🚨 Franchise Markup Fee: Understanding the Hidden Costs of Franchise Businesses

Today Korean Social News | 2025.04.28

📌 'Franchise Markup Fees' Increasing Conflicts in Franchises... Wave of Lawsuits Spreading

💬 At a franchise exhibition in Seoul, franchisees revealed their struggles, contrary to the expectations of hopeful entrepreneurs. Conflicts between franchisors and franchisees are intensifying due to markup fee issues, with lawsuits for fee refunds emerging in some industries. The Fair Trade Commission positively evaluated improvements in unfair trade practices, but demands for restructuring the franchise business model continue to grow stronger.

Summary

• Franchise markup fees are additional profits that franchisors make from the prices of products supplied to franchisees.
• Franchisees bear more operational costs than expected because of these fees.
• Recent increases in markup fee-related lawsuits are driving demands for improvements in the franchise industry structure.

1️⃣ Definition

Franchise markup fee refers to a revenue structure where franchisors supply products to franchisees at prices higher than market rates and profit from the difference. Simply put, franchise owners may see low initial franchise fees, but end up paying more due to these markup fees.

Franchise markup fees directly impact the profitability of franchise businesses and are essential to check before starting a business.

💡 Why is it important?

• Markup fees significantly determine the actual operating costs of franchises.
• Higher-than-expected product costs can reduce franchise profitability.
• Understanding the markup fee structure before signing a contract is key to successful business ownership.

2️⃣ Types and Characteristics of Franchise Markup Fees

📕 Main Types of Franchise Markup Fees

• Markup fees from essential product supplies are most common. Franchisors supply certain products to franchisees to maintain brand consistency and quality.

  • For example, chicken franchises require franchisees to purchase chicken, sauces, and packaging materials from the franchisor or designated suppliers.
  • The franchisor sets prices higher than actual market prices and takes the difference as profit.
  • This system provides franchisors with stable revenue but creates an ongoing cost burden for franchisees.

• Markups also occur during equipment and facility supply. Markup fees can arise when franchisors directly supply or designate specific suppliers for equipment and facilities needed to open a franchise.

  • For café franchises, coffee machines, baking equipment, and interior materials must be purchased through franchisor-approved channels.
  • During this process, franchisors either receive rebates from equipment suppliers or directly set higher prices to make a profit.
  • Even if initial investment costs seem low, franchisees may end up paying more during the facility purchase process.

• Markup fees are sometimes used instead of royalties. Some franchises use markup fees as their main revenue source instead of explicit royalties.

  • Instead of paying a percentage of sales as royalties, franchisees indirectly provide income to franchisors through product purchases.
  • This method has the advantage of reducing royalty burden when sales are low, but costs vary depending on product usage.
  • In the Korean franchise market, the markup fee method is more common than royalties.

📕 Legal Status of Franchise Markup Fees

• Markup fees themselves are not illegal. Markup fees are a widely used revenue model in the franchise industry and are not illegal in themselves.

  • Franchise law does not prohibit markup fees and recognizes them as a legitimate way for franchisors to generate revenue.
  • However, franchisors must transparently disclose how they determine product prices and the differences from market prices in their disclosure documents.
  • This is to ensure that potential franchisees can make reasonable decisions based on sufficient information.

• Unfair markup fees are subject to regulation. Setting excessive markups or violating disclosure obligations can lead to legal issues.

  • Franchisors may violate fair trade laws if they set significantly high prices during product supply or fail to provide sufficient information.
  • Forcing unfavorable trading conditions on franchisees or recruiting them with false or exaggerated information is strictly regulated.
  • Recently, legal regulations related to markup fees have been strengthening to protect franchisee rights.

Main Features and Considerations of Markup Fees

1. Information Asymmetry: Transparency issues arise due to information differences between franchisors and franchisees
2. Impact on Revenue Structure: Markup fees directly affect the actual profitability of franchises
3. Mandatory Disclosure: Franchisors must specify product supply pricing policies in disclosure documents
4. Bargaining Power Imbalance: Franchisees have limited negotiating power regarding supply conditions
5. Cost Calculation Complexity: Initial investment costs alone make it difficult to accurately predict actual operating costs

3️⃣ Impact of Markup Fees and Dispute Cases

✅ Impact on Franchisees

• Markup fees can be a major cause of reduced profitability. Franchise markup fees have a significant impact on actual franchise profitability.

