Buying a franchise can provide you with instant customer recognition,
a well-designed business model, marketing and operational support, and
volume purchasing, but it can also bring you the potential for disputes
with your franchisor.
The relatively high level of litigation in franchising has little to
do with the people involved – in general, franchisors and franchisees
are no more litigious than anyone else in business. Rather, the conflict
emerges because the two parties make money in different ways.
Understanding these differences helps franchisors and franchisees avoid escalating disagreements to the level of litigation.
At its heart, franchising is a business arrangement in which one
party (the franchisor) rents a business model and brand name to another
party (the franchisee), who uses it to sell products or services to end
users. The “rent” that the franchisee pays is usually calculated as a
percentage of the his or her gross sales. That means franchisor profits
increase with franchisee sales, leading franchisors to adopt policies to
maximize sales at franchisee locations.
Franchisees, however, make money by generating revenues that exceed
their costs. Therefore, they seek policies that maximize profits at
their locations.
The policies that maximize outlet-level sales aren’t the ones that
maximize outlet-level profits, causing conflict between franchisors and
franchisees. A good example is the use of buy-one-get-one-free
discounts, which are common in retail businesses. Done right, a
buy-one-get-one-free discount will bring more customers to a retail
outlet, boosting sales. That’s clearly beneficial to the franchisor
whose earnings are linked to outlet-level sales.
But the discounting strategy might not boost the franchisee’s
profits. If it doesn’t boost the size of the average customer purchase,
the franchisee could be worse off. The buy-one-get-one-free promotion
could raise the franchisee’s costs (by the amount of the free item) but
not boost its revenues.
The conflict between the franchisor and franchisee is rooted in the
economics of franchising, not in the two parties having “bad” attitudes.
The franchisor wants the couponing strategy because it will make more
money, while the franchisor doesn’t want it because it will not be made
better off. If enough money is at stake, the end result could be a
lawsuit between the two parties.
Disagreements over discounting strategies aren’t the only disputes
driven by franchisor and franchisee goal divergence that result in
litigation. A couple of years ago Burger King and its franchisees ended
up in court over a disagreement about late night hours. Burger King
wanted its franchisees to stay open late to sell more fast food to those
seeking it at off hours.
To the franchisor, the strategy made perfect sense. If franchisees
sold a few more burgers and fries to midnight diners, Burger King would
bring in more royalties, which would boost its bottom line. But staying
open late caused the franchisees to lose money. They had to pay
employees for the additional hours even though their late-hour revenues
were less than those wages.
The difference between maximizing sales and profits also leads causes
franchisors and franchisees to fight about adding locations. Even when
an additional location cannibalizes sales at an existing outlet,
franchisors are better off because the new establishment boosts
system-wide sales. But it does necessarily benefit the initial
franchisee, who might have the same cost of operations, but lower sales.
