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Few in the franchising world doubt that McDonald's is a world-class organization.

Hallam Movius and Lawrence Susskind hold out the mouth-watering proposition that McDonald's is a world-class negotiation organization. And, they offer up their recipe for turning your franchise into something similar. Their recipe is contained in Built to Win. The ingredients are familar enough to anyone with knowledge of the Harvard Negotiation Program or Mutual Gains Approach.

McDonald's Is Built to Win

Why should other franchisors care that McDonald's overwhelming advantage is due, in part, to its negotiation capability with franchisees and vendors?

Well, if true, then despite the notorious secrecy of McDonald's, Movius and Susskind offer the posibility that your franchise system could duplicate McDonald's advantage by following their Built to Win curriculum.

That's a very tempting offer.

Let's look more closely.

"Happily, we sometimes find that leaders have recognized the value of relationships and converted them into bottom-line opportunities. For many years, Bob Jackson (most recently a vice president and division operating officer) was a highly successful regional general manager at McDonald's, responsible for an area of the United States that comprised more than six hundred sites.

His region was consistently among the best performing in the country. When we first interviewed Jackson [in 2003], it was clear that he and his most successful colleagues were already following a number of practices encompassed by the mutual gains approach (my emphasis). Jackson repeatedly described negotiations in which he worked with owner-operator franchisees to implement marketing plans, technology upgrades and other operational initiatives.

'Many times we have interests and goals in common. But sometimes the corporation's interests are not identical with the owner operators.', he commented. 'We do best when we work jointly with our franchisees to solve the problems and difficulties that come up, taking their worries and concerns seriously and trying to share information and invent options to address those concerns and interests while advancing our own.

'Having a good relationshiop helps to create value far out into the future, because you gain trust and the next time a hard problem comes up, you're in a much better position to deal with it productively." Movious and Susskind [pages 40-45]

Effective Cooperation

Now, you and I know that franchisees can be downright nasty and refuse to engage in constructive dialogue with the franchisor. (And franchisors don't fix nasty -they look to terminate nasty.)

Especially when it comes to: marketing, upgrades, retrofits, menu item changes, and numerous other operational issues. Franchisees feel the dynamic is: the franchisor's plans using the franchisee's money.

Franchisor and franchisee interests, positions or goals, can be either adverse, in common, or a mixture of both.

McDonald's, says Jackson, takes these differences seriously and provides sufficient information to the franchisees to establish a collaborative working relationship which advances everyone's interests. (It also helps the franchisor's credibility that they own 20% of the units. Thus, this franchisor isn't alwasy using other people's money.)

Operational choices made by McDonald's have a long projected payback. A good working relationship extends the trust created today to commitment tomorrow. This coordination is valuable. It is not a traditional asset because it is not owned by the corporation. It is an intangible value, which nonetheless can be measured.

Increase value and get a better bottom line.

Now, do you think other franchise systems can be Built to Win or is McDonald's in a unique position?

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Happy Thanksgiving

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You are a young cartoon writer, starting your career after returning from World War II.

You don't know it, but you are going to gross over 1 billion dollars from your cartoons, during the next 1/2 century.

You start off with a fight with the syndicate, and cannot get this satirical cartoon printed.

So, over the next 50 years, you get even by publishing every Thanksgiving the famous gag between Lucy and Charlie Brown.

Now, everyone knows who you were really satirizing, in 1951.

Not much has changed, sorry to report.

uncoveredPEANUTS.jpg

This is well known negotiation game - the Confidential Information Game.

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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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When researching a franchise, either as buyer, prospective franchisee, or credit analyst, one item of a franchisor's FDD is worth serious attention: how many locations have been sold but are not opened?

The opposite of churning franchisees, is SNO'ing them: selling them a location or territory, which never opens, and then scooping the franchisee fee.

Depending on the terms of the franchise agreement, the franchisee fee is usually not refundable. At best, if you have been SNOed, you might be entitled to partial refund. (Various class actions have litigated this issue.)

The SNO data is found in Item 20 in the FDD, a document hardly every reviewed by any of the public, analysts or prospective franchisees.

Yet, it provides valuable information to those willing to look. With all this public information, why does pre-sale churning continue?

(When information is public, but bad inferences are being made despite the public information being available, it is normal to suspect that people are simply not paying attention to the information that is available. The law generally doesn't accept this an excuse for getting the wrong end of the contract.)

Here are three examples of the type of SNO information that is revealed in the FDD.

1. From the 2010 MRI International FDD.

Management Recruiters International has a clean and informative item 20. The first thing you see is this:

System Wide Summary MRI.jpg

You can see that the system has contracted from 903 to 828 in 3 years. Something to ask about.

Table 5 has a helpful column for the number of SNO's.

Projected SNO's.jpg

We go to the bottom of table 5 and find out that there are zeros SNOS, but 30 projected new outlets.

Total SNOS.jpg

All in all, a pretty clear picture with some obvious follow up questions that need to be asked. One is, how many of those projected outlets did get opened? (And remember to document the questions and answers.)

2. Auntie Anne's Pretzel's Item 20 from the 2010 FDD.

Auntie Anne's Item 20 Table 1.jpg

We can see that there was growth in the system from 2007 to 2009, from 667 to 741.

Next, we are given some SNO data.

Auntie Anne's SNO 1.jpg

The trend of SNO's from 2007 to 2009 appears to be getting better, with more stores opening than being sold.

Finally, let's look at Aunite Anne's Table 5.

Auntie Anne's Table 5.jpg

Ok, we have 12 SNO's and another 27 projected opens. Nothing too alarming here, but again worth a couple of follow up questions.

3. Kiddie Academy's Item 20 from their 2011 FDD.

The data is not presented as cleanly as the Auntie Anne's or MRI Item 20 data, which may not be the franchisor's fault. But, there is a very important detail, filed in an later amendment, which we will get to shortly.

Here is Table 1 from Kiddie Academy.

KA Table 1.jpg

Alright, this is not entirely clear. But, it appears there has been decent growth from 2007 to 2010, from 77 units to 106.

But, when we read the amendment, a number of startling details emerge to counter-act this rosy picture of growth.

KA Amendment.jpg

This states that approximately 21% of the system was allowed to leave! Voluntary termination, but the franchise territory did not remain part of the system!

Well, that certainly must be a very interesting story - and a prospect would want to track down all the details behind this "voluntary termination". You would certainly want to meet the franchisee who had this much bargaining power on termination - he took his territories with him. Sort of like losing the war but imposing sanctions on the victor! Extremely agile bargaining on behalf of the franchisee. Not so much by the franchisor.

Let's look at the SNO data.

KA SNO.jpg

This is downright scary: 34, or almost 35% of the existing units, are SNOs. This sounds like a franchisor who is desperate to replace royalties lost in the "voluntary termination". There could be other explanations, but this is a huge big detail story to run down with the franchisor. (Perhaps, the length of time to open these stores takes longer than a year? Could be, and you have to checking this.)

In Conclusion - Remember Charlie Brown, Lucy, and the Football.

The cartoon below should be a reminder to all prospective franchisees not to rely on the legal skills of a beagle.

Read and understand the item 20 data instead. If you don't want to read it, and your current business lawyer doesn't want to get paid to read it for you, then consider hiring an attorney who specializes in this area.

1995 SNO 2 Lawsuit.gif

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Franchises are created or started by a single founder.

The founder faces an interesting strategic challenge in persuading enough franchisees to voluntarily pay for & add value to the franchisor's property - the franchisor's trademark and confidential information.

1) If enough do, then we will all be better off because we have formed a brand.

2) However, some will not live up to the brand's standards and free-ride on the brand's reputation.

If enough of us expect that others will free-ride, we won't live up to the brand's standards either.

Our brand may just flounder along.

This problem is known by many names: social dilemma by game theorists, the social contract by philosophers, the buy-in problem by management theorists, and the tragedy of the commons by political theorists.

What sort of personality is effective and gets the job done?

How does the franchise system get buy-in from the franchisees? What happens when the founder leaves the system?

How does the franchisor continue to get buy-in from the franchisees?

Some social psychology research on social dilemmas suggests that the franchisor must be dominant and aggressive to lead.

A social dilemma exists when we know that if some us coordinated, we would be better off. But, we also know that most us think that not enough of us will coordinate and so any benefit is illusory.

