Is a master franchise the best option?

It is conventional to grant a master franchise when expanding internationally. But are there better options? 

To decide on whether using master franchising is the best fit you need a different way of looking at your business plan. This new analysis will test whether you fully appreciate what are the risks and benefits of master franchising and whether they are the ideal fit for the future of your business and the needs of your franchisees.

THE RIGHT WAY TO EXPAND INTERNATIONALLY

It is essential that you have a clear business plan and then evaluate whether master franchising will be the best method to achieve that plan. It is vitally important that you know when master franchising as a method could be the wrong option for your business costing you millions of dollars in lost revenue.

In your business plan you need to have decided:

• your existing business operations are running profitably
• you have a sustainable competitive edge in the international target markets
• you have sufficient financial and management resources to devote to the new International project but not enough to complete it through a wholly owned subsidiary
• your organisation is confident at dealing at distance, with different time zones, currency, legals, local customs and languages
• what are the acceptable risks you are willing to commit to in the establishment and ongoing operation of the overseas activities
• a clear social media and marketing campaign appropriate for the target country
• the key strengths and expertise of the party to operate your franchise in the foreign country\
• what to do if all of your well thought out plans end up in disaster

ASSESS THE RISKS

With a documented business plan in hand, it is now time to assess the risks and benefits of whether the master franchising route will be the best method to achieve your aims. Like every business method, there are pros and cons which must be precisely understood so that if needed a decision can be made to walk away either from the country or from particular negotiations with a master franchisee.

Your management team as the guardian of your franchise brand must fully understand what is involved in the master franchising process as it is usually a long-term commitment of several decades and will directly influence the success of the brand worldwide.

Equally vital is to ensure that the negotiated terms work best for the strengths of the foreign country representative as a poor fit is likely to lead to failed performance targets, damage to the brand, opportunities for competitors and ultimately expensive disputes.

ELEMENTS OF MASTER FRANCHISING

A master franchise is established through a detailed contract which sets out the roles, responsibilities and performance obligations placed on your own business and on the potential master franchisee. This contract passes over effective control into the hands of the master franchisee to operate your franchise system either directly or via a sub-franchise model.

A considerable amount of time should be spent in preparing this documentation in advance of further enquiries into the target country because once it is signed the franchisor has in effect handed over the franchise and allowed the master franchisee to hold itself out as the owner of the franchise brand.

Each role and responsibility in the master franchise agreement needs to be costed in detail, assessed for likely profit to be generated from each activity, balanced depending on the anticipated skills of the master franchisee and the laws of the target country.

Many businesses fail to undertake this step and so are not able to evaluate which clauses of the agreement affect economic viability and the determinators on the percentage royalty and return on investment for both the franchisor and the master franchisee.

NEGOTIATING STRATEGIES

The most common situation is that the franchisor seeks to enter a new country without having a proven business model within the target country. Consequently it is vital to have detailed knowledge of the target country so that during negotiations there is a rational and justifiable argument for the master franchisee to pay initial master franchise fees which are often substantial.

Typically a franchisor will calculate the initial master franchise fee as either:

• a pre-set arbitrary fee because someone paid a similar fee in another country
• a fee to cover real costs plus a profit margin
• a development fee entitling a certain number of locations to be established with a right to pay again for additional locations
• a fee that is justified by projected return on investment justified on detailed methodologies, technology and operating support provided by the franchisor
• an amount as a prepayment for discount of future royalties

In turn a master franchisee will want to learn sufficient information about your brand to understand whether they are better off purchasing the rights from you or walking away or setting up in competition with you.

It is a very unwise franchisor that relies on the protection of a confidentiality agreement when proceeding with these negotiations. It will always be a calculated risk as to the level of information that is supplied and when essential know-how can be, if ever, disclosed. External consultants will often need to be brought in to assist in making this decision.

The master franchisees will usually ask:

• what skills do you expect me to have?
• what knowledge do you already have about my country?
• what makes your franchise competitively better and able to be better than competitors?
• what assistance will you provide when current plans are not successful?
• what protection will you provide if the reputation of the brand is damaged internationally? will all critical information be held in escrow by a reputable stakeholder while we learn to trust each other?
• for details of each dispute within the franchise system
• are there any aspects of the franchise system that must be purchased from the franchisor after the initial set up?
• how often will you travel to my country to provide in country assistance and training over the next five years?

These are challenging questions and often difficult to answer at an early stage in the business relationship.

These questions are carefully used by a master franchisee to determine what will be the future relationship that could exist with you as franchisor and both parties must quickly determine whether they can exchange information confidentiality and with a level of commercial trust.

When taking to account cultural and language difficulties it is vital that both parties are assisted by experienced experts to avoid the dangers of misunderstanding, overconfidence and gullibility.

MASTER FRANCHISING: TOO GOOD TO BE TRUE?

