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Why minimum performance clauses can boost your franchisees' output

Written by Kate Legg on Wednesday, 12 October 2016. Posted in Legal

Ensuring franchisees are upholding certain standards is vital for any franchisor. Minimum performance clauses provide the perfect framework to guarantee franchisees are delivering results

Why minimum performance clauses can boost your franchisees' output

There’s a strong commercial incentive for franchisees to perform at their best. After all, the franchisee owns their own business and reaps the rewards of their efforts. Equally, they will suffer in a very direct way if their business underperforms. You may therefore wonder why minimum performance clauses are used in franchise agreements.

Defining a purpose

Minimum performance clauses were rarely seen in older agreements but are now commonplace. One reason for this is that a franchisor needs to be able to take action against an underperforming franchisee to protect the brand, the wider network and, occasionally, the franchisee themselves. Many networks also use a performance review process as an added layer of motivation for franchisees – no one likes to come last. On a more constructive note, performance monitoring means there is a process of continual improvement across the network as everyone strives to move up the rankings.

Considering the kinds of clause

As the name suggests, minimum performance clauses are stipulations that require franchisees to attain a certain level of performance, with sanctions being put in place if the required standard is not met. The exact nature of the requirements differ widely from network to network but generally clauses fall into two categories: quantitative requirements, which require the franchisee to achieve numerical targets like a minimum monthly turnover or annual sales growth; or qualitative requirements, which tend to be more subjective and relate to wider, operational issues.

Setting sanctions

The specific sanctions imposed for failing to achieve the minimum performance standards will be set out in the franchise agreement. Typical sanctions might include: losing the right to renew at the end of the current term unless performance improves; financial sanctions, such as paying a minimum fee; a requirement to undergo additional training or be supervised by the franchisor; or, in the worst case scenario, termination. Importantly, the franchisor’s reaction should be proportionate to the franchisee’s breach, so if a franchisee narrowly misses a target, sanctions should not be as severe as for a franchisee who falls a long way off.

In a well-run franchise, failure to achieve a minimum performance target will trigger a process through which the franchisor supports the franchisee and helps them to improve. Termination should always be a last resort and only used after the franchisee has been given time and support to try to do better.

Selecting a target

Minimum performance targets should be set with extreme care, both in choosing the areas that will be assessed and then setting an appropriate minimum level for each one. A good starting point is to consider the factors that are most fundamental to the successful operation of the business. You can then set performance targets for each of those functions.

Once the areas for monitoring have been chosen, thought needs to be given to where to set the bar. Comparing franchisees to others in the network is tempting but may not be appropriate if either there are relatively few franchisees in the network or if there are significant differences between their local businesses. For example, a new franchisee would be expected to have a very low turnover but very high sales growth compared to a franchisee who has been operating for many years. Other factors that may make drawing direct comparisons between franchisees difficult are significant differences in local market conditions or the size or spread of the territory.

If there are large differences between franchisees, then any performance measuring process will need to take them into account. For example, new franchisees could be granted an initial grace period whilst they establish themselves, during which time the minimum targets won’t apply.

Averaging performance across the network as a whole is one way to mitigate the differences between franchisees but in that case the target must be set at a level that is well below the average. Otherwise, by definition, there will always be some franchisees who may still be successful in their own right but that may not be able to match performance of the best franchisees due to reasons beyond their control. Also be mindful that franchisees at the extreme ends of under- or overperformance may distort the average.

It’s also important to remember that the targets for these clauses are intended to be set at a level that represents the absolute minimum required for the business to be viable. The franchisor may well set other higher performance targets in business plans or as part of a programme of mentoring and motivating franchisees but these should be separate to the minimum performance clauses and fall outside the franchise agreement.

Minimum performance clauses are a valuable weapon in the franchisor’s armoury when it comes to protecting both franchisees and the brand. However they must be chosen with extreme care. It’s important that the target is set at an absolute minimum, not at a level that the franchisor would like franchisees to achieve in an ideal world. Failure to achieve a target should result, in the first instance, in the franchisee being given extra help and support to help them improve. More serious sanctions and, ultimately, termination should only be used as a last resort.

About the Author

Kate Legg

Kate Legg

After more than a decade advising other business owners, Legg has recently fulfilled a long held ambition and become one herself. Now the founder, director and CEO of Komerse, a legal practice specialising in commercial law and franchising, Legg is clearly practising what she preaches.

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