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When Should You Provide an Exclusive Territory to a Franchisee?

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I was given a recent dilemma from a new franchisor whose management could not agree on whether or not to provide exclusive territories. I provided this analysis:

Generally when you have a product or service that the franchisee's customers will be drawn only from local areas around physical location, then exclusive territories make the most sense, because your franchisee believes he has no way to "keep the competition" from taking his customers, and that there is no way to draw replacement potential customers from afar.

This is generally WHY franchises buy a franchise, because of the perceived benefit from competition the exclusive territory gives. I say "perceived" because honestly the success of a particular franchisee really depends on his business acumen and marketing efforts, not on the fact he has an exclusive territory.

But the franchisee perceives he has an advantage, so he is willing to buy the franchise that gives the exclusive territory, over the competing franchise he is looking at that does NOT give an exclusive territory. (If all franchises in a particular industry do not give an exclusive territory then there is no issue).

But if your competitors all have exclusive territories, you will want to offer the same OR some other more attractive benefit that your franchisor competitors do not offer, such as better pricing or lower fees or different services your competitors charge for, etc.

Having said that clearly there are problems with having territories, such as encroachment claims (which some states entertain even when the encroachment is outside the actual territory lines). If you have no territories, you have no encroachment claims. Period.

(Of course there is always unfair business practices claims, which is what we call it in Calif, when someone does something you don't like!).

Another negative about giving territories, is that, generally in new systems, the first set of franchisees are given territories, that are later are clearly recognized to be, way to large.

The problem then becomes that the franchisee simply does nothing to develop the client base when he becomes satisfied at some lower than expected level of customers, knowing there can never be any competition from a neighboring franchisee.

This results in low market penetration for your product/service, and there is nothing you can do about it since you are locked into the territory. (Hint about what to put in your FDDs and franchise agreements to avoid this problem--either minimum sales quote to maintain territory, OR minimum royalty amount).

Can you sell franchises, some with territories, some without? Well, if everything is the same, no. If you have a way to differentiate why one franchisee would receive an exclusive territory and one would not, perfect!

For example, in the printing franchise world where I came from, franchisees would not receive territories when their location was in a high density metropolitan area such as Washington D.C., since their potential customers (small businesses) were all bunched up in a very tight geographic configuration, as opposed to the the more rural or suburban less metropolitan areas, where the franchisees did receive territories.

That was a legitimate distinction which did not promote discourse among those franchise owners...and of course this was clearly disclosed in the FDD.

Another approach is to offer two separate and distinct franchises with a few differentiating features; one with an exclusive territory higher priced, and the other with less features, no exclusive territory, lower priced. Both versions can even be identified in the same FDD offering, so as not to double the registration costs.

Another approach, is make small contiguous territories, selling only one, yet giving a franchisee the right of first refusal to purchase perhaps at a discount any number of contiguous territories based on some level of penetration (sales level) within his existing territory, or within a certain time-frame, some other parameter.

This way the franchisee does receive both a small, but exclusive territory AND the right to expand his exclusive territory if he is working the system well; and, you as Franchisor receive both a benefit in keeping a contiguous territory "open" for purchase and development by a new franchisee, while at the same time, if you have a very good existing franchisee who wants the continuous territory, you receive another franchise fee plus the expanded development from a good player.

SO if you are going to give territories, my suggestion is to keep them fairly small either based on population, zip code, city, or a certain radius around the physical location, rather than several counties....

Remember the goal is market penetration of your product/service, and the larger the territory, the less incentive for the franchisee to quickly develop the entire territory, and the less system wide sales you will achieve, from which you are to receive royalties and other payments

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About this Entry

This page contains a single entry by Janet Martin published on November 12, 2012 10:57 PM.

FTC "Clarifies" Item 12 Requirements was the previous entry in this blog.

How to Disclose Officer and Franchisor Earnings in the FDD is the next entry in this blog.

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