Franchising a Hong Kong Business: How to Test Whether Your Fees Are Sustainable

A profitable company-owned outlet may not leave a franchisee with enough operating cash once royalties, marketing contributions and system fees are added. Hong Kong businesses preparing to franchise should test their fees through a pilot before setting prices and recruiting franchisees. The aim is to establish whether franchisees can keep trading after paying those fees, while head office has the resources to deliver its promised support—creating a sustainable foundation for the franchise network.

1. Separate opening costs from ongoing support costs

Do not bundle every head office expense into a single initial franchise fee. First, prepare two cost schedules based on when services are delivered, then decide which costs the initial fee should cover and which require ongoing charges.

Pre-opening costs may include site assessments, initial training, preparations for opening and on-site launch support. Record the person responsible, working hours, travel costs and external expenditure for each item. Training delivered personally by the founder also has a cost; it should not be treated as free simply because no additional salary is paid.

Ongoing support costs include outlet visits, refresher training, purchasing coordination, system maintenance and marketing support. Distinguish between costs that rise as the number of outlets grows and those that can be shared across multiple outlets. Do not assume that a larger franchise network will necessarily make support cheaper.

Every proposed fee should answer three questions: what does the franchisee receive, how will head office deliver it, and how will services outside that scope be charged? For example, specify whether initial training includes resits, catch-up sessions and training for new employees.

If head office also earns income from supply margins or supplier rebates, include this in the overall calculations. Looking only at the stated management fee can understate the costs franchisees actually bear.

2. Recast the company-owned pilot as a franchise business

A pilot can begin in a company-owned outlet, but its accounts must be adjusted to reflect the circumstances of an independent franchisee. Use actual sales and cost data from the same period, then add the proposed royalties, marketing contributions, software fees and mandatory service charges to produce a modelled franchise profit and loss statement.

Pay particular attention to these commonly overlooked items:

• Staffing costs: Use the realistic cost of employing a suitable manager and staff, rather than assuming the owner will cover shifts without pay.
• Rent: If the pilot benefits from an older lease or preferential terms from a related party, model a separate rental scenario for a new franchise outlet and clearly state the basis of the estimate.
• Purchasing costs: Use the supply terms genuinely available to franchisees, not discounts reserved for head office.
• Equipment expenditure: Treat depreciation in the profit and loss statement separately from purchases, repairs and replacements in the cash budget to avoid double-counting.

Alongside the profit and loss statement, prepare a monthly cash budget covering deposits, stock, wages, supplier payment terms and platform settlement times. A profit on paper does not mean there will be enough cash when the rent falls due.

The test period should cover representative quiet and busy periods, rather than only the opening promotion or the strongest trading months. Keep a clear comparison between actual data and modelling assumptions so the team knows which findings have been validated and which still need testing.

3. Compare fee structures through stress testing

Use the same model to compare fixed monthly fees, turnover-based percentage charges and arrangements with a minimum fee. Fixed monthly fees make budgeting easier but can be more burdensome during quiet periods. Percentage charges move with turnover but do not guarantee franchisee profitability. A minimum fee may reduce the flexibility that a percentage-based arrangement would otherwise offer.

Stress tests should use evidence-based scenarios, such as quiet-month sales recorded during the pilot, price changes already announced by suppliers or documented rental assumptions. Do not choose an arbitrary sales decline and present the resulting figures as a validated forecast.

Examine both sides in every scenario: after paying all fees, can the franchise outlet provide reasonable remuneration for its owner and maintain sufficient working capital? After collecting those fees, can head office cover the support it has promised? If head office must continually collect new initial franchise fees to service existing outlets, the fee model needs restructuring.

Set internal pass criteria before testing, such as an acceptable cash shortfall, required reserves and a cap on support hours. If the model fails, prioritise changes to the outlet format, working processes or service scope. Do not rely solely on optimistic sales assumptions to make the figures look viable.

4. Turn the findings into clear contract terms

Hong Kong currently has no legislation specifically governing franchising, nor a dedicated mandatory franchise disclosure or filing regime. The ‘two outlets, one year’ requirement and related filing and disclosure rules under mainland China’s Regulations on the Administration of Commercial Franchises should not be treated as statutory requirements for local franchising in Hong Kong.

However, the absence of franchise-specific legislation does not mean there are no legal obligations. The relationship is governed by common law contract principles and applicable legislation, including the Misrepresentation Ordinance. Brand licensing involves the Trade Marks Ordinance, while pricing and supply restrictions must also be assessed under the Competition Ordinance. Any pilot profit figures or payback estimates used in recruitment must accurately explain their basis, limitations and assumptions. Modelled results must not be presented as guaranteed returns.

Ask a Hong Kong lawyer to document the fee arrangements in the franchise agreement, clarifying at least:

• How turnover is defined, including the treatment of refunds, discounts, delivery-platform commissions and gift vouchers.
• When each fee starts accruing, when payment is due, how records will be checked and how disputes will be handled.
• Permitted uses of marketing contributions and the income and expenditure reports head office will provide.
• The mechanism for fee changes, notice arrangements and charges on renewal, transfer or termination.

If introductory discounts or temporary fee waivers are offered, the internal model should still test the position once normal charges resume. This avoids mistaking short-term subsidies for long-term profitability.

Practical takeaway: Complete the cost schedules, modelled franchise profit and loss statement and cash-flow stress tests before setting fees. Only a model that franchisees can afford and head office can deliver should move on to formal recruitment.