Franchise Site Selection and Impact Policies

By Michael Seid, Managing Director, MSA Worldwide

Franchisees and territorial rights

In other articles, we look at ways franchisors grant territorial rights to their franchisees. Taking advantage of opportunities and new locations that become available because of market changes frequently raises contractual and other issues, including the actual or perceived impact a new location will have on an existing location.

• For franchisors that have granted exclusive territories to their franchisees, the opportunity to expand into some new centers may not be possible because of those franchisee agreements.
• For franchisees whose territories are defined by the four walls of their businesses, the potential damage caused by development of a sister location a quarter mile away may difficult to accept.

The issue of encroachment in franchising often creates barriers to establishing critical mass and brand development

Even the most ardent franchisee advocate will admit that balancing the rights of individual locations often conflicts with those that benefit the overall brand performance. Territorial decisions in franchising are frequently driven by the needs of franchise sales and franchisee relations. But setting limits on where locations are placed years before the opportunity or market conditions are available – or even known – is unique to franchising.

However, a handful of franchisors have crafted an imperfect middle ground – Impact Policies – where franchisors do not grant a protected territory to their franchisees, but where franchisees still have some territorial protection. An Impact Policy establishes guidelines and procedures by which franchisors can create a safe harbor, whereby franchisees are given an opportunity to address their concerns about a new location prior to its development.

• Franchisors we have spoken with do not view Impact Policies as contractual obligations owed to their franchisees.
• Rather, they view them as beneficial programs which can be changed and even cancelled depending on their overall impact on the franchise system over time.

How impact policies work in franchising

Typically, each Impact Policy provides the franchisee (or a group of franchisees) with notice that a location is being considered within a defined distance or area nearby their location(s), and gives them a set period of time to raise the issue of impact with the franchisor. Even where a franchisee has no protected or exclusive territory, some of the policies create a secondary impact area outside of the boundaries of any contractual area agreed upon.

Who pays for franchise Impact Studies?

Generally, but not always, the cost of an Impact Study is borne by the requesting franchisee, if the result of the report predicts that the economic impact on the existing location will fall below the predetermined hurdle. The range for impact varies depending on the franchisor and their industry, but none were higher than 15%.

Where the results of an Impact Study support franchisees’ concerns, the cost of the study is either paid for by the franchisor, or by the franchisee or developer who originally proposed the new location. Where the Impact Study shows that the impact would fall below the predetermined hurdle, the cost of the study – generally under $10,000 – is paid for by the franchisee claiming impact.

Typical provisions in franchising impact policies

Each franchisor’s impact policy varies as they relate to eligibility, rate of required impact, methods of appeal, who pays for the study, and rights of the franchisee should the developed location actually prove to be detrimental after development. Some of the impact policy provisions include:

• Only franchisees that meet certain compliance standards (current on fees, good standing, superior brand performance, etc.) may be eligible to request an Impact Study
• The franchisee can meet with senior management to discuss their concerns
• The franchisee can accept a defined reverse royalty, rather than continue to protest the new unit’s development
• The franchisor may be obligated to keep the Franchisee Advisory Council informed about potentially impacted locations
• The franchisor may, under certain conditions, continue to develop the location
• The franchisee may be able to request non-binding mediation. Depending on whether or not a resolution is reached in mediation, binding arbitration can be triggered. Where outside mediation or arbitration is provided for, the timing, process, participants, and potential penalties are each defined by the policy.

Impact Policies have a low adoption rate

Formal written Impact Policies have been around for nearly two decades, and have frequently been discussed at conferences, but the number of written policies adopted by franchisors is relatively few. The reasons for the low adoption rate are many:

• Impact Policies may create contractual obligations for the franchisor which are unintended.
• Once established, modification or discontinuance of the policy may be difficult.
• The rate of impact used is frequently arbitrary and may not have any rational basis other than its ability to be acceptable to the franchisees.
• The size and maturity of the franchisor do not lend itself to needing a policy.
• The impact rate may not be universally agreed upon and therefore may not be accepted by franchisees.
• The process takes time and can be costly.
• The results may not meet the franchisees’ or the franchisor’s expectations.
• Impact Policies may have the unintended consequence of creating barriers to the development of new locations, even when a new location is appropriate and the likelihood for impact is low.

Are Impact Policies beneficial in franchising?

They can be, and we routinely evaluate the potential of developing them with our clients when we think they might be beneficial. But, for most franchisors, Impact Policies can create barriers for growth.

It’s preferable to decide where to allow development of new locations based on market needs. Where there is a solid basis of trust within a franchise system, this is still the preferred method for market expansion.