A successful market development plan should mean more units opened, more profits, and happiness for everyone. Working with others to develop proactive communications and satisfactory economic, intangible and relationship issues should help grow your brand more effectively and build greater franchise relationships.

 

By Joe Lewis

 

For franchisors, one of the inherent conflicts in expanding your brand is the tension between optimizing your market penetration and maintaining strong relationships with your franchisees. Most franchisees want you to build brand awareness by opening new units in their market… until you open one in their back yard. Then the legal right to do so and the theoretical arguments of why you should do so go out the window and all hell breaks loose. So how do you minimize the conflicts in this situation, and what do you do when you have one?

 

Franchisors use many different approaches. But whatever approach you choose, you should start by making the commitment to develop a strategic plan and provide the time, people and resources to work through all the variables affecting your particular expansion model. It is critical to your future growth and that of your franchisees.

 

One of the first considerations in developing your plan is to examine the underlying assumptions of how you will develop your markets. Will you award single franchise agreements only, area development agreements or some other structure? What measurements will be used to determine the optimum number of units that can be established in each market? These usually include key demographics, such as population density, traffic patterns, geographic features and other factors relevant to your concept. Strong analytical tools have been developed to aid in understanding your customer profile and can give you probabilities of impact from the location of new units. 

Protected territories

 

A critical decision in this process is whether you are going to establish a protected territory that prevents you, as the franchisor, from granting rights to others in the territory. Some concepts do not provide protected territories at all. The franchisee is only granted the right to operate from an approved location, and the franchisor reserves its rights to locate a unit at any location, “as franchisor, in its sole and exclusive discretion, deems appropriate.” 

 

This approach provides the most flexibility to address unique markets, such as high population density markets, where units can literally be located across the street from another. But the reservation of these rights requires the franchisee to have faith that you, as franchisor, will exercise your discretion to locate new units prudently, so as not to materially impact the franchisee’s sales. If the franchisee is not yet a believer, he may attempt to negotiate a protected territory. Whether you allow a protected territory will depend upon your commitment to core principles underlying your development plan and your negotiating leverage. Will you walk away from quality deals because of this? Or, will you change your plan to include a reasonable protected territory? This is a business decision leadership must make up-front based on its expansion plan; otherwise, the development team may be pressured to negotiate territories when a strong franchisee candidate insists on protection.

 

Many franchisors ultimately provide a protected territory. The next critical decision point is how to define the territory you may grant. Territorial rights may differ depending for example, on whether you are offering traditional units, non-traditional units, rights to sell and market products or services, or alternative channels of distribution. If you define these rights too broadly, you may limit the brand’s ability to optimize penetration of the market and take advantage of the full brand recognition and economies of scale that franchising provides. This can result in the loss of significant royalties over time. On the other hand, defining the territory too narrowly may cause the franchisee to be concerned about whether his sales will be affected by other units — even units located outside the protected territory.    

 

This is when it is worthwhile to confirm your underlying assumptions and the viewpoints of your team. Is your protected territory drawn in a way to allow optimum expansion in the market? What factors affect that? Does your protected territory take into account changes in the market over the long term as your brand awareness and market share increases? 

 

Your FAC will surely tell you where the objections (and possible claims) from your franchisees will arise. What, then, can you do to minimize those objections and risks to your franchisees prior to opening? What steps can the parties take if there is an unanticipated impact on sales after a new unit opens? Obtaining franchisee input and addressing these questions should minimize your and your franchisees’ risks and improve another critical element of your franchise growth plan: increased sales through positive franchisee validations to prospective new franchise candidates. 

Pre-opening considerations

 

Once you have confirmed your assumptions and expansion plan into a market, consider whether you are going to allow development at any location outside of the protected territory or reserve the right to disapprove a location even if it is outside the protected territory. Many lawyers recommend against having a formal policy; instead they may advocate relying solely on the express terms of the contract. Decisions may be made on a case-by-case basis or informal guidelines may evolve. Others would rather have a policy or guidelines in place to help ensure that approvals will be handled clearly and consistently. If you will disapprove some locations because of the potential impact, what will your basis be for doing so? Some franchisors establish a threshold percentage to include whether it will be a material and long-term impact on the existing unit before making this decision. Will you (or should you) consider the existing franchisee’s sales volume and return on investment? Will the decision differ if it will impact a unit that has high sales and strong cash flows, versus one that has low sales and weak cash flows?

 

Another consideration to address in your policy is whether you will communicate to the existing franchisee your intention of opening a new unit in an adjacent trade area. If so, what will that communication entail? Will you give the existing franchisee the opportunity to object and provide evidence of how the new store may impact it before you proceed? Will you offer any impact studies to support your decision (assuming you have time to complete the impact studies before you lose the lease or property)? Will you give the existing franchisee an opportunity to purchase the rights to the adjacent territory? This may provide a winning solution for you and the existing franchisee, but this option may not be advisable if it will delay the sale of the market or if the existing franchisee is not financially qualified. Another consideration is will you condition the award on the franchisee’s past operations history or other such factors? 

 

If your decision is to move forward with a new franchisee in an adjacent trade area that may impact your existing franchisee, how will you handle this? One proactive approach is to let the existing franchisee know that a lease is being secured in the adjacent market. Then, the operations and marketing teams can immediately begin working with the existing franchisee to develop a plan to increase sales and mitigate the risk associated with this new unit opening. Handled properly, a cross-marketing plan between the existing and new franchisees’ unit could increase the customer base of the shared trade area and improve relations between the two.  

Post-opening considerations

           

If you have done your planning properly prior to opening, the impact on existing locations should be immaterial or short-term. However, what if this is not the case? If you have located the new unit outside the protected territory in accordance with the language in your franchise agreement, you should have a strong legal basis for your actions. However, your franchisee is not likely to care about that, particularly if it is losing money and sees that as your fault. In that case, the franchisee’s first question is likely to be: What are you going to do about it?
 

One option is to do nothing, because you done nothing legally wrong. That is not likely to sit well with the franchisee, as you may have surmised. This is an emotional issue for the franchisee, and it may will lead to an adversarial relationship. This in turn, can result in loss of time, diversion of resources, risks of litigation, and the intangible costs of having a bitter franchisee influencing new franchise candidates with negative validations.   
 

Another option some franchisors consider is to evaluate the impact on the franchisee and provide monetary or other assistance during the impact period. This may include, for example, matching the existing franchisee in marketing funds to build back sales more quickly, helping with remodeling efforts, or waiving a certain amount of royalties. Another option is to evaluate the existing franchisee’s trade area to determine if relocation may improve the existing franchisee’s prospects. Relocation options may be limited by whether the franchisee can afford to relocate (and what you may do to make relocation more affordable) and what the franchisee’s current lease obligations are.

Oh, Happy Day!

 

After you devise a strategic plan to address the multitude of issues related to your development of markets and its impact on existing franchisees, your reward should be that more units are opened, more profits are made, and everyone lives happily ever after. But even if that happy day never comes, working with others to develop proactive ways to communicate and manage the economic, intangible and relationship issues associated expansion should help you grow your brand more effectively and establish greater trust in your franchise relationships.

 

Joe Lewis is Vice President and General Counsel of Smoothie King Franchises, and serves on IFA’s Franchise Relations Committee. Smoothie King is a global brand with over 900 stores in the United States and internationally. Some of the views expressed in this article are the author’s own and may not necessarily include those of Smoothie King. Find out more about franchise opportunities at Smoothie King by visiting www.franchise.org/smoothie-king-franchise.

 

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