By Dr Mark Abell and Shelley Nadler Bird & Bird
Multi-unit / multi-brand franchisees have long been a feature of the US franchise market, a great many of this have become hugely wealthy and some have even floated. Without them the US franchise market could not have expanded as it has done. These exciting new large-scale franchisees have started to emerge in the UK Although the master franchisee/owner operator franchisee model of franchising has a role in franchising in the UK, many are beginning to realise that it has a number of severe limitations and that franchisors looking to launch their brands in the UK should be looking to engage with successful multi-unit franchisees.
Through the emergence of successful multi-unit / multi-brand franchisees in brands such as Costa, Domino’s and KFC a key resource has evolved. Due to market saturation and hence a lack of opportunity for further significant expansion within their current brands, these multi-unit operators can be usefully exploited by other franchised brands looking to turbo-charge their growth within the UK.
Who are these multi-unit / multi-brand franchisees?
Typically, these multi-unit/multi-brand operators are individuals who, through years of operating well developed franchise concepts, have developed a strong set of operational skills together with an effective operational and managerial infra-structure. Many of them have professional backgrounds as accountants, lawyers or MBA graduates. They have applied their professional training and rigour to the effective implementation of their chosen concepts (often fast food and coffee shops), whilst at the same time taking a bigger picture and strategic view as regards the structuring, financing and growth horizons of their business.
Often they acquire their first franchise at a young age and this is usually in the food and beverage sector. These operators are good negotiators and have a history of finding securing good locations at competitive rents. They also understand how to motivate and retain good quality staff which ensures that standards are maintained for stores whether they are operating one or fifty. Many multi-unit / multi-brand operators have invested heavily in real estate and worked strategically to build a portfolio of brands that can occupy adjoining sites in a hub type structure. These operators know how to keep costs down by sharing resources. Importantly, these operators all have access to substantial capital that is available to invest in appropriate projects.
Once established as a multiple franchisee with one brand the multi-unit franchisee typically switches to a non-competing brand to spread the risk. Lessons have been learnt following the BSE crisis in the 1990’s when sales of burgers plummeted that it is good to own more than one type of food concept. The same could be said of the KFC chicken shortages earlier this year. So, the multi-unit / multi-brand franchisees learnt to diversify, perhaps owning a chicken, pizza and coffee brand. With worries regarding staff shortages following Brexit, multi-unit/multi-brand operators are looking for new opportunities in sectors where there is greater reliance on technology and less need for staff. Many are looking at fitness and wellness concepts and service concepts that are less labour intensive.
Interestingly, these multi-unit/multi-brand operators typically do not want to become master franchisees as they feel that requires a different skill set and does not play to their key strengths, which is operational implementation rather than the recruitment, training and management of franchisees. Another appealing factor is that these multi-unit/multi-brand operators are often regionally based within the UK and they understand the geography and markets in those regions. Appointing a number of regional multi-unit franchisees rather than one master franchisee could quickly give a foreign brand coverage across the UK.
The advantages and disadvantages of dealing with multi-unit/multi-brand franchisees
From a franchisor’s point of view the great attraction of such multi-unit/multi-brand operators is that they have a huge amount of operational expertise and an established infrastructure and the financial resources to expand quickly. If a foreign brand is seeking to enter the UK in a competitive sector (such as gyms) by using experienced multi-unit/multi-brand operators the brand owner may be able to quickly get coverage in the UK ahead of other gym brands. In allowing multi-unit franchisees to open multiple stores, franchisors know they are dealing with someone who has experience of the system and a proven track record and will need so much less support then a new franchisee. Often successful multi-unit franchisees are able to take over poor performing franchisees. A system that uses multi-unit operators will have less franchisees to deal with but this can be a blessing and a curse.
Partnering with such franchisees is not without a potential downside for franchisors. Fundamentally the nature of these multi-unit/multi brand franchisees means that the classical relationship dynamics between the franchisor and its franchisees are bound to be impacted due to the size and bargaining power of the franchisee. These franchisees do have the resources to challenge the franchisor. Another disadvantage is that by over extending themselves they are not able to implement a new brand concept. There is also a risk of know-how leakage and potential cross contamination between different concepts.
However, matched against the obvious commercial upside these risks are clearly manageable so long as franchisors do not simply ignore them. Franchisors will probably need to adapt their ways of working for multi-unit / multi-brand franchisees but if care is taken we believe it will be worthwhile.
How can franchisors best engage with multi-unit/multi-brand franchisees?
To be successful in the UK market most foreign brands need to invest a good deal or time and money adapting the concept to the UK market or finding a developer or master franchisee with sufficient faith in the brand to make that investment for them. For well-known legacy brands that may be possible but for many smaller brands that is often a struggle. By partnering with a successful multi-unit/multi-brand operator, such franchisors can effectively pilot and adapt their brand to the UK market on a relatively low risk manner. Of course, it is critical that this new style relationship is properly structured and documented. A classic joint venture is unlikely to work but a subordinated equity type relationship is a proven way of structuring an effective catalyst for such a relationship.
A subordinated equity arrangement is a variation on the traditional joint venture model adapted for the franchise industry. In a subordinated equity arrangement, a franchisor takes a minority shareholding in a franchisee company but the primary relationship between the parties remains that of franchisor and franchisee rather than as joint venture parties. The franchisor exercises the usual controls over the franchisee under the franchise agreement rather than by holding board and shareholders meetings under a joint venture agreement. A special purpose vehicle is set up with the multi-unit franchisee as the majority shareholder and the franchisor holding a minority stake. Multi-unit franchisees favour this arrangement as the franchisor “has skin in the game” and it will encourage the franchisor to establish a “boots on the ground” presence locally to help set up the new concept. The franchisor benefits by having the greater rewards that equity participation brings and also, in some cases, the option to buy out the franchisee company once the concept is established at a pre-agreed valuation.
If a foreign brand already has a master franchisee in the UK accessing good unit franchisees is always a challenge. Potentially good operators can find it difficult to obtain the required capital to invest in a franchised business and many of those with the available capital do not fit the brand profile or are unlikely to be good operators. Also, managing a large number of individual franchisees spread the length and breadth of the country is a stretch for many developing franchise concepts. Engaging with multi- unit/multi-brand franchisees could be a solution to this challenge for master franchisees.
New start up UK based franchisors can also take advantage of multi-unit/multi-brand franchisees. Proving a concept and establishing the first 10 or so franchise outlets is a hard and slow process for new franchisors. One potential solution to this is partnering with a multi-unit/multi-brand franchisee and leveraging off of its operational expertise and infrastructure. Clearly this type of relationship is very different from the classical franchisor/ franchisee relationship but, properly structured – perhaps through a subordinated equity structure (as mentioned above),this could enable brands that will otherwise struggle to get over the sustainability threshold as regards the number of outlets, to leap frog over those market entry barriers and establish themselves as a successful and credible brand much more quickly and with fewer difficulties than would usually be the case.
The way forward
So, in conclusion, the UK franchising market has evolved, in an almost Darwinian fashion, to offer franchisors the opportunity to take advantage of a new “gene pool” of relevant expertise and capital that handled appropriately can greatly add to their chances of success. Foreign franchisors and UK start-ups should consider developing their brand in the UK using multi-unit / multi-brand franchisees rather than appointing a master franchisee.
The key is to ensure that the relationship with them is captured in an appropriate legal mechanism. Joint Ventures rarely succeed, particularly between franchisors and their franchisees. Instead, subordinated equity structures and other specially developed relationships can be used to ensure a full alignment of interests and mutually attractive exit strategies.