Understanding Franchise Relationship Structures

Sep 20, 2017 | General

Franchising, at its core, is a way for a company to expand and distribute its products or services. In “Traditional Franchising,” product manufacturers use a downstream distribution system to get their products to market. In “Business Format Franchising,” companies sell the rights to use their operating systems to deliver their products or services to the public (like typical fast food franchising).

The main factor that differentiates these two types of franchising is that in traditional franchising, it’s the product that takes centre stage and in business format franchising, it’s the delivery system that is the most important element.

Most people looking to open a franchise will enter into a business format franchise relationship with a franchisor. 

Although it’s becoming more common for franchisors to call their franchisees “franchise partners,” that moniker is a misnomer. Franchising is not a partnership because there is not equal footing for both parties. Although they share a common brand, the franchisor and franchisee are two completely different entities in completely different businesses. 

The franchisor is in the business of growing, managing and supporting the overall brand and franchise while the franchisee is in the business of selling the products or services as per the system developed by the franchisor.

The exact relationship between franchisor and franchisee will be laid out in the franchise agreement you sign. This is a relationship that can be structured in many different ways. 

Single-Unit Franchises

The oldest and simplest form of franchising, this is where a franchisee is granted the right to operate a single branded location for a fee. While this remains a popular way to franchise, it does have some drawbacks for the franchisor. Because each location requires training and support, it can slow down franchise growth and raise the costs of training and support.

Multi-Unit Franchises or Area Developers

Becoming more common is multi-unit franchising. As the name suggests, multi-unit franchisors develop more than one franchise location, usually in a single geographical area, so they develop that entire area. Because multi-unit franchisors are obligated to develop an agreed-upon number of franchise locations over a set period of time, they can help quicken the pace of franchise expansion.

Multi-unit franchisees sign a development agreement when they enter into a relationship with a franchisor and for each location they open, they sign a separate franchise agreement.  If they cannot stick to their development schedule, the franchisor usually retains the right to cancel the development agreement and seek other franchisees for the areas still left undeveloped while the franchisee is still allowed to run the locations they did manage to develop.

Owning multiple units has significant benefits for both the franchisor and franchisee. In addition to the aforementioned fast tracking of expansion, it can also cut down on training and support costs for the franchisor and give them more control over growth. Multi-unit owners may also be able to shift personnel between their locations when required and make larger purchases to save money on goods and shipping.

Master Franchising

This type of relationship allows a franchisee to become a franchisor. The franchisee will have the right and obligation to open a certain number of locations, like a multi-unit franchisee, but in addition to that, they will also be able to recruit new franchisees and make money from the franchisees they recruit. Essentially, the master franchisee acts as the franchisor in a given area. 

When a franchisee enters into this type of agreement, they will generally pay a master franchising fee and then be able to collect a unit franchise fee from each franchisee they recruit into the system. They also collect royalties from their recruits, which they share with the franchisor. The master franchisee is responsible for drawing up their own Franchise Disclosure Documents and each franchisee they recruit enters into a franchising relationship with them rather than the franchisor.

Although this system is not as popular as it once was because it’s now much easier to recruit for and run a franchise system from a distance, meaning the franchisor can perform those duties without the need for help, it is still a method commonly used by franchisors when entering into international markets.

Area Representatives

This is basically a step down from a master franchise agreement in that the area representative, while still acting as a recruiter, does not actually enter into any agreement with the unit franchisees they recruit. 

Essentially, the area representative is a commissioned franchise sales and support person who pays the franchisor a fee for this relationship, but also shares in the franchising fees and royalties paid by any franchisees they recruit.

Much like multi-unit franchisees, area representatives sign an agreement that obligates them to develop a certain number of franchises over a set period of time in a specific geographic area. The franchisees they recruit will enter into a franchising agreement directly with the franchisor and there is no need for area representatives to draw up their own franchise disclosure documents.

Other Franchise Options

Conversion franchises are independent businesses that operate in the same industry as a franchise and choose to become part of the franchise system by signing a franchise agreement and adopting the franchise’s brand and operating system. 

Non-traditional locations are franchise locations that open as smaller units inside larger mass gathering locations (like a stadium, airport, college campus, etc) where foot traffic is generated by other activities hosted by the larger facility (like sporting events, concerts, etc). 

It’s important to understand the type of franchising relationship you’re entering into so you choose the right one for you. FranNet can help you find the perfect franchise to connect with. Sign up for a free FranNet franchise search and consultation today.