Do such groups need to be lead by a dominant and assertive leader in order for the benefit of coordination to be real & exist?

Robert Livingston and many others argue for this conclusion. Lending support to benevolent dictator picture of a franchisor founder.

Being kind and self-sacrificing will get you plenty of friends, but won't help you win a corner office, argues management professor Robert Livingston.

The altruistic are typically seen as good people, but not dominant and aggressive enough to lead, Livingston's research shows.

"On the one hand, generous individuals are admired," he says.

"On the other hand, they may be perceived as feeble 'bleeding hearts' who lack the guts to make tough decisions.

When do we need dominant and aggressive leaders?

Livingston, argues that in social dilemmas "when groups had to compete against each other, dominant individuals rose to the top while benevolent people were least likely to be elected." (It is well worth listening to Livingston explain his theory of leadership in more detail.)

On the other hand, Tom Schelling explained, almost 35 years ago, the solution to a social dilemma didn't need a certain personality type. The solution required the existence of a group disciplined enough that, even though resentful of free-riders, its discipline could be profitable for the group (though even more profitable for those who stayed out.)

A combination of discipline but resentment. Not altruism, not dominance, but a combination of discipline with a type of resentment focused on the free riders would stop the group from unraveling.

Trainers in leadership have been using social dilemma exercises to produce various "AHA" moments, for quite some time. One such exercise is called "Win as Much as You Can". The AHA moment it produces is about self fulfilling predictions.

What is Next?

I want to step through an analytic discussion of the Win as Much as You Can exercise. (Only by playing it with real people can you get the experiential content. In most cases, the group fails to coordinate, and remains in the state of nature - and more so with dominant and aggressive leaders!)

Then, I am going to suggest an alternative exercise and provide reasons why, if Schelling is right, this new exercise should provide an "AHA" moment about how discipline and resentment can hold a group together.

In what follows, there will be -for some too much- use of calculation, simple graphs and decision theory. So let me give away the conclusion quickly -right after the description of the game.

Win as Much as You Can Game.

You and three others each have two choices, play Red or Blue, R or B. What each of you gets depends on what the others play and your choice, according to this table.

Group Individuals

4 Reds - Red player gets -1.

3 R, 1 B - Red players gets 1, Blue Player -3.

2 R, 2B - Red players get 2, Blue Players -2.

1R, 3B - Red player gets 3, Blue Players -1.

4 Blues - Blue Players get 1.

If this game is played, say for ten rounds, each player by playing only B, could win 10. Yet, in the thousands of exercises trainers have completed, almost no one or group gets to this outcome. (In most exercises, there are two bonus rounds, which simply complicates the scoring for no good theoretical reason.)

The group coordination of 4B's almost never happens. Even if it was expected, then some expect others to cheat and play R, and so they would play R first to "protect" themselves against the cheaters they have become.

Self fulfilling prophecies are at the heart of many a bad decision in which we start to expect the other person to act in a way contrary to our wishes - "seeing" them this way makes it more likely that they see us as acting contrary to some of their wishes. And so it goes.

But not always, and that is a bit curious. Schelling had an insight into this problem. Not all of us, at the same time, have to see everyone else as a possible threat which unravels the group's coordination.

Is Schelling right? Here is what I will show. If he is, then by changing the (1R, 3B) payoff to Red player gets 3, Blue Players get 0, two things should happen.

First, more groups should have higher scores in the modified Win as Much as You Can Game.

Second, the subgroup of 3 Blue players that coordinates should experience discipline and resentment.

By coordinating, the 3B players can lift themselves out of the state of nature, in which they all receive -1, to 0, for a gain of 1, but the R free-rider gains 3. Note, Schelling is not saying that this subgroup has to form, only that if a subgroup does, it will be this one.

And if it stays together, discipline and resentment will run together. Discipline need to stick together and resentment against the free-rider, who plays R.

If you are a trainer, you can run both exercises, report back - all without having to do any of the calculations, which follow below.

Justification

But for the intellectually curious, we push on.

It seems unlikely that the group will play 4 B's together. Further, if one person should correctly forecast that the group was leaning to 4 B's, it would be in their interest to act as if they were going to play B, just in order to play R at the last possible moment. Much like a good poker player bluffing the table.

Only one can succeed at this strategy - and this success will invite mimics. Soon the coordinated strategy of 4 Bs will completely unravel.

The remainder of this article will provide reasons justifying why the small change in the original game should bring about some subgroup coordination.

1. Transforming the Win as Much as You Can Exercise into a Multi-Person Prisoner's Dilemma Game.

First, we will take some time to show that the Win as Much as You Can game is a special social dilemma, one Schelling called a "Multi-Person Prisoner's Dilemma."

A prisoner's dilemma is a social dilemma in which the unraveling is caused by enough people reasoning using a principle from decision theory: If no matter what everyone else does, I would be better off choosing R over B, I should always chose R.

There is much to be said for this rule. Some have elevated it to a canon of rationality. If others disagree with the rule, then when it is available, their decisions make those who follow the rule better off.

The well-known problem with the rule is that its use in a multi person prisoner's dilemma produces dismal results.

(A word is needed about the diagrams that follow. I usually make mistakes drawing them - especially when I "know" how they should turn out. To avoid making mistakes, I have created a checklist or algorithm, which helps me. For those more talented than I, this checklist will be too tedious. However, for you and I, I believe it to be helpful.)

The Payoff Algorithm

Step 1. Identify the choices and individual can make, R or B.

Step 2. Identify the outcome the group can arrive at, counting each outcome as distinct based upon whether the individual played R or B.

Only Step 2 needs an illustration. Consider the pattern 3R, 1B. This is two outcomes - if you played Red, the outcome is 1, while if you played Blue, the outcome is -3.

Step 3. Count the outcomes in a systemic manner and plot.

There are eight outcomes in this case and not 10 because 2 patterns 4R and 4B have only one outcome, while all the other patterns have two outcomes.

How should we label these eight outcomes?

One way is to pick a variable k, running from 0 to 3, where k is the number of other individuals playing B. The outcome O2k+1 is the outcome where you play B and k other individuals also play B. The outcome O2k+2 is the outcome where you play R and k other individuals play B.

The outcomes range from O1 to O8.

O1 is the outcome where k=0, nobody else plays B, but you do. The payoff to the B player if the pattern is (3B, 1R) is -3.

O2 is the outcome where k=0, nobody else play B, and neither do you. The pay off to the R player if the pattern is 4R is -1.

For, k=1, 2k+1 =3 and 2k+2=4.

O3 is the outcome in which one person plays B, and so do you. The payoff to the B player if the pattern is (2B, 2R) is -2.

O4 is the outcome in which one person plays B, and you don't. The payoff to the R player if the pattern is (1B,3R) is 1.

Let's summarize all of the outcomes.

Pay Off.png

We can now draw a diagram, with k on the X axis, and the Y axis reflecting the payoffs of B and R, given k people have chosen already to play B.

There are two easy things to read off the graph.

Thumbnail image for Win as Much as You Can 3.PNG

1. Red dominates Blue - for no k, or group of individuals, would be better to be part of the k group of B players. For each k, you are better off being a R.

2. But O2, 4R, is a bad place for everyone compared to O7, 4B.

For those wondering if this hasn't been a lot of work to recover some obvious points, there had better be a reward for making it this far.

The reward is O5, and the horizontal line we can draw from O2 - the state of nature. The horizontal line is the payoff in the state of nature, any outcome above that -short of complete group coordination- is a group whose discipline is both profitable, yet profitable to leave.

Thumbnail image for Win as Much as You Can 4.PNG

The outcome O5 or the pattern (3B, 1R) has a payoff of -1, but is tantalizing close to the optimum 4B, O7.

If 3 players to played B, how much harder would it be to get the last person on board?

In this case, it should be very hard. For the R player, the pattern in O5 is the outcome O8 - how can you persuade him or her to accept 1 instead of 3?

Thus, if three players can coordinate their actions by playing B, their payoff isn't greater than the state of nature, O2. Partial coordination doesn't pay and it doesn't make it more likely that full coordination is reached. Two players cannot do any better.

But, what does the diagram look like if we change O5? Let's just move it above the horizontal line and give the B players 0 instead of -1, at O5'.

Thumbnail image for Win as Much as You Can 5.PNG

Now, the coalition of 3B in this new game satisfies Schelling's criterion:

"The smallest disciplined group that though resentful of free-riders can be profitable for those who join (though more profitable for those who stay out)."

