Why Franchise Agreements Favour the Franchisor
This article appears in the May/June 2014 issue of Business Franchise Australia & New Zealand
For anyone that has read a Franchise Agreement, they will know that the Agreement is often extremely one-sided.
The Franchise Agreement has of course been drafted by the franchisor’s lawyers and consultants for the benefit of the franchisor. The rights of individual franchisees are often secondary. People who are looking at a Franchise Agreement for the first time often feel that this is unfair. However, if a prospective franchisee feels particularly aggrieved about the level and type of controls that a franchisor would wield over them then they would be best to re-evaluate at the outset whether buying into a franchise system is right for them, as the controls that a franchisor has are there for a very good reason. A review of issues faced by franchise systems that are focused on the food and beverage sectors provide prime examples of why franchisors draft agreements this way.
The food and beverage sectors contain many high profile franchise systems. Many of them are truly international brands. It is hard to think of any other sector that would compare in that regard. Many brands that are not internationally known are still highly successful household names throughout Australia and New Zealand. Examples include burger chains and other fast-food restaurants, various bars, cafes and branded restaurants. In each case a lot of advertising money, time and effort is spent in building the branding behind such systems. Further, a lot of money is spent fitting out premises, hiring staff and establishing each individual franchise. It is quite common for fit out amounts alone to be a seven figure sum and the cost of running each individual franchise is an extremely significant sum.
It is not uncommon for franchisors in these industries to wear dual hats. They not only act as franchisors for operations being run independently by franchisees, but they also run ‘corporate stores’, a scenario that occurs when a franchisor is trying to get market saturation and it either consciously chooses to retain some of the stores itself, or in other instances it has not yet found the right franchisees for those operations. Therefore, franchisors have a deep and vested interest in ensuring that the franchise system is run correctly and that the brand is perceived by the public in the best possible light.
Because of the high profile nature of many of these franchise chains, a bad experience that is publicised within one store can have a significant impact on the brand, and therefore the profitability of every other franchisee and also the franchisor. The negative impact is not normally limited to the franchise outlet that the bad publicity originated from.
It is absolutely critical that there are proper procedures in place within each franchise system to deal with customer complaints. There is an old adage, one that rings true in many instances, that a complaint from a customer can turn that customer into an advocate of your business if it is dealt with the right way.
To ensure a positive customer experience, many franchise systems in the food and beverage industry have embedded at their very core a philosophy that ‘the customer is always right’. A franchisee is required to bend over backwards to please a customer when dealing with disputes and complaints. In addition to this requirement, franchisors often have robust mechanisms for receiving complaints from customers and dealing with customer feedback. There is often a requirement on franchisees to log complaints and to report them through to Head Office. This helps the franchisor track issues and the way that they are resolved to ensure that franchisees are acting appropriately.
Franchise Agreements always contain terms that give the franchisor the power to deny rights of renewal on certain grounds. Examples often include when a franchisee receives too many complaints, or if a franchisee is not effectively resolving the complaints that they do receive. This allows a franchisor to hold a significant amount of control over a franchisee. The last thing a franchisee can afford to do is to lose the right to renew their franchise. That would result in the loss of the significant investment they have put into their business due to poor performance in an area that they have direct control over.
Even though the food and beverage industries face many similar issues, they do have their own individual issues that franchisors must keep strict controls over too. Looking first at food based franchise systems, the quality of the food produced is an absolute key. The franchisor must somehow maintain control over the suppliers of product so that quality is maintained within each franchise operation.
This is not necessarily an easy thing to do, especially in relation to fresh meat and produce, which are generally locally supplied. Franchisors that are based in one geographical region often struggle to ensure that the produce sourced in other regions and supplied within the system meet minimum standards. However, failing to do this can have an adverse effect on businesses that are using suppliers that provide an inferior product. It is therefore incumbent on franchisors that want to maintain control within their franchise system to dedicate the resources necessary to ensure that the supply lines are providing product that meets the standards that they require.
In the beverage side, the disruption to brand reputation that can occur if liquor laws are breached is extreme. A recent example in New Zealand had one store in a major supermarket chain banned from selling alcohol for a seven day period due to the sale of liquor by that store to an already intoxicated person. That organisation as a whole received a lot of bad press due to that sale and the lack of systems it had in place to train staff to appropriately recognise situations where a sale should not proceed.
This can have a large impact on turnover. It has been estimated that it may affect the turnover of that supermarket by up to 10 per cent in the week that it is unable to sell alcohol. In the case of a bar or restaurant where the core business involves the sale of alcohol the ramifications can be even more disastrous. Repeated breaches of the liquor laws can lead to the revocation of liquor licences, the inability to obtain a renewal of a licence, or the re-issue of a new licence of conditions that reduce the viability of the business, such as increased restrictions on trading hours. This can have a catastrophic affect for a franchisee who loses their business. It will also have an impact on the income earned by the franchisor through franchise fees and it will certainly also have a negative brand impact for the franchise chain as a whole. Innocent parties can be detrimentally effected through no fault of their own.
All this means that franchisors can, and must, maintain strict controls over the critical standards that must be maintained within a franchise system. This is particularly so in the food and beverage industries, so as to ensure that quality and reputation are maintained at all times. If a person is looking to buy into a franchise in one of these industries then as part of their due diligence investigations they should be making enquiries of existing franchisees to ensure that franchisors have robust procedures for ensuring quality and control are maintained at all times. If a franchisor is seen to be ‘hands off’ then that is not necessarily a positive thing.
Mark Sherry, LLB (Hons), BCom, is a Partner with Harmans Lawyers New Zealand. He leads the commercial and property team, specialising in franchising, hospitality, rural law, property matters and asset protection.
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