I SUSTAINING FRANCHISEE RELATIONSHIPS

When franchising works it is magical – franchisors rapidly expand their geographical coverage, franchisees have a proven system that allows them to realise their personal goals and reduce their risk, and consumers benefit from great products and services. Relationships are at the heart this success. Successful franchise networks are built on an interdependent partnership between franchisor and franchisee, where each plays a key role and achieves more by working together. When you attend a franchise conference for one of these high-performing franchise networks, you feel the spirit of cooperation and commitment to a shared vision for success. Franchisees are proud to be part of the brand and speak highly of the products and services they provide in their local area. And when proven franchise concepts do not flourish, we can normally trace the root of the issue to ineffective franchisee relationships. It is important that lawyers understand this reality and not only draft documentation that positively underpins the relationship, but also ensure that it functions within the regulatory environment to best effect ensuring that the relationship is not 'holed under the waterline' by laws that directly or indirectly regulate franchising.

II WHY RELATIONSHIPS MATTER

Having a network of engaged and successful franchisees is not simply an altruistic aim – it makes commercial sense:

  1. engaged franchisees who feel valued, buy into the franchisor's vision and are committed to the partnership are likely to perform better. Often the face of the brand, they will go the extra mile for customers and maximise their sales territory. In management franchisees, they will better motivate and get the best of out their teams;
  2. investing in franchisee relationships also reduces litigation. Franchisees who feel supported and value the partnership are less likely to bring costly disputes. If they have an issue, they are more likely to talk about this with their franchisor and try to find an amicable solution;
  3. franchisees will embrace change. Franchising is built on trust – if a franchisee does not trust the franchisor, they are likely to be defensive about any changes to the franchise model, even if these are intended to help them be more successful. The leadership team will find itself spending more time communicating the reasons behind changes and overcoming objections than driving the business forward;
  4. investing in franchisee relationships reduces the risk of an independent franchisee association. If franchisees do not feel valued and listened to, they are more likely to establish an independent franchisee association, similar to a staff union. This can create a 'them and us' mentality, and the franchisor could soon find itself negotiating with nominated representatives; and
  5. unhappy franchisees undermine franchise recruitment. One critical step that all prospective franchisees should take before signing the franchise agreement is to speak with existing franchisees. If these are dissatisfied or regret having chosen to invest in the franchise, prospective franchisees may be put off from investing in the franchise. Moreover, in the age of social media and blogging, negative reviews by disengaged franchisees can quickly proliferate across the web, damaging the franchisor's reputation.

III IT STARTS WITH RECRUITMENT

Good franchisee relationships begin before a franchisee joins the franchise network. The way franchisees are recruited and how expectations are set during the recruitment process will have a long-term bearing on the quality of their relationship with the franchisor.

Franchising is often described as a business marriage because of its long-term nature and the aspect of partnership. The recruitment process is the best time for clarifying the expectations of both parties and ensuring these are realistic. As well as ensuring that the prospective franchisee has what it takes to be successful, the franchisor must set clear expectations and not just about the potential financial rewards, but also the sacrifices that they will need to make. This can include having to follow someone else's system rather than truly being one's own boss, and the time and work–life balance sacrifices that may be needed, especially in the early years. If expectations are not aligned, the franchisee can quickly come to resent the partnership, increasing the likelihood of dispute and litigation.

For master franchisees and area developers, there are some additional considerations. While the exporting franchisor will want to set a development schedule or recruitment targets, it is critical that these are realistic. The most successful international franchisors also recognise the importance of adapting their concept for local markets and cultures, before ramping up franchisee recruitment. They listen to feedback from the master franchisee for a better understanding of the local marketplace and culture, and make necessary refinements to the model and products and services.

In a number of jurisdictions, such as the United States, Canada, France, Spain, Italy, South Africa, China, Malaysia and Australia, there are franchise-specific laws that aim to ensure optimal transparency and so minimise any mismatch of expectations. In such jurisdictions, lawyers are bound to advise their franchisor clients on how to comply with these laws. However, it is important to appreciate that mere compliance with these pre-contractual laws does not always, per se, guarantee the recruitment of appropriate franchisees. More is required as regards the way in which the 'sales' process is managed.

