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Sep, 10 2010

Minimum guarantee revisited

FRANCHISE business is, in a way, a redox equation between the franchisor and the franchisee. This implies that in order to maintain the alliance's equilibrium, both have to react to each others' needs.

FRANCHISE business is, in a way, a redox equation between the franchisor and the franchisee. This implies that in order to maintain the alliance's equilibrium, both have to react to each others' needs. From the Indian fashion industry's perspective, the alliance has evolved from the time when Indian markets did have the present robustness and acceptability towards new products/concepts. A typical fashion franchise preposition in the past has been such that the franchisor's priorities remained centric towards expanding into new markets with its successful products and formats. On the contrary, a rather conventional and risk-averse franchisee would seek tried and tested model, which had an inherent ability to yield returns, either in the form of rentals or minimum guarantee. Those had been the good old gold days when minimum guarantee clause prevailed in almost any typical fashion franchise alliance. Visibilty and location being the only criteria to launch an international product in a naïve India market of 1990s, a risk-free franchise contract seemed the win-win situation for both the parties involved.

Evolving with time

Change was round the corner in the next decade that saw influx of capital in the Indian market. The market was loaded to its capacity with various fashion product categories. With the retail landscape changing, there emerged larger scope for innovative new formats to capitalise on the prevailing neo consumerism. Clearly, such vibrant market space is conducive for the new stream of entrepreurial energies. Franchise business model is best suited for an Indian investor, who has a moderate risk appetite but an innovative approach towards business. This augmented visible readiness for the business model. The agreement, however, needs to evolve with time. Most of the fashion and lifestyle brands now seek a franchise relation, in which both stakeholders equally share the risk as well as returns of the business.

Numerous interviews were conducted of participants involved in the supply chain of fashion products. It was observed that there is a striking difference in expectations related to the minimum guarantee clause. While franchisors have moved on from the times when they would offer a minimum guarantee to facilitate franchisee recruitment, franchisees still look forward to a franchise preposition where the risk is minimised. The prevalent anomalies in a fashion franchise brand has restricted healthy franchising, which leads to a scenario where either the franchisee was duped by an upcoming fashion brand or the franchisor ended up with a sleeping franchise partner.

Minimum guarantee for franchisor

What does minimum guarantee mean to a franchisor? The following 10 points should serve as an answer.

Most of the fashion franchisors are reluctant in offering a minimum guarantee. Most of the franchisors interviewed were reluctant to provide any sort of minimum guarantee in tier II and III cities. Although all mass fashion brands are looking forward to expansion, they still consider it risky than in mature metro markets. In smaller town markets, brand owners look for entrepreneurs, who have the ability to develop the markets.

There are two ways of calculating minimum guarantee. One way is to cover cost of operation of the business. Second way is to return margin cover. Elements of minimum guarantee could be rent, including VAT, interior depreciation cost, deposit interest mostly at a rate of 10 -12 per cent and operating cost.

On an average, 20-30 per cent of commission is offered in the apparel industry. The commission negotiations depend on the brand equity of the parent brand. Most of the new and upcoming brands offer higher commissions in the range of 30 per cent while the established and known brands offer 22-25 per cent. It was observed that in a typical fashion franchise model, whether it is with or without the minimum guarantee, the total cost to the company for that outlet never exceeds 25-30 per cent. This means that if the franchisor offers minimum guarantee or commission or a hybrid, which includes both elements, the net margins remain the same. For instance, it can be 20 per cent minimum guarantee element plus 10 per cent commission element (Hybrid model) and so on. Probably for the same reasons, many franchisors were of the view that minimum guarantee clause doesn't matter to them unless they are getting the right people and location.

Many franchise mangers involved in expansion of well-known fashion brands revealed that Return on Investment (RoI) in both the models remains the same. Project viability on larger canvases ultimately determines the costing element. Most of the franchisors identify key locations as well as prospective franchisees on the basis of value they bring to the distribution network and hence, a determinate of various negotiations.

Most of the product distribution franchisors have strategic orientation towards owning properties at key locations in metro as well as highstreets. It was also observed that some of the franchisors believe in keeping the key location stores as company-owned since they hold an important enabler in establishing benchmark business/retail practices. Franchisee profile holds utmost importance for the franchisor because coherent business partner is the key to success. One key observation shared by a seasoned franchisor was that there are two different kinds of franchisees; one who is from the similar industry background and the other new. The latter has the highest possibility of seeking minimum guarantee, as he is not aware of the business know-how. Most of the franchisors in any case prefer entrepreneurs with previous industry experience so that both of them are on the same wavelength in realising a mutually beneficial decision.

Generally, the franchisee expects a return of 15-16 per cent from an outlet. As per the industry norm, ideally, selling expenses per store that a franchisor is comfortable with is 25 per cent. Taking both their expectations in consideration the project viability is estimated.

Minimum guarantee nowadays has many evolved versions likes RoI guarantee, where the franchisor ensures the agreed Return on Investment in the stipulated timeframe .Another type of risk cover used is loss protection model, in which the franchisor makes certain zero loss scenario after quarterly or half yearly reviews.

Many franchisors believed in the strength of their products and their brand equity. Hence, they consider investment in regional and store marketing, as against offering minimum guarantee to the franchisee. In the long run only the core product offering will ensure profitable sustainability.

Many brand owners did agree that selling a franchise model sans minimum guarantee assurance does create problems in franchisee recruitment. If an investor is used to getting minimum guarantee in the past, it is difficult to convince him about another format. New brands specially are more risk-prone, hence, are expected to offer risk cover to make their business model investor-friendly. Unfortunately, many a times, minimum guarantee is simply offered to lure franchisees. This, however, restricts healthy franchise practices of mutual business risk-sharing.

The most important conclusion of the survey was that franchisors don't mind offering  minimum guarantee where the need be, as its just way of calibrating cost and margins. However, increasing discomfort towards the format is due to irresponsible behaviour of franchisees in the past, which might have led to considerable business loss. Once the roles and responsibilities of both the parties involved are well established, there is no scope of a murky blame game afterwards.


One of the vital inference for aspiring fashion inventors is that the days of risk-free franchise business preposition are no longer around. When brands are evolving towards format franchising, Indian investors must become less risk-averse and start owing up to the responsibilities in a fashion franchise venture. Only when both the franchisee and the franchisor are mutually connived about the business model should they go ahead with the franchise alliance, attenuating both short term and long-term profitability of each other.

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