● Author
– Jinkook Lee, Fellow

● Go to related report
– KDI FOCUS, Conflicts in the Franchise Industry: How to Forge a Win-Win Partnership.(https://bit.ly/2NCugQK)

● KDI Website
– http://www.kdi.re.kr/kdi_eng/main/

Conflicts between franchisors and franchisees are growing. To examine the causes, KDI conducted an analysis of the relationship between the contract conditions and conflicts.

Firstly, the results revealed that franchisees paid an average of 120 million won in setup costs to the franchisor―half for the interior and half for other costs that include franchise and training fees and the deposit, among others.

In terms of the interior, franchisors have come under fire for forcing franchisees into contracts with specific firms in order to secure the revenue from the rebate.

Franchisees are, of course, allowed to chose their own interior design firm but the high supervising fee that is demanded by the franchisor means that there is little or no cost-saving.

Additionally, if interior costs become a main source of revenue for a franchisor, the focus is placed on increasing the number of stores rather than helping franchisees with their sales.

Franchise fees are a reflection of a brand’s reputational capital, and generally increase with the number of stores and number of years in business.

It was found that franchisees experienced a rise in sales as the fee increased in line with the amount of knowhow and prestige transferred.

Next, an examination was conducted on the monthly royalty payments that are paid after a store opens.

Seven out of ten franchisor stores entered a royalty contract during the analysis period, and the majority were fixed-sum, which is not contingent on sales figures, than a fixed-percentage.

Often, franchisors would entice franchisees into a purchase contract for raw materials and equipments with royalty discounts.

But, it was found that the bigger the discount, the higher the intial royalty fee was, necessitating a closer examination of whether such discounts are actually effective.

In terms of the effect royalties have on sales, the fixed-percentage, which encourages more active assistance from the franchisor to franchisee, had a positive impact while no significant impact was found for the fixed-sum royalty.

Finally, on an investigation of closed territories, the analysis discovered that the wider the territory, in which a store would have monopoly, the higher the sales would be.

Then, how do contract conditions affect the sales and operating profits of either party?

A rise in the franchise fee and royalty contributed to the sales and profits of franchisors and the sales figures of franchisees, but not thier operating profit.

In addition, a rise in the number of stores and competition led to higher costs in relation to sales. Contract conditions had a contradictory effect for the parties, ultimately resulting in conflict.

Meanwhile, while the sales and operating profits of franchisees increased with the growth of a closed territory, thanks to more customers, that of the franchisor’s decreased due to the limitation on the number of stores.

Based on the above findings, it is expected that the heated debate over closed territories will continue.

(Interview with the author)
In order to succeed in the franchise business, franchisors must have first-hand experience in the market. Regardless, 60% of franchisors do not have directly-managed stores which means that numerous business risks could be transferred onto franchisees. Franchisor’s should be made to clearly disclose their experience operating stores to enable entrepreneurs to chose a brand wisely. Regarding the franchise contract, the usage of the fixed-percentage royalty should be expanded. To make this possible, a data-processing infrastructure is needed so that franchisors are able to gain a fuller understanding of their sales. Also, items that do not fit in with the uniformity of the product should be excluded from the purchase agreement by establishing clear guidelines on what the essential items are. And, with the exception of the basic logistical costs, additional margins should be included in the royalty rather than the purchasing price.

#Franchise #Sales #Partnership