Australian Franchises

Exclusive Territories - Brilliant or Bad

Exclusive Territories - Brilliant or Bad

Are they necessary or are they destructive?

Franchisors make one of the biggest decisions when they choose exclusive territories without considering other options. It is serious because once you have set your franchise model up and it is part of the franchise agreement and you have promised this as a benefit to franchisees, it is very difficult to change if you decide in hindsight that you have it wrong.

Firstly let’s consider the definition of exclusive!

Exclusive and Territory can each mean many things.

Generally 'exclusive' is assumed to be an absolute right for the franchisee to conduct its business within the defined territory with a right to stop both the franchisor and any other franchisee within the franchise system to come into that territory or provide goods or services to customers within that territory. However, it is possible for a franchisor to put restrictions and conditions on such an absolute arrangement just in case the franchisee underperforms but that could mean costly litigation. The consequence of exclusivity is also that the franchisee that has an exclusive area is only able to service customers within that territory and so cannot expand the business because the other franchisees are equally “protected”.

Having decided how exclusive the definition of 'exclusive' is then these rules need to be applied to the Territory which is nominated and granted to the franchisee. One would be the locality protection of a franchisee’s anticipated area of business, office or retail store.  In other words a geographical territory defined by postcodes, suburbs or other boundaries that prohibits another franchisee or indeed the franchisor from locating their business within that territory. The purpose of this policy is to give the franchisee protection from competition from others within their own franchise system and to have adequate customers to service. In essence this sounds very fair and reasonable.

The geographical boundary becomes sacred and franchisees must never cross the borders to obtain business in a neighbouring territory. In essence once again this sounds fair and reasonable. In this situation the franchisees often believe that they are better off because their patch of turf and potential customers are protected from intruding franchisee neighbours.

These situations when put to potential franchisees that have never been in a small business before will usually think that the offer of an exclusive territory is fantastic and think that on face value it is a very fair and equitable proposition.

Of course franchising covers just about every industry imaginable and this means that territory decisions for franchised companies may vary significantly so the examples given in this article are just the tip of the iceberg when it comes to the range of choices that a franchisor needs to make about whether to have an exclusive territory or not.
If we break down the sector into two segments in franchising being Retail and Service we can soon see the vast differences in how you might want to apply your territory policy.

Let’s start with retail!

Exclusivity that prevents competing franchisees doing business within the territory.

If the franchise model for retail has an exclusive territory then we must consider the two meanings, firstly the exclusive rights so that another franchisee cannot set up shop in your territory. It all sounds nice and safe for the franchisee and they will never have a competing franchisee anywhere near them but let’s consider this;

Many franchise companies when they start up can try to make an assessment of what they think their market share could be across the State or Nation, and with new concepts it is usually even harder to really know how large your brand can be and how much market share you can really obtain, so what to do?

Good market research will certainly help but the anomalies can be through unforseen threats or market changing factors, such as fads, trends, competition and various external threats that you may not have foreseen. Some brands may be affected with restricted growth and some brands will have larger growth than they could ever have imagined.

So my question is; “why set up your business model with predetermined restrictions via exclusive territories in the first place when you really don't know the potential of the brand”. The reason that I bring this up is because I have worked with many franchised organisations that regret setting up exclusive territories in the first place, as it has impeded their growth and surprisingly has given competitors an advantage.

Let’s consider this restriction on growth, it is in my opinion that a Franchisor’s duty to its franchisee business partners is to maximise the growth of the company, in other words place as many franchisees out there that the market place can safely bare. It is also the Franchisor’s duty to increase the value of the franchisees’ businesses by maximising the brand exposure for all franchisees.

With this in mind I cannot think of any situation that should require an exclusive territory policy under this particular definition.

The argument might be that it stops the Franchisor from doing the wrong thing, by placing too many franchisees around the State or Nation and causing harm to some of the franchisees. Maybe 20 years ago I would have agreed with this but times have moved on, franchising is more sophisticated nowadays and the laws have certainly become much more protective of franchisees’ rights.

But even without the law as back up you would have to ask yourself “why would any franchisor in their right mind purposely cause harm to their franchisees by placing another franchisee too close, especially if there is not enough market share. The franchisor relies upon the success of their franchisees to be successful themselves.”

This is why most food franchisees do not have an exclusive territory; in fact the notional territory is just the premises of the franchisee.

A franchisor should be sophisticated enough to understand the market, demographics and target market to understand the limitations and growth prospects.

Testimony to this is the McDonalds case in Victoria in the year 2000.

Check the publication on this case.

