The current franchise fraud erupting in New Zealand where a rogue master franchisee of home services franchise Green Acres is alleged to have sold 200 unauthorised ironing franchises and pocketed the cash is a another example  of the need to approach the use of master franchising with extreme caution.

While the concept of selling off regions or entire states to a master franchisee in a domestic market appeals to many systems with ambitious growth targets and limited capital resources, the reality is that master franchising is not always the best way to grow a business, and can indeed give some franchisors cause for regret.

The Green Acres experience is a perfect example, with its brand sullied by the fraud allegations that continue to unfold in the New Zealand press, and the integrity of the franchisor itself called into question, albeit Green Acres had no knowledge of its master franchisee’s actions. But that’s part of the problem of master franchising – franchisors not knowing what their master franchisees are doing and then still being found to be liable either in a court of law (as in the original Lenards case in South Australia a couple of years ago which was later overturned on appeal), or in the court of public opinion.

The Green Acres experience begs the question – how robust were the franchisor’s monitoring and management systems to allow the scam to go undetected for so long? Surely one or two unauthorized franchise sales might have flown under the radar for a short period of time, but nearly 200?

This demonstrates the inherent danger of master franchising. For franchisors to be good at it, they need tight, highly defined management systems and controls that are usually lacking or non-existent during the early stages of development when master franchising is considered either in response to unsolicited requests, or in an effort to accelerate market coverage. Unfortunately for many, the hard-won lessons of master franchising come at great cost later on, often at the same or greater cost than the initial investment received for the sale of the region or state. (And let’s reiterate that this discussion of master franchising is limited to a domestic setting, as it is expected that franchisors granting international master franchises are usually quite mature in their domestic market before agreeing to export).

Other problems with master franchising are the dilution of ongoing fee income to the franchisor, and roadblocks to franchise growth if the master franchisee is incapable of expanding the network. In service franchises this can be a considerable problem, where master franchisees are unable to down tools on their own territory or customer base because there is insufficient income from royalties or franchise sales to replace it (or their daily customer workload is such they are simply swimming against the tide).

For these reasons it is not surprising that we have seen a number of networks over the years step away from master franchising, either by buying back the farm, not renewing master franchise agreements, or simply avoid this method of expansion altogether.

For new systems however, the temptation remains to take a large up-front investment from a master franchisee and sort out the problems thereafter. But increasingly, the risks outweigh the rewards.

By Jason Gehrke, Director, Franchise Advisory Centre (Copright, 2008)