Franchise Lingo: Beyond the Basics

The classic business format model expanded over time into more complicated forms, which allowed franchisors to grow more rapidly and at less cost. Franchisors created the master franchising model, which involved the selling of development rights to third-party entities who took over many franchisor duties. There are three main variations to the master franchising model:

1. Master Franchising

In master (or regional) franchising, the franchisor sells the development rights in a particular market to a master franchisee who, in turn, sells individual franchises within the industry. The master franchisee is responsible for attracting, screening, signing, and training all new franchisees within the territory. Once established, ongoing support is generally provided by the parent franchisor. The master franchisee is rewarded by sharing in the franchise fees and the ongoing royalties paid to the parent franchisor by the franchisees within the territory.

2. Sub-Franchising

The franchisor grants development rights in a specified territory to a sub-franchisor. After the agreement is signed, however, the parent franchisor has no ongoing involvement with the individual franchisees in the territory. Instead, the sub-franchisor becomes the focal point.

All fees and royalties are paid directly to the sub-franchisor. It is solely responsible for all recruiting, training, and ongoing support, and passes on an agreed upon percentage of all incoming fees and royalties to the parent franchisor.

In a sub-franchising relationship, the potential franchisee has to be doubly careful in his or her investigation. He or she must first make sure that the sub-franchisor has the necessary financial, managerial, and marketing skills to make the program work. Secondarily, the potential franchisee has to feel comfortable that the parent franchisor can be relied upon to come to his or her rescue if the sub-franchisor should fail.

3. Area Development

The franchisor grants exclusive development rights for a particular geographic area to an area development investment group. Within its territory, the area developer may either develop individual franchise units for its own account or find independent franchisees to develop units. In the latter case, the area developer has a residual equity position in the profits of its “area franchisees.”

In return for the rights to an exclusive territory, the area developer pays the franchisor a front-end development fee and commits to develop a certain number of units within a specified period of time. The front-end fee is generally significantly less than the sum of the individual unit fees. Individual franchisees within the territory pay all the contractual franchise, royalty, and advertising fees directly to the parent franchisor.

The area developer shares in neither the franchise fee nor in ongoing royalty or advertising fees. Instead, the area developer shares only in the profitability of the individual franchises that it "owns." In essence, the area developer is buying multiple locations over time at a discount, since the franchise fee and (frequently) the royalty fee are less than the per unit rate.

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