This was a battle over McDonalds opening company stores to close to existing franchisee’s stores following their philosophy that a consumer that cannot find a McDonalds will buy elsewhere and so a sale will be lost. The outcome was that McDonalds were found not to have breached their agreement as they had the right to open up stores as they deem appropriate.

The franchisee stores of the two nearby McDonalds are still both trading and part of the claim was a loss in revenue but this rectified itself over a period of time and the real bonus was that by having two McDonalds closely nearby that they did not end up with a competitor setting up around the corner from the first franchisee.

The point being; McDonalds as a large organisation with the research and funds available understood their market and understood their ability to grow without damaging their franchisees’ businesses. McDonalds concentrate on looking at the operational factors of a franchised business and focus on what customers want so that as soon as the franchise store has reached a viable revenue point and there are still more customers wanting the product, they look to establish an additional cluster of stores so that there is no room for a competitor.

Exclusivity that prevents the franchisee from soliciting customers outside of their territory.

Well this one is probably a “no brainer” for retail as you cannot prevent customers from shopping anywhere they like especially if you are considering online sales. Do you really want to ask a customer for their address and then turn them away if they do not live within the exclusive territory! So this type of exclusivity does not really apply to Retail. This point is even more obvious when we look at franchising in the services sector.

Let’s have a look at exclusivity in the service franchise sector.

Exclusivity that prevents competing franchisees locating within the territory.

This is probably not too different to retail but a franchisor should not make the mistake of just copying retail strategies in developing a franchise service model.

If you are a service franchise company with a retail presence then many of the same considerations would apply, why restrict the franchise brand from growth and why would the franchisor want to set up two individual franchisees close nearby unless it is good for business for everyone and gives customers what they want.

If you are a service franchise without a retail presence then really it should not matter where the franchisee’s office is based, it is more of a consideration for where your customers will be.

For instance in a town if there are two franchisees the geographical location of the office is immaterial but one franchisee may be encouraged to run the North side and the other the South side. It may or may not be more convenient for the franchisees to be located in or near their territory for convenience, reduced travel and other cost benefits, but regardless, is there really any necessity for an exclusive territory?

Exclusivity that prevents the franchisee from soliciting customers outside of their territory.

This is the real issue for debate. Service franchised companies have to go out into the market to solicit for business either from the domestic market or business market so the franchisor has to work out the best way to do this.

Let’s consider the various types of industries, lawn mowing, mortgage services, financial services, car repair, cleaning services, pet minding services, vending machines, maintenance services and so on.

There are also concepts that come under retail services such as gymnasiums, health spas, hairdressing etc. However, unless any of these concepts actually take their services to the customer’s homes or premises they should be treated in the same way as the McDonalds example.

So exclusivity for services in this case means that you have your own territory where you and only you can market for business. Seems fair, but let me put a different perspective on this deal!

Firstly for micro systems like house cleaning and lawn mowing the territory would need to come down to streets or a suburb to be affective.

Here is the real issue as experienced by many service type franchise companies.

They have created borders like the borders of a country and we all know what happens when you get two competing countries. When you create borders you create wars, hopefully not violent wars just disagreements. It’s like two neighbours and one neighbour takes an inch too much of ground, or their dog excretes on the others lawn or the noise is too loud from parties or they don’t maintain their place to a good enough standard. Yes it can be violent.

The biggest problem is telling a business person that they cannot sell their services in a neighbouring territory when of course you can't stop customers from talking to the business person and tempting them on a daily basis to make that extra sale. It sounds fine at first but as soon as a franchisee gets a referral from one of their happy customers or a family member lives in another territory then guess what’s going to happen. Remember franchise networks are made up of real people with real personality traits that vary across the board and no matter how smart your recruitment process is you will never stop a mix of differing personalities and that means that not all of your franchisees will follow the system completely. How can you blame them trying to make as many sales as possible when the end result is that they make money for themselves, they make money for the franchisor through royalties and they make customer’s happy.

Having exclusive territories is a formula for constant battles, the franchisor ending up as the meat in the sandwich trying to fix the issues according to the agreement, and taking up too much valuable time. These are the sort of issues that can certainly ruin a National Conference.

So what is the alternative? Do not have exclusive territories

At the very early stages in developing a franchise model once again it is the franchisor’s responsibility to understand the market place. Even a brand new franchisor should be able to work out a safe growth potential for any given region which will look even better without having to carve up into little boxes or territories.

This is simply a matter of saying, our business model works well with X amount of customers for a franchisee, we have estimated that this Town, City or region can adequately handle 5 franchisees, however we will grow at rate that will allow the franchisees to become established before we expand too much. The beauty of this is that if you have underestimated your potential you have the ability to expand either with your existing franchisees or new ones.

