort to improve the business systems, and a continuing payment to the franchisor of ongoing royalties (typically 3 percent to 6 percent of the gross sales of the franchised business) in return for participation in the franchise program.
Fee and Buying Power Balance. One of the obvious advantages of being part of a large group of same-brand retailers is that it maximizes a franchisee’s wholesale buying power. When a franchise system harnesses that power and substantially drops the costs of the franchisees’ inventory through negotiated distributor discounted prices and rebates, it can actually offset the royalty expenses incurred by the franchisee, and the business is, in an important sense, balanced.
Information Balance. A well-established franchisor is an invaluable source of market information for an individual franchisee, providing in-brand and competitor feedback, new product testing ideas, trends, and peer reassurance. This is an important intangible benefit to the franchisee, an information stream not available to an independent owner.
Advertising. Another obvious advantage of a network of retail businesses under the same brand is the power to purchase advertising that would be out of reach for an independent business. Most franchise systems leverage this power by requiring each franchisee to contribute a percentage of gross sales, usually ranging from 1 percent to 2 percent, to a pooled advertising fund to be spent to promote the common brand. In well-established systems there may be a monthly product promotion package sent to franchisees, including window banners, printed tabletop tents, and other point-of-purchase materials coordinated with radio, television, or print advertising, all purchased through the pooled advertising fund.
In all healthy franchise systems the franchisor-franchisee relationship is in careful balance for the duration of the relationship. In great franchise systems, where the franchisor appreciates and values of the financial well-being of the franchisees on the ground in the marketplace, the balance of value received for the price paid is designed to tip decidedly toward the franchisee.
Andrew Caffey is one of the nation’s leading franchise legal specialists and he represents franchisors across the United States. Caffey served as General Counsel of the International Franchise Association, a member of the Governing Committee of the ABA Forum on Franchising, and Chair of the ABA Forum on Franchising. He also is a member of the bar in Maryland and the District of Columbia, and a member of the Panel of Neutrals of the American Arbitration Association. Caffey has appeared on numerous franchise programs and is a frequent speaker and author on subjects of franchise and business opportunity regulation.