  • In some franchises, raw material costs account for 40-50% of sales, with a considerable portion going to franchisors as markup fees.
  • If product purchase costs are higher than initially expected, franchise net profits decrease significantly.
  • Especially in competitive markets, franchisees often bear the entire cost burden as price increases are difficult.

• They serve as a major source of conflict and disputes. Markup fees are becoming a main cause of conflicts between franchisors and franchisees.

  • Disputes arise when the scale of markup fees, not fully recognized when signing the franchise agreement, becomes a major burden after business operations begin.
  • Conflicts intensify when franchisors maintain supply prices despite falling raw material costs in the market.
  • Dissatisfaction grows particularly when franchisees must purchase mandatory items from franchisors despite being able to buy the same products cheaper elsewhere.

✅ Major Dispute Cases and Legal Responses

• Markup fee refund lawsuits are increasing. Recently, there has been an increase in franchisees filing lawsuits for refunds of excessive markup fees.

  • In 2024, the Seoul Central District Court ordered a partial refund in a lawsuit filed by chicken franchise owners, ruling that "the franchisor collected markup fees exceeding reasonable profits."
  • Similar lawsuits are proceeding in various industries including pizza and coffee, with some franchisees responding through class action lawsuits.
  • The key issues in these lawsuits are the standards for "reasonable markup" and whether franchisors fulfilled their information disclosure obligations.

• Fair Trade Commission regulations are being strengthened. The Fair Trade Commission is strengthening monitoring and regulations on unfair trade practices related to markup fees.

  • In 2023, the Commission issued correction orders and fines to several franchisors who failed to clearly state the difference between product supply prices and market prices in their disclosure documents.
  • They are also investigating and sanctioning cases where the scope of essential items was unfairly expanded or excessive price differences were set.
  • Recently, they are also encouraging industry self-improvement efforts such as establishing voluntary regulations through cooperation with franchisee organizations.

4️⃣ How to Check Markup Fees and Response Strategies

💡 How to Check Markup Fees Before Starting a Business

• Thoroughly analyze the disclosure document. It's important to check markup fee information through the disclosure document before signing a franchise agreement.

  • You can find the list of essential items and pricing policies in the "Details and Trading Conditions of Items Needed in Franchise Operations" section of the disclosure document.
  • Pay particular attention to content related to product supply in the "Support for Franchisor's Management and Business Activities" section.
  • Franchisors are legally required to provide the disclosure document 14 days before signing the contract, so use this time to analyze it thoroughly.

• Refer to existing franchisees' experiences. The experiences of current franchisees are very helpful in understanding the actual burden of markup fees.

  • Request a list of current franchisees from the franchisor and visit or contact them directly to ask about actual product purchase costs.
  • Gather information about the brand's product supply conditions through online business communities or franchisee meetings.
  • The experiences of franchisees who closed their businesses can provide important clues to identify causes of profitability decline.

💡 Response Strategies for Franchisees

• Pre-contract negotiation and clear condition setting are important. Clarifying and negotiating markup fee-related conditions before signing a franchise agreement is most effective.

  • You can request that the scope of essential items, pricing methods, and adjustment standards based on market price changes be clearly stated in the contract.
  • You can prevent sudden cost increases by including clauses about advance notice periods for price increases and increase limits.
  • Another approach is to negotiate conditions allowing external purchases for some items or introducing adjustment mechanisms after price comparisons.

• Actively use your legal rights. Franchisees have several legal rights related to markup fees.

  • If a franchisor demands additional costs not specified in the disclosure document or provides false information, you can terminate the contract or claim damages.
  • Collective response through franchisee organizations is also an effective strategy to increase negotiating power.
  • If unfair trade is suspected, you can report to the Fair Trade Commission or use dispute mediation procedures.

