By Amy Cheng and Allison Grow Ryan, Cheng Cohen

Franchise systems are built on consistency: franchisors, franchisees, and consumers all rely on common standards, products, and services across the brand.

So what happens to the franchisor-franchisee relationship during times of volatility? Franchise business leaders across industry sectors are planning for growing volatility in the coming months and years — be it through tariffs, labor shortages, changing consumer behavior, or cost inflation. This article looks at how those changes may impact the franchise relationship and highlights some strategies to consider when that relationship is put under strain.

One Brand but Two Bottom Lines

While the franchisor and its franchisees rely on the same brand, they are independent businesses with related but distinct responsibilities and revenue streams. Typically, franchisees carry the responsibility for day-to-day business operations. They manage costs; they hire employees; they pay for inventory; and they depend directly on the profitability of those operations. Franchisors, in turn, are responsible for maintaining the overall franchise system, standards, and support structure, relying primarily on franchisees’ sales and resulting royalty payments.

This model works because franchisees take pride in running their own businesses and benefit from connections to a uniform system and brand. But times of financial stress will test even the strongest franchisor-franchisee relationship. While system shocks like inflation and tariffs impact franchisors and franchisees alike, franchisees are often the first to feel the pressure to their profitability, and franchisee contractual defaults, requests for rescission, claims of franchisor underperformance, and threats of litigation all spike when money grows tight. Regardless of the franchisor’s efforts or responsibilities, a franchisee who cannot make ends meet may not be satisfied by a franchisor’s best-in-class operations manual or a top-tier POS system.

Providing Support During Times of Strain

Understanding that franchisees are the first to feel the impacts of volatility, savvy franchisors keep on top of market forces that impact franchisees and — even without a legal obligation to do so — address what they can to mitigate the strain on their franchisees. Current trends have franchisors preemptively evaluating tools to manage costs and vendor contracts.

Today’s market environment has most businesses looking at costs. Franchisors may consider creating and sharing cost-control playbooks. This could include practical tools to analyze labor and expenses or spreadsheets to calculate ROI for marketing or other investments. Some systems may partner with particularly strong franchisees or the franchisee advisory council to create or convey these tools, both to mitigate risk and to leverage those entities’ direct relevant experience.

Depending on the nature and size of the system, franchisors may be able to leverage their scale to work with existing (or new) preferred vendors to alleviate franchisees’ cost burdens. While franchisors ultimately cannot dictate the costs charged by third-party vendors, in some cases they may be able to negotiate concessions or flexibility in vendor contracts. Some examples of concessions franchisors may consider negotiating include:

• Price;
• Payment terms;
• Vendor marketing contributions/incentives; and
• Vendor exclusivity.

In some cases, franchisors may also be able to provide temporary development flexibility to franchisees — such as deferring capital improvements or participation in new mandatory initiatives — without harming the overall brand. This will be a brand-by-brand decision and depend on a range of factors such as industry sector and markets served. While such flexibility can be helpful to franchisees, franchisors should document any concessions given to franchisees, and obtain a release in exchange, to ensure that temporary leniency does not lead to a long-term waiver of the franchisor’s rights and obligations to enforce system standards.

Knowing When (and How) to Exit

While additional franchisor support can go a long way in protecting the franchise relationship during times of volatility, it is not always sufficient. Recognizing when a relationship is no longer tenable is critical. A franchisee’s chronic underperformance, flagrant breaches of the franchise agreement, or fundamental misalignment on the value of the brand can all signal that it is time to part ways. Even if it results in a lost unit, ending a bad relationship can ultimately benefit the system as a whole.

There are many ways to end a franchise relationship — some contentious and some not. On one end of the spectrum is termination followed by litigation to enforce a franchisor’s contractual rights. While this approach is necessary in some cases to protect the trademark or set an example, it can be expensive, time-consuming, and contentious. Often, franchisors and franchisees can work together on a softer exit. Buybacks, resales, and mutual walkaways — where feasible — can reduce business interruption and reputational harm. But even if a franchisor is willing or even prefers to mutually agree on a reasonable exit, the franchisee may not cooperate.

Nonetheless, it is important to consider the system when negotiating the exit of one franchisee. In normal circumstances, the history of the franchisor’s business relationship with a particular franchisee, its unique P&L, and market differences can all warrant addressing franchisee exits on an individual basis. But where external forces are creating a volatile business environment for the entire franchise network, franchisors are well served by acting with consistency and predictability. In any case, franchisors should always avoid setting harmful precedents. For example, exits that waive the noncompete (where the noncompete is enforceable) or do not strictly protect the trademark may negatively impact the system.

Conclusion

While this article has principally looked at challenges to the franchise relationship, that relationship is also a source of strength in volatile times. Through their system-wide reach and relative financial steadiness, franchisors can often be a source of both stability and flexibility during turbulent times, helping franchisees weather difficult circumstances together far better than they could alone.

Amy Cheng and Allison Grow Ryan are partners at Cheng Cohen LLC. For more information about IFA supplier member Cheng Cohen, please visit franchise.org/suppliers/cheng-cohen-llc/.