Area Development...who’s The Master Anyway? Howard Bassuk So you want to build an empire! You want to be part of something, big, strong, dynamic, and well respected. You will not be satisfied with owning several franchised territories alone, you want more! However, you don’t want to re-invent the wheel if there is one out there you can ride along with. You know enough to know you don’t want to try to build your empire all by yourself. Starting your own franchise company does not seem to make sense but simply owning one or more units of a particular franchise doesn’t satisfy you either. Is there a way to do all these things? The answer is YES! Its called “area” or “regional development”. The basic idea of “area or regional development” is to have a franchisee who also acts as a local adjunct to the franchisor. As this adjunct the area developer is not just a franchisee, but is also the franchisor’s support person in a local market. Under this arrangement, the area developer and the franchisor share both the responsibilities to the franchisees, and the revenues from the franchisees. Franchisors often like having regional or area developers as part of their system and infrastructure. With area/regional developers, the franchisor can have regional management without having corporate employees. This “regional or area developer” for lack of a better description, is part franchisor, and part franchisee. In fact, depending on the exact nature and scope of the work and contract between the franchisor and the developer, an area developer could become a sub-franchisor required to have his/her own franchise offering circular (UFOC). Fortunately most area/regional developers are not required to become sub-franchisors. They typically enter into an agreement with the franchisor whereby they, as a regional or area developer provide certain local support to the franchisees in a specified region or area. They become, to a greater or lesser degree, the rough equivalent of a regional manager. In return for providing these local services, the franchisor and the area developer each get a share of the franchise fees and royalties paid by the franchisees in the region owned by the developer. Although there is no mandatory formula for dividing these funds, the fee splits typically range from 50%-50% to 60%-40% (with either side getting the higher or lower percentages). To earn the “developer’s share” of the franchise fees and ongoing royalties, the developer, depending on the particular deal, will help assist the franchisor in many different ways. These can include everything from helping to find franchisees and locations for them, to assisting franchisees in their lease negotiations, and opening and ongoing training and assistance. This allows, a franchisor to provide localized support, and better responsiveness to franchisees’ needs without having to have the cost burden created by employees. As such, many franchisors feel that any fees or royalties paid to area developers are well earned. For the area developer, their investment of time and money can also be a good one because a mature and well-developed region can produce both impressive fee and royalty revenues for the area developer, and an exciting and dynamic workplace environment. It can be lucrative, challenging, stimulating, and enjoyable! Although area development can be both extremely exciting and extremely rewarding, it is not without significant commitment and risk to the regional/area developer. There is no guarantee of what will happen in the region that a developer buys, yet developers can expect to pay a substantial fee to acquire that region. Many times the fees are quite reasonable compared to the opportunity regional ownership offers, but even so, some fees, depending on the size of the region acquired, and the opportunity that is being acquired, can amount to hundreds of thousands or even millions of dollars! There can be a real benefit for the franchisor as well. In addition to receiving a fee for granting the area rights to a developer, the franchisor also gets someone who can provide greatly needed local support for franchisees in local marketplaces. These developers are counted on to provide the critical help that franchisors must provide to their franchisees, while still managing finite financial and human resources. For a younger franchisor, area/regional developers can be a real blessing! Regional developers can help franchisors grow more quickly then they could otherwise on their own. Instead of hiring people to provide local support, the franchisor is paid a fee by the developer for the rights to develop the particular region. As such, the franchisor not only does not have to hire a local or regional support person to provide these services, he/she is paid to grant these rights! When done properly, the franchisor can use these funds to complement other needed parts of the business, and further facilitate growth and stability within the system! And, the franchisor often gets a very capable manager! Most of the regional developers that I have seen have solid management credentials, are hard workers, and are committed enough to the system to have invested in the franchise themselves. Not only do they pay a fee for the rights to the region/area that they acquire, they often open the region’s “prototype” location for the franchise. The regional developer like the franchisor, also has a large upside potential. If the developer can successfully develop a region and they