Pizza Hut lost in court. Now hundreds of others want to sue.

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Pizza Hut lost in court. Now hundreds of others want to sue.

Published: 27 Nov. 2024, 18:19 Updated: 27 Nov. 2024, 20:55

Audio report: written by reporters, read by AI

Passerbys walk by a Pizza Hut store in Seoul on Nov. 5. [YONHAP]

Pizza Hut Korea's recent court loss for unfairly charging extra fees for ingredients supplied to its franchisees has other food and beverage (F&B) franchisees reviewing contracts and contemplating lawsuits of their own.

Franchisees of Baskin Robbins — operated by SPC in Korea — and fried chicken chain BHC could sue their respective headquarters over markup fees added to the supplied materials, industry insiders said Tuesday. Around 400 shop owners plan to file a lawsuit against Baskin Robbins and 300 owners against BHC. Franchisees of fried chicken spot Kyochon and beverage chains A Twosome Place and Ediya Coffee could also potentially file lawsuits against the brands.

Franchise operators profit by adding additional fees to materials they supply to their franchisees — their distribution margin is the amount they make off their supplies, subtracting the materials’ wholesale price. Franchisees had to pay an average of 28 million won ($20,000) in 2022 in such fees, according to the Fair Trade Commission (FTC). Chicken franchises charged the highest average markup fees, relative to revenue, at 8.2 percent, followed by coffee, bakery and pizza chains at 6.8 percent, 5.5 percent and 4.2 percent, respectively.

After franchisees started to voice their disdain against the “hidden royalties” mixed in with ingredient costs, the government amended the enforcement decree of the Fair Transactions in Franchise Business Act in 2018 that enforced franchises to disclose the markup amount by category in the information they give to current or potential shop owners. The franchise business act was further amended in January of this year that made information about the supply chain costs to be mandatorily included in franchise contracts from July.

“Franchise royalties are fees charged depending on the stores’ sales, but the markup fee is charged unrelated to the shop’s sales, and so the FTC has continuously tried to regulate markup fees while encouraging royalties as part of profit structures,” said licensed administrative agent Park Jae-hyung.

Food models are displayed as part of an exhibition at the International Franchise Show at Coex in Gangnam District, southern Seoul, on Oct. 31. [NEWS1]

The feud over markup fees levied on ingredients came into full swing after 94 Pizza Hut franchisees won a lawsuit filed against their headquarters for unjust enrichment at an appellate trial in September. The store owners alleged that Pizza Hut Korea had imposed additional costs separate from royalties of which franchisees were not notified in advance. The Seoul High Court partially sided with the franchisees and ordered Pizza Hut Korea to return the 21 billion won it had received in markup fees from 2016 through 2022.

“Headquarters did not disclose how much of a margin they were taking for each of the materials they supplied in the contract, so there was no justification for the markup fees in this case,” said Shim Jae-won, a lawyer at law firm Here.

“This will put a brake on industry practices that failed to properly disclose supply chain fees,” Shim said.

The court ruling evoked starkly different reactions within the industry. Franchisees welcomed the ruling, as it was expected to more strictly enforce disclosures of supply chain costs. A spokesperson for the Korea Franchisee Union said it would make “the murky practice of charging markup fees become more transparent.”

“Some store owners are looking into legal action, with some discussing a potential class action suit with law firms,” the spokesperson added.

Others in the industry fear that the lawsuits will continue. Most franchise operators only receive supply chain fees, with no royalties attached, and some think that business model should stay.

“Just like how supermarkets only show consumer prices and not the profit margin on their products, some franchise headquarters have not individually marked margins,” said a spokesperson for the Korea Franchise Association.

“However, most operators in the domestic franchise industry only receive supply chain fees and don’t take royalties, in a business contract model that is different from Pizza Hut's, so it’s worrisome that firms will be grappling with lawsuits,” the KFA person said.

One insider from the chicken franchise industry said that “most operators properly specify the markup fees in contracts and as part of their information disclosures. It is concerning that lawsuits seem to be filed indiscriminately based on just a partial court ruling.”

Visitors look around booths at the International Franchise Show at the Coex convention center in Gangnam District, southern Seoul, on Oct. 31. [YONHAP]

Experts say that in addition to making markup fees more transparent, franchise operators should also diversify their profit models, such as by introducing royalties.

“Franchises charging markup fees isn’t illegal, as it is a system recognized by the franchise business act,” said Jung Yeon-sung, a professor in Dankook University’s Department of Business Administration, adding, “What’s important is that they fully explain and consult with the franchisees in advance, so that they have a full understanding of it.”

“Royalties are fees paid for brand power; but in Korea, where brands have low levels of brand maturity, companies have relied on a profit model centered on supply chain fees rather than through royalties,” said Ahn Seung-ho, a professor at Soongsil University’s School of Business Administration.

“It is necessary that they find profit channels other than the markup fees,” Ahn said.

BY OH SAM-GWON [[email protected]]