Is it true? Can this simple change in pay-offs actually make a difference or is this a theoretical possibility only? What do you think will happen if this training exercise is played with both games instead of just the standard game? We need to try it and see if Schelling's analysis bears fruit.

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You believe that your franchisor has intentionally, with little or no justification, inflicted serious economic harm on you and other franchisees.

A group of franchisees has formed The Fight Association, and wants to hire the biggest baddest franchisee trial lawyer to punish the franchisor. The Fight Association's trial lawyer fires a couple of strongly worded missives to the franchisor, with the message: Capitulate or be Sued.

Some other franchise owners, horrified by the damage to the relationships, to the brand, and their ability to resell their own units, want some form of negotiation, discussion or mediation with the franchisor. Even in face of the clear economic damage inflicted by those working at the franchisor's corporation.

Should you fight or negotiate?

1. Fight your franchisor only when they have shown themselves to be an unreliable negotiating partner.

2. It is smart to start bargaining from outcomes that neither party can from either the litigation or arbitration process

3. The franchisee community as a whole needs to commit resources to continual training in interest based communication. If interest based negotiation is going succeed over the long haul, you need to commit funds to training.

Background- Managing Mental Traps

Robert Mnookin is the Director of Harvard's Program on Negotiation, and so it unsurprising that he frames the advice in his book as a way of managing two types of mental or intuitive traps, one set of traps which promotes fighting and the other which promotes cooperation.

(This is conceptually similar to one of the original themes from the Harvard Program on Negotiation: negotiation is the rational management of the inherent tension between claiming value and creating value, explored more throughly in The Manager as Negotiator, Lax and Sebenius.)

Mnookin identifies (6) mental traps in Chapter 1 of the book, and then goes on to evaluate (7) major confrontations in which one or both sides could reasonably see the other as the devil; someone who had intentionally inflicted serious harm with little or no justification. (Of particular interest to the franchise community is the chapter 8, "Disharmony in the Symphony".)

Here are Mnookin's traps, which shape the perceptions of the conflict

1. Tribalism involving an appeal to group identity, creating an in-group. It is us against them. Universalism is at the opposite end of the scale, the tendency to overlook important differences in culture, history and group identity. "Why it is just business, after all."

2. Demonization is the tendency to see the other party's action completely defined by being rotten or bad to the core. Contextual rationality is the impulse to find reasonable explanations for individual bad behavior.

3. Dehumanization is way of putting the other party outside normal moral concerns, treating them as a mere object. The other end of this spectrum is one of Redemption: everyone deserves a second chance.

4. Self-righteousness is the tendency to frame the problem in which you are blameless, but the other fellow is entirely to blame for this problem. The other extreme is to see parties always being Equally at Fault for a conflict.

5. Zero-sum trap in which my interests necessarily are in opposition to yours. At the other end is the view that there is always an Win/Win which makes both parties equally well off.

6. The Fight/Flight response, which for the franchisee community would be litigate or sell. At the other end of spectrum, we have Policy of Accommodation.

Finally, there is the call to battle in which the trial lawyer has to call out the franchisee troops for a battle with the franchisor in using the language of war, and the techniques of demonization, tribalism. and others.

The (3) Lessons: When to fight, How to Negotiate, and How to Follow Through.

(1) When to Fight - Only Fight as a Group with an Unreliable Business Partner.

In Chapter 5, Mnookin, relying upon recently declassified reports, examines Churchill's decision not to negotiate with Hitler. He does a remarkably good job of situating us in a world in which Hitler's manifest evil is not yet apparent and Churchill's War Cabinet is unmoved by Churchill's emotional appeals.

It is not known yet that Dunkirk will be a resounding success, that England will win the Battle of Britain, nor that Hitler will uncharacteristically hesitate for many months about deciding to cross the English channel.

A Britain that had insufficient resources to win a war on their own, seemingly without powerful allies, had to seriously consider whether a separate peace might be worth entering into.

Churchill was convinced that Germany was aiming at enslaving England, but his War Cabinet was more persuaded that Germany's goal was only more territory in Eastern Europe.

Since both England and Germany shared a hatred of Communism, it made sense to the War Cabinet that Germany would have to turn east and face down Russia.

What was critical, according to Mnookin, was that Churchill eventually framed the problem this way: if the negotiation was to fail, and this was likely given Hitler's total unsuitability as a bargaining partner, then British morale would be so undermined that they could not credibly commit a fight to the finish. The failed attempt at negotiations with Hitler would end in surrender.

This strikes me as correct. If the party you want to negotiate with has shown themselves to be utterly capricious, unable to be counted upon, then the very attempt at negotiation, should it fail, will undermine the group's commitment to prolonged litigation.

Fortunately, I don't believe that many franchise systems -although there are a few- have franchisors who have absolutely no credibility as a bargaining partner.

My own view, is that systemic challenges are not well suited to litigation, but the franchisor who owns little or no units will have always have trouble convincing the franchisee community to adopt systemic changes, when there has been a local history or either mistrust or bad decisions.

It will be hard for the franchisee community in these cases not to see the franchisor as acting intentionally to harm their own economic interests and misplaced litigation is the likely result.

(2) How to Negotiate out of Shadow of the Law

In 1983, after a bitter commercial fight, IBM and Fujitsu concluded an agreement over the extent to which Fujitsu could use, copy, or otherwise reverse engineer IBM's operating system. One year later, the agreement was in shambles - with each side reasonably convinced that the other had acted intentionally to inflict serious economic harm on the other with out justification. Devils!

For the next 10 years, Mnookin would play an important role both as arbitrator and mediator in both settling and assisting the parties to settle their dispute.

At one point, Mnookin and the other mediator, Jack Jones, had to convince each party of viability of IBM giving Fujitsu the right to inspect, in a very secure environment, IBM's source code. This was needed if Fujitsu was going to be able produce a compatible IBM OS, without infringing or copying on IBM's source code.

IBM could have rejected this deal by saying "Are you crazy, Fujitsu is a major competitor! The 1983 agreement doesn't give them the right to inspect our source code and they will never get that in arbitration. Screw them."

Fujitsu might have also rejected the deal because the restrictions placed on them by the secure environment were highly disruptive to their own programming practices.

But what both parties, even though intense rivals, came to see was that starting from a point which was not available through either litigation or arbitration produced an agreement superior to what any party could get through litigation or arbitration.

This is important advice: don't start bargaining from only those outcomes possible from litigation or arbitration. Both the franchisor and franchisee community need to focus on what would be the best outcome for all of them, and identify what steps need to be taken to get there - especially in the face of previous intractable conflict.

(3) Follow Through and Interest Based Negotiation Training

The last lesson is very important for the franchise community. In 1997, Mnookin was contacted after a bitter strike by San Francisco orchestra.

The orchestra's bargaining committee was itself bitterly divided, barely on speaking terms. Management's representative was seen as a destructive bully, intent on getting his own way.

"Moreover, the musician's relationships with one another were badly strained. They were traumatized. They had no authority structure, no strong leadership in collective bargaining."

Mnookin was able, in the short term, to introduce both sides to interest based negotiation, which involves both active listening and the management of creating value versus claiming value techniques. Both parties took part in the standard Harvard negotiation program, with some excellent short term results.

The parties spent, in 1998, six days in total to come to a new contract. However, they had spent almost 14 month in communication and in joint sessions prior to the bargaining at the table. "For complex negotiations, with critical conflicts behind the table, this is an appropriate ratio." says Mnookin.

However, 6 years later the symphony negotiating committee shunned additional training in interest based techniques, despite having new members who did not have these skills.

It's new attorney was suspicious of interest based negotiation and had argued in public that collective bargaining was essentially adversarial in nature and that the best deals could only be made when everyone was facing collective disaster.

Interestingly, the former management representative, Pastreich summarizes the value of interest based negotiation best:

"The greatest value of adversarial negotiation might be the opportunity it gives musicians to express anger and frustration accumulated during 3 years of doing a job that, by its very nature, allows them relatively little control over their working lives, while the greatest value of interest based bargaining might be the opportunity it gives musicians to work with managers and board members at solving problems in an atmosphere of teamwork and cooperation."

The parties did not make the necessary long term commitment to interest based negotiation, so reverted to the ordinary form of collective bargaining - a process which favours the ill prepared, but obstinate negotiator.

