By Michael Seid, Managing Director, MSA Worldwide
In other articles, we have looked at ways franchisors grant territorial rights to their franchisees. Taking advantage of opportunities and new locations that become available because of market changes frequently raises contractual and other issues, including the actual or perceived impact a new location will have on an existing location. For those franchisors that have granted exclusive territories to their franchisees, the opportunity to expand into some new centers may not be possible because of the franchisee agreements. For franchisees whose territories are defined by the four walls of their businesses, the potential damage that may be caused by the development of a sister location a quarter of the mile away may difficult to accept.
The issue of encroachment frequently creates impediments to the establishment of critical mass and brand development. Even the most ardent franchisee advocate will admit that balancing the rights of individual locations often conflicts with those that benefit the overall brand performance. Territorial decisions in franchising are frequently driven by the needs of franchise sales and franchisee relations. But, setting limits on where locations are placed years before the opportunity or market conditions is available or even known is unique to franchising.
However, a handful of franchisors have crafted an imperfect middle ground where franchisors do not grant a protected territory to their franchisees, but where franchisees still have some territorial protection. Impact Policies are the methods used. An Impact Policy establishes guidelines and procedures by which franchisors can create a safe harbor whereby franchisees are given an opportunity to address their concerns about a new location prior to its development. As a policy, the franchisors we spoke with did not view these as contractual obligations owed to their franchisees. Rather, they viewed these as beneficial programs which could be changed and even cancelled depending on their overall impact on the system over time.
Typically, each policy provides the franchisee or a group of franchisees with notice that a location is being considered within a defined distance or area nearby their location(s), and gives them a period of time to raise the issue of impact with the franchisor. Even where a franchisee has no protected or exclusive territory, some of the policies create a secondary impact area outside of the boundaries of any contractual area agreed upon.
Generally, but not always, the cost of the impact study is borne by the requesting franchisee if the result of the report predicts that the economic impact on the existing location will fall below the predetermined hurdle. The range for impact varies depending on the franchisor and their industry, but none were higher than 15%. Where the results of the study supported the franchisees’ fears, the cost of the study was either paid for by the franchisor or by the franchisee or developer who originally proposed the new location. Where the study showed that the impact would fall below the predetermined hurdle, the cost of the study – generally under $10,000 – was paid for by the franchisee claiming impact.
Each franchisor’s policy varies as they relate to eligibility, rate of required impact, methods of appeal, who pays for the study, and rights of the franchisee should the developed location actually prove to be detrimental after development. Some of the provisions include:
- Only franchisees that meet certain compliance standards (current on fees, good standing, superior brand performance, etc.) may be eligible to request an Impact Study
- The franchisee can meet with senior management to discuss their concerns
- The franchisee can accept a defined reverse royalty rather than continue to protest the new unit’s development
- The franchisor may be obligated to keep the Franchisee Advisory Council informed about potentially impacted locations
- The franchisor may, under certain conditions, continue to develop the location
- The franchisee may be able to request non-binding mediation. Depending on whether or not a resolution is reached in mediation, binding arbitration can be triggered. Where outside mediation or arbitration is provided for, the timing, process, participants, and potential penalties are each defined by the policy.
Formal written Impact Policies have been around for more than a decade and have frequently been discussed at conferences, but the number of written policies adopted by franchisors is relatively few. The reasons for the low adoption rate are many:
- Impact Policies may create contractual obligations for the franchisor which are unintended.
- Once established, modification or discontinuance of the policy may be difficult.
- The rate of impact used is frequently arbitrary and may not have any rational basis other than its ability to be acceptable to the franchisees.
- The size and maturity of the franchisor do not lend itself to needing a policy.
- The impact rate may not be universally agreed upon and therefore may not be accepted by franchisees.
- The process takes time and can be costly.
- The results may not meet the franchisees’ or the franchisor’s expectations.
- Impact Policies may have the unintended consequence of creating barriers to the development of new locations, even when a new location is appropriate and the likelihood for impact is low.
Are Impact Policies beneficial? They can be, and we routinely evaluate the potential of developing them with our clients when we think they might be beneficial. But, for most franchisors, establishing impact policies can unnecessarily create barriers for growth; making decisions regarding where to allow development of new locations based the needs of the market is preferable. Where there is a solid basis of trust within a franchise system, this is still the preferred method for market expansion.
Do you have further questions about impact policies in franchising?
MSA can provide expert guidance on developing a successful and sustainable franchise system.