Expanding a franchise in Italy through Master franchising: the economics
Master Franchising is the most common method to expand a franchise in Italy. The popularity of Master Franchising has also economic reasons, since it generally requires less resources by franchisors and allows more revenues than direct franchising. But some conditions must be met to reach this target: above all a correct quantification of the portion of fees charged by master franchisee and shared between the latter and the franchisor, and a careful analysis of performance requirements and expenses. In the initial stage of its development, master franchising’s costs are usually higher and returns are lower than in area development franchising, while in a later stage the returns may be higher, if the master franchisee’s development program is greater and faster than that of an area developer.
1.Economics of Master franchising
Master Franchising is by far the most common method to expand a foreign franchise network in Italy, as shown by the 2021 survey made by Assofranchising.
The popularity of Master Franchising in Italy (as well as worldwide) has various reasons; one of them is that it usually requires less resources from the franchisor and allows more revenues than direct franchising, making this method more “appealing” for the international expansion of their franchise than other solutions.
As we have seen in another article by adopting the Master franchising scheme, the franchisor grants to the Master Franchisee the right to enter into exclusive sub-franchise agreements in a specific area with the sub-franchisees.
The Master Franchisee therefore represents the franchisor in the country involved, since it has direct relationships with the Italian sub-franchisees and collects fees directly from them, while the franchisor has contractual relationships only with the Master franchisee.
From a general prospective, Master Franchising ensures the franchisor usually lower revenues than direct franchise, since it does not receive royalties directly from the sub-franchisees but only from the Master Franchisee.
Still, the economics of Master franchising are usually more favorable for franchisors than those of direct franchising. This is explained by the structure of the relationship between the two parties involved, franchisor and Master franchisee.
2. Sharing fees between Franchisor and Master franchisee
For the sub-franchise rights granted by the franchisor, the Master franchisee generally pays to the franchisor an initial fee, of an amount that varies according to the size of the territory granted exclusively, and a continuing franchise fee, often calculated as a percentage of the turnover of the Master franchisee.
Franchisors and master franchisees usually share the fees paid by the sub-franchisees to the master franchisees. Royalties and franchise fees are generally a fraction of what they are in a direct franchise relationship, with the Master franchisee generally receiving the lion’s share of the revenues from both.
In the Italian practice, the franchisor generally receives on average between 20% and 40% of the franchise fee upon each unit opening, and between 30% and 50% of royalty revenues.
The portion of fees charged by master franchisees that is shared between the franchisor and the master franchisee should be determined based on a detailed financial analysis and an understanding of specific support services required.
Because all the parties to a master franchise must generate at least a market rate profit for the relationship to succeed, franchisors should model their expenses of supporting master franchises and their sub-franchisees and efficiently allocate duties for servicing sub-franchisees between the franchisor and the master franchisee.
3.Performance requirements and expenses
In structuring a Master franchising transaction, two elements are of critical importance: performance requirements and expenses.
The speed with which the franchisor is able to establish the Italian franchise organization will be a critical element in determining when it will achieve positive cash flow. If the Master franchisee is not willing or able to commit to an aggressive development schedule, it is important to insert into the master franchise agreement provisions requiring him to cover all direct expenses until a certain number of franchises have been established.
Franchisors should know what their costs will be before determining what fee to charge a master franchisee. If the projected income from fees, based upon the projected number of franchised outlets and the amount of fees the master franchisee can charge sub-franchisees is projected to be inadequate to generate enough profit for both the franchisor and the master franchisee, a different strategy may be needed.
The franchisor must decide which of the tasks and expenses are to be borne by the Master Franchisee. Whereas in direct franchising all costs of recruiting, training, and supporting franchisees are the sole responsibility of the franchisor, franchisors and master franchisees share obligations to support the sub-franchisees in the proportion that is established in the master franchise and sub-franchise agreements.
Franchisors should determine appropriate allocation of responsibilities to the master franchisee, and whether they will be able to charge fees in Italy that are the same as or higher than fees the franchisor charges in its home market. This would normally be done by examining fees charged by competing franchisors and master franchisees in Italy. Then, based upon the allocation of costs it has prepared, franchisors should determine what portion of the initial and ongoing fees will be received by them and the master franchisee.
4.Master franchising and Area Development: an economic comparison
The franchisor’s duties in the initial stages of adapting the concept in a master franchise relationship are generally greater than in an area development relationship, and the fees received from the operation of franchised outlets in return are lower, until a critical mass of sub-franchisees has been established in the master franchisee’s territory.
In fact, a master franchise approach is likely to adversely affect a franchisor’s cash flow during the early stages of a franchise relationship when compared to the use of an Area development approach, unless the initial fee charged for a master franchise is sufficiently greater than the fee charged to area developers (assuming the same development requirements).
From a franchisor’s perspective, in the initial stage of its development, master franchising’s costs are higher and returns are lower than in an Area development relationship. In general, Master franchising makes the most sense if the resources that might be used by an area developer to open its own units are leveraged through a franchise program which facilitates a faster growth of many more units than the area developer could establish with the same resources.
Avv. Valerio Pandolfini
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The information contained in this article is of a general nature and is not to be considered an exhaustive examination of the various issues, nor is it intended to express an opinion or provide legal advice. Specific legal advice must be provided with regard to individual cases.