The usual reason to proceed along the master franchise path is to enable a franchisor to expand quickly using the capital and local country knowledge of an experienced master franchisee. Where the master franchisee is correctly selected the results can be impressive providing significant growth via wholly-owned or sub-franchised units.

However a study of 142 master franchise ventures across 37 countries found that only 39 percent survived until the end of the initial development commitment period of typically five years.

Franchisors will see from these figures that greater research and preparation is needed for international success.

As an illustration of how difficult it is to legally enforce international master franchise agreements only five of the 87 failed ventures resulted in reported lawsuits. Many of the failures could have had a negotiated settlement but unfortunately many would have been simply the franchisor walking away[1].

Unfortunately, most franchisors will admit:

• the size of the master franchisee territory should have been smaller
• key performance targets were never achieved and even harder to enforce
• royalty payments and gross revenue were understated by the master franchisee
• everything was more complicated than expected
• return on investment was diluted due to delays, unexpected tax consequences, import duties and additional management time devoted to oversee and check on the master franchisee
• sub-franchisees complain that they are not getting proper support from the master franchisee which in turn lowered gross revenue and royalty payments
• high turnover of master franchisee management, degrading overall skill capabilities
• the master franchisee had too much control and would not follow directions promptly or at all
• the master franchisee owned multiple brands which initially seemed a benefit but turned out to be a disadvantage
• the foreign country legal system was either ineffective, too slow or too expensive to resolve disputes

REGIONAL OR AREA DEVELOPERS

A master franchisee is given the direct right to grant sub franchises and also to open their own locations. Instead, a regional developer works on behalf of the franchisor to recruit potential sub-franchisees and the franchisor directly grants sub-franchise rights and retains control over legal and communication channels with those that are operating individual locations.

A regional developer will be granted a smaller development area and obliged to recruit, train, mentor and oversee franchisees. The franchisor can step in and take over those obligations promptly to protect the reputation of the brand and can always collect royalties directly from each franchisee.

A regional developer is often expected to own at least one franchise so that they have a full practical understanding of the operation of the franchise business but are not required to invest millions of dollars in additional infrastructure, a commitment usually demanded of a master franchisee.

Both a regional developer and the master franchisee have key performance targets. If either fails a franchisor would like to step in and appoint a replacement.

Legally this task is more straightforward when dealing with a regional developer territory as typically the regional developer has no income until paid by the franchisor whereas during a dispute a master franchisee will often continue to collect all royalties and often refuse to pass on any to the franchisor.

Both will be heavily involved with recruitment of franchisees and growth of franchise units within the territory.

However once the territory reaches maturity it is far easier to persuade a regional developer to move on to a new territory as there will be a marked increase in revenue generated through new recruitments. Conversely, it is more difficult to move on a master franchisee as they see increasing revenues and less work as their territory reaches maturity.

REGIONAL DEVELOPER’S SKILL SET

When selecting a regional developer, that person may not always have the full set of skills capable of great recruitment of franchisees together with ongoing management and training expertise to ensure that franchisees can perform their tasks to the high standards needed to protect your brand and generate good revenues.

As each of the required skills is found to be less than adequate, the advantages over a master franchisee diminish.

However with good initial investigation, this can be identified quickly so that the wrong appointment can be avoided, an investigation task which is far more difficult when dealing with a corporate master franchisee who will often tell you that their multi brand status proves that they have the skills without them opening up to proper scrutiny.

WHAT IS THE RIGHT CHOICE?

The seven-point checklist is:

1. Have you decided on international expansion for the right reasons?
2. Does your franchise brand require the benefits that a master franchise process offers?
3. Could your brand be better served using a regional or area developer process?
4. If a compromise international expansion model is required, is a regional developer more appropriate?
5. Could using multiple regional developers provide a higher set of initial fees than a single master franchisee?
6. Are there legal reasons that would prohibit you from using the regional developer process?
7. Which in the medium term will be a better protection of the reputation of your franchise brand?

TREND AWAY FROM MASTER FRANCHISING

There are many strong arguments in favour of regional developers who are often as capable as a master franchisee and more focused by the incentive that they can rapidly recruit an optimum number of franchisees within a territory and then move on to another territory to do the same job again.  This leaves the franchisor with strong revenues sufficient to then appoint staff or contractors to provide the ongoing management and training for franchisees.

Such a move will require additional expertise within a franchisor’s management team as at first glance it would appear far easier to appoint a master franchisee for a country and leave it to them to take over as if they were the franchisor.

Experience now shows that any franchisor that does take this attitude, does so at their own peril and may well be accused of brand neglect by a collective of franchisees.

Franchisors need to maximise their brand value and revenues as they expand internationally.  Deciding between a master franchise and regional developer method is a critical aspect to the success of your franchise.

This article is for general information and the reader should seek specific expert advice before taking any action.

[1] See http://www.franchise.org/franchise-news-detail.aspx?id=38406: October 2005 study by Prof A Kalnins