When Unit Economics Diverge: Fixing the Financial Misalignment Between Franchisor & Franchisee

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Three Takeways

Alignment drives profitability. When franchisors and franchisees focus on unit-level economics—not just sales growth—both sides strengthen long-term value.

Transparency builds trust. Clear communication about fees, ROI, and responsibilities prevents the resentment that erodes even strong systems.

Incentives shape behavior. The best franchise models reward collaboration, not competition, between franchisor and franchisee.

Last spring, I had two contrasting meetings in one day. The first, with a franchisor and the second, with a multi-unit operator in the same system. Both convinced the other side was “winning at their expense.” The franchisor pointed to flat royalties despite record marketing spend; the franchisee showed a P&L where rising wages erased the quarter’s profit. Same brand, same data—two very different realities. That gap isn’t about attitude or perspective; it’s about incentives that don’t line up.

In a market that’s only getting more complex and competitive for small businesses, franchisors and franchisees are better off pulling in the same direction. But alignment doesn’t happen by accident. It takes transparency, clarity, and education.

In this article, we’ll look at the common roadblocks to alignment, the key considerations each side should weigh, and practical steps to move forward together.

Two Realities, One System: Why Incentives Feel Misaligned

On the day last spring when I had these contrasting conversations, I can’t say it was a surprise. For years, I have had conversations with franchisees and franchisors who don’t feel their financial fortunes are being considered by the other party.  Being a independent third party, I can say I think this is often the truth.

Unit-Level P&L vs. Royalty Stream

At a basic level, franchisors are primarily incentivized to focus on franchisees’ top-line performance. Many franchisors I’ve spoken with rationalize this by saying their responsibility is to drive sales, while it’s the franchisee’s job to turn those sales into profit. They also point out that they provide resources—training, financial education, and tools—that franchisees often don’t fully utilize.

Franchisees, on the other hand, see things differently. While they agree that revenue is the lifeblood of their business, they often feel that franchisors will push for top-line growth at any cost—even if it hurts their margins or workload.

In an International Franchise Association survey from 2025, 37% of franchisees cited labor availability, cost, and quality as their top challenge, while only 15% pointed to weak sales. That gap underscores a fundamental truth: while franchisors are often focused on driving revenue, most franchisees are more concerned with operating profitably.

Fee Structures Track Revenue, Not Profit

A few years ago, at a franchise convention, I was giving a talk to potential franchisees about the financial realities they would face. During the session, someone raised their hand and asked, “Why don’t franchisors base their royalties on profit instead of sales?”

It’s a fair question—and one that gets to the heart of franchise economics. A flat percentage royalty tied to sales can easily misalign incentives, especially during low-margin phases. And by “low-margin phases,” I mean the polite version of saying the business isn’t making much money. So, on paper, it seems logical to shift the entire system to royalties based on profit rather than revenue.

But there are a few legitimate reasons why that doesn’t work in practice. First, most small business owners do everything they can to minimize taxable income. It’s not that they’re dishonest—it’s that they’re rational. Every dollar in profit is a dollar that gets taxed, so many owners push expenses to the edge of what’s allowable. That makes “profit” a flexible number, and not a reliable basis for royalties.

The larger issue is control. Franchisors simply don’t have enough influence over each franchisee’s day-to-day operations to fairly tie their income to profit. They can provide training, brand standards, and marketing programs—but they can’t dictate how a franchisee hires, pays, or retains staff. They don’t set rent, choose every vendor, or manage local advertising budgets. Those operational levers, which heavily determine profitability, are largely in the franchisee’s hands.

For those reasons, franchisors are justified in basing royalties on revenue, not profit. Still, there’s room for a middle ground—a structure that better aligns incentives without abandoning practicality. We’ll explore that later.

Communication and Compliance Gaps

One of the most damaging factors in the franchisor–franchisee relationship is a lack of transparency. While I fully believe franchisors should be creative in developing new revenue streams from their intellectual property, it should never come at the expense of franchisees. If a fee is charged, it must deliver clear value. Opaque or poorly explained fees erode trust faster than almost anything else.

