Monday, February 22, 2010

How does a franchise define profitability?

To most franchise owners, profitability is THE single definition of success. The greater the profits, the greater the success.

It has been my experience that nearly all franchisee/franchisor conflicts revolve around profitability. Franchisors have developed a business model that they believe should be successful for a local franchisee. The local franchisee is obligated by contract to follow various standards, purchase certain equipment and sell certain products or services. Over time, conditions change and the franchisor has the right to change some or all of these franchisee obligations. This should not be a problem, in theory, since everyone is seeking to maximize profitability.

So where is the problem?

To me, the problem is in the definition of profitability.

A franchise owner sells product or provides service in return for compensation from the consumer. After paying all bills, any remaining monies are the profit for the franchise owner. The franchisor, however, has a different revenue stream.

A franchisor derives revenue primarily through royalty payments (along with sales of franchise licenses and some other activities.)

There are times when a franchisor can undertake logical actions that increase their revenue stream through royalties – which are based on franchisee revenues – while also negatively impacting on local store profitability. Perhaps a franchisor attempts to increase store traffic through couponing or free offers that franchisees perceive as being too aggressive. Alternatively, a franchisor may end up competing with franchisees through Internet web sites or direct accounts with larger customers. Some recent examples of disagreement are restaurant franchisees who complain about what they believe to be money losing products or promotions.

Some would suggest that the franchisor pay more attention to franchisee profitability, sometimes by basing royalty payments on this determination. The franchisor, however, may argue differently. After all, the franchisor does not have control over local store operations. A poorly operated franchise could suffer from excessive expenses due to poor local management. Furthermore, an operation where the franchise owner chooses to have only a limited involvement is less likely to be successful. Finally, the franchisor normally does not have control over how funds are dispensed for a local franchise. From this perspective, it makes no sense for the franchisor to derive their revenue stream from anything but top line revenues.

By defining profitability differently for a franchisor and franchisee, it is easy to understand the reason for these conflicting priorities. It can also explain disagreements as to the interpretation of a franchise agreement that most likely appeared to be reasonable when it was signed many years ago. The risk of disagreement on a wide range of business issues will increase, as does internal conflict, as the definition of profitability diverges between franchisor and franchisee.

The FranchiseFacts survey, at, looks at franchisee profitability in detail. To us, profitability is not one number that can be presented as indicative of the industry. Our Franchisee Satisfaction reports should be able to correlate profitability with diverse factors such as number of locations, rural vs. urban, education and other criteria. It is our intent to delve into the factors that most impact on profitability. Survey participants are assured that their individual responses will always remain anonymous.

Next posting: Resolving Franchisee and Franchisor Conflict

FranchiseFacts – Capturing the franchise experience

Perry Shoom, FranchiseFacts
Capturing the franchise experience!

Franchisee Survey in progress at
If you are a franchise owner or store manager, please participate!


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