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Franchisor Concern: Will My Franchisee Compete With Me?

By Manuel V. Siggaoat, CFE

Managing Director, Francorp

As a consultant, I talk to several people a week who are thinking about expanding their business through franchising. For sure, there are many advantages if done correctly. After all, franchising has already helped many companies grow. However, one of the most common fears would-be franchisors have is whether or not they are just teaching franchisees the business know-how that will eventually be used to compete with them.

“What if I train my franchisee and he uses that knowledge to put up his own business and compete with me? Am I digging my own grave with franchising?”

This is a valid concern. To be honest, I have seen cases where this has happened. I have seen franchisees, disgruntled and disillusioned with their franchise investment, put up a competing business and go head-to-head with their franchisor.

However, this is something that is preventable. Here are some safety nets to discourage franchisees from turning against their franchisor.

 

1. Include a Non-Compete clause in the Franchise Agreement

A Franchise Agreement should include non-compete provisions within the contract. Basically, this provision states that the franchisee should not put up or invest in a business that competes with the franchisor’s business. The franchisee is bound from doing so (a) while the franchise agreement is in effect, and (b) some years after the franchise agreement has expired.

 

While including a non-compete provision will help, it is not enough. I will not go into details but there are several ways a franchisee can circumvent this provision. So in other words, a non-compete clause is a necessary but insufficient provision – it should be found in a franchise agreement, but by itself will not prevent franchisees from competing with a franchisor.

Besides, non-competition provisions are not in effect forever. They expire a few years after the end of the agreement.

 

2. Give Continuing Value

A better way to keep franchisees from competing with a franchisor is by providing continuing value. This means that aside from use of the name, the franchisee benefits from products and services that the franchisor provides during the course of the business.

 

2.1 Proprietary Products

Not teaching franchisees everything about the business is one way to keep them from using what they learn against you. The franchisee is dependent on the franchisor to supply proprietary products and services. Proprietary means those relating to the ownership of the brand or business. These are usually related to the franchisor’s intellectual property, like recipes and branded merchandise.

Instead of giving the entire recipe to the franchisee, franchisors may provide ready-to-use sauces, mixes, marinades, etc. to the franchisee. For retail concepts, franchisors provide branded merchandise, meaning those products that contain the brand’s logo.

Since these are proprietary items, they are available only from the franchisor and cannot be bought in the open market.

 

2.2 Killer Support Services

Franchisors are supposed to provide ongoing support to franchisees. For the purposes of this discussion, killer support services are those that are so outstanding and very critical to the franchisee’s business, yet very expensive or difficult to do on his own (in the computer industry, a killer app is a software so compelling it makes consumers want to get the hardware just to be able to use the software).

For example, a topnotch business intelligence software that provides data for making critical business decisions at the unit level can be a source of competitive advantage. Since it may be very expensive to install on his own, a franchisee would be discouraged from scaling this high barrier to entry.

A world-class marketing program is another example of a killer support service. Especially if the program is highly effective and brings business to all units on a consistent basis.

If franchisees rely on these killer support services for their business but find it difficult or very expensive to replicate on their own, then a franchisee will stay within the fold.

 

3. Keep Franchisees Happy

There are several legal and structural ways to keep franchisees in the system. But I’ve seen that the best way to keep franchisees from competing with their franchisors is by keeping them profitable and happy. If a franchisee is profitable and is happy with the relationship with the franchisor, he would not think about bolting the system and putting up a competing business. He may, in fact, even invest in an additional unit, become an area franchisee, or encourage other investors to become franchisees themselves.

Financial and strategic planning for the franchise business is therefore very crucial. The franchisee fees, royalties, markups, advertising contribution and other fees charged by the franchisor should be well within reason. Considering expected sales and relevant expenses, the profits and return on the franchisee’s investment should be attractive. The way a franchise is structured should result in a win-win arrangement, where both franchisor and franchisee benefit.

Sometimes, not all plans come to fruition, though. As the saying goes, the best-laid schemes of mice and men often go awry. The most well-thought-out business plan may not work because of unforeseen circumstances. What is important when that happens is how the franchisor will go the extra mile to help the franchisee cope with the crisis, or how fair his exit strategy for the franchisee is.

To summarize, a franchisee can be a franchisor’s worst enemy or best business partner. It depends on how the franchisor structures his franchise and how he manages the relationship with the franchisee.

 

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