Master franchising: is this the right growth strategy for your business?

By Sarah Stowe | 18 Apr 2016 View comments

Master franchising is the right strategy for some systems but not all. Image: A2zinc.netMany franchisors, at some point during their business, consider master franchising. Master franchising can create new opportunities and new income streams. However, master franchising is not appropriate for all franchise systems and careful consideration as well as expert advice should always be sought prior to embarking on such a major decision.

A master franchise is defined in the Franchising Code of Conduct as "a franchise in which the franchisor grants to a subfranchisor the right:

  1. to grant a subfranchise; or
  2. to participate in a subfranchise."

In practical terms, a franchisor will grant a subfranchisor the right to operate as a franchisor for a specific territory.  That territory can be a country, a state or a region.

There are a number of significant advantages and disadvantages to franchisors adopting a master franchising model, some of which are set out below.

Advantages of master franchising

1. Growth and expansion

Master franchising can be an excellent way to grow and expand an existing franchise network especially in regions in which the franchisor does not have a presence.

In addition, the subfranchisor can attend to many of the time consuming functions that a franchisor would ordinarily undertake.  These include recruitment of franchisees, marketing and compliance. This approach leaves the franchisor free to focus on other areas of the business.

2. Increased focus on territories

Appointing a subfranchisor for a particular territory can also mean that the master franchisee will have local experience or knowledge about that territory.  As an example, the market in Australia may be extremely different from that in the US.  Appointing a local subfranchisor ensures that any market differences can be addressed by the subfranchisor, who is more likely to have local knowledge.

3. Increased profitability

Master franchising provides franchisors with an ability to earn extra revenue.  Master franchise fees have the capacity to add significant amounts of additional income to the franchisor, notwithstanding reductions in other income (as the master franchisee will take a portion of each collected fee).

For example, a US franchisor who grants a master franchise to an Australian subfranchisor will avoid many costs and the Australian subfranchisor will become, in effect, the Australian franchisor for the franchise network.  The US franchisor will save the time and costs of setting up an Australian subsidiary and putting in place ever-complex tax effective structures. 

In addition, most master franchise agreements require the master franchisee to pay to the franchisor an upfront fee which can be significant and a proportion of the fees payable by unit franchisees.  The obligation on the subfranchisor usually applies irrespective of whether the amount is actually collected by the subfranchisor from unit franchisees.  In this way, the franchisor can ‘quarantine’ its losses through the subfranchisor.

The franchisor's costs and expenses will also be lower as the obligations of recruiting, appointing, managing, supervising franchisees and marketing the franchise network in the territory of the subfranchisor will be the latter’s obligations.

4. Compliance with new Code

Through the introduction of the new Code on 1 January 2015, compliance with the Code for a franchisor that is involved in master franchising has become significantly easier.

In the past, a franchisor and subfranchisor both had to provide their own disclosure document to each unit franchisee.

Since 1 January 2015, all that is required from the franchisor is the information required by item 7 of the disclosure document template prescribed in Annexure 1 of the Code.  This information is unlikely to require regular updates beyond an update of item 7.4 which relates to actions taken by the franchisor.

Disadvantages of master franchising

1. Loss of control

A key potential disadvantage is that franchisors may lose control of various elements within the franchise network.  This includes the relationships with unit franchisees, the content of the franchise documents and compliance.

This is especially relevant to overseas franchisors who may not be aware of the relevant regulatory requirements and may be unable to oversee operations.

In that case, it is critical for a franchisor to have a very close relationship with the subfranchisor, together with a well drafted master franchise agreement and numerous checks and balances built into the franchise network which work together to alert the franchisor to problems as they arise.

2. More fingers in the pie

Depending on how the master franchise is structured (and subject to the point above), a master franchise system can mean that a large chunk of monies received by the subfranchisor are retained by the subfranchisor.

If a careful cost benefit analysis is not undertaken early, this could have an adverse impact on the franchisor's revenue.  Specialist accountants must be consulted prior to implementing a master franchise model.

Conclusion

The question of whether or not to enter into a master franchising arrangement must be considered strictly on a case by case basis. While the above represents some of the advantages and disadvantages, they may not apply to every franchise system.