received 40%-60% of the ongoing royalty from all the open stores in that region, plus any revenues from a location or locations that he/she also owns. It can be extremely profitable! To give you an idea of what this can mean, let’s look at some hypothetical returns that an area developer may enjoy. Let’s assume that there are 50 locations in a particular region, and that each of these locations produces $300,000 per year in revenue. That means that the annual revenue in the region would be $15,000,000. Let’s further assume that the royalty paid is 6%. Therefore, the royalty on that revenue would be $900,000. If you were the area/regional developer, and you got 50% of the royalties paid, you would earn $450,000 a year, not counting any money you made from your own locations! Not bad for getting up each morning! A regional developer can probably earn more money in a franchise system, than anyone other than the franchisor, but he/she will have a lot of responsibility too, so its hard work! However, after a few years, the burden on regional developers lessens as new units in the region become fewer, and the older units need less and less day-to-day support. A region, in its mature stages can be absolutely heavenly for the area/regional developer. It can provide both significant revenues, and significant freedom. This combination can more than pay back any risk, investment or hard work from the early years. So the rewards sound great! But, the regional developer usually has to be more of a risk taker than a normal franchisee. He/she has to be willing to pay the franchisor for the rights to help develop an area that has virtually no other franchisees at that point. And, because area/regional development is most attractive to franchisors when they are young and need more help to grow, most area development deals come from franchisors that are less proven then a more mature and chartable franchisor would be. So it's a win-win, right? Franchisors get investment dollars to help them grow, and they get managers to provide local support without having to hire people. The regional/area developers get an opportunity to build and own a region for a developing franchise company. If the combination of the franchisor and the regional developer are successful in building the region, both the regional developer and the franchisor can enjoy strong revenues for many, many years! But not so fast! While it may sound like the perfect recipe for a match made in heaven, it may be anything but that! Like so many other things in life, “Area/regional development” is fraught with both positive and negative possibilities, both of which happen regularly, and like so many things that sound good at the beginning, regional/area development can be a very mixed bag. A potential negative for the franchisor is that they are mortgaging future revenues in return for early local support. As the franchise becomes more mature, the needs of the franchisees tend to become more national in scope, and the regional developer is not the person or place where solutions are best generated. Because of this, the franchisees increasingly look to the national franchisor for solutions. However, with as much as 40%-60% of the royalty revenue still going to the regional/area developer, a sizable and precious part of the available revenue never makes it to the franchisors' coffers, and is therefore unavailable for use in providing needed products, and services. This can mean that although the franchisees may be paying large amounts of royalties, it is possible that the amount that the franchisor receives is not enough to enable the franchisor to provide some needed programs! Additionally, the franchisor can be put in a very difficult position if an area developer turns out not to be as competent as the franchisor first thought he/she would be. In a normal employer-employee situation, the employer could simply replace the employee who was not performing adequately. It’s not that easy with an area developer that is not the right person for the job. The franchisor might have few or any viable options in terms of replacing a regional developer that is not as good as the franchisor and the franchisees need. Although the area/regional developer probably has a strong management background, there is no guarantee that he/she will be good at the diverse requirements needed in their region. It also does not mean that they fit the particular franchise that they buy, and may mis-match. Since the franchisor is ultimately the one that most franchisees look to, the franchisor may wind up having to fix the problems created or not solved by their own regional developers! On the other side of the coin is the possibility that it is the franchisor who may not have the business ability to continue to grow throughout the various development stages that are required. There is no foolproof way to predict how far a company will go, so a person investing in a region, has to make part of his/her investment on faith! The bottom line on all of this? Area or regional development can be a great boon to both the franchisor and the regional developer. However, there is also risk involved for both sides. A franchisor may not want to offer regional opportunities after it gets to a certain level of maturity, so most opportunities will be young. If you think that area or regional development makes sense to you, and you can find the right franchisor to do it with, it may turn out to be a great long term investment.