Understanding Exclusive Territory – ‘Bricks & Mortar’
The rules regarding exclusive territories differ between ‘Bricks & Mortar’ (location-driven) and Mobile/Service Franchises (Marketing-Driven). This article is specific to ‘Bricks & Mortar’ franchises. Please refer to a separate article entitled “Understanding Exclusive Territory – Mobile/Service Franchises” for an explanation of the rules for exclusive territories related to Mobile/Service franchises.
What is an “Exclusive Territory”?
"Exclusive territory" is a frequently misunderstood term. Many franchisors no longer award exclusive territories preferring to restrict the grant of the franchise to the exclusivity of the location itself or to the mall in which the premises are located. This type of exclusivity is more common with established franchisors. Emerging franchisors may be more flexible on this issue.
Franchisees often misunderstand the rationale that applies to the size of a territory and consequently insist on a territory that it too large which can be a detriment, rather than a benefit, to them. The size of any exclusive territory does not dictate the ultimate success of the unit; however, it should be big enough to allow the franchisee to obtain the maximum performance from his or her unit, but not so large that it will prevent the franchisor from obtaining optimum market share. The franchisor is naturally reluctant to grant any exclusive territory that might impede its growth.
A franchise system can be destroyed by awarding too many franchises in one area - or too few. Too many franchises in one area may starve them of business if there are not enough customers to support every franchisee. On the other hand, although a franchisee does not want to be competing directly with other franchisees in their area, the franchise units should be close enough to take advantage of the synergy that is created when a number of units are operating in close proximity.
One alternative available to the franchisee is to negotiate an option on any franchise that is to be awarded in an adjacent territory. Most franchisors will be hesitant about making such a commitment, as it could be premature for the franchisee to acquire a second franchise at the time the franchisor wishes to expand. This situation has the potential to create conflict because the franchisee could view the franchisor as denying them the opportunity for expansion, when in fact the franchisor may be acting in the franchisee's best interests.
The grant of an exclusive territory typically restricts the franchisor from placing another franchise within the territory, but it does not give the franchisee right to open another franchised unit within the territory. Neither does it give the franchisee the exclusive rights to customers within the territory. A franchisor cannot prevent a franchisee in one territory doing business with customers located within the territory of another franchisee.
The best advice for a prospective franchisee when negotiating the size of the territory is to be reasonable and assess what is actually in their best interests from a logical, rather than from an emotional, standpoint. When analyzing the size of the territory and the impact of another franchise operating in the adjacent territory, it must be remembered that the franchisor could place another franchise just outside the boundary of an established territory.
How is an Exclusive Territory Defined?
An exclusive territory can be defined by a number of methods including a certain radius from the location, postal walks, postal codes, municipal limits and natural boundaries such as rivers. As previously mentioned, it may be restricted to a mall or the location itself. Some methods work better in certain situations than others. For instance, a radius would not be effective in a situation where there are two distinct trading areas separated by a river. It may be practical, and indeed beneficial, to locate franchises on either side of the bridge, but because of the close proximity of the two locations a radius may have to be ridiculously small. The criteria for the optimum size of the territory can sometimes be determined by demographic studies, with a provision that allows franchisors to place additional units in the territory if certain events take place e.g. population growth exceeds a certain figure or percentage over a specified period of time. One factor that must be taken into consideration is the effect caused by latent market demand, which increases the potential of the marketplace as consumer awareness of a particular product or service gains recognition. Franchisors typically want to award exclusive territories that retain some flexibility for modification if market conditions change.
What about Competition from Company-Owned Stores?
Another important issue is the franchisor's position on company-owned and operated stores. Most franchisors consider that it is essential to keep up-to-date on market changes and consumer expectations by maintaining its own stores. Company-owned stores can be used to train new franchisees, provide a base of information that the franchisor can use to guide its franchisees, and test new concepts or products before offering them to franchisees. However, a potential franchisee should be certain that franchising is not a sideline for a company that has a substantial number of stores of its own and should ensure that they are not going to be competing against company-owned stores in their territory.
Alternative Channels of Distribution
There may be a clause in the franchise agreement that grants the franchisor a reserved right to distribute products through what is generally referred to as “alternative channels of distribution” with your exclusive territory. Effectively, this means that although the franchisor may be restricted from awarding another franchise, or operating a company owned and operated location within the franchisee’s territory, they have the right to sell the product through other channels such as; on-line, kiosks, food trucks, shopping centres, airports, hotels, stadiums, and amusement parks. The reservation may be allow the use of the franchisor’s trademarks or operate under a similar or different name.
These types of provisions may be not be inappropriate if there is a possibility that the products may be sold through avenues such as food trucks or sports arenas; however, the franchisee has to consider whether the provisions are reasonable. If not, the only options are (a) attempt to have the provisions removed, (b) attempt to negotiate some acceptable modifications with the franchisor, or (c) look for a different franchise.