In those jurisdictions where there are no franchise-specific pre-contractual obligations, it is nevertheless advisable for the franchisor to prepare and deliver documentation to its potential franchisees that will help minimise the risk of recruiting inappropriate candidates or encouraging franchisees to become involved in the franchise on the basis of a misunderstanding. Again, a pre-contractual disclosure document by itself is not sufficient. There must be an appropriate pre-sales process implemented, of which the disclosure document is merely one part.

IV UNDERSTANDING EACH OTHER'S ROLE

The power of franchising comes from interdependence: understanding each party's role, and that the parties will be more successful by working together, is the key to sustaining excellent franchise relationships.

i The role of the franchisor

The franchisor's role is to provide the proven system, support and mentoring that enables franchisees to achieve their personal and financial goals, in line with expectations set during the recruitment stage. The franchisor must maintain and enforce system standards to protect the brand, provide leadership and a clear vision for the future, share best practice and innovate to ensure the products and services remain competitive. The franchisor must continue to provide a fair deal through value-for-money management fees and royalties in return for support and brand value. This role must be reflected faithfully in the franchise agreement and indeed in some jurisdictions, such as Indonesia and some of the EU Member States, such provisions are mandatory.

ii The role of the franchisee

If the franchisor's role is to provide a proven system and ways of working, the franchisees' role is to follow this and maximise sales in their territory. They should do this in a way that enhances the brand by providing great customer service, supporting their fellow franchisees and sharing best practice.

Although some franchisees refer to themselves as the franchisor's customer because they pay a management fee or royalties to the franchisor, this does not accurately describe their role. Instead of a supplier–customer relationship, it is a two-way partnership and both franchisor and franchisee have obligations to each other.

In some jurisdictions, such as Vietnam, there are mandatory provisions that must be included in the franchise agreement and that reflect the role of the franchisee.

V MOTIVATING FRANCHISEES

One of the most-quoted benefits of developing a franchise network is being able to tap into the self-motivation of franchisees, who will be more driven and enthusiastic than a company employee. While this can be true, many franchisees reach their comfort zone and fail to develop fully the territory they have been allocated. This will undermine the franchisor's sales. This is something that must be borne in mind when structuring the franchise and drafting its documentation, particularly in respect of cross-border franchising.

A provision granting the franchisee an exclusive territory is usually requested by the franchisee, particularly in international franchises. In view of the substantial investment the franchisee is making, this is understandable. However, it can create problems when the franchisee reaches his or her comfort level. A variety of drafting devices can be used to minimise this risk, such as minimum sales targets, minimum number of outlets, areas of prime responsibility, rather than exclusivity, and so on. However, these are merely ways of reducing the risk, not avoiding it. It is therefore vital to understand what motivates franchisees so the franchisor can help to motivate them to perform better.

It is often and incorrectly assumed that what will motivate a franchisee is maximising the financial returns. Instead, as Abraham Maslow described in his classic 1943 paper 'A Theory of Human Motivation',2 human beings have varying and more complex motivations other than simply maximising income or profits.

i Maslow's hierarchy of needs

Applying Maslow's theory to franchisees, their potential needs, from basic to transcendental, include:

  1. physiological: breaking even and paying the bills;
  2. safety: making steady profits with no cash-flow worries;
  3. social: a better work–life balance and support and camaraderie with fellow franchisees;
  4. esteem: recognition as a successful business owner or winning business and franchisor awards; and
  5. self-actualisation: building a business empire (e.g., multiple stores and being in control of one's own destiny).

By understanding franchisees' 'why' – their unique and personal reason for investing in a franchise – the franchisor can tap into this motivation and help fuel their drive to build their business.

ii Understanding the franchisee life cycle

From first becoming a franchisee to eventually selling their successful business, most franchisees experience key stages that affect their levels of motivation and overall relationship with their franchisor. It is important for franchisors to understand these and adapt their approach accordingly. These stages are often referred to as the child, adolescent and adult phases:

  1. Child: during the first few months there is an initial honeymoon period with the franchisee excited but slightly nervous about their new adventure. Many franchisees have never operated their own business before so they are very dependent on the franchisor's initial training and support. Provided the franchisor has delivered on the promises it made during the recruitment process and the franchisee becomes profitable, they are likely to be happy and highly motivated.
  2. Adolescent: as the franchisee gains experience and has absorbed the initial training, they may begin to think they know better and try to change certain processes or ways of doing business. In the industry, we call this 'reinventing the franchise system'. In established franchise networks, this is counterproductive because the franchisor has tested those same ideas in years gone by and found they did not provide an optimal solution. As the franchisees' sales grow, so do their management service fee payments to their franchisor – these are normally a percentage of their turnover. They may begin to question and challenge the value they are receiving from their franchisor in return. This issue is more challenging for franchises built predominantly on know-how rather than a strong brand or franchise system; after this knowledge is transferred, the franchisee has a weak dependency on their franchisor.
  3. Adult: mature franchisees realise that they've signed a long-term agreement with their franchisor and, provided they both fulfil their roles, they can achieve more together. Successful franchisors can tap into this experience by inviting successful, long-serving franchisees to sit on a franchise advisory council and inviting their opinions and suggestions on key network decisions, while still retaining the final decision. However, at the same time, they need to ensure they are continually innovating and providing good value for these established franchisees, who will have ever higher expectations.

Some franchisees of course, never make it all the way through these key stages. Some may get stuck in the adolescent phase, especially if they are not as successful as they expected and look for someone to blame. As well as being aware of these key stages, some franchisors will explain them to new franchisees when they join. By signposting their likely emotions, it helps to build trust, shows they are not alone and helps them progress from adolescent to adult as quickly as possible.

iii Exit planning

Some franchisees may have reached their comfort zone, a level where their income is in line with their desires, so they take their foot off the gas and enjoy more time away from the business. One way to motivate franchisees out of this is through exit planning. Discussing how much they want to earn during their retirement and the desired resale value of their business can help to spur them into action and into growing the current business. If franchisees are also focused on maximising their profitability as reported in their annual accounts, their behaviours may change. For example, they may become more frugal when claiming expenses. If a small minority have also been earning revenue but not reporting this to the franchisor, breaching their agreement, they have an incentive to correctly report this so it can be taken into account when valuing their business.

A sign of a healthy franchise network is resales. This helps to demonstrate the ability for would-be franchisees to invest in the franchise, build their business and realise a healthy resale price several years later. New franchisees will often provide a different perspective and help to inject energy into the franchise network, especially if these can realise big gains in performance, showing incumbent franchisees the hidden potential.

The franchise agreement needs to capture this need for resales, and reflect and provide for it in an appropriate manner, with careful and subtle drafting.

VI ESTABLISHING A FRANCHISEE ADVISORY COUNCIL

A franchise advisory council (FAC) is a group of established franchisees who meet with the franchisor's executives to discuss commercial business issues that are relevant to the majority of franchisees. This could include product development, new marketing campaigns or operational changes designed to help move the franchise system forward.

FACs provide a structured vehicle for constructive two-way communication between the franchisor and franchisees. The FAC serves as a sounding board for the franchisor, before new initiatives are rolled out system-wide. Often, by engaging with the FAC, a new initiative will be better received by the network because the FAC has provided a metaphorical stamp of approval. For franchisees, the FAC provides a forum in which to voice their concerns and suggest ideas – in essence, it fulfils the basic human need to have a say and influence what will affect us. Ultimately the final decision-making authority should remain with the franchisor, but any franchise executive worth their salt will ignore the FAC's advice and feedback at their peril.

It is important to invest time to establish a FAC on solid foundations. A robust and well-thought-out legal structure is essential. A badly structured FAC will most probably have a negative impact on the business. A good FAC must have a carefully crafted constitution that governs how it operates, the frequency of meetings and the scope of what discussion items are acceptable (and unacceptable). What is ultra vires and what is intra vires must be clearly stated. If management service fees and royalties are not up for discussion, this must be made clear at the start. It can help to clarify that any changes and areas of discussion must be focused on growing the size of the pie, rather than how this is shared between franchisor and franchisee. The resulting discussions are likely to be much more collaborative and beneficial to all involved.