Conclusion

Franchise relations are not going to change overnight, but many franchisee associations, franchisors, and counsel can learn a great deal from Mnookin's book on negotiation.

Finally, the thoughtful exercises Mnookin prescribes in managing the (6) traps are worth reviewing to see which could be employed in your franchise system.

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A couple of years ago, I was asked by Fortune 500 company about my ideas on "adult learning" and how to teach negotiation to their sales teams.

And the franchise complex sale is a negotiation, especially when the legal product -the franchise agreement- is not readily negotiable.

This was a very serious question, and it was an exciting opportunity for me to make a real difference to the organization -if the setup was right.

Organizations come down with enthusiams, which lack weight and the project leader is moved on to something new and shiny.

Sadly, for both of us, the main pre-requisite for continuous learning of negotiation in a sales environment was not in place.

When I learned of this, my visible enthusiasm for the project waned - perhaps at a later date, I thought.

What was this company missing?

It is useful to recall what Peter Drucker said about continuous learning in a corporation.

Feed back from the results of a decision compared against the expectations when it was made makes the even the moderately endowed executives into competent decisions makers.

So, how do we get continuous learning in sales or negotiation? (Without continuous learning, "training", "CRM software", and "best practices"are just words.)

One way to improve the organization's negotiation capacity - to turn a "moderately endowed sales team into a competent & professional negotiating force"- is to insist on a standard of recording expected versus actual results.

Every sales professional and some negotiators are familiar with the idea of a sales as a process, a sales funnel, which moves the prospective buyer from interest, to engagement, and through the sales door and off to customer service.

A sales funnel consists of discrete steps or stages. At any stage, a modern CRM should be able to predict based upon recorded historical results the chances that this buyer at this stage will result in a sale, and when that sale will likely occur. It is just a numbers game - with the right funnel.

The map of expected to actual is called "efficient" when it is roughly equal to line x=y; if we predict rain 14% of the time and 14 times out of 100 it rains, our prediction is efficient.

Most of our forecasts and processes remain stubbornly and wildly inefficient for the want of recording our intitial expectations and matching them up with the actual results.

Consider the salutory effect of your entire sales team recording, comparing, and then modifying your firm's CRM to make it more efficient, in the sense just described.

Even the most moderately endowed sales team could be turned into a a competent & professional negotiation force within several years. (If you only had a standard CRM, a negotiating brain.)

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The Vanishing Competent Franchisor

Franchise investors find, often too late, that the unique systems and concepts in which they have invested are neither unique nor have even competent execution by the franchisor.

The reasons for this are several. Some of them are the natural vicissitudes of living in any competitive marketplace over time, but others are fault ridden. Which is which? What are the identifiers? How early can they be spotted and what can be done to avoid or thwart them?

So far the courts have not seemed hospitable to the notion of going beyond the explicit wording of carefully drafted agreements entered into by seemingly sentient adults. From a macroeconomic perspective this is exactly what courts should be doing, as enforceable agreements are indispensable capital that underlie the value of enterprises.

But are the franchisees caught in an ever tightening noose of business contraction so constrained by contract language that the only diagnosis is: suffer a financially excruciating death? Should bankruptcy be the only resort/cure to being in contract with people who rely on legal enforceability?

How far can franchisees go without violating fundamental contract rights and thereby effectively changing franchisor inability into franchisee liability? Where is the line between act or die on the one hand and legal suicide on the other?

The Legal Framework

In today's franchise agreement one finds that the mission statement is not a term of the agreement. None of the hortatory rhetoric of the sales pitch/marketing materials is ever to be found anywhere in the actual contract language.

There is a bright line between all the positive reasons for investment and the machinery by which the investment, once made, is to be managed, performed and observed.

Investors seem not to notice that what convinced them to invest in the first place is nowhere to be found in the agreement itself. Franchise investors are in the main due diligence illiterate.

The agreement always provides that the goodwill of the business and the brands are all the sole and exclusive property of the franchisor and that the franchisor may change its configuration at any time, for any reason and without having to field test and performance prove any change before compliance with it is demanded of the franchisees.

The franchisees covenant to execute the business model as directed by the franchisor in the manual and otherwise, including participation in all programs mandated by the franchisor on the terms stated, all as may vary from time to time, and to guaranty the payment of royalties out to the end of the contract term regardless of termination or other reason for failure.

All fault for nonperformance is placed upon the franchisees while all decision making prerogatives belong exclusively to the franchisor.

Many attempts to modify the absolutist right versus wrong, franchisee versus franchisor abrasive interface have been tried and they have all come to naught.

Most of them have been in the guise of an imaginary unwritten covenant of good faith and fair dealing and more recently in the form of a so called franchisee bill of rights that exists neither in statute, ordinance or other document having any legal force whatsoever.

Finding Operational Salvation

Where does that leave the franchisees who see themselves caught in abandonment of the brand by the franchisor and in the inability of the franchisor to respond effectively to changes in market conditions?

Litigation/confrontation seems not to provide a remedy. Self help so often leads to litigation/confrontation.

And yet no one can live at sword points.

The only present tense answer to this problem lies in effective but insistent relationship management that is initiated by the franchisees acting mostly in concert with organization and a high level of competence that seems at such moments to be available only from the franchisees themselves.

How does that work?

Up to now it doesn't work at all/yet. Commitment at any effective level seems not to be an ability of groups of franchisees. As their collective minds now work, they feel entitled to competence/protection as a matter of "right" (whatever that is) and because of that they are simply waiting for someone to provide it.

Since no "right" on earth is self executing, no matter what they taught you in political science class, attitudes of entitlement produce nothing useful. Why can't franchisees seem to recognize that obvious fact?

They didn't get what they bargained for - in their minds - and want "justice". Inasmuch as what they signed on to did not provide for what they thought they were getting, they, as adults, in law are getting what they bargained for. The correct analysis is that they failed to recognize that the agreements they signed never said that they get what the sales pitch/marketing materials said they were getting.

They are not a "family".

They are in business by themselves.

They are not their own boss.

Nor, have they invested in any commercial vehicle that has prospects for a successful future -without a lot of work being done.

The courts enforce what they signed, not what they later wish they had signed.

Where does that leave them? It leaves them with only self help and self help is fraught with liability risk. The choice in a franchise system that is draining away their resources is between slow financial death and taking the risk associated with a turnaround through self help. How in hell does one accomplish that?

The Road To Glory

The road to glory is paved with personalities. There are definable personalities who are running your franchisor company. Their characteristics are known, unfortunately not any more deeply that epithetically. The things that need to be fixed spring from what is happening in the market place and the fact that their abilities to guide the company through the happenings without hurting franchisee financial performance are inadequate.

A method of approach has to be configured. It is not realistic to expect collaboration from people if your opening gambit is to itemize in loudly proclaimed expressions all their perceived shortcomings.

There is, after all, a bit of sonofabitch in each of us. We aren't perfect either. At least tacit recognition needs to be given to the fact that a close evaluation of our own constituency would uncover some warts too.

I am good and you are awful will not yield a desired response or open that door through which you must walk. This is reality.

I have sat in too many franchisee association meetings listening to epithets hurled at franchisor managers by people who were chronically late with many obligations, to put it mildly - and the principal reason for not doing what was agreed to was always self serving opportunism.

In some instances the franchisor was aware of the defaults but tolerating them for later use as bargaining chips - something that every franchise agreement specifically allows the franchisor to do but not the franchisee.

When the pain in the ass franchisee wants consent to open additional stores there will always be this stuff in his file to justify a refusal of consent. The same goes for anything else a franchisee might want to do that requires franchisor consent. The uses of those seemingly small peccadillos are many and delicious, which I have elaborated elsewhere.

While the personality profile of the people we must deal with is configured, and we have devised a few plans for how best to make the approaches we want to make, a goals agenda should be made and ranked in order of priorities. There are several, time being one and cost efficient feasibility being another. Rank the goals. Some goals will be interrelated so that they may be presented and achieved as a package, while others may need spacing.

Goals and projects need responsible people to take charge of their execution. Within your group there will probably be more than one person with a special interest in particular goals as well as the skill sets necessary to accomplish them. Identify them and privately vet their suitability and willingness to put forth the effort in a timely manner.