The positive approach to non-exclusive territories is this:

  1. The same rules apply for everyone and everyone has an equal opportunity in the market place. I think it’s called a free market
  2. You are not inhibiting sales people to do what they are meant to do, make sales.
  3. You have the freedom to attend to referrals, one of the most successful tactics in Local Area Marketing. You can promptly respond to the best type of customer of all – the customer that gives referrals
  4. It becomes friendly competitive between franchisees but also realise that each sale means that a competitor outside of the franchise brand is excluded
  5. The franchisees for that region can actually get together and combine their Local Area Marketing spend to get a better result for everyone (synergy)
  6. They will swap customers if it is geographically or financially beneficial

This is not a theory; this is a tried and proven initiative that has been implemented into new franchise systems but also into existing systems that become weary of the issues surrounding exclusivity. Of course you cannot change an existing system over night as many franchisees feel that something is being taken away from them instead of realising that the change is opening up great opportunities. Even McDonalds have not done too badly with a non-territory model.

I have personally been involved with several systems that went through the change. Sure it took a great deal of planning and working with franchisees in order to make such a significant change to the business model. However, with perseverance eventually everyone agreed and the franchisees are now testimony to a much better working model and praise the initiative.

The positive feedback has been fantastic from franchisees. This business model for service type franchises works even for a vending machine franchise operation. But this also needs to have ground rules set in place. Making sure that franchisees are not seen to be fighting over a customer is essential and once this is sorted out the real benefit is that the entire franchise brand creates a great customer database.

The issue is this, no matter what style of operation that you have, you will think that yours is a little different, and yes to an extent that is true, especially with logistics but the overall philosophy does not change. How you overcome the quirks of any individual system is to have ground rules or as I like to call them “Rules of Engagement”.

These are the set of rules that would be part of your operations manual detailing what you can and can’t do specific to your style of operation, so as to create a basis to work together amicably.

No system is perfect and so what you should apply as a key part of your franchise rules of engagement is a dispute resolution process for any conflict that arises between franchisees, with the franchisor having the final say so that the rest of the franchisees feel safe. Of course if something becomes more serious the external mediation process may be more appropriate.

There is a territory method known as a Prime Marketing Area (PMA). This is to restrict marketing and promotion of the franchise business outside of a specified geographical area. The purpose of this operational initiative is, for example, to prevent a franchisee based in one State running a newspaper to advertise in another State as really in such a situation the franchisee would not be able to adequately service the customers. This is ok but there is still an argument about not restricting a franchisees’ growth where it can be shown that customer service standards do not drop.

For instance, there is a marketing franchise system that provides many services online and they use the internet broadly for promoting their services. So if face to face meetings are not necessary and operational manual standards are maintained then the question remains, why restrict the franchisees at all?
So Prime Marketing Area’s may be suitable in some cases but not all as we know that every general statement is false!

The Internet and Exclusive Territories

The world of technology is expanding at an incredible rate, which impacts upon business methods and strategy. What worked yesterday is not necessarily right for tomorrow and as good business managers we have the responsibility to make change. The best example is the effect of online sales against retailers, who knows what the shape of retailing will bring in the next few years. You will not stop it happening so we need to adapt and change.

The Internet and online sales will have a direct impact upon some franchise systems; there are no territories or boundaries on the Internet, so consider these questions:

  1. Do you as retailers set up an online shopping cart?
  2. What price will you sell your goods at? The public probably expect to get things cheaper online but you can’t under cut your franchisees.
  3. Do you share the online rewards with your franchisees and how?
  4. How do you control marketing online as service providers if you have exclusive territories?

It is very hard to see how any of these questions could be answered by a system with exclusive boundaries.

In Conclusion

What makes a franchise brand strong; happy customers that see no reason to buy from a competitor. A franchise brand that cannot be flexible enough to meet this goal will end up like the dinosaurs. One of the best ways to create inflexibility is through the use of exclusive territories that fail to recognise that by using such a structure you are promoting petty disputes between franchisees within the franchise brand and forgetting that the real way to success is to do everything to drive sales and meet all of the needs of your customers. If you have an exclusive territory policy and it works well and you have never had the issues as described, then congratulations, you are very much the exception in my opinion.

However, if you are starting out then it is important to consider the style of territory management for your system and there is simply not one answer for everyone, but I would strongly advise anyone to consider the extremes of exclusive territories before you lock yourself into such an inflexible business plan.

Philip Ciniglio
Managing Director
Market Minds

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