Franchising 101: Master franchise and area development agreements

Expanding your business to new territories is essential for your growth. Franchising can be a great tool to achieve this, but what is the right model for your business?

One popular business model is master franchising. Under a master franchise agreement, the master franchisor grants to the master franchisee a specified area where the master franchisee has the right not only to open franchise units itself, but also to “sub-franchise” to third parties. Typically, the master franchisee will be required to first open a number of pilot units in the territory before sub-franchising to others. The key challenge with master franchising is control. The master franchisor does not have direct contact with the sub-franchisees, whose contract is with the master franchisee. If there are problems at the sub-franchisee level, the master franchisor is dependent on the master franchisee taking appropriate action. Master franchising is popular in the services industry (lawn care, cleaners, electricians, tutors), but it can also be used in quick service restaurants (QSR) and convenience retail. Examples are Pizza Hut, Neighborly and Circle K.

Area development agreements provide for a simpler model: the operator is obliged to open and operate the franchised units itself within a specified area, but cannot sub-franchise to third parties. The problem of control does not arise as there are just two parties. However, it can be challenging to find an area developer with the resources to develop an entire country. From a structuring perspective, the key question tends to be the separation between the operation of single units and the development obligations. This model is preferred by retailers and some restaurant brands.

Both of the above multi-unit models effectively allow the franchisor to cover a substantial area while dealing with one counterparty namely the master franchisee or area developer (rather than managing a network of single unit franchises).

Under a single unit franchise agreement the franchisor grants the franchisee the right to operate just one unit. Creating a large franchise network in this way may prove to be more time consuming and expensive than using one of the multi-unit models. It takes time, energy and money to recruit, train and support several franchisees. Some franchisors allow the same franchisee enters into multiple unit franchise agreements and consequently operates a large number of units. Well known examples include Domino’s Pizza and McDonalds. Single unit franchise agreements are also often used in the hotel sector where strategic brand positioning is based on matching a property at a carefully chosen location with the most compatible brand.