COMPENSATION POLICIES FOR FRANCHISING BUSINESS Robert T. Justis, Louisiana State University Peng S. Chan, California State University - Fullerton Ben L. Kedia, Memphis State University ABSTRACT Many changes have taken place in franchising organizations during the last quarter century including the compensation practices for franchisors and franchisees. This article investigates the compensation systems which are generally used in franchising organizations. This paper covers the reward and incentive policies which may be used by franchisees and franchisors for different level managers in promoting and motivating their employees. INTRODUCTION In today's rapidly changing world, over one-third of retail sales in the United States are handled through franchising outlets. Over 20% of our gross national product is attributed to franchising operations. Franchising has become the fastest growing method of doing business in the world today. Franchisors and franchisees both depend upon highly motivated and dedicated employees to help run and operate their business practices. The compensation policies which are used in a franchise organization need to be solely tailored for that franchise organization. Traditional compensation systems which are found in well-established or bureaucratic organizations often hamper the desired performance levels in franchising organizations. One example, the seniority- based compensation systems, while being very useful and beneficial for manufacturing firms, often are detrimental or send a poor message to employees in franchising organizations. In this article we review the compensation policies which can be used to encourage and develop proper attitudes and behaviors of franchising employees. Characteristics of a Franchising Organization There are specific characteristics which differentiate franchising organizations from other traditional organizations. The main differential is found in the partnership which exists between the franchisor (headquarters corporation) and franchisee (local store). The franchisor is looking for growth through enlarged number of units being opened and larger sales volumes per unit. The franchisor is interested in selling franchises and developing company-owned stores on as rapid a basis as possible. The franchisee, on the other hand, is looking to utilize an established system to establish their own business units. The franchisee wants large sales and improved profits. Franchisees act as entrepreneurs in that they are individuals who establish a new business for the purpose of developing profit and growth. This entrepreneurial trait is characterized by the innovative behavior of the franchisee. Franchisees have a tendency to use strategic management practices as they search for growth and profit opportunities. Key Employees The key employees of both the headquarter organization and the franchising organization are concerned with profitability, innovation, creativity, cooperation, and a desire to have a highly successful franchise outlet. The compensation policies established for these employees should be developed by the franchisor or the franchisee to properly inform these employees that their behaviors are responsible for the success and profits of the organization. Proper attitudes and behavior should be properly rewarded. There are two different groups of individuals in franchise operations which need specific reward strategies based on their performance. These two groups include: (1) the headquarter organization staff responsible for the operations and sales of franchise units and (2) the managers and assistant managers of the individual (franchisee) stores. ORGANIZATION LIFE CYCLE The organization life cycle is an important concept which allows us to relate the compensation policies (including incentive programs) to the business strategy and practices of the franchising organization. The organization life cycle as adopted by a franchising organization consists of four organizational stages including: (1) start-up, (2) growth, (3) mature, and (4) decline. The organization life cycle can illustrate the developmental stages of a franchising organization

with the sales revenues and size of the organization (see Figure 1). The organizational life cycle matrix shown in Figure 1 relates the organizational characteristics with the different compensation packages and incentive programs for both the headquarters organization staff and the franchisee staff. Start-up Stage. The growth rates for most beginning franchising organizations is often very slow during the start-up phase. This slow start-up is generally coupled with a small number of units actually sold and opened during the first few years of operation. The central focus of the franchising business is generally aimed at developing financing for the organization and controlling costs. It is during this stage of business that risk is very high and it is difficult to attract employees and provide them with sufficient pay and incentives to encourage them to join the franchise operation. Growth Stage. The growth stage is shown during a rapid expansion. It is quite often during this time period, often from two to ten years, that the franchise will expand from twenty to more than a hundred stores. As stores begin to open, other people begin to realize the impact these stores may have and the opportunity for personal and financial success. The focus of the business is centered around