[The Trap of Low-Capital Startups]⑤Easy Profits for Headquarters: Franchisees Open, Headquarters Cash In

Profitable Just from Franchise Fees
Recruiting Franchisees Despite Market Saturation
Royalties, Advertising Contributions, Commissions, and More
A Wide Range of Cost Burdens for Franchisees

Editor's NoteIn Korea, starting a franchise business often begins with taking on debt. Small business owners fall into the trap of aggressive lending, lured by the promise of "low-capital startups" from franchises eager to expand their network. Even when sales are generated, franchisees who start out with loans find it difficult to actually make a profit. If business slows even slightly, many cannot withstand the pressure and end up bankrupt. This article examines how franchisees are enticed by the bait of "low-capital startups" during the franchise process and how excessive borrowing can lead to dangerous consequences.

How do franchise headquarters make a profit? The franchise fee is the starting point of their revenue. When a new franchisee signs a contract, they pay a franchise fee to the headquarters, which usually starts at around 3 million to 5 million won, but for well-known franchises, the market price is set at over 10 million won.

According to reporting by The Asia Business Daily on October 18, despite the economic downturn, the number of companies participating in franchise startup expos continues to increase. At the IFS Franchise Seoul Startup Expo, around 150 companies participated during the COVID-19 pandemic in 2021. The number of participating companies grew to about 250 in 2022, slightly decreased to around 230 in 2023, but then surged to approximately 350 companies in both 2024 and this year.

It is also common for headquarters to recruit prospective franchisees by accepting applications for their own startup information sessions online. This month, a chicken franchise headquarters is holding two startup information sessions in Seoul on the 16th and 30th. Another street bar franchise headquarters has announced four startup information sessions in Gwangju, Busan, and Daegu just in October. A salad franchise, which is holding an information session in Seoul on the 20th, also accepted applications through its website. These examples show the continued popularity of franchise startups, even considering the saturated market and economic downturn.

Once a franchise agreement is signed, the headquarters can receive royalties from the franchisee on a regular basis. Although it varies by industry, this means paying for the use of the brand either annually or monthly. Some require franchisees to pay several million won once a year, while others set a certain percentage of monthly franchise revenue. Industry insiders say that even recruiting just one new franchisee at a consultation or expo is profitable for the headquarters due to the franchise fee. One industry official commented, "The cost of renting a consultation booth at a startup expo is usually around 3 million won. If a contract is signed at the booth, the franchise fee per store is several million won, so the headquarters always profits in the end."

In addition, the headquarters can earn extra income from training fees, supply margins (markup on raw materials and supplies), advertising contributions, and commissions from franchisees. The franchise industry explains that these are strategic costs to maintain brand value. Headquarters invest in standardizing interior design, service, and food ingredients to ensure a consistent atmosphere and taste at every franchise location.

The problem is that, due to the opaque revenue structures of franchise headquarters, the cost burden on franchisees often translates into increased profits for the headquarters, fueling growing controversy over unfair practices. On October 1, the franchise headquarters of MegaMGC Coffee, N House, was fined 2,292 million won and ordered to correct its practices by the Fair Trade Commission for requiring franchisees to purchase ice machines and coffee grinders only from the headquarters as mandatory items. It was revealed that N House had added margins of up to 60% in the process.. In March, All F&B, which operates the Jokbal Night Market franchise, was ordered by the Fair Trade Commission to correct its practices and fined 94 million won for forcing franchisees to purchase packaging products only from designated suppliers. The franchise contract stipulated that if a franchisee purchased goods from a non-designated supplier, the headquarters could suspend supply or terminate the contract.

Recently, following a court ruling involving Pizza Hut, lawsuits have been filed in the franchise industry to recover supply margins (markup on supplied goods). A supply margin is an additional markup the headquarters adds to goods and raw materials supplied to franchisees, but the calculation method is often unclear and the amounts are criticized as excessive. In September last year, the Seoul High Court ruled that 21 billion won in supply margins collected by Pizza Hut headquarters from 2016 to 2022 constituted unjust enrichment. The court rejected the defense of "industry practice" and ruled that if the headquarters did not specify the supply margin in the franchise contract or did not reach an individual agreement with each franchisee, there was no basis for collecting it. The lawsuit is awaiting a Supreme Court decision next year.

Not only supply margins but also interior costs are often set in a non-transparent manner. Interior costs typically account for more than half of the total startup cost, but in most cases, franchisees cannot choose their own interior contractor and must use one designated by the headquarters. It is difficult for franchisees to determine the actual cost of materials or how much margin the headquarters is making from the franchise contract. One franchisee said, "Even if you use a contractor other than the one designated by the headquarters, during the pre-opening inspection, headquarters staff will find fault and force you to redo the work."

Within this structure, the revenue gap between franchise headquarters and franchisees is widening. According to analysis by Leaders Index, a corporate research institute, based on data from the Fair Trade Commission's Franchise Business Information System and the electronic disclosure system, the average annual sales per franchise store among 115 franchises dropped by 7.6%, from 327.23 million won to 302.48 million won between 2022 and 2024. In contrast, the total sales of franchise headquarters jumped by 10.8%, from 43.1565 trillion won to 47.7963 trillion won during the same period.

Experts advise that, in addition to stronger regulatory measures, aspiring entrepreneurs should thoroughly check all details in advance. Noh Seungwook, CEO of the startup mentoring platform Changtalk, said, "Headquarters are well aware that their unfair practices violate the Franchise Business Act, but they continue because the profits from franchisees far exceed any fines. The level of penalties for legal violations should be raised, such as by strengthening liability for damages, to serve as a deterrent."

He added, "Even if it is difficult for franchisees to check every page of the contract and disclosure documents at the startup stage, they must carefully review any toxic clauses in advance. If necessary, they should seek help from experts such as franchise transaction specialists."