This has gotten so bad that in July 2024, the Federal Trade Commission warned franchisors of unfair or deceptive practices. There’s simply no justification for hiding behind vague charges or mandatory programs that don’t provide measurable benefit. Personally, I’ve turned down clients who engage in these practices—it’s not a foundation you can build a healthy system on.

That said, transparency isn’t a one-way street. Many franchisors express frustration that large parts of their intellectual property, training programs, and operational systems go unused or ignored. They invest heavily in tools and resources designed to support franchisees, only to see minimal engagement. Over time, this can create a “swim-or-sink” mentality, where franchisors feel compelled to pull back their support or let underperformers fail.

On this point, I understand their perspective. I’ve seen countless financial training sessions go unattended and operational best practices dismissed because franchisees think they “know better.” True alignment requires trust—trust that each side will uphold its responsibilities, utilize the tools available, and do everything possible to strengthen their part of the business.

Transparency & Trust: A Two-Way Checklist for Franchisors and Franchisees

Building alignment starts with clarity. Both sides share responsibility for maintaining open communication, fair expectations, and visible value in every dollar exchanged. Use this checklist to evaluate whether your system’s transparency builds trust—or quietly erodes it.

  • Ask “Where’s the Value?” Before Any Fee or Expense – Every fee—whether it’s a royalty, marketing contribution, or technology charge—should have a clearly measurable return for both parties.
  • Put Financial Assumptions in Writing – Clearly document what’s included in fees, what’s optional, and what outcomes are expected. Avoid gray areas that leave either side guessing.
  • Track Engagement, Not Just Availability – Tools, training, and resources don’t create value if they’re unused. Both sides should track participation and measure outcomes.
  • Share the Same Financial Language – Align definitions of “profit,” “margin,” and “ROI.” Misunderstanding these terms can derail productive conversations and decisions. While this may seem silly, I have seen several misunderstanding due to a difference in definitions.
  • Franchisors: Be Transparent About Revenue Streams – If you’re creating new income sources (rebates, required vendors, or tech fees), disclose how they support the brand—and the franchisee’s bottom line.
  • Franchisors: Link Fees to Outcomes
    Don’t charge for systems, programs, or marketing unless there’s a clear performance metric tied to them.
  • Franchisors: Show How You Reinvest – Communicate where collected fees go—whether into marketing, innovation, or support—so franchisees see the return on their investment.
  • Franchisees: Engage With the Resources Provided – Attend training, review financial guidance, and use operational tools before criticizing their effectiveness.
  • Franchisees: Respect the Brand Investment – Recognize that system fees fund brand growth, support, and long-term equity for everyone—not just the franchisor.
  • Franchisees: Ask Questions Early, Not After the Fact – Don’t wait until frustration builds. If a fee or policy isn’t clear, ask for documentation and examples before assuming bad intent.

Rewiring Incentives for Alignment

One of my favorite exercises to solve a problem is what I call a “blank paper” exercise. Essentially, it starts with defining a problem and then coming up with solutions without being tied to any existing constraints or processes.  So, with that in mind, here three of my “blank paper” ideas.

Smarter Royalties

A flat royalty doesn’t always align incentives. There are two potential solutions.

First, implement a tiered royalty structure tied to revenue bands. For franchisors who understand their unit-level economics, this approach allows royalties to scale while protecting franchisee cash flow and still rewarding growth. It gives franchisees breathing room early on and motivates both parties to pursue sustainable top-line expansion.

Second, consider splitting the royalty into two parts—a fixed monthly fee and a variable royalty. In this model, the royalty rate is lower than a traditional one, while the fixed fee represents the consistent value the franchisor provides each month. From both perspectives, the fixed portion acknowledges a baseline level of support and allows realistic budgeting. The variable royalty then reflects the upside—the shared benefit of strong performance. When value is high, both sides win; when it’s low, both share the impact.

