[비즈한국] Companies sometimes make decisions that are difficult to explain by money alone. Understanding the laws and systems hidden within them can provide a deeper look at the inner workings. ‘Business Law Insights (Al-Sseul-Bi-Beop)’ introduces clues to help understand business trends.
Franchising is often called "one of the best business models," "the most successful method of business expansion," or the "essence of systematic management." Franchisors can expand their businesses with relatively low costs by recruiting franchisees (store owners), and franchisees can settle into the market early by receiving trademarks, trade secrets, and operational know-how from the franchisor.
According to the ‘2024 Franchise Business Status Statistics’ released by the Korea Fair Trade Commission (KFTC), unlike the stagnation in the industry's external growth, the average sales per franchise store have shown stable growth. While the average revenue for small business owners in 2023 was approximately 200 million won—a 14.9% decrease compared to the previous year—the average revenue per franchise store was about 350 million won, a 3.9% increase. Even though there are frequent complaints about the tyranny of franchisors, there is a reason why a significant number of businesses starting up around us are franchises.
Since the essence of a franchise business lies in the transfer or distribution of risk, running a franchise store is no easy task. If a franchisor were confident in securing profits solely through opening new stores, they would increase the number of directly operated stores rather than recruiting franchisees. Most franchise business models are concentrated in dining, retail, and services like education. These sectors are often criticized for "barely covering labor costs," and they generally have low margins and high closure rates.
As the share of franchise businesses in small-scale self-employment has grown, sharp criticisms regarding poor management or the tyranny of franchisors have emerged, unlike in the past. While seeing this makes one feel relieved for the protection of franchisees, it also makes one think that it would be impossible to even consider starting a franchise business in the future without massive capital and excellent planning ability.
In this article, we examine the unique characteristics of Korea's franchise industry, which relies heavily on logistics and distribution, and the legal regulations surrounding them. Article 2, Paragraph 1 of the Franchise Business Act defines a "franchise business" as a continuous transactional relationship between a franchisor and a franchisee.
· The franchisor allows the franchisee to sell products or services according to certain quality standards or operational methods using their own trademark, service mark, trade name, signboard, or other business signs, and provides support, training, and control over management and business activities accordingly.
· The franchisee pays a franchise fee to the franchisor in exchange for the use of business signs and for support and training related to management and business activities.
According to this definition, the profit model of a franchisor should be royalty income received in exchange for providing a brand, operational know-how, and systems. However, in Korea's franchise industry, the share of royalty income is minimal, and most franchise profits come from distribution margins earned in the process of supplying products to franchisees.
This has led to the criticism that "the reliance on logistics and distribution is too high." Furthermore, it is pointed out as a harmful practice that disputes over forced purchasing between franchisors and franchisees are constant, and that franchisors lose the motivation to develop business models and innovate continuously, instead settling for distribution margins.
According to media reports, in developed countries like the U.S., most revenue comes from royalties and licensing fees, while logistics and distribution are carried out in the form of cooperatives voluntarily formed by franchisees, thereby avoiding disputes like forced purchasing.
However, I have never seen such cases in Korea, and given the general disregard for trade secrets and intellectual property rights in Korean culture, I am not confident that overseas models can be adopted. This is because there are many cases where a franchisee absorbs a franchisor's trade secrets and operational know-how, then leaves the franchise to operate a store in a similar manner, just changing the signboard or menu slightly, and it is difficult to respond to this under Korean law or social sentiment.
The franchise business laws and the KFTC are aware of the problems in Korea's franchise industry, which relies excessively on distribution and logistics, and are regulating the industry through various methods. The first is the ‘Essential Items’ regulation. Essential items refer to items that a franchisor forces franchisees to purchase from themselves or a designated business partner to secure a unified image for the franchise and maintain consistent product quality.
In principle, forced purchasing of specific items in private transactions is not permitted. However, given the nature of franchise businesses, which center on the protection of trademark rights and the maintenance of service uniformity, some degree of forced purchasing for essential items is allowed.
Instead, it requires that the necessity of these items for franchise management be objectively recognized, that they be explicitly stated in the franchise agreement, and that if trading conditions are changed to the disadvantage of the franchisee, prior consultation with the franchisee must be conducted.
For example, in a kimbap franchise business, forcing the purchase of cleaning supplies, detergents, or equipment sanitizers as essential items is not permitted. However, designating poultry or sauces as essential items in a chicken franchise, or coffee beans or cakes in a coffee franchise, can be allowed.
The second method is the regulation of ‘Margin-based Franchise Fees’ (Gap-in-Gyeong-Ui-Geum). This refers to the portion of the price a franchisee pays to the franchisor for products that exceeds a reasonable wholesale price.
Franchise laws require that whether such fees are collected, the average fee per store, and the ratio of these fees to total revenue per store must be disclosed in the disclosure document. Those wishing to start a franchise can decide whether to proceed based on this information in advance.
However, in a recent pizza franchise case, the Seoul High Court ruled that if the basis for collecting these margin-based fees was not clearly stated in the contract, not notified in advance via disclosure documents, or if the franchisor did not actually participate in the product supply chain (e.g., forcing purchases through another business), then the fees collected by the franchisor constitute unjust enrichment. This has prompted the industry to review the grounds and legitimacy of collecting such margin-based franchise fees.
The stance of the law, the KFTC, and the courts to reduce the reliance on logistics and distribution in Korea’s franchise industry is clear. Although it is not an easy path, franchisors must re-examine their current status of essential item designation and the legal grounds for collecting margin-based franchise fees. Franchisees also need to review whether they are complying with regulations within reasonable limits.