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Franchise territories are not always as exclusive as you may think

Written by Kate Legg on Tuesday, 04 December 2018. Posted in Legal

Exclusive territories are common in franchise agreements. But that doesn’t mean it’s easy to get it right

Franchise territories are not always as exclusive as you may think

Most franchise networks operate on the basis of giving each franchisee their own exclusive territory. However, the wording in the franchise agreement will always need to be checked as exclusive can mean different things in different agreements. Almost all franchise agreements will have some exceptions to the rule. 

Offering exclusive territories usually makes sense in the context of a franchise network. It avoids franchisees from the same network competing with each other. At best, it could be embarrassing if a client of one franchisee received a sales call from another franchisee in the same network. At worst, it could lead to franchisees devaluing the brand if they undercut each other and engage in price wars. 

However, franchisors risk putting all their eggs in one basket by granting exclusive territories if areas are given to franchisees who fail to fully develop it. A valuable bank of potential customers could go untapped if the sitting franchisee is happy with their existing turnover and fails to further develop the business. 

To limit this risk, the franchise agreement will often contain the right for the franchisor to withdraw exclusivity or alter the boundaries of the territory if the franchisee either fails to achieve required performance targets or breaches the franchise agreement. This protects the franchisor against an under-performing franchisee who may be sitting on an untapped gold mine but refuses to develop it. 

From a franchisee perspective, the right to operate exclusively in an area is a significant part of the bargain they paid for when they chose to join the franchise network. So withdrawal of exclusivity or changes to the territory should always be considered a last resort after the franchisor has exhausted all other avenues to try to correct any problems.

National accounts

Moreover, franchise agreements will often contain other exceptions to the exclusivity rule. For example, the franchisor may reserve the right to serve national account customers either directly or by passing national accounts to another franchisee.Advertising and marketing

A specific challenge can arise in relation to advertising and marketing activities. Historically, many franchise networks created their territories to match the areas covered by Yellow Pages. As other forms of advertising became more important, it’s become almost impossible to limit advertising activities to solely within the franchisee’s territory. Any form of online advertising or social media can be viewed from anywhere in the world. Similarly, an advert placed in a local newspaper may be delivered to households outside the franchisee’s territory or a radio advert could be heard by someone outside the territory.

Although it’s lawful for franchisors to place conditions and limitations on franchisee advertising activities, franchisees can’t be stopped from carrying out passive advertising which isn’t specifically targeted at a particular area but happens to be received by someone in that area.

Cross-border enquires

Franchise networks ought to have a procedure in place for dealing with situations where a franchisee receives an enquiry from a client outside their area. Some insist they should be passed to the local franchisee in the client’s area either with or without compensation to the franchisee who received the original lead. Others allow the franchisee who received the enquiry to continue to serve the client even though they are outside the franchisees’ territory. Again, this may or may not involve paying compensation to the sitting franchisee in the client’s actual area.

Another challenge can arise when it comes to unsold territories. In such cases, a franchisee may be permitted to operate in unsold, neighbouring territories but the franchisor must have a pre-agreed process for what happens when the neighbouring territory is sold. This will usually involve the original franchisee passing the relevant clients over to the new franchisee, either with or without compensation being paid.

The extent to which geographical issues arise is dependent on the nature of the business. For example, in the case of a network that provides services in the client’s home, it’s easy to establish which area a particular customer premises falls into. But complications arise when a client lives near the border between two territories. In that case, the client’s nearest franchisee may be the one in the neighbouring territory.

Networks that rely on customers travelling to the business may find it almost impossible to restrict which customers use which franchisee. For example, a client may live in one area and work in another. The franchise that they use could vary on each occasion depending on whether they are travelling from work or home. In these cases, exclusivity is usually limited to an agreement that the franchisor wont allow any other franchisees to open business premises within the exclusive area.

Setting up territories

For young networks, choosing the size and location of each territory can be particularly challenging. If areas are too small, there may not be sufficient sales potential for franchisees to be successful. Conversely, if the areas are too large, franchisees might not be able to fully exploit the territory leaving potential sales untapped.

Most franchise networks aim to keep each territory roughly the same size but this needs careful consideration. Depending on local geography and demographics, two territories of the same geographical size could have vastly different sales potential. For example, consider an area within a three mile radius in a heavily populated town compared to an area of the same size in a remote country side.

Local geography becomes even more complicated in networks that involve driving between appointments at clients’ premises. Travel distances between clients may be longer in a more remote area but take less time to drive than if travelling in a town with heavy traffic.

Getting the size and location of territories wrong will be a costly mistake for franchisors. Once an area has been allocated, there is little scope to change it. A franchisor may have to buy back the area at significant expense and/or pay compensation to the franchisee if the territory is to be reduced in size. 

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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