Your Franchise Territory:

Cause for Comfort or Conflict?

by Patricia Schaefer

Under optimal conditions, properly allocated franchise territory is a win-win scenario for both the franchisor and its franchisees. The franchisor is allowed the capability to adequately penetrate market areas for maximum sales and profits, while franchisees are afforded sufficient territory to generate desired revenues without undue competition or "cannibalization" from fellow franchisees.

Unfortunately, though, the very issue of franchise territory has been one of the leading causes of conflict, dispute, and litigation in the franchise industry. One common complaint today comes from franchisees of large franchise systems; where franchisors sometimes allow the establishment of additional franchises in close proximity to existing franchisees. As a result, this diminished territory sometimes leads to a significant drop in sales and slashed profits for those franchise owners already established in a geographic area.

One such group of franchisees recently filed an encroachment lawsuit against their fast food franchise system. The judge in the case dismissed the suit. It seems the written franchise contract took legal precedence over the franchisees' argument that they had received oral promises of exclusive territories from the franchisor.

This unfortunate circumstance lends credence to the following advice: The time to address the issue of territory -- like so many other franchise issues -- is before the purchase of the franchise. With the assistance of a qualified franchise attorney, territory rights and responsibilities cited in the franchisor's UFOC and franchise agreement need to be assessed prior to the purchase of any franchise.

Exclusive versus non-exclusive territories

It would seem to be in a prospective franchisee's best interest to seek out franchises that offer protected and exclusive territory rights within a designated geographic area. In fact, a study performed by the Institute for Operations Research and the Management Sciences shows that 91 percent of successful franchises have defined territories. Additionally, the study shows that new franchise chains that adopt exclusive territories are more likely to survive over time than chains that do not.

However, it should not be assumed that an exclusive territory is always critical for success. The nature of the franchised business may be such that the franchise is not particularly vulnerable to local competition. It would be in prospective franchisee's best interest to speak with current franchisees to determine how the lack of exclusivity has impacted their franchise sales and profitability.

Questions to ask

Look for the answers to these questions when assessing territory offered by a franchisor:

• Will the territory be exclusive, non-exclusive or will there be no territory at all (i.e., some retail franchises are defined by location such as a particular shopping mall)?
• How are the franchise territories determined? Can you choose your territory or where the site within the territory will be located?
• Is there a disclosure on the territory granted and are the precise boundaries clearly defined? Does either the franchisee or the franchisor have the right to renegotiate territory boundaries?
• Are there any minimum sales quotas or conditions imposed on franchisees in order for them to retain territorial rights?
• Can the franchisor or franchisee establish another franchise within the geographical area, or relocate the franchise? Under what conditions?
• If the franchisor can establish a future franchise in the territory, will the existing franchisee be considered before any third party, and have a "first right of refusal"?
• What rights does the franchisee have both inside and outside of the designated territory? For example, are there restrictions on franchisees from soliciting or accepting orders outside of their designated territories?
• What are the franchisor's intentions for the bordering territory? Might this have an impact on your territory?
• If the franchisor chooses to open a similar franchise company under a different trademark, how will this affect your franchise territory? What will happen if the franchisor acquires or merges with a competing franchise company that has franchises in your franchise territory? Will your franchisor compensate you fairly for any resultant loss of business?
• What is the history of how the franchisor has handled territory disputes or litigation in the past?
• What do existing franchisees think of their contracted franchise territory rights?
• What are the strengths and weaknesses of offered franchise areas?
• Are there other competitors in the franchise territory? How close in proximity are they? What competition is projected in five or 10 years' time?
• Is the franchise territory large enough? Will there be enough customers to make the franchise a success?

In the event that verbal assurances are given by a franchisor with regard to specifics of the franchise territory -- those that are not stipulated in the UFOC or franchise agreement -- be sure to get confirmation in writing. And remember, address any concerns about your franchise territory before purchasing the franchise. Addressing concerns afterward can be an uphill undertaking and a recipe for a soured business relationship. Worse still, inadequate territory protection or rights can significantly hinder your chances of business success.

Copyright 2006, Attard Communications, Inc.