Why minimum performance clauses in franchise agreements are important to ensure high-quality services for the entire network
All franchisors ought to monitor the performance of their franchisees. This is one of the basic requirements expected by the British Franchise Association (bfa) and the European Code of Ethics and is fundamental to run a successful franchise network. Without performance monitoring, the franchisor would be oblivious to whether standards and processes are being adhered to and generally, whether the franchisee is developing or damaging the brand. However, many networks go further than simply monitoring performance and also include minimum performance clauses in the franchise agreement.
Reason for minimum performance clauses
The general logic is that if a franchisor grants an exclusive area to a franchisee, the franchisor wants to ensure they fully develop the area – otherwise the franchisor may be losing out on valuable clients because the exclusivity provision stops the franchisor from putting anyone else in the territory. There is also an argument that in granting the franchise, the franchisor assumes that the franchisee will attain at least a certain level and if they fail to achieve the minimum standard, then it won’t be economic to operate that business. In a worst case scenario, failure to achieve basic, minimum standards could be harmful to the brand and the wider network, So it’s important that the franchisor is able to take action in those circumstances.
Types of clause
Although minimum performance clauses are common, there is no one-size-fits-all approach to determining what should be covered or the target level that should be set. Most clauses focus on quantitative measures – such as turnover, royalties or growth rates. But it’s possible to include qualitative measures such as customer satisfaction or adherence to operational standards. A starting point is to consider what are the essential elements needed to operate the business successfully and then set targets based on those elements.
Having decided what to measure, the next question is where to set the bar. The basic principle here is that the target should genuinely be set at the minimum acceptable performance level and not at an aspirational level. For example, the targets set in a business plan should be significantly higher than minimum performance targets because the business plan targets ought to stretch the franchisee but still be achievable.
Many networks assess minimum performance against the performance of other franchisees in the network. Although, this is not always advisable as there may be important differences between different franchisees that skew the figures. For example, a new business would be expected to have low turnover but high growth rate, compared to an established business which is likely to have high turnover and low growth. In relatively young networks, there may not be enough franchisees to make comparisons within the network meaningful.
It can be tempting to set minimum targets based on average performances across the network. This helps to account for local variations between individual franchisees. If this method is used, it’s important the target is set at a level well below the average. By definition, at any given time there is likely to be around half of all franchisees in the network performing at or below the average level, so the average is not an appropriate target as a minimum. Instead, a lower proportion could be used, for example a target which is, say, 50% of the average performance or a level that comprises the bottom 10% of all franchisees in the network.
Quantitative measures are easy to judge objectively. Qualitative measures are, by nature, more difficult to assess and likely to be subjective. As a result, qualitative measures require careful planning to ensure there is a system for measuring performance across the network in a fair and consistent way. This could include, for example, scoring franchisees on a range of performance measures and then comparing average scores.
Failure to achieve minimium targets
Once minimum targets have been set, it’s important to consider what the consequences of failing to achieve then should be. Ideally, failure to achieve a target should be used to trigger an improvement process in which both franchisor and franchisee work together to improve the performance of the business.
Some networks contain clauses that allow the franchisor to withdraw exclusivity in the event of failing to achieve minimum targets. This means the franchisor doesn’t lose out on potential new business in the area by enabling the franchisor to introduce a new franchisee to operate that area. However, it also means that an already under-performing franchisee now has to contend with the extra pressure of competition from the new franchisee, which may not be the best approach. There is also a risk that competition between franchisees in the same area may damage the brand.
An alternative to removing exclusivity would be to reduce the size of the territory. However, this may also add further pressure to the under-performing franchisee. In a worst case scenario, failure to achieve the target may result in termination. However, the nuclear option should always be an absolute last resort.
In any event, the franchisee ought to be given a reasonable opportunity to improve with support from the franchisor before any serious, adverse consequences apply.
Occasionally, networks give the franchisee the right to terminate if minimum targets are not being achieved, although this is rare. Given the franchisee will have invested heavily when starting the business and termination means the franchisee loses the opportunity to recover their investment I would still prefer to see a process where the franchisee and franchisor work together to improve performance before termination arises.