CRITICAL DEVELOPMENTS IMPACTING FRANCHISE BUSINESSES IN 2021
Distribution of products in the franchise model are taking center stage in the first quarter of the year.
By Joyce Mazero, Polsinelli, PC
Supply Chain Fulfillment and Supply Contracts
The most obvious impact on franchise (and all) businesses in 2021 will be the fallout from COVID-19. COVID-19 impacted many aspects of franchise systems and operators — from changing suppliers, on-shoring, consolidating and changing standards, to lease and landlord issues, to insurance coverage and more. COVID-19’s impact on manufacturers’ ability to supply products in needed volumes and on a timely basis is still being felt. Now more than ever, the success of a franchise system lies in its resiliency. As restrictions lift and demand increases, franchisors or approved suppliers are likely to be unable to satisfy, or will be significantly delayed in fulfilling, their contractual obligations to their franchisees and other customers. This will result in loss of volume and revenue and ultimately possible long-term damage to customer loyalty. Accordingly, franchisors and franchisees continue to need to determine which of the operational changes made to combat COVID-19 should remain in place and evaluate their contractual remedies under supply chain contracts to eliminate or reduce liability and seek replacement sources of supply. These include exclusivity, requirements, minimum quota and allocation provisions as well as “Force Majeure” clauses, a common provision intended to relieve or excuse the contracting parties of liability due to extraordinary circumstances which are unpreventable because they are not within the control of the contracting parties. Other potential remedies to consider include contractual defenses of impossibility of performance, frustration of purpose and the UCC’s Failure of Presupposed Condition and Substitute Performance, as well as insurance coverage.
Enterprise Smart Contracts
Franchisors and their suppliers will increasingly see the benefits of using smart contracts in their supply agreements. Further, franchisors and franchisees continue to want a more transparent and reliable supply chain. Smart contracts automatically execute and confirm “if, then” obligations (e.g. exchanging performance for payment) including, for example:
• To pay on a given date, depending on a level of turnover or sales volume
• To confirm products have been delivered, certified and accepted for import/export purposes
• To spot a defective product and isolate adulterated food products so that damaging circumstances can be rectified in real time
An enterprise smart contract is the composition of all of its parts, which increases efficiency and transparency across the supply chain. Once signed and locked, the enterprise smart contract executes on these terms and conditions. The major components of the enterprise smart contract in the coming years will include external input of data or triggers required to fulfill the execution requirements of the contract agreed to by the counterparties and observers.
The speed, immutability and transparency of enterprise smart contracts provide the benefits of blockchain technology and enhance the privacy, scale, performance and management capabilities expected of the enterprise. Cryptographic proof is required to prove authenticity and establish trust in the external sources.
Close to 40 percent of businesses were using artificial intelligence (“AI”) before COVID-19 and its use in retail has grown since. Use of AI in franchise systems, already substantial, will likely grow to over 90 percent over the next 12-18 months. Taco Bell is using AI in its in-store kiosks, where it gives product driven recommendations to customers. Machines take voice orders at Dominos. McDonald’s uses it in drive-thru menu boards. AI permits franchisors and franchisees to look at the likely future developments of their operations and businesses, including the impact of spending decisions, the targeting of resources and the responses to customer views of the franchise brand via social media and instant review sites. AI will give franchisees data on the local level, along with access to more systemwide data across the franchise network. Brands are finding that AI allows the human team members to have an increased positive impact on business by moving them from administrative work to customer engagement. It assists franchise companies in hiring and retaining people in growing markets. Through AI screening, considerable franchisee time and effort in hiring decisions can be saved. AI can also be used to customize training programs based on employees’ interests, strengths and aspirations. In addition, it facilitates collecting and using data and measuring results. In an economy that values customer experience, AI will facilitate obtaining and analyzing data on how customers are reacting to the franchise brand, product and services. AI data and applications can also support analyses of patterns and trends leading franchisors and franchisees to make decisions about the products to serve, to whom and when, and implement those decisions.
Off Premises Sales and Delivery Systems
In 2020, restaurant franchisors increased their focus on off-premise options through on-demand delivery, primarily through more strategic arrangements with third-party delivery companies. In 2021, restaurants will continue this focus, including making adjustments to price models, renegotiating commission rates and incorporating their own branded ordering platforms. Delivery aggregators are also saddled with their own profitability problems and are working to improve their relationships with frustrated restaurants.
Delivery services represent one of the most significant growth areas for the technology and restaurant industries. A recent National Restaurant Association (NRA) survey revealed over 70 percent of consumers surveyed ordered meals for takeout or delivery from their favorite restaurants during the pandemic and over 40 percent used third-party delivery services to obtain those meals. With the continuing impact of COVID-19 on restaurant operations, there are no signs of decreased demand. Consistent with consumer demand for no-contact delivery, restaurants and delivery companies are also implementing technological innovations to provide customers food in an efficient, fast and protective manner including testing and integration of delivery via drone (by Domino’s and Zomato, internationally) and via robot (by DoorDash, Starship Technologies, and Eat24, a subsidiary of Grubhub).
But there has been significant tension between restaurant companies and delivery companies. Primarily this tension exists because delivery companies charge delivery fees and commissions that eat into and can eliminate any restaurant profit on a delivery order. To combat the effect of delivery fees on restaurant profit, many restaurant companies created internal delivery arrangements with outsourced couriers, charging customers a delivery fee or increasing menu prices in order to maintain at least their most loyal customers. Some states and increasingly cities are imposing a cap on delivery fees that delivery companies can charge and exploring other regulations. Many restaurants are pushing the desirability of curbside pick-up services to combat the impact of delivery fees on restaurant profit and expanding into their own virtual kitchens. Other tensions arise out of restaurant companies’ insufficient insight into their customers’ experience with the delivery service, such as the inability to promptly deal with customer complaints and difficulties in monitoring the delivery company’s compliance with quality assurance standards for food products and services.
On December 16, 2020, the NRA released its Public Policy Principles for Third-Party Delivery that define best practices for third-party delivery. The seven principles, which DoorDash, UberEats, Postmates, and Grubhub endorsed, focus on permission, consent, and safety, including, among other things, that restaurants have a right to know and determine when and if their food is delivered and that customers should expect the same degree of food safety from delivery as they do when dining in a restaurant. Further, the principles provide that restaurants should be able to offer customers alcohol through delivery companies and that the contract’s terms and practice should include transparency of fees charged by delivery companies, as well as costs, terms, policies, marketing practices involving a restaurant and its likeness, insurance, indemnification and responsibility for collecting and remitting taxes. In an NRA survey, over 90 percent of survey takers supported these principles. Restaurant and delivery companies and their legal counsel will hopefully take note of these principles and use them as a baseline for future negotiations.
Joyce Mazero is the shareholder and co-chair of global franchise and supply chain practice group at Polsinelli, PC. For more information about International Franchise Association (IFA) supplier member Polsinelli, visit franchise.org/suppliers/polsinelli.