Whatever type of franchise a franchisor is granting – development rights, regional/ master franchising rights, or the rights to operate a single unit – it faces the common problem of resolving the difficulty of dealing with the different comfort thresholds of its franchisees. By Manzoor Ishani of Surrey law firm, Sherrards.
This is important when a franchisor grants exclusive territorial rights because in so doing it is in effect selling its rights to that particular market. In such circumstances, the franchisor will naturally be keen to ensure that the franchisee exploits its area to its fullest potential. This can been done by imposing minimum performance targets, motivating the franchisee, or a combination of both.
So far as minimum performance targets are concerned, these can in practice be no more than fiction. There is little point in having a minimum
performance target unless it is capable of being achieved, and at the same time meaningful in a purely commercial context. A franchisee with a low comfort threshold (and who is, therefore, easily satisfied with its performance) will merely do the minimum and sit back. If minimum performance targets are not readily attainable but difficult to achieve, franchisees may not always attain them. In those circumstances what is the franchisor to do?
A franchisor’s ultimate sanction will always be termination. However, there may be very good reasons why a particular franchisee has failed to achieve its performance target and the franchisor may therefore be reluctant to terminate for that reason.
The franchisor may, however, not take the same view with another franchisee, who has had similar
problems in attempting to achieve its performance targets but for different reasons. The second franchisee and the franchisor may disagree as to the reasons why it failed to achieve its targets. In those circumstances, if the franchisor terminates the second franchisee and not the first, it may be storing up problems in the future. It may be accused of being capricious, or of discriminating between franchisees for personal, rather than purely business reasons. Multiply this by the number of franchised outlets and the problem becomes apparent.
It follows therefore, that if performance targets are to be meaningful they have to be enforced. Inconsistency can breed contempt. This is particularly true of individual franchisees, but less so of development and regional/master franchisees, because such franchisees are by their nature mature business people and are expected to some extent to rely on their business acumen.
The second problem with minimum performance targets is, how is a franchisor going to decide what the performance target should be for the first year, or indeed how is it to know what a minimum performance target should be in year two, year five, year seven, or year ten? The problem in trying to determine, with any degree of accuracy, a minimum performance target is made infinitely more difficult if the franchise concept is novel.
Kwik-Strip is a good example. Kwik-Strip is in the business of furniture stripping and restoration. At the time that the franchise was established, no such service was available to the public. If a customer had a Victorian pine dresser with six layers of paint that needed stripping, the only way he could get the job done professionally was to take it to a restorer. Generally the service was only available to the trade and was quite expensive. With the arrival of Kwik-Strip it became possible for a customer to take the dresser direct to a local Kwik-Strip outlet to have it stripped at a reasonable price.
In such circumstances, where the size of the market has yet to be determined, how does a franchisor begin to fix minimum performance targets (usually called development schedules in development and regional/master franchise agreements) in any meaningful sense?
For individual unit franchisees, the target tends to be a minimum level of turnover of the franchisee over a given period. In the case of a development franchisee, it is usually a combination of the number of outlets to be opened and their turnover. For a regional/master franchisee, the target is usually the number of sub-franchisees it is able to attract.
What both franchisors and franchisees have found to be unacceptable is an annual or periodic negotiation of minimum performance targets for the forthcoming year(s). This introduces an element of contention in the relationship and for that reason has seldom been successful. Moreover in such circumstances, complicated mechanisms need to be introduced into the contract to determine what happens if the parties cannot agree. No development or master/regional franchisee will accept a unilateral imposition of targets on a periodic basis by its franchisor.
Some would also argue that a franchisee who achieves a certain level of turnover simply because a piece of paper requires it to do so, does not necessarily make a good franchisee.
If one looks at motivation, the problem of the comfort threshold becomes more apparent, particularly in the case of individual unit franchisees. Most individuals have different thresholds.
People work for different reasons. Some work all the God given hours because they wish to make lots of money, others because they are workaholics or because they wish to build an empire. Some work for pleasure, whilst others see their work as a means to an end.
Many people are content to do an honest day’s work for a reasonable return and spend the rest of their time with their families, playing golf or pursuing whatever other interests they may have.
There is absolutely nothing wrong with that, and as the owners of their own businesses, it is their prerogative. However, franchisors may resent the exercise of this prerogative because it has a direct impact upon their profitability.
A franchisor will be faced with a dilemma if the person to whom it has granted exclusive territorial rights (and it is rare in the case of the grant of development or regional/master franchisees for this not to be the case) is more easily satisfied than the franchisor. Having granted exclusive territorial rights to a franchisee, the franchisor has effectively locked itself out of that particular market. If the franchisee then performs only according to the minimum performance criteria, or to the level of its comfort threshold, what is the franchisor to do?
In an ideal world a franchisee should achieve the maximum turnover of business that is possible in the territory to which it has been granted exclusivity.
In granting the exclusive territory, the franchisor would expect its franchisee in the fullness of time to achieve, say, 100 units of business, whether it is from the sale of the franchised products or services by an individual unit franchisee, or the sale of franchises by a regional/master franchisee, or in the case of a development franchisee, the opening of new outlets and/or sale of the franchised products or services.
However, what if the franchisee hits its comfort threshold at 60 units and thereafter refuses to bust a gut to secure the other 40 units of business? The franchisee is essentially happy with its lot. That may be fine for the franchisee, but what about the franchisor? The franchisor sees 40 units of business going begging. It is missing its percentage of the turnover of the 40 units which would flow to it through the payment of continuing franchise fees.
In the case of a development or regional/master franchisee, the consequences for the franchisor are more serious because the franchisee will have created a demand which competitors may now step in to satisfy.
But it may be worse than that. Both the franchisor and franchisee will suffer in the long term because if there are 40 units of business going begging, then sure as eggs are eggs, a competitor, seeing the potential, will step in and in so doing will not only soak up the 40 units, but may well succeed in taking another 10 or 15 units from the franchisee as well, thereby leaving both franchisor and franchisee worse off.
It should not be forgotten that for the most part, franchisors are in business to make money for their shareholders, and as much of it as they possibly can whereas individual unit franchisees, as we have seen, go into franchising for a variety of reasons. Not all go in only to make as much money as they possibly can.
What seems on the face of it to be a straightforward argument in favour (from the franchisee’s point of view) of the granting of exclusive territories has turned out not to be necessarily so. The pattern of franchising in the UK now suggests that franchisees are more vociferous in their demands for exclusive territories and franchisors are more acquiescent.
I can think of no transaction where the refusal by the franchisor to grant exclusivity to an individual unit franchisee has been a deal breaker, or where the business failure of either franchisor or franchisee has been attributed to the fact that either exclusive territorial rights were granted, or that they were not. In the UK at least, the invisible hand of market forces appears for the most part to have regulated franchising without the need to create artificial monopolies.
However, the same cannot be said of development and regional/master franchisees where it is common practice for franchisors to grant, and such franchisees to demand, exclusivity. Without the protection offered by exclusivity such franchisees will not commit the resources needed to develop the franchise within their territory. By the same token, such franchisees also accept that hand-in-hand with the grant of exclusivity go minimum performance targets. However, unlike individual unit franchisees, there is room for negotiating minimum performance targets in the case of development and regional/master franchisees.
Furthermore in my experience franchisors take greater care in selecting development and regional/ master franchisees. Where the relationship between the franchisor and this type of franchisee is a good one, franchisors are more amenable to revising minimum performance targets in favour of a franchisee who has under-achieved for a good reason, for example because retail premises in its territory have become difficult to acquire.