increasing the number of stores sold and opened. The focus of the compensation program is around recruiting, training, and retaining key employees. The risk factor is moderating during the growth stage and success is on the horizon for the headquarter's franchising operation. It is important during this stage that key employees receive compensation for their several skills. Employees need to be recognized for their sales efforts as well as for handling new start-up franchises. Mature Stage. Generally the mature stage will occur after the franchise has been operating for six to ten years and the number of units have increased to over one hundred throughout the United States. Sales revenues have increased from mediam to large and the growth rate continues moderate to strong. The main focus of the business is generally around profitability and the risk factor has declined to being low. The pay and incentive side is generally focused on the consistency or motivation of the key employees. Decline Stage. If a franchising corporation begins to decline, it is primarily because the franchisees have become disgruntled with the franchisor due either to lack of sales or services provided from the franchisor to the franchisee organization. The growth rate may begin to decline and become negative and earning power of the business will also be declining. The risk factor is becoming high and the central focus of the business becomes survival rather than profits. The pay and incentive focus is often around cutbacks and lay-offs. However, it is important to retain key employees if the business is going to turn around and recover. Compensation Policies for the Headquarter's Staff The beginning franchising organization is generally divided into three different executive offices including: (1) president's office, (2) director of sales, and (3) director of operations. These three offices form the executive staff of most beginning franchising organizations and constitute the main creative, innovative, and driving force in the development of the franchising program. The base salary and benefits of these three key individuals is often the below the market level initially, but as the organization expands and develops through the growth stage, the salaries and benefits should be raised to a competitive market level. As the organization evolves into the mature stage, these individuals are often above the market level of compensation. Many of these key employees are initially brought on board because of incentive programs including initial stock options with broad participation by this very select number of people. As the organization will grow, the stock options would become more limited to key employees, and finally during the mature stage a stock purchase program may be initiated as an additional incentive for a limited stock option program to other employees. The short-term incentives are generally in terms of stock or cash bonuses based upon performance of the key employees. For key employees, the stock option may be the strongest incentive or inducement for joining the beginning franchising corporation. Stock options are a great attraction and incentives for a new employee. These options also have the tendency to hold on to top talent as they see the organization grow and develop. The most common stock options would include incentive stock options (ISO), non-qualified stock options (NQSO), and restricted stock. With the ISO, the employee receives an option to purchase stock at a specific price at the time the option is granted (generally the book value or market value) and would have up to ten years to exercise such option. With the ISO, no tax is paid when the

grant is exercised: however, the gains on selling the stock will receive capital gains treatment. The non-qualified stock option, while similar to the ISO, does require the employee to pay taxes when the option is exercised as well as when the stock is sold. The restricted stock option generally remained with the company for a fixed period of time, usually three to seven years. Stock options have become more and more valuable in attracting employees both initially and during the growth stage. As the company grows, the eligibility for stock options becomes more restricted with only the key executives and specially targeted employees being able to participate during the growth and mature stages of the business. The director of sales and sales staff may often receive commission of $500$2000 for each franchise sold. This commission incentive is generally based on 3-15% of the initial franchise fee. Cash bonus systems may also be developed for the operations manager and his staff, generally based upon the sales increase of franchise and company-owned stores for which they have direct responsibility. Compensation Policies for Franchisee Units The franchisee generally has two major classifications of employees who receive salary and pay incentives. These generally include the store manager and the assistant manager(s). The salary structure for managers and assistant managers is generally very competitive within local markets and franchise stores should try to ascertain what the competitive base salary is competing stores. A franchisee is generally responsible for the success and profitability of the franchising unit. Therefore, the franchisee wants to bring on board the best managers and assistant managers available to insure the success and