5️⃣ Related Terms Explanation

🔎 Royalty

• Royalty is a fee paid for using a trademark.
• Royalty refers to the cost that franchisees pay for using the franchisor's brand, know-how, and system in a franchise system. It is typically set as a percentage of sales (usually 3-7%) and paid monthly or quarterly to the franchisor.
• While most international franchises use the royalty method as their main revenue model, many franchises in Korea prefer the markup fee method instead of royalties. Royalties have the advantage of linking the franchisor's interests directly to the franchisee's success, as they are tied to sales.
• The biggest difference between royalties and markup fees is in transparency and linkage. Royalties are clearly calculated based on sales, while markup fees vary according to product purchase volume and price differences, making it difficult for franchisees to predict exact costs.

🔎 Disclosure Document

• A disclosure document is a mandatory information document that franchisors must provide to prospective franchisees.
• A disclosure document is a document that franchisors must provide to prospective franchisees before signing a contract, as required by franchise law. It contains important information about the franchisor and the franchise business. This document is registered with and managed by the Fair Trade Commission.
• The disclosure document includes the franchisor's general status, legal violations, franchise status, franchise fees, product supply conditions, business activity conditions, education and training explanations, and other key information needed to assess the franchise business.
• Regarding markup fees, pay special attention to the "Details and Trading Conditions of Items Needed in Franchise Operations" section. Here you can check essential purchase items, pricing methods, and differences from market prices.

🔎 Essential Items

• Essential items are products that must be purchased from suppliers designated by the franchisor.
• Essential items refer to products that franchisees must purchase from the franchisor or franchisor-designated suppliers according to the franchise agreement. These are set to maintain brand uniformity and quality.
• Franchise law allows franchisors to determine the scope of essential items, but requires them to clearly state this in the disclosure document and disclose it to franchisees. If the scope of essential items is excessively broad or unreasonably set, it can be sanctioned as an unfair trade practice.
• Recent court rulings have put a stop to practices where items with no direct relation to brand uniqueness are designated as essential items to collect excessive markups. Before starting a business, it's important to carefully examine which items are designated as essential and whether their scope is reasonable.

6️⃣ Frequently Asked Questions (FAQ)

Q: Which is more advantageous for franchisees: markup fees or royalties?

A: Whether markup fees or royalties are more advantageous depends on business characteristics and conditions. Royalties are linked to sales, so the burden decreases when sales are low, and franchisors become more interested in increasing franchisee sales. Also, costs are calculated transparently, making predictions easier. On the other hand, markup fees are determined by product usage regardless of sales, so the burden can increase if you use many materials even with low sales. However, it could be more advantageous if sales are high but product usage is low. Generally, the royalty method is preferred for transparency and predictability, but in practice, you should compare the specific conditions of both methods (royalty rate, extent of markup, etc.) to make a judgment. Before starting a business, it's important to accurately understand the franchisor's revenue structure and calculate the cost burden under various scenarios. Also, some brands use a mixed approach of royalties and markup fees, so you need to consider the overall cost structure comprehensively.

Q: How can franchisees respond when they feel markup fees are excessive?

A: There are several ways franchisees can respond when they feel markup fees are excessive. First, collective negotiation with the franchisor through franchisee councils or organizations can be effective. Group negotiation can have stronger bargaining power than individual franchisees. Second, you can request materials proving the validity of product prices from the franchisor and demand reasonable adjustments through comparative analysis with market prices. Third, you can use dispute resolution procedures according to the franchise agreement. By applying for mediation to the Franchise Business Dispute Mediation Council of the Korea Fair Trade Mediation Agency, you can attempt to resolve issues faster and more cheaply than through litigation. Fourth, if the franchisor collects excessive markups different from what was stated in the disclosure document or provided false or exaggerated information, you can report to the Fair Trade Commission. Lastly, if the above methods don't resolve the issue, you might consider legal action. Recent court cases have increasingly ruled for the return of excessive markup fees, so there is a possibility of remedy through litigation in clearly unfair cases. Whatever method you choose, it's important to first thoroughly review the contract and disclosure document and collect relevant evidence.