Each goal must have its own business plan. The plan must be cross examined viciously before it is presented, because that is exactly what management is going to do. If you cannot defend your thesis you have just wasted a lot of time and your credibility. Debug the plan to the greatest extent possible. There is an inside track for the plan. Find the management person who controls the track and win his/her support.

Until you have actually proved your ability to create and execute brand enhancing new concepts it is a hard sell. Once you have made your bones life will become easier unless you get cocky or careless.

You save up reputational wampum just like you save money. Don't spend your credibility before you make your bones on the next projects. Winners know how to share credit and shut the hell up about how great they think they are.

The road to franchisee primary participation in brand enhancement is not easy at first.

There will always be detours. It has to be managed and counseled by people who understand the process. Find such people and bring them on board to help guide you.

Theirs will be the job to ask the tough questions that members of your group will not want to ask for reasons of political correctness.

They pull their weight.

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Tamerlane group's purpose is to prevent you from shooting yourself in the foot when you see a bad event threaten to develop.

Our focused expertise in crisis management can prevent these situations from developing if we are called before someone makes self-humiliating public statements/files absurd lawsuits.

The famous negotiator William Ury has a nice story about how to solve difficult negotiations.

"Well, the subject of difficult negotiation reminds me of one of my favorite stories from the Middle East, of a man who left to his three sons 17 camels. To the first son, he left half the camels.

To the second son, he left a third of the camels, and to the youngest son, he left a ninth of the camels.

Well three sons got into a negotiation. Seventeen doesn't divide by two. It doesn't divide by three. It doesn't divide by nine. Brotherly tempers started to get strained.

Finally, in desperation, they went and they consulted a wise old woman.

The wise old woman thought about their problem for a long time, and finally she came back and said, "Well, I don't know if I can help you, but at least, if you want, you can have my camel.

So then they had 18 camels. The first son took his half -- half of 18 is nine. The second son took his third -- a third of 18 is six. The youngest son took his ninth -- a ninth of 18 is two. You get 17.

They had one camel left over. They gave it back to the wise old woman."

I love this story, but one thing just bothered me.

If the wise old woman is the paragon of wise mediation, how come she makes nothing off of solving this difficult negotiation?

She gives a camel, solves a hard problem and gets nothing back for solving the impossible. That doesn't seem like a great business model.

Although her reputation as a problem solver grew, she still couldn't make any money solving the variants of the problem: dividing candy at Valentine's, dividing tracts of land, corporate votes, etc. Although, she did get a lot of speaking gigs - which helped.

She tried everything. But, she couldn't make the solution scale. Two groups of 17 still returned no profit.

The wise old woman was getting frustrated. She declared that "it was impossible" to make a profit solving this type of fair division problem.

Her grand-daughter, however, saw through the riddle.

She was a camel broker, matching buyers with sellers of camels.

She immediately began the 18 Lot Camel market, selling lots of camels of 18, but at near cost.

Bewildered, the wise old woman wondered how the both of them were going to survive making next to nothing on each transaction. How was volume going to help?

The next group of claimants who needed the wise woman's assistance had 35 camels and not 17. And her daughter was excited. Why?

Well, the wise old woman did her negotiating trick again. She added her one camel to get 36, gave 18 or 1/2 to the first claimant, 12 or 1/3 to the second claimant, and 4 or 1/9 to the last claimant.

Lo and behold there were 2 camels left, which the wise woman took as her fee.

She made a one camel profit - all because her daughter created a competitive market for 18 lot camels! Even though groups of 17 or 18 claimants were not profitable for the wise women, putting both groups together to form a bigger group with 35 camels was.

Sometimes, 0 + 0 = 1.

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Within the next 15 years we will see dramatic changes in the franchising business.

Today the business is saturated with "me too" so-called concepts that lack adequate business model legs to survive even at marginal profitability through the lifespan of their franchise agreements.

Their FDDs are fiction and fantasy, and those who buy them lack relevant sophistication for small business investment (to put it mildly). In plain English, they are sold to fools who sign ridiculous draconian franchise agreements critically lacking in merit level consideration.

Soon they are whining to be let out of the deals as realities they could have discovered pre-investment descend upon them and they recognize the terminality of what they did. This will begin to change.

The franchise business cannot grow on toxic deals that are just myths designed to fleece morons.

The world does not need any more pizza, hamburger, sandwich, Mexican, Asian, ice cream, cake and fruit stores, print shop, single product, all other kinds of retail stores franchises.

When what is sold through a franchise system becomes available through alternative distribution channels that do not pay franchise relationship expenses, or over the Internet, franchisees are detrimented and lose investment value.

Anytime a franchise is configured so that the franchisor gets paid your revenue stream and then deducts what you owe from that and remits the rest to you, you will be robbed into bankruptcy.

Moreover, every time it is suggested that some new government program is afoot, someone designs a fantasy concept to fit it. Someone is now, for instance, selling franchises in which the mythical profit opportunity is based entirely upon Obama care being upheld by the Supreme Court. Even if it is there will not be sufficient funding to cover the care services that will be provided, a return on that investment plus revenue sufficient to cover to costs of being someone's franchisee.

The Old Model franchise business provided a living for legions of franchise lawyers who were essentially clerks grinding out template franchise agreements and FDDs, many hundreds of whom are now walking the streets looking for law jobs, presenting resumes that show they spent the last ten years being overpaid clerks.

The economic meltdown we are now enduring has impacted franchising as well.

So what should we expect the next phase of franchising to become. Here is my take on it.

1. Investor quality will change. Fewer investors will charge into buying a franchise without competent pre investment deal due diligence assistance. The horror stories are now so pervasive that greater care will be taken before betting the farm on someone's optimistic descriptions of so called "concepts".

To be sure, there will always be suckers, which means there will always be bozo franchise deals to be sold to them. As long as there are sheep there will be wolves.

But more intelligent franchise investing will mean that only revenue credible franchise opportunities will attract financially responsible operators.

Revenue credibility will have to be demonstrated in the sense that there is a provable track record of financial success after the costs of being a franchise are accounted for - all the costs of being a franchise, not just those specified in what is laughingly called today a Franchise Disclosure Document (FDD).

Franchises today that describe themselves as having a franchising expense of 10 % to 13 % of gross sales are in reality at 20 % to 25 % of gross sales. Such franchises have no legs and will only bankrupt investors.

2. Smarter buyers will force changes to the draconian terms of today's franchise agreements. Among the clauses that will be modified or eliminated will be those that tie in purchases, that run revenue through the franchisor's hands before the franchisee gets his share, that provide for so called liquidated damages upon termination, that prohibit group dispute resolution proceedings, that force acknowledgment that representations made were really not made at all, and no reliance provisions.

Intelligent investors will refuse to accept terms that put them in a serious bind should things not be as represented.

Courts will refuse to allow enforcement of contract provisions that exonerate fraud through the artful use of language. Bad facts will cause a re-examination of just how sacrosanct contract language has to be.

It may be that this carve out is limited to franchise investment cases of certain profiles, but some way will be found to curb the "license to steal" provisions that are today in every franchise agreement.

3. Life cycle characteristics will become a more aggressive segment of due diligence. No one will any longer rely on the fairy tales told in franchisee interviews, as it is now sufficiently obvious that franchisees rarely tell the truth to prospective investors for many very valid reasons, including fear of franchisor retaliation.

Expectations that franchisee associations will provide a reservoir of truthfulness for investors may not come to fruition in the next 15 years.

The problem with that is that truthfulness is not attractive if it would result in making it more difficult for franchisees to sell their franchised businesses. Franchisees should not be expected to act contrary to their perceived interests in order to protect third parties. Will that aid and abet franchise fraud?

Of course. The solution to that issue will again come only from competent deal due diligence in addition to legal due diligence. Those who offer only legal due diligence will find it harder and harder to attract franchise investor clients.

People will more maturely recognize that so called government regulation of franchising is a myth and that they conduct competent pre investment due diligence or face failure. Were it otherwise we would not just now be exposing the massive "liar loan" schemes in which franchisors insert fraudulently inflated financial performance information into the SBA loan application process to enable SBA backed bank loans for franchise offerings that haven't the slightest possibility of providing return on investment.