When drafting the constitution, franchisors need to consider how franchisees will be elected to the FAC. This can either be done by democratically electing franchisees or by the franchisor appointing them – both have pros and cons. A survey conducted by the International Franchise Association (Wulff, 2005)3 showed that of its franchisor members that have established franchise advisory councils, more than 90 per cent have their FAC members elected by franchisees, rather than appointed by the franchisor.

This creates a risk that the FAC could be dominated by disgruntled franchisees looking to gain greater stature and vent their frustrations. However, if appointed by the franchisor, other franchisees may feel that the FAC does not represent them, and they may disengage from the process. Nevertheless, with an effective chair and ground rules, a FAC can help to improve communication, give franchisees a voice and reduce the likelihood of franchisees starting an independent franchisee association.

VII LEVERAGING TECHNOLOGY

Effective franchisee relationships are built on information. Embedding a franchise management software solution can underpin this. For franchisees, an effective system can ensure they always have access to a library of the latest documents, procedures and templates from their franchisor. This may also help empower them to conduct their own local marketing, selecting from and tailoring centrally made marketing resources within parameters set by their franchisor. Many systems also include forums, which if properly set up, can aid peer-to-peer sharing of ideas and best practices, as well as discussion groups.

For the franchisor, a franchise management solution will typically be used by franchisee support executives to log key conversations and compliance records; by the legal team to track legal agreements; and by head office teams to communicate with franchisees. The system can also provide a wealth of business intelligence and facilitate franchisee-to-franchisee benchmarking.

VIII MAINTAINING FRANCHISEE SUPPORT AS YOU GROW

Independent franchisee-satisfaction surveys are a powerful tool in ensuring that franchise systems are in a rude state of health. This involves asking franchisees to provide feedback on the support they receive, the quality of their relationship with their franchisor and their overall satisfaction.

Research by Smith & Henderson shows that as franchisors expand beyond 40 franchisees, for many, their levels of franchise satisfaction decline.

There are two reasons for this. First, in a smaller franchise network, franchisees often have a direct channel through to the managing director or founder of the business. They are on hand if a franchisee has any issues, and their passion and commitment to the business and franchisee support is unmatched. As the franchise network expands, they need to recruit more staff and these may not share their commitment to great franchisee support and communication barriers can set in. Some franchisors may also be reluctant or unable financially to scale their support team in line with the growth of the franchise network, causing this to be diluted. Therefore, many franchisors that reach 40 franchisees struggle to sustain their good franchisee relations.

Such franchise systems either stay at this level, struggling to grow, or they invest time, money and energy improving their support and cultivating strong relationships with their franchisees. This fuels their growth and is the reason why there are many very large franchisors with outstanding levels of franchisee satisfaction and excellent franchisee relations. This is particularly so with franchise systems that have an international presence. Regular communication between franchisors and their franchisees, by way of independent surveys and otherwise, is a key way of enabling the business to update and adapt its legal documentation to effectively protect the best interests of the franchise system and help ensure its healthy growth.

Established franchisors face another challenge. Mature franchisees, who are often paying a significant monthly management service fee to their franchisor but are less dependent on them for training and day-to-day support, begin to question whether they are getting value for money. One way of tackling this is to establish new support initiatives aimed at helping these mature franchisees reach the next level. This can involve 'mastermind' groups, helping the franchisees benchmark their operational costs and advanced leadership training for them or their staff.

IX SUMMARY

When franchising works it is a powerful tool with which to grow a business – it allows companies with products and services that consumers want to rapidly expand their geographic reach while tapping into the entrepreneurial drive of an owner–operator. Relationships are at the heart of this success. The most successful franchise companies understand this – they invest and cultivate their relationships with their franchisees because it helps drive their success and ensure that their legal documentation is constantly developed to reflect their changing needs.


Footnotes

1 Steven Frost is managing director at WorkBuzz and Mark Abell is a partner at Bird & Bird LLP.

2 Maslow, A Theory of Human Motivation (Merchant Books, 1943).

3 Wulff (2005), 'Advisory Councils: Effective Two-Way Communications for Franchise Systems', International Franchise Association Franchise Relations Committee. Available at http://franchise.org/files/Advisory%20Councils.pdf.