Conflicts in the Franchise Industry: How to Forge a Win-Win Partnership - KDI 한국개발연구원 - 연구 - 보고서
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KDI 한국개발연구원


KDI FOCUS Conflicts in the Franchise Industry: How to Forge a Win-Win Partnership 2019.09.19


Series No. No. 96, eng.

KDI FOCUS Conflicts in the Franchise Industry: How to Forge a Win-Win Partnership #중소기업 #산업 일반(기타)


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“Has this place changed again?” “Another chicken place?” “How many franchises are there on this street?” Conflicts between franchisors and franchisees are growing. To examine the causes, KDI conducted an analysis of the relationship between the contract conditions and conflicts. Firstly, the results revealed that franchisees paid an average of 120 million won in setup costs to the franchisor―half for the interior and half for other costs that include franchise and training fees and the deposit, among others. In terms of the interior, franchisors have come under fire for forcing franchisees into contracts with specific firms in order to secure the revenue from the rebate. Franchisees are, of course, allowed to chose their own interior design firm but the high supervising fee that is demanded by the franchisor means that there is little or no cost-saving. Additionally, if interior costs become a main source of revenue for a franchisor, the focus is placed on increasing the number of stores rather than helping franchisees with their sales. Franchise fees are a reflection of a brand’s reputational capital, and generally increase with the number of stores and number of years in business. It was found that franchisees experienced a rise in sales as the fee increased in line with the amount of knowhow and prestige transferred. Next, an examination was conducted on the monthly royalty payments that are paid after a store opens. Seven out of ten franchisor stores entered a royalty contract during the analysis period, and the majority were fixed-sum, which is not contingent on sales figures, than a fixed-percentage. Often, franchisors would entice franchisees into a purchase contract for raw materials and equipments with royalty discounts. But, it was found that the bigger the discount, the higher the intial royalty fee was, necessitating a closer examination of whether such discounts are actually effective. In terms of the effect royalties have on sales, the fixed-percentage, which encourages more active assistance from the franchisor to franchisee, had a positive impact while no significant impact was found for the fixed-sum royalty. Finally, on an investigation of closed territories, the analysis discovered that the wider the territory, in which a store would have monopoly, the higher the sales would be. Then, how do contract conditions affect the sales and operating profits of either party? A rise in the franchise fee and royalty contributed to the sales and profits of franchisors and the sales figures of franchisees, but not thier operating profit. In addition, a rise in the number of stores and competition led to higher costs in relation to sales. Contract conditions had a contradictory effect for the parties, ultimately resulting in conflict. Meanwhile, while the sales and operating profits of franchisees increased with the growth of a closed territory, thanks to more customers, that of the franchisor’s decreased due to the limitation on the number of stores. Based on the above findings, it is expected that the heated debate over closed territories will continue. [Interview with the author] In order to succeed in the franchise business, franchisors must have first-hand experience in the market. Regardless, 60% of franchisors do not have directly-managed stores which means that numerous business risks could be transferred onto franchisees. Franchisor’s should be made to clearly disclose their experience operating stores to enable entrepreneurs to chose a brand wisely. Regarding the franchise contract, the usage of the fixed-percentage royalty should be expanded. To make this possible, a data-processing infrastructure is needed so that franchisors are able to gain a fuller understanding of their sales. Also, items that do not fit in with the uniformity of the product should be excluded from the purchase agreement by establishing clear guidelines on what the essential items are. And, with the exception of the basic logistical costs, additional margins should be included in the royalty rather than the purchasing price.
□ Korea’s franchise market is wavering. Amid the heavy concentration of food service businesses and the high number of inexperienced franchisors, franchisees have had little opportunity to grow. Moreover, the terms and conditions of franchise agreements have become a source of contention due to their contradicting impact on the performances of franchisors and franchisees. Accordingly, government efforts are needed to overhaul information disclosure documents so that they accurately reflect the information and data on, for example, the franchisor’s experience and background, and the franchise store’s average sales figures, etc. At the same time, the fixed-percentage royalty should be promoted through discussions with respective industries and guidelines established for essential items. Actions must include exploring temporary measures to strengthen the qualifications for franchise businesses, particularly in sectors that show a high concentration of certain businesses.

- Korea’s franchise market is growing rapidly, not only in size but also in terms of the number of franchisors, brands and franchisees.

- The growth has come with increasing conflict over issues such as information asymmetry and imbalances in bargaining power.

- The growth has come with increasing conflict over issues such as information asymmetry and imbalances in bargaining power.

- Just as in the self-employed sector, food service accounts for a huge percentage of the franchise market.

- More than half of food service franchise stores sell fried chicken, traditional Korean food (hansik ) and coffee.

- About 60% of franchisors have no experience in operating directly-managed stores and rely solely on their franchisees.

- The percentage of brands with directly-managed stores is high in lowsales sectors such as fried chicken, drinking establishments and hansik .

- The more franchisors are in contact with the market through direct management of stores, the more likely it is for franchisees to improve their sales.

- The setup cost that franchisees pay to franchisors is approximately 120 million won on average.

- Fanchise fee is the price of a brand’s reputational capital and tends to rise as the brand adds more directlymanaged stores or stays longer in business.

- Costs for interior fit-outs account for the largest percentage in the setup cost.

- When a franchisee independently hires an interior contractor, the franchisor charges a high supervision fee which cuts into the franchisee’s cost savings.

- 25.4% of brands adopted a fixed-percentage royalty while 41.8% use a fixed-sum royalty.

- In the fixed-sum royalty contract, franchisors have less incentive to work to improve the sales of franchisees.

- In some cases, franchisees are given royalty discounts (70-100%) in return for purchasing raw materials and equipment from a supplier designated by the franchisor.

- Closed territory is an exclusive geographic and administrative area where a franchisee may conduct its business. 80% of closed territories are established based on distance.

- High franchise fees tend to entail significantly high sales gains.

- The number or percentage of direct stores can be a useful metric to measure the stability of sales.

- The sales increase from the fixed-percentage royalty implies that franchisors are more motivated to improve franchisees’ sales if their profits are aligned.

- Increases in franchise fees and royalties erode the operating profit of franchisees.

- Of the franchise agreement conditions, what actually improved franchisees’ sales and operating profits was the protection of closed territories.

- Franchise fees and royalties generate certain increases in franchisors’ sales.

- Increases in the franchise fee and royalty also incur an increase in franchisors’ operating profits.

- Franchise disclosure documents should contain more specific information particularly about the franchisor’s experience with directly-managed stores to enable prospective franchisees to make prudent decisions about the business item and brand.

- Franchisors should strive to establish IT infrastructure to transparently examine franchisees’ sales.

- Guidelines should be drawn up for essential items through discussions between the government and industry, and franchisors should be encouraged to include the distribution margin for raw materials and equipment in the royalty.

- Actions should be taken to temporarily impose stricter requirements for franchise businesses in sectors with a heavy concentration in a few items.
 Ⅰ. Issues

 Ⅱ. Three Facets of the Franchise Market

 Ⅲ. Analysis of Franchise Agreements

 Ⅳ. Effects of Contract Conditions on Franchisees’ Management Performance

 Ⅴ. Effects of Contract Conditions on Franchisors’ Management Performance

 Ⅵ. Conclusion and Policy Recommendations
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