4. Similarly, realists will no longer expect real government assistance in improving the quality of franchise pre investment disclosure or of franchise relationship abuse restraints. Investors will know that if the franchise provides the franchisor the right to be a predator that is precisely what will happen. The vehicle for most of these changes will be the more substantial investors who can afford multi unit and area development deals. Single unit investors will continue not to have the bargaining power to get the best terms or the best deals.

The single unit investor will continue to be the victims of franchise charlatans more often than not, as single unit investors tend to fail to purchase competent deal due diligence help.

Established multi unit operators often buy area deals from new or recent franchisors, believing that they know how to make the business model work and won't suffer if the newbie franchisor isn't up to speed on support.

With all the bottom feeding going on, it should be expected that good operators may take advantage of the difficulty of a brand and buy it for nickels and dimes.

Any new owner with franchise knowledge knows that you can always find ways in today's franchise agreements to squeeze more money out of the franchisees, and that if you squeeze them to death that really isn't much of a loss.

The acquiring good operator company can take those locations and convert them to their brand. Those locations can be had with a mere swap of releases in most instances, as the starveling franchisees would see a walk away as a positive event compared to having to pursue bankruptcy as the way out of the franchise agreement with its liquidated damages and personal guaranty clauses.

When the new crop of toxic guaranteed failure franchise concepts dries up over the next ten years this will become less of a factor.

Some of these going broke franchise systems are also conducive to money laundering by narco traffickers as well as a front system for drugs distribution itself. One day someone will do an expose on the use of decay stage franchise systems by narco traffickers.

By 2030 I expect to see franchising have a different and better look.

It will be harder to bring a franchise to market, so only better franchises will make it. Charlatan franchise consultants who tout that anything can be franchised in order to get people to hire them to help franchise their businesses, usually drop outs from past over the hill franchise companies, will be less and less credible as they are exposed for over selling the ability of any franchise company to extract large extraneous revenue streams out of any franchise system, regardless of its success in attaining any significant measure of growth.

More of these guys would already be defendants except that they usually are judgment proof and not worth suing.

There will be very few viable new franchises. The good ones will be extremely rare. Indeed, the good ones are already extremely rare, as certain popular categories are already too overcrowded and price sensitive to be investment worthy. That includes the all time favorites in the fast food business. None of them is worth having. The few good ones are not being franchised, like Chipotle Grill for instance.

Toxic new franchises will tend more to lean toward technological themes and be sold to nerds with no business savvy.

You have to be really stupid to buy a food franchise today, or to buy any franchise that is already 20 years old. The few good old ones are bought by existing operators when they become available, and new buyers never get a chance to buy them. Why allow a resale to a newbie when someone who already has a positive operating history in that same franchise is willing to buy it?

Vulture capitalists are securitizing old franchise agreements in moribund companies and categories.

Bain Capital is scamming the public into buying stock in over the hill Dunkin Donuts, saying that this regional geriatric has new life in expanding westward.

That ought to be a great lesson in what not to invest in. Bain reaped millions in fees; risked nothing; and loses nothing if price of the stock crumbles. It is the franchise version of the mortgage backed securities scam that created so much damage in 2008.

One could posit that, having learned nothing from the mortgage backed securities fiasco, franchising is headed for its own royalties backed securities disaster, and that is certainly not unlikely. If so, the ball should drop within the next few years. It is unfortunate that evil begets evil until the roof falls in, but so it seems goes life these days. This is the kind of abuse that I expect to assist in turning the market in franchising from a thieves market into a more rational market over the next 15 years.

In an intelligent investor's world, no one would go near any franchise related investment without extremely competent deal due diligence in addition to the legal due diligence. When asked what in franchising today is worth investing in, my usual response is NOTHING for the moment. There may be isolated niche opportunities, but only extremely competent deal due diligence could possibly perform the tests necessary to identify a real opportunity from a false opportunity masquerading as a real opportunity.

Franchise law practice now is centered more upon people wanting to find ways to escape from the franchises they invested in. I look forward to the positive changes I anticipate in the next 20 years or so.

As always, you can call me, RIchard Solomon, at 281-584-0519.

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Two and half years ago, I wrote about the class action in Tim Horton's -part based on interviews with the class action representatives.

Now, that Burger King intends to buy Tim's, I thought it was useful to revisit the post.

Because the Burger King has an independent franchisee association, while Tim Horton's does not. Yet.

The result of the franchisee's class action lawsuit being dismissed is that Tim Horton's, the franchisor, lost a major business battle. In a rare summary judgment motion., the reasons for the judgment, part 1 and part 2 can be read here, a motions judge dismissed the franchisee's class action.

But, now Tim's will now struggle mightly to get same operator expansion as a result of this legal victory.

Like any mature franchisor, Tim's relies upon same operator expansion for its growth. It is fortunate to have a substantial number of operators who have grown with the system from near the beginning.

Sophisticated operators know that franchise operations need modification and changes. And Tim's is no exception. This type of operator needs to know how to plan and budget for such changes, paying for them in part by the expected increased return.

But, now that planning process is riddled with uncertainty.

In 2002, after considerable debate with its franchisees, Tim's introduced a centralized baking system. Tim's baked centrally and shipped frozen products to its stores. (Only in Canada could one say with a straight face that these baked goods were "Always Fresh".)

The par baking facility was funded by the TDL Group and constructed by its joint venture partner, IAWS. These joint venture partners contributed approximately $95 million (US) in 2002.

During 2002 to 2009, the 3,000 franchise owners collectively contributed approximately $100 million (Can.) for store modifications, without which the joint venture partner's par baking facility would be useless.

At issue in the class action lawsuit, was whether either the franchise contract or the equity of fair commercial dealing required that the return on the joint venture partnership be commensurate with the return on the franchise owners collective investment.

This would appear to be a difficult question of fact and law requiring a trial.

But, the motions judge handed Tims and TDL, a complete legal victory yet possibly a business disaster.

As reported by Robert Thompson, who wrote Ron Joyce's biography, the founder of Tim Horton's,

"Stores had once made upwards of 20-percent margins, a windfall for the mom-and-pop shops that were often operated by pioneers who entered the business in the early 1970s. Margins fell under Wendy's management, and Joyce was concerned they would continue to decline after the IPO, which is exactly what Jollymore alleges was the case.

These days, those close to Joyce say stores are lucky to make 13 percent, a steady decline from a decade earlier."

Sophisticated operators like the representative plaintiffs, the Jollymores, know now that the franchise contract doesn't require any equitable sharing on the returns made as the result of the franchisee's collective investment of new capital.

The Court sanctioned unfairness will make it difficult for Tim's to continue to grow with same operator expansion.

Analysts of the public company may wish to reflect on another franchisor who spurned same operator expansion - Jackson Hewitt. Bankruptcy looms nearer when the experienced franchisor operator as a group doesn't expand. The Jackson Hewitt franchisors did not share equitably with the franchisees the fruit of the Refund Anticipation Loan program, "RAL". The franchisees refused to expand the system, and so when the franchisor needed their support it wasn't there. The franchisor needed the franchisee's support for expansion when the RAL program was gutted by the IRS.

We can hope that the Jollymores, Ron Joyce, and the other franchise owners will now see the wisdom in what Colonel Sanders saw many years ago when he imbude his franchise owners with real protection - for the betterment of the franchise system.

"When Colonel Sanders sold Kentucky Fried Chicken, he feared his franchisees would lose control of their own businesses and the future that they were working toward and in which they had invested.

So he encouraged them to unite to protect the franchisees that he considered part of his own "family" and to give the franchisees a voice in the future development of a concept which would prove to be far greater than was envisioned at the time.

This brought about several small meetings with early franchisees and in 1965 the Southeastern Kentucky Fried Chicken Franchisee Association was formed and formally organized in Atlanta, Georgia.

Ten years later, the AKFCF (our national association) was incorporated in the same city.", from the Association of Kentucky Fried Chicken Franchisees website.

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Flee, freeze or fight are the 3 known animal brain responses to danger.

1. Zebras flee from lions.

2. Deer freeze when facing danger.

3. Yet, crocodiles fight for their food.

All of three responses involve spending energy, or in business terms - money.

How you respond to danger is a matter of both personality and tactics.

A different sort of problem faces us when we run into difficulty, trouble or an obstacle in our business - expanding our business, growing sales, or keeping our customers.

We have different tactical choices - beyond flee, freeze or fight.

We can try to fake-out our adversary who can spend more money and energy to stop us.

Fake-outs are well known in war.

