The Benefits of Being an Area Developer

04/08/2018 08:00 | Start a business

What is an area developer in franchising

 

If you’re dreaming of becoming the owner of a large franchise empire, you may be exploring ways to open several units in a relatively short period. Area development agreements are one way of doing this, and they can benefit franchisees in many ways. Here, we look at what area developments are, what the advantages are for franchisees, and what risks are involved for both franchisors and franchisees.

What is an area developer?

An area developer is an individual who enters a franchise agreement to establish a certain number of franchise units over a defined territory. They differ from other multi-unit franchisees in the fact that they don’t naturally acquire additional units one at a time, but enter a contract that dictates how many units they need to set up, how long a period they have to launch them, and what territory they must be situated in. As well as being known as area developers, this type of franchisee is often referred to as a multi-unit developer.

Different types of area developer

While we’ve defined an area developer as a franchisee that enters an agreement to

  1. Open a certain number of franchise units
  2. Over a predetermined period
  3. In a clearly defined territory

It's also important to recognise that there are many different types of area developer and many different motivations for entering such an agreement. For instance, private equity franchisees will have drastically different intentions to strategic franchisees. Some franchisees will want to own several units in their local area. There are many different motivations for becoming an area developer, and each will approach the project differently.

Why become an area developer?

There are many different reasons why becoming an area developer is an attractive proposition. Here, we look at five of the most important explanations.

1. Market exclusivity
Becoming an area developer ensures that you secure the rights to a territory and prevent other franchisees from benefitting from your target market. If an individual starts by opening a single location and attempts to build their business by growing one unit at a time, there’s no guarantee that another franchisee won’t make the most of your success and open their unit in relatively close proximity. While many franchises offer franchisees the rights to an exclusive territory, this is generally a lot smaller than the space reserved for an area development agreement.

2. Reduced franchise fees
While area developers will typically pay the same franchise fee as other franchisees for their first unit, the cost will usually decrease as you open more units. Franchises often offer a tiered pricing system or reduce the payment expected for each unit opened. For instance, with a tiered system, the franchisor may charge the full fee for the first unit, then offer a 10% reduction for units two to four, and knock off 20% for the fifth unit and any more that come after. An alternative system may see the franchisor drop the price by 2% each time a new unit is opened. This drastically lowers the cost of franchises for individuals who are certain they want to open more than one unit.

3. Lower royalty fees
Some franchisors will offer area developers lower royalty fees once they’ve opened a certain number of units. This makes sense for both the franchisee and franchisor, as the cost of supporting area developers decreases with each unit opened. This is mainly because the individual franchise units share much of the same infrastructure. In some cases, solutions provided to the area developer can be applied to all the franchise units at no additional cost. Consequently, the franchisor pays less to support the area developer’s units and the franchisee pays a lower royalty fee in a mutually beneficial arrangement. Lower royalty fees encourage greater franchise development and expansion.

4. Economies of scale
Area developers can also benefit from economies of scale. Rather than making purchases for a single unit, franchisees can combine the spending power of all their units, reducing the cost attributed to each location. While economies of scale also apply to franchisees that open a single unit at a time and don’t operate under an area development agreement, it typically takes far longer to reach a level where economies of scale have an impact on costs.

5. The franchise model and expansion
The franchise model is designed to facilitate expansion; area development agreements, in particular, are a means of encouraging rapid expansion. If you want to secure an exclusive territory and rapidly launch several franchise units, area development agreements may be the best way to go about it.

Risks

There are some risks associated with area development agreements. For franchisors, there's the possibility that you'll choose the wrong developer and be stuck with an inappropriate franchisee for a long period. The fact that they're also entitled to open multiple franchise units means that they could have an adverse effect on a significant portion of your total franchise units, severely harming your reputation. For franchisees, the principal risk is that your initial units aren't as successful as you had hoped, but you're tied into a contract that requires you to open more.

Conclusion
Area development agreements are a useful tool for facilitating expansion and securing the rights to a particular territory. They allow those franchisees who know that they want to eventually open multiple units, to do so at a lower cost and prevent competition from infringing on their market. If you’re able to plan that far ahead and believe a territory can accommodate several units, area development agreements are beneficial in several ways. From lower royalty fees to exploiting economies of scale, these advantages make area development agreements an exciting investment opportunity.

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