Understanding the Franchise Territories Issue

"To be or not to be, that is the question."

At least it was for Shakespeare. In the franchise industry, the question might better be phrased as, "To be granting exclusive territories or not to be, that is the question." And it is a big question--not only for the franchise company, but especially for you as a prospective franchisee.

One of the most important aspects of any franchise relationship involves the determination of the protected territory that will be allocated to the franchisee. The bottom-line purpose for having a protected territory is to ensure there won't be undue competition for the franchisee from the sales of products or services by another outlet using the same brand and/or operating system. The key word in the preceding sentence is "undue."

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This subject is almost certainly the greatest cause of conflict in the franchise industry over the past 10 or 20 years. The goal of both parties--the franchisor and the franchisee--is generally to maximize the sales and profit performance of the units in their franchise system. What makes this issue so difficult is that there are two conflicting schools of thought in terms of how best to accomplish this goal.

One argument is that this goal is best met when the protected territory size is large enough to ensure there's virtually no chance that another outlet operating under the same brand or system will "cannibalize" any of the possible sales that might be achieved by another operating unit. The counter argument is based on the concept of maximizing total market share for the brand, in order to maximize the aggregate performance of all the units in the franchise system.

Either argument, taken to its extreme, becomes self-defeating. The challenge in achieving balance between these arguments is to reach a decision about the relative importance of brand awareness and consumer convenience in terms of driving sales and profits.

Most new franchisees (and many existing ones as well) intuitively believe in the merits of the first argument. The belief is that the elimination of any chance of cannibalizing sales would result in maximizing sales and profits from each existing unit, which is typically their goal.

If we carried this argument to its extreme, we would only have one McDonald's in all of Chicago, since any additional units might potentially cut into some sales that the one unit could have otherwise attained. Of course, if there were only one McDonald's in all of Chicago, most consumers wouldn't accept the inconvenience of traveling to it and most would also never have heard of the McDonald's brand, since the advertising budget of only one unit wouldn't allow for the ubiquitous level of advertising we have come to experience from this brand.

The second argument is typically favored by franchisors, perhaps because they usually make their money in royalty fees expressed as a percentage of gross sales so they have an economic incentive to see gross sales maximized. If we carried this argument to its extreme, it would mean putting a McDonald's on every street corner in all of Chicago. This would almost certainly create the highest possible gross sales from the marketplace and therefore maximize the income of the franchise company. Of course, this density of units would almost certainly cannibalize sales to the point where none of these outlets could operate profitably, and therefore this strategy would be unsustainable.

So what's the right answer? The fact is that it depends. It depends on the franchise system you are looking at. It depends on the product or service that underlies the business model of the franchise and how the product or service is marketed or sold. And, finally, it depends on you and the franchise company being able to determine an answer that you're both comfortable with.

The right answer for a McDonald's might be completely wrong for a Curves or a ChemDry or any other franchise, since they are all completely different businesses. This is a big reason why this issue is so difficult to deal with to everyone's satisfaction.

The answer is that a balance must be struck. This is no easy task, but it's a balance that creates the best overall situation for both the franchisees and the franchisor. Maximizing total aggregate sales volume, while at the same time protecting individual unit profitability, creates a rising tide that lifts all boats in the franchise system. Good franchisors are trying to achieve the highest market share and gross revenue possible, while also maintaining individual unit profitability at levels high enough to sufficiently compensate franchisees so they are willing to stay in business and continue building the brand with further units.

Unfortunately, this is not an exact science and even many well-meaning franchise companies can make errors in attempting to find this ideal balance. When this happens in a way that results in too many units being put into too small of a market area in too short a period of time, it often results in conflict and even litigation between franchisees and franchisors. When a mistake happens where protected territories are too large, it often results in slow growth of the brand and slow growth results for the franchisees.

As a general rule, you'll find that the larger and more successful a franchise system is, the smaller the protected territories are. That's not to say there are no protected territories in these systems, just that the protected territories are no larger than they have to be to create the proper balance for growing the system with a minimum of conflict.

If you are considering becoming a franchisee in any system, make sure to carefully investigate this issue before deciding to get the franchise. If the franchise does not have protected territories (or if you think they are too small) ask lots of questions before making a decision on the business and be prepared to walk away if you can't get comfortable with the answers. The fact is that it is very difficult to address the issue of protected territories after you become a franchisee, so get this important job done in advance.

Look at the UFOC to determine what protected territory is commonly granted to a franchisee. Also pay close attention to any rules you see in the UFOC concerning geographical restrictions on marketing or sales in the business, since these types of restrictions often provide as much or even more protection than the territory definition.

Give some careful thought to the business model of the franchise to determine what seems fair to you in terms of protecting your business if you become a franchisee. Consider how you will be marketing the business to attract customers. Will you have enough potential customers protected from marketing efforts of your fellow franchisees to be successful? Will there be enough units developed to create an advertising pool sufficient to drive the success of your business?

Finally, and most important, call a number of the existing franchisees and ask them what their opinion is about the balance being struck by the franchisor in relation to this critical issue. Forewarned is forearmed--take advantage of the franchisees who've gone down this path before you to find out if this critical issue is being handled properly by the franchise prior to investing in the franchise. If you take the time to make sure that the issue of protected territories is being addressed to your satisfaction prior to becoming a franchisee, you'll be a long way down the road to success in your new business.