Understanding Exclusive Territory – ‘Mobile/Service Franchises’
The rules differ between ‘Mobile/Service Franchises’ and ‘Bricks & Mortar’ (fixed location) with respect to exclusive territories. This article is specific to ‘Mobile/Service Franchises’. Please refer to the article above entitled “Understanding Exclusive Territory – ‘Bricks & Mortar’ Franchises” for an explanation of exclusive territories that are relevant to ‘Bricks & Mortar’ franchises.
Mobile franchises are essentially businesses that come to your place of business or residence e.g. pet grooming, car detailing, roof cleaning, gardening services etc. These types of franchises are very popular at the moment for a number of reasons including the following:
- They are scalable. The franchisee can add vehicles as consumer demand increases.
- They are affordable. In most situations you can lease the vehicle and equipment with a relatively low down payment.
- Most mobile franchises can be operated from a home office. The franchisee is not required to invest in expensive leasehold improvements or commit to long term property leases.
- There is more flexibility with respect to scheduling than a ‘Bricks & Mortar’ business.
What is the size of an “Exclusive Territory”?
Prospective franchisees often misunderstand the rationale that applies to the size of a territory and consequently insist on a territory that it too large, which can be a detriment, rather than a benefit, to them. A franchise system can be destroyed by awarding too many franchises in one area - or too few. Too many franchises in one area may starve them of business if there are not enough customers to support everyone. On the other hand, although a franchisee does not want to be competing directly with other franchisees in their area, they should be close enough to take advantage of the synergy that is created when a number of franchisees are operating in close proximity.
Prospective franchisees are naturally concerned about the effects of market saturation within their trading area and may be reluctant to depend on the judgement of the franchisor as to how much business can be drawn from that area. They often have the mistaken belief that the size of the exclusive territory awarded is directly related to the economic performance of their franchise. The size of any exclusive territory should be big enough to allow the franchisee to obtain the maximum performance from his franchise, but not so large that it will prevent the franchisor from obtaining optimum market share.
The best advice for a franchisee when negotiating the size of the territory is to be reasonable and assess what is actually in their best interests from a logical, rather than an emotional, standpoint.
How is an Exclusive Territory Defined?
Typically, the territory for a mobile/service business is defined geographically (e.g. a city or an area outlined in black on a map in situations where it is difficult to define the territory simply in writing). The postal codes within the territory are usually included as most on-line management systems are postal code driven. Any postal codes that are issued in the future within the specified geographic area are assigned to the territory.
Requirement to Add Vehicles
Franchisors have learned from experience that they can’t rely on franchisees to grow their business incrementally by adding additional vehicles as consumer demand increases. By way of example, a rule of thumb in the lawn cutting business is that one vehicle can service one hundred customers. Once that threshold is reached it is deemed that another vehicle is required in order to satisfy consumer demand. Also, the effect caused by latent market demand, which increases the potential of the marketplace as consumer awareness of a particular product or service gains recognition, must be taken into consideration. Good franchisors recognize the necessity to award exclusive territories that retain some flexibility for modification if market conditions change or marketing knowledge increases. The franchise system must be able to service consumer demand or the door is left open for the competition to gain market share and build their brand. The franchisee may be required to pay a small option fee to the franchisor if they elect to add an additional vehicle to their territory.
The common thinking amongst franchisors used to be that franchisees would naturally add a second and third vehicle etc., as consumer demand increased. However, the reality is that each franchisee has their own level of comfort with respect to expanding their business. Some franchisees get to three or four vehicles and decide that (a) they are comfortable with their level of income, and (b) they don’t want the hassle or expense of adding more vehicles. Consequently, in order to protect the brand the franchisor needs to have some type of mechanism that will trigger a requirement for the franchisee to add a vehicle, or alternatively have the right to introduce another franchisee into the territory. This may seem onerous but keep in mind that the franchisee always has the right to add a vehicle and some franchisees do in fact build large fleets of vehicles over time.
If the franchisee decides that they do not want to exercise their option to add a vehicle, the franchisor typically has the right to take back some of the geographical territory and/or postal codes and reallocate them to a new franchisee.
‘Gray Areas’ are areas that are not part of any other franchisee's territory, nor an area served by franchisor's "company-owned" operations. Some franchise agreements allow franchisees to service customers in Gray Areas; however, that right is usually subject to the sale of the territory located in the Gray Area to another franchisee.
The franchisee does not receive any right of first refusal or other rights of any type to a Gray Area by virtue of its operations in that Gray Area and the franchisor typically has the right to sell any territory located in a Gray Area at any time, without advance notice to the franchisee. If the franchisors receives notice from the franchisor it must immediately cease all marketing activities in that Gray Area. The franchisor may give a notice to cease marketing without regard to whether a territory in the Gray Area has been sold to another franchisee.
The bottom line is that a franchisee can service customers in a Gray Area but they do not have any goodwill and can lose those rights at any time.