Franchise Fees & The Tyrant

Franchise fees are integral to the continuity of R&D in the face of changing fortunes in the parent company. Franchisee’s receive funding in the form of access to a line of credit, which they could voluntarily use purchase to products and services on an as-needed basis. Instead we oblige them to take out loans to pay into a common pool of shared products and services. We view franchise fees as premium payments on an insurance policy: members pay into a common pool of research assets to insure they will always be available regardless of market conditions and the buffeting winds of the corporation.

Franchise fees cross legal entities. One legal entity pays fees to another with the intent the other will combine similar payments from all members to provide goods and services in common to all. Franchise fees represent a legal obligation. Neither side can unilaterally restructure of the obligation, and both sides can step back from the obligation in the event of a default on the part of the other.

We use franchise fees in World Class R&D to pay for membership+ benefits: shared services, governance structures, common infrastructure, organization of member activities, etc. We do not allow these benefits to be viewed as ‘economies of scale’, as a means to leverage ‘purchasing power’, or as resources to be allocated among members. This view plays into the hands of the tyrant, who looks to usurp a portion of the savings for personal aggrandizement. Individuals get neither credit nor personal power from any supposed ‘savings’ achieved for the benefit of the many. We do not care about savings, because as we'll see below: the sole intent of franchise fees is to avoid usurpation of R&D spend by the tyrant.

Franchise fees paid in by members cover 30-40% of all corporate R&D spend, with the corporation making up the difference. We’re looking for skin-in-the-game. The corporation signals+ its commitment to R&D by maintaining its share of the funding. Analogous to what is seen in the Venture Capital industry, the funding agent+ is expected to contribute both money and expertise in exchange for over-sized investment returns. The corporation's 'expertise' is delivered in the form of payments to the franchise. Our challenge is to avoid a situation of moral hazard+: where either party shirks responsibilities once the transaction has been consummated.1 We seek a means to make it financially painful for either party to renege on prior commitments.

Franchise levels are built similar to service levels in the cable industry. Everyone gets basic, but there are tiers of premium service for the novice, the mid-life, and the mature members of our franchise. You can always cut back to basic, but you typically stay within a premium tier because there is great value at each level of service. There is no rationing of services. Each member pays for and receives its chosen level of service, or is reimbursed by the franchise to seek out those services in the open market.

Across-the-board cost cutting measures by the corporation become self-defeating. They risk pushing franchise members back to basic levels of service, reducing franchise fees and undercutting any hoped-for cost savings on the part of the corporation. We have voluntary members. These are successful franchise operators who are now self-funding, but who opt to remain as franchise members because of the value they see in its services and products. These will be the first to leave (permanently), along with their franchise fees, in the face of arbitrary cost cutting measures.

The corporation gains no advantage from shirking, because it is immediately offset by a reduction in cost-sharing by the members. This is a bit of an accounting trick, in that members merely substitute direct purchases of services (off the corporate books) for shared services (on the books). The point is that we use franchise fees so members can leverage their 30-40% contribution to lock in the corporation’s 60-70% contribution. For this trick to work, of course, franchise services must be on-the-books of the corporation as expenses, and not held in a separate legal structure that can be conveniently shortchanged in times of arbitrary cost-cutting.

You're making me, the franchisee, pay both debt interest and a significant franchise fee? That’s not fair! It’s irrelevant. Funding agents can demand 10x return on an investment or 5x return. The expected level of return demanded by the funding agent swamps any noise from outgoing payments. The franchise fee offsets expenses normally incurred by the venture capitalist as a contribution of business expertise to the effort. In exchange the franchise operator receives a better deal on its funding. They pay a lower premium for financing and are able to become debt free much sooner than is typically seen in a Venture Capital agreement.

Franchise fees are essentially cost-neutral to the franchisee, and do much to minimize the risk of shirking on the part of the franchisor. Franchise representatives have a majority vote in the operations of franchise: fee structures, service levels, procedures for redress and reimbursement, etc. The franchise structure is set up for the benefit of the franchise membership. Members join the franchise with the expectation of receiving extraordinary levels of benefits, and protecting the corporate contribution is key to meeting this expectation.

  • 1. It could also be that individuals act more responsibility once a contractual agreement has been consummated.