Jennifer Kulyk & John Sotos
Published on August 31, 2017
Posted in: Blog, Jennifer Kulyk, John Sotos
Food order and delivery apps are rising in popularity. Most are familiar with names such as UberEats, Foodora, and Doordash. Just recently, McDonalds partnered with UberEats to offer food delivery services to customers. Many restaurant franchise systems are encouraging or exploring the use of food delivery apps, in large part because they represent a new revenue source previously unavailable to all except the few who invested heavily in home delivery infrastructure.
Anything driving an increase in top line revenues and from a new customer base would presumably be welcomed by both franchisors and franchisees. However, third party service providers generally levy hefty charges of up to 30% of the cost of each food order, on which some franchisors levy their own suite of fees. The right of a franchisor to collect fees on third party delivery service provider charges has sparked tensions and raised debate. In order to consider this issue in further detail, it is first necessary to review how delivery apps generally work.
When a customer places an order using a delivery app, two transactions take place. The first transaction occurs between the customer and the third party provider. Ordering and payment is made via the app by the customer to the provider for the full price of the food order plus, in some cases, a delivery fee. The order is then transmitted via the app to the restaurant in order for the restaurant to fill the order.
The second transaction occurs between the third party service provider and the restaurant. In this second transaction, a commission/service fee (often calculated as a percentage of sales) is deducted by the provider on the amount collected from the customer for the food order prior to remitting the remaining revenue to the restaurant. Many third party delivery service providers remit payment to partnering restaurants on a weekly or monthly basis.
Some franchisors have required franchisees to pay royalty and marketing fund fees on the full price charged to a customer who orders via a delivery app, viewing deducted third party service fees as an expense like any other. In other words, even though a franchisee ends up receiving payment for the food order less the provider’s service fee, the franchisee must pay royalty and marketing fees on the full price of the food order. This is complicated by the fact that a franchisee restaurant’s POS system may record the order at the full price, which means that a franchisee is required to reconcile the full price charged to the customer by the provider and the payment actually received by the franchisee from the provider at the end of each week or month.
So, is the practice of collecting franchisor fees on the full order price collected via a third party app appropriate and permitted by the agreement between a franchisor and its franchisee? The answer lies in the franchisor’s rights relating to the collection of royalty and marketing fees. It is common for franchise agreements to stipulate that franchisees pay royalties and ad fund fees as a percentage of “gross sales” or “gross revenue”. The crux of the issue therefore lies in whether the service fees charged by third party delivery service providers are captured by the definition of gross sales or gross revenue as set out in the applicable franchise agreement.
Definitions of gross sales/gross revenue vary from system to system, but may be generally understood as total proceeds received by a franchisee for goods and services associated with restaurant operations. Some definitions of “gross revenue” are more expansive and open-ended, while other are more restrictive. Yet, in many cases, it appears that the definition of gross sales or gross revenue may restrict a franchisor’s right to collect fees on the full order price paid by a customer using a delivery app.
A key reason for this relates to the nature of the transactions that take place in connection with a customer’s food order made via a third party app. As described above, the only transaction that directly implicates the franchisee with respect to income is the second, in which the franchisee receives the remitted payment from the provider. The customer transaction does not occur through the franchisee and the full price paid by the customer for the food order is not, at any point, received by the franchisee.
Given the above, franchisors should carefully review their definition of gross sales or gross revenue to determine whether it needs to be revised in line with the decision to collect royalty and marketing fees on the full purchase price associated with food orders via third party apps. Likewise, franchisees may want to review their franchise agreements to determine whether the franchisor has a right to collect fees on such amounts, in the event such collection is already occurring. Along with revisiting the definition of gross sales or gross revenue, it is recommended that a franchisor review its franchise agreement to determine whether further updates are needed to address changes in the rapidly growing world of technology affecting the restaurant industry.
Determining the scope of a franchisor’s right to collect royalties and other fees involves interpretation of the definition of gross sales or gross revenue. In some cases, there is not always a clear answer. It is advisable to consult legal counsel to ensure compliance with respective rights, whether as a franchisor or franchisee.