Q. What do I need to know about delivery apps in restaurant franchising?

Photo of a burger and fries on a white plate

How are delivery apps changing the restaurant industry?

Disruptive technology has hit the restaurant industry in recent years, expanding the range of options for consumers to order their favourite meal in a fast and convenient way. Most are familiar with names such as UberEats, Foodora, and Doordash. Third party delivery apps offer restaurants the ability to outsource delivery, increase online promotion, provide more convenient options to consumers, and potentially increase revenues.

What impact has this had on franchised restaurants?

Many restaurant franchise systems are exploring the use of food delivery apps. Accompanying this movement are questions related to how outsourcing via technology platforms impacts the relationship between franchisors and franchisees. 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 per cent 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 arisen as an area of uncertainty.

How do delivery apps 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 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 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. You should note that many third party delivery service providers remit payment to partnering restaurants on a weekly or monthly basis.

How are franchisors treating the collection of fees on delivery orders?

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, treating deducted third party service fees as a business 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. Franchisees new to using delivery apps should give themselves extra time to reconcile all of the fees and payments made.

What should you look for in your franchise agreement to determine if your franchisor has the right to levy 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/revenue as set out in the applicable franchise agreement.

Definitions of gross sales/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/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 transaction, 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.

Technology is changing the restaurant industry, and given the issues surrounding the use of third party delivery apps, franchisees should review their franchise agreements to determine the scope of a franchisor’s right to levy fees.

Jennifer Kulyk
Associate, Corporate and Commercial Department
Sotos LLP