Marketing and Technology Fees That Prove Their Worth

Marketing and technology fees are among the most common friction points in franchising—especially when franchisees can’t clearly see what they’re getting for the money. But the goal shouldn’t be to abandon these fees; it should be to make their value measurable.

One approach is to tie add-on fees to performance metrics, such as increases in customer traffic, lead volume, or online conversion rates. Franchisors can retain control by setting the metrics and evaluation period, but they should share the resulting data with franchisees to demonstrate the return. For instance, if a new digital advertising fund or mobile-ordering app is rolled out, results should be tracked system-wide and reported quarterly.

Another practical safeguard is to use a pilot-first policy before full implementation. Test new fees or platforms in a sample group of markets to validate ROI and refine execution. If performance targets aren’t met, the franchisor can either delay system-wide rollout or adjust cost-sharing terms—without setting a precedent of permanent fee reductions. This keeps innovation moving forward while signaling good faith and financial accountability.

Shared-Cost Remodels and Structured Payback Windows

Remodels, rebranding initiatives, and technology upgrades are vital to keeping a franchise system competitive—but they’re also flashpoints for misalignment. Franchisees see the capital cost immediately, while franchisors see the brand benefit later. The key is not to eliminate remodel requirements, but to structure them with predictable economics.

A balanced model starts with shared cost accountability. Franchisors can offer partial rebates, fee credits, or financing support tied to verified completion and adherence to brand standards. This allows the franchisor to maintain control over design and timing while acknowledging the franchisee’s financial reality. To make this a true win/win, a franchisor might require a extension on their agreement in order to participate in a rebate program like this. While this sacrifices short-term revenue, it will increase the overall long-term value of their system.

Equally important is to formalize a payback window—a realistic expectation for when the remodel investment should begin generating returns. This can be based on the average debt-service coverage ratio or projected revenue lift from similar updates across the system. When franchisors communicate these payback assumptions upfront, franchisees are far more likely to buy in and execute the upgrades on time.

Finally, capex initiatives should be accompanied by transparency in vendor selection and pricing. Allowing limited flexibility in sourcing (within approved parameters) can reduce resentment while still protecting brand quality and consistency.

When Incentives Collide: The Quiznos Lesson

At its peak, Quiznos looked unstoppable. The toasted-sub franchise expanded to more than 5,000 locations across the U.S. in the early 2000s, powered by aggressive franchising and bold marketing. But behind that growth was constant conflict between franchisees and franchisor. Franchisees claimed that while the brand profited from expansion and supplier mark-ups, individual stores were struggling to stay afloat. Many said they were required to buy all ingredients and supplies from company-approved vendors at inflated prices, leaving little margin after paying royalties and other fees.

As tensions grew, hundreds of franchisees banded together and filed lawsuits accusing Quiznos of structuring the business to benefit the corporate parent at the expense of its operators. In 2009, the company settled a class-action case for roughly $95 million, though the damage to trust and reputation was already severe. When franchisees closed stores in droves, the same royalty system that once fueled growth began to collapse.

By 2014, Quiznos filed for Chapter 11 bankruptcy, its store count reduced to a fraction of its former size. The brand’s rise and fall became a textbook example of how misaligned incentives—where the franchisor earns revenue even when franchisees lose money—can destroy a system from within.

The Economics of Partnership

Franchise systems work best when both sides remember that they’re partners in the same equation. A healthy franchisor–franchisee relationship isn’t built on perfect alignment — it’s built on the discipline of staying aligned as conditions change. Markets tighten, labor costs shift, and new technologies emerge, but the shared goal should always remain constant: profitable, sustainable units that strengthen the brand over time.

When franchisors design programs and fees with clear value, and franchisees engage fully with the tools and data available to them, both sides win. The systems that endure are the ones where transparency isn’t an annual talking point — it’s a daily operating principle.

The gap between franchisor and franchisee will never disappear entirely. But when incentives are structured thoughtfully and trust is maintained through clarity and communication, that gap can become a productive space — one that fuels innovation rather than frustration. In an increasingly competitive landscape, alignment isn’t just good ethics; it’s good economics.

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