Facing an enemy of even roughly the same size, it becomes dangerous and too bloody to go through them.

Even facing smaller forces -with their backs to the wall- can be trouble: the Texans at Alamo and the Greeks holding off the Persians at the Thermopylae pass.

When an adversary is truly committed to defending a position, has dug in, with no good escape route, successful armies have chosen to fake-out the enemy. Pretend to engage, bypass, and have the enemy waste or expend its supply line.

The early Scottish had an advanced fake-out strategy. With their bagpipes blaring from miles away, the Scots marched into battle promising great fierceness, yet from far enough way that some the enemy could slip away. Enough slipped away and the battle was won without a fight.

We see remnants of this advanced fake-out strategy when a franchisor announces a new multi-unit deal or some international expansion.

They are announcing from afar that they intend to occupy the field very soon and that the independents would be better off selling, shutting down or moving on. Keep this in mind the next time you see this type of announcement.

What are you revealing about your own company's intentions with your announcements? Are you credible?

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No one doubts that the interest of the individual is not the same interest of the group the individual is part of. Stars on teams, athletic or management, have special troubles aligning their interest with the team's goal. Even more so, when their team is unlikely to succeed at achieving the team goal.

The star may, despite being nominated as the leader, put his own goals ahead of the team's goal -bringing about a poor team performance.

Seeing how "lousy" the team is, the leader may be even more emboldened to put his interests ahead of the teams because team performance is so lousy.

Soon, team performance completely unravels.

Can you tell in advance which leader will fail to be effective?

Fail not because they are not talented, but fail because his followers don't believe that the leader believes that he can effectively discipline the "lousy" group to act as a unit?

Training Exercise

Here is a short exercise to determine how effective a leader is when confronting this problem - how to form coalitions when trust is needed to overcome skepticism.

This is a simple Simon Says task. The team and individuals gets points for following you. You win by getting the most points. But people also get more points if they accurately predict that the small group will not form a coalition, and ignore you. (This exercise is based on an exercise by Gerald Williams, the "Win as Much as You Can Game." Thomas Schelling analyzed a similar problem with his multi-person social dilemma games.)

The task is easy to describe. You have to get people, 3 on your team, to follow your commands, but your interests are not completely aligned with your team's interests.

You can utter one of two commands, "Left" or "Right". If you say "Left", the team wins if they all follow and say "Left". The entire team, including the Leader, wins one point. But, if you say "Left" and some other people say "Right", then you are penalized, along with your followers who also said "Left".

If you say "Right", however, only those who say "Right" win and those who say "Left" lose. But there is a catch: this time, if the entire team says "Right", then they all lose, including you.

To allow for learning, cooperation, and communication, play ten rounds of the game. Have a 5 minute discussion at round 3, 6, and 9. Otherwise, play in without overt communication. Limit the time in each of these rounds to 30 seconds.

The individual with the highest highest score wins the game, whether the team leader has the highest score doesn't matter.

Payoffs for the Game

Here is a chart which summarizes the exercise in terms of outcomes and pay-offs.

Are You an Effective Team Leader?

Outcomes Payoffs
4 Rights Everyone -1
3 Rights 1 Left Rights +1 Left -3
2 Rights 2 Lefts Rights +2 Lefts -2
1 Right 3 Lefts Right +3 Lefts -1
4 Lefts Everyone +1

(As an exercise, play a couple hands, using ordinary playing cards to get feel for what happens. Pick 4 red cards, for "Right", and 4 black cards for "Left".)

The game starts off with everyone making a guess about what you and the others will do.

How can you be an effective team leader in this simple game? You want a high or the highest score - but how can you achieve this?

A good and effective leader will get everyone to say "Left", even though some people will be better off by saying "Right". Can you hold your group together? Or will some just pretend to follow?

Achieving Disicpline

How would you turn this group of individuals into a disciplined group that would play only four Lefts?

Suppose that you started out by saying "Left" yet not everyone guessed this. How would you persuade those in the Right to give up their gains? How could they credibly commit to giving up future gains on future plays? How could they do this before the communication round?

What if you started with saying "Right" and found out that one other person guessed "Right" and two others guessed wrong. You would get 2, the other Right person would get 2, while each of the players who guessed "Left" would lose 2.

What would you expect on Round 2? Likely, those who lost would switch their strategy. It is reasonable that everyone would now play "Right" and each team member would lose 1.

It is reasonable, but if as team leader you could coordinate everyone on 4 Lefts, then each person would win 1. Can you do that? Can you do that after winning 2 from each Left on the first round? Can you do it without communicating with them, until the third round?

Now, let's make it harder - reward the team leader with an big bonus at the selected times, rounds, 3, 6, and 9, if he or she can get the group to say "Left" while he or she alone says "Right". Increase the size of that bonus - to reflect the "talent" of the team leader on the bonus round.

Will the group stay disciplined, or will it grow resentful? Will your followers expect you to eventually say "Right" and so "protect" themselves by guessing "Right" before you do? If everyone says "Right" on one round, who is going to say "Left" on the next round?

Try this exercise at your next franchise convention - see who can and who cannot effectively discipline the group. You might be surprised with the results. It would be very telling if none of the franchisor's C-Suite were effective leaders in this simple discipline game.

If your franchisor executives cannot lead in this simple game, then how are they doing in the real world?

(If you thought this was interesting, you need to subscribe to Strategic Stories Newsletter. Click here.)

In 2012, I led a Independent Franchisee Association Roundtable Discussion at the IFA Legal Symposium in Washington D.C. Below is a summary of the discussion.

Predominantly we had franchisor attorneys at our table, although in the first session I was not the only attorney who primarily represents franchisees or dealers.

1. Recent FTC Rule

The table members did not see much effect from the recent amendment to the FTC Rule in the way that franchisors deal with their associations.

This would be disappointing for franchisee advocates to hear, as there was hope that the amended rule might create more market pressure in favor of the associations.

2. Decision Making by Association

Overall the franchisor attorneys at our table, and Mr. Saukas, a franchisor, displayed what I personally found to be a surprising level of resistance to the idea that franchisees, through their independent association, should play any role in the franchisor's decision-making process with respect to the brand.

This view was forcibly stated by several participants and none of the franchisor attorneys in attendance seemed to dissent.

The sentiment seemed to be that independent associations have no business seeking to invade the franchisor's decision-making province. Franchisee arguments to the contrary did not seem to persuade this crowd.

3. Why an Association instead of an Advisory Council?

 The franchisor attorneys also questioned why the franchisees would need an independent association in systems where there is a franchisor-sponsored advisory council. Obviously, it was recognized that franchisees may tend to regard a FAC as a rubberstamp, which is often the impetus for forming an independent association.

But again there was not much sympathy expressed for this position.

4. Incentives offered by an Association

One incentive offered to encourage franchisor acceptance of associations was the notion that, on any given issue if the franchisor can persuade the association of the merits of its position, the fact that the association approved the franchisor's decision could be evidence of the franchisor's good faith, which could be useful to the franchisor in the event of any challenge by any other dissenting franchisees.

This has worked in systems in which I have represented the association. But there did not seem to be much enthusiasm at our table for this carrot.

5. When to Recognize an Association

The question of what constitutes recognition of the association was also discussed. There is no formal process for this, unless of course in a given system the franchisor and the association enter into a contract. Experience teaches that this usually happens after a lawsuit.

The question of when the association represents a sufficient number of franchisees to have standing was discussed. There is no clear bright line. 

What makes a person think about taking his or her present business and franchising it, becoming a franchisor? It isn't just the fact that they have heard of Ray Kroc and what he did with Mc Donalds or the miraculous story of Wendy's having come into what everyone thought was an already overcrowded hamburger franchise universe, having to practically give away their first few franchises, and then eventually becoming another superstar franchise organization.

Of course, every franchise salesperson claims that his or her franchise offering is going to be the McDonald's of the widget industry, as McDonald's has become the quintessential term for ultimate franchising success.

No. It takes more than that. We think the typical potential franchisor has a profile that goes beyond mere anecdotal celebrity references to the rich and famous.

An irreducible minimum requirement, before anyone is eligible to even think franchising, is a business operator who had at least several years successful experience operating the 'model'. The 'Model' is not the franchise company. The model is the business that the franchisees will operate if the concept is sound. Throughout this article you must constantly distinguish between the model, the business to be franchised, and the franchising company. They are completely different kinds of businesses. The failure to constantly keep this distinction in mind is one of the leading causes of early franchisor failures.