profitability of the business. The initial benefit package for managers and assistant managers is generally below the market level because of limited finances available in franchising. It is important that the base salaries be competitive for initial managers and assistant managers. Several first time managers of franchising operations are recruited from competitive firms and promoted from assistant managers to store managers. The managers and assistant managers from a specific unit are generally quite young and don't have a lot of experience in management or operations. The long-term incentives for these individuals are often provided through travel and profit-sharing programs. Travel programs have been very successful for franchise managers and assistant managers and should vary from year to year, while profit-sharing may often be anywhere from 3% of the sales of the franchise unit. Figure 2 illustrates the incentive or cash bonus system which may be used for store managers and assistant managers in franchising outlets. The short- term incentives are often based on cash bonus systems. Many managers or assistant managers develop an incentive system based on sales or percent of increase of sales or a previous period of time. Figure 2 illustrates how a manager with a 13% increase over the previous year's quarter would receive a $1000 bonus with two assistant managers. This bonus could rise to $6000, assuming expected increases in business sales. Also shown are different travel incentives for store managers and assistant managers who have been able to obtain expected sales levels for a given period of time. There is generally a differentiation in reward structures between the store manager who may be going to Honolulu and the assistant store manager who is sent to Orlando, FL. Combining the cash bonus system with the employee profit-sharing program and travel plan provides a generous basesalary and benefits package for the managers and assistant managers in the franchisee stores. This system should allow the franchisees to recruit, train, and retain the necessary key managers in a franchising operation. CONCLUSION Both franchisors and franchisees need to be able to recruit, train, and retain top quality executives to manage and run their respective operations. Many franchisors fail in providing appropriate compensation systems both in a short run and long run, and are unable to keep their key executives for a long period of time. We have identified in this article specific compensation policies which would help both the corporate headquarters organization as well as the individual franchisee units. We have reviewed the choice pay incentive systems based upon the development stage of the franchise life cycle. Key executives are the strength of the franchising system. To be able to retain these executives a fair and proper compensation policy needs to be developed for the key executives and the headquarters or animation as well as the managers and assistant managers in the individual franchise units. Both long-term and short-term incentive packages

need to be developed and used to insure success of the franchising units. Figure 1 Relationship between stages in the life cycle, organization characteristics and compensation strategy for franchising firms. -----------------------------------------------------------------------------------------------------------------Organization Characteristics Start Up Growth Nature Decline ----------------------------------------------------------------------------------------------------------------- Corporations: Years 0-3 variable, 2-10 10 plus variable Size (no. of units) 1-20 21-100 101 plus variable Sales Revenue very small small to medium medium to large declining Growth Rate slow rapid moderate negative Pay & Incentives attract employees recruiting, retention consistency, layoffs, Focus innovation, training motivation cutbacks motivation Risk Profile high moderate low high Headquarters Staff: Base Salary below market level market level at or above at or above market level market level Long-Term Incentives (broad participation) (limited partici- stock purchase, not offered pation) cash bonus Short-Term Incentives stock or cash bonus cash bonus profit sharing not offered Franchise, Company-Owned Staff: Base Salary market level at or above at or above below market level market level market level Long-Term Incentives travel, profit travel, profit travel, profit cash bonus sharing sharing sharing Short-Term Incentives cash bonus cash bonus cash bonus cash bonus Figure 2 INCENTIVES FOR COMPANY - OWNED STORES Increase in quarterly sales over previous years' quarterly sales Percent Increase Total Store Bonus Mgr. Asst. Mgr. Asst. Mgr. 0 - 2.0% No bonus 0 0 0 2.01 - 4.0% 400 200 100 100 4.01 - 6.0% 800 400 200 200 6.01 - 9.0% 1200 600 300 300 9.01 - 12.0% 1600 800 400 400 12.01 - 15.0% 2000 1000 500 500 15.01 - 18.0% 2400 1200 600 600 18.01 - 21.0% 2800 1400 700 700 21.01 - up 3200 1600 800 800 STORE MANAGERS: Any company-owned store manager with annual sales of $500,000 or more for any continuous twelve month period between now and Dec 31, 1991 will receive a 7 day, 6 night expense paid trip to Hawaii for two. ASSISTANT STORE MANAGERS: Any company-owned assistant store manager with annual sales of $500,000 or more for any continuous twelve month period between now and Dec 31, 1991 will receive a 5 day, 4 night expense paid trip to Orlando, Florida for two.