To Own Or Not To Own Corporate Establishments: That Is The Question!

Franchisors regularly ask us whether or not it is preferable for them to maintain and operate corporate establishments, i.e., establishments in their network that are owned by them (directly or through subsidiaries controlled by the franchisor).

Before launching a new franchise network, it is always strongly recommended that the franchisor have tested its franchise concept in a few of its own establishments.

A franchisor who has followed this recommendation already has, even before granting his first franchise, one or, even better, a few corporate establishments.

Afterwards, is it preferable for the franchisor to continue to own and operate such corporate establishments, or should the franchisor's network consist only of franchisee-owned establishments?

Here are some of the advantages and disadvantages of a franchisor owning corporate establishments:

Advantages:

• The franchisor retains 100% of the profits made by its corporate establishments;
•  Corporate establishments can serve as training centres for both franchisees and employees of the franchisor and franchisees;
• Corporate establishments may also serve as testing and demonstration centres for the franchisor's new products, services and initiatives;
• The fact that the franchisor owns corporate establishments shows its confidence and interest in the success of the establishments in its network;
• The franchisor's ownership of corporate establishments also allows the franchisor to better understand the reality of the franchisees in terms of the operation of establishments in its network;
• The ownership of one or more corporate establishment is likely to increase, in many circumstances, the confidence of franchisees in the competence and good intentions of the franchisor. From the point of view of competence, franchisees will give additional credibility to a franchisor who operates and owns one or more corporate establishments in a given market. From the perspective of intent, consider, for example, the introduction of new products or promotions. When the franchisor owns a corporate store, it can use it to test new promotions and product mixes before offering them to the franchise community. This contributes greatly to eliminating the mistrust of certain franchisees, who might otherwise consider that the franchisor is using the franchisees as "guinea pigs", without taking any risks himself (especially in the case of promotions that involve giving discounts or freebies to the general public from the franchisees' inventory).

Disadvantages:

• The franchisor must itself make the necessary investments to set up and operate its corporate establishments;
•  The franchisor must ensure the sound management, including the day-to-day management, of its corporate establishments, which requires additional resources different from those required for the management of a fully franchised network;
• There is a risk that franchisees may feel that, in various situations (including procurement, advertising or the implementation of new and interesting initiatives), the franchisor favours its corporate establishments over its franchised ones. It is therefore necessary that, at all times, the franchisor refrain from treating its corporate establishments more favourably than its franchised locations. In particular, the corporate establishments should contribute, in the same manner as the franchisees, to the network's common advertising fund;
• When the franchisor operates one or more corporate establishments, whether it likes it or not, these will often be perceived by the franchisees as the "yardstick" or reference. This leaves the franchisor little room for error, especially when it temporarily takes over the business of a franchisee to operate it in a corporate manner. In fact, if a corporate establishment does not perform well or, occasionally, does not respect the norms and standards imposed by the franchisor, this establishment will be opposed to the franchisor as a "reference" to justify the failures of a franchisee in the event of a slowdown or a less rigorous respect of the norms and standards of the franchisor. The franchisor will therefore often have to dedicate considerable amounts of human and financial resources to ensure the impeccable operation of each corporate establishment. In fact, the franchisor will be judged on the basis of its weakest corporate link.

Various studies conducted in the United States and Australia between 1990 and 2005 have shown that, in general, franchised establishments performed better financially than corporate establishments.

On the other hand, the same studies also show that corporate establishments are more effective in implementing changes and are more successful in meeting the franchisor's quality standards.

One of these studies also came to the conclusion that, from a purely economic point of view, the formula allowing a franchisor to achieve the best possible profitability was the one according to which approximately 2/3 of its network was composed of franchised establishments and 1/3 of corporate establishments.

In 2014, Australian psychologist, author and franchise expert Greg Nathan reported the following findings from research his team conducted with 35 franchise networks operating, in total, nearly 7,000 establishments, 18% of which were corporate (either operated by the franchisor itself or by a subsidiary of the franchisor):

• Sales of corporate establishments increased by an average of 6% when they were converted to franchised establishments. Conversely, sales of franchised establishments decreased by an average of 4% when they were converted to corporate establishments;
•  Franchised establishments showed better profitability than corporate establishments mainly due to better control over labour costs, which were on average 10% higher for corporate establishments;
• The state of the establishment before conversion (corporate to franchise, or franchise to corporate) has a significant impact on its performance after conversion. For example, poorly run franchised establishments have seen their sales increase following their conversion to corporate establishments. On the other hand, well-run franchised establishments saw their sales decrease following their conversion to corporate establishments;
• Supporting corporate establishments is a significant cost for a franchisor. According to Greg Nathan, supporting a corporate establishment requires four times more time and resources from the franchisor, especially for human resources management and employee training;
• While all indications are that franchised establishments generate more sales and show better profitability than corporate establishments, many franchisors successfully operate corporate establishments that are highly profitable when properly managed;
• Finally, Greg Nathan noted a certain paradox in terms of compliance with franchisor standards, customer satisfaction and marketing. While corporate establishments were more compliant with the franchisor's standards, programs and systems, making them easier to manage, franchisees are more committed and proactive in their efforts to grow their customer base and improve customer loyalty, but offer some resistance to the franchisor's programs that they do not feel are effective for these purposes, which presents a real management challenge for the franchisor, but also ultimately leads to better results.

While no Canadian study has confirmed this, it is likely that these findings apply to Canada as well.

Ultimately, the decision to maintain corporate establishments depends on the structure, resources and business plan of the franchisor. Therefore, there is no single answer for all franchisors.

For some franchisors, the holding of corporate establishments is occasional or temporary, for example as a result of the exercise of a right of first refusal when a franchisee wants to sell its business or an option to purchase when a franchise agreement is terminated. In such cases, the franchisor may acquire and operate one or more franchised locations in order to improve their performance or to update them (particularly with respect to layout, furniture and equipment) before reselling them to a new franchisee.

However, in certain sectors of activity (for example, the pharmaceutical sector in Quebec), the law addresses this issue by prohibiting a franchisor from owning, directly or through a subsidiary, a franchised business.

Fasken has all the experience and resources necessary to help you structure and manage your franchise network, whether in Quebec, other Canadian provinces, the United States or anywhere else in the world.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.