In all likelihood, a reasonably franchisable concept will be operated by its owner in multiple locations, all running successfully. This evidences that the concept is replicable and that it can be run by managers who can be trained. If the owner has to be everywhere all the time to keep the multiple units afloat, that is a strong sign of replication difficulty.

Either the system is too complicated to teach to a lot of people, or it is idiosyncratic, the extension of the owner's unique personality, unlikely to be successfully replicated with others at the helms of the various units.

In such a scenario, it is to be expected that customers have helped plant the seed of franchisability in the owner's mind. People come in, have the customer experience for that business, and exclaim their pleasure, their having been impressed with the idea and the manner of its execution, and their belief that it would be very nice to have such a business in their home town. 'Have you ever thought of franchising this?' will have been asked many times.

Eventually, the owner's thought processes turn into the franchise thinking neighborhood, and he starts talking to people who are in franchising, no matter at what level they may happen to live.

The model owner starts hearing money talk - initial fees of $30,000, royalties of 6% - 8% of gross sales, an advertising fund swollen with franchisee contributions of another 2% of gross sales, area development agreements through which entire states are sold off with large initial fees and a contractual requirement to build out and open a substantial number of stores within a very short time.

The model owner goes to the library and reads up on success stories of multi-millionaires who made it big from franchising.

There are no stories of franchisor failures - wrong spin control. In the world of franchise literature, everything is wonderful all the time, prospects are always bright, franchisor organizations constantly bestow awards upon their membership at conventions held in exotic places.

Soon, the model owner is slavering over a virtual feast of franchising good fortune and is ready to write checks to get the structure established, to get to the first sale. The entire focus becomes sales fixed, there is a great hurry to get to that first closing, and carts get put in front of horses.

The franchise sale is the last step in establishing a potentially successful franchise system, not the first. To be sure, even after the sale there are details like franchisee training, site selection and store opening assistance, but even these post sale responsibilities have to be prepared and tested well before the first sale closes.

Where does one start, then, in deciding to franchise. One starts with trying to find the answers to the feasibility issue.

Albeit I have a very good business that I have operated successfully in several locations for several years, how can I find out whether this concept, configured as I have configured my own businesses, has very good potential as a vehicle for franchising? If more people began here, at the real beginning, fewer franchisors would be in failure and fewer franchisees would have wasted their investments in an incompetently evaluated franchise opportunity.

Unfortunately, so many new franchisors start with lawyers drawing up contracts and disclosure documents, a fantasy trip with zero value and enormous potential for harm.

What the lawyers have never learned is that the legal work has to match the business concept, not vice versa.

The legal work is done last. Then it can, if done by attorneys who understand the franchising business as well as simply being able to draft contracts, become a charter that has rational positive value to the franchise relationship rather than merely being some set of rules cut and pasted out of somebody else's franchise documents, that most surely won't fit the situation to which it is being applied in many very difficult areas, and that become litigation breeding machines.

The business comes first, not the legal work.  (Part 1 of a four-part series on Why New Franchises Fail.)

Many, including myself, refer to franchising as an industry... even though we know it's really not an industry. A business model is probably one of the better definitions, but what does that really mean?

When referring to a franchise, even many within franchising choose from a variety of terms as a point of reference - franchise organization, franchise system, franchise company.

Of course, there's also the varying terms relating to the franchise relationship - franchisee, franchise partner and not to mention the slang, zee. And to the other side of the relationship - franchisor, head office, corporate office, parent company... and yes, zor.

And what's the difference between franchisor and franchiser?

Confused yet?

And, franchise locations are independently owned and operated. Yet, the franchise relationship is interdependent... or at least it should be interdependent and not dependent or independent upon... Well, you get it, right?

Now let's look at the people serving the franchise community. Yep, franchise community is another reference for the franchise list above but let's move on. Franchise consultants, do they sell or consult? How about franchise brokers, sales agents, sales representatives, and again, franchise consultants. Whew!

Moving down the chain there are franchise suppliers, service providers and vendors... What's the difference? Preferred or approved? Is there really a difference?

Of course, there are references to segments within franchising such as master franchising and sub-franchising... Which one is correct? And, isn't the sub-franchisor actually the master franchisee? I guess it all depends on which end of the relationship one is on.

How about now - confused yet?

Franchise services means what, and providing services to who? Franchisee to end-user? Franchisor to franchisee? Franchise service provider to franchisor and/or franchisee?

Same can be said of franchise marketing, right? Does marketing in a B2B or B2C scenario but within a franchise environment mean that it's franchise marketing? Or, is franchise marketing actually marketing to franchise candidates?

Speaking about franchise candidates, when is a candidate actually a candidate and not a lead or just an interested party? Does this fall under franchise sales or franchise development? And who's in charge - the VP of Franchise Sales, VP of Franchise Development, or VP of Franchising?

And then there's reference to franchise professionals. Is a franchisee a franchise professional? How about if the franchisee is a multi-unit franchisee with 25 locations? How about a franchise attorney? Franchise service provider?

If a franchise executive is a franchise professional, at what level of management does one begin to be considered a franchise professional? How about within the franchise organization itself? Secretary, if their support is purely administrative as opposed to an admin that actually communicates with franchisees?

Oh, and should the CEO of a franchise company be considered a franchisor as we often refer to them as such at franchise events?

Ironic how franchising is the replicating of a system with focus on consistency in image, appearance, product and service from one location to another. Yet, there's little consistency in the terminology used to define many aspects of franchising

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McDonald's Corporation is ramping up the growth rate of new restaurants in the USA.

We can understand the challenge management faces - they must keep total sales growing to increase corporate income. If same store sales are slowing they have to try to increase sales with new stores. Stores that open below projections still produce incremental income for the corporation.

We've been here before.

Let's review the history of the "Convenience Strategy"

During the 1970s and most of the 1980s McDonald's USA opened 300 to 350 restaurants per year in the USA. In the early 1990s the pace fell to less than 200 per year. Apparently management did not feel this adequately presented McDonald's as a "growth company" to investors.

In 1995 management announced the"Convenience Strategy", a plan to increase new store development. That year they opened 597 free standing restaurants and 533 "satellites" in the USA. The year 1996 saw 542 new stores and 184 satellites in the USA.

The results? Massive cannibalization of existing stores. Not only were sales of existing stores severely impacted but the new stores were missing their projected opening volumes by 30% to 50%. Hundreds of domestic Operators were driven into insolvency and forced out of the system.

You may have seen some of these former Operators holding hand made cardboard signs at busy intersections.

The most important thing to remember about the disastrous Convenience Strategy is at the beginning Operators were thrilled with the prospects and eagerly lined up for the new stores. Who could blame them? They'd just been through a period where new stores were a rarity. How were the Operators to know that McDonald's would be building new stores in all the wrong places?

Fast forward to today, could McDonald's be oversaturating the USA again? Keep in mind that when the Convenience Strategy was announced the USA had less than 10,000 McDonald's locations vs. over 14,000 today. Is there room in the USA for a large number of additional McDonald's stores?

I think most veteran McDonald's Operators would respond in the negative. Low volume stores with high rent factors? No thanks.

So instead of getting excited about new McDonald's stores in their area Operators should be wary about the likely negative impact on existing sales and cash flow.

What should an Operator do if new locations threaten their patch of stores? It's becoming more common for Operators to turn down new stores or not pitch for them in the first place.

In the process of doing so they might attempt to educate the regional decision makers on why the site doesn't make sense.

Yes, there are downsides to turning down new stores, but the risks to your business are much higher today than when McDonald's USA actually was a growth company.

Preemptively Operators might involve their RLC in monitoring new store growth. Individually this might be an opportunity to ask for a review by the Ombudsman before a store opens, not after the damage is done (there is still an Ombudsman isn't there?).

Another avenue is to work with local politicos and keep the location from being permitted in the first place. It's been done before though few of us talk about the back story.

We can't expect McDonald's management to remember, or fear repeating, the biggest blunder in the history of the McDonald's system. I think it's been expunged from corporate memory. There are few people left in McDonald's management who were in positions of influence at the time of the Convenience Strategy.

Since this insane growth was never recognized as a mistake by Oak Brook - history can repeat itself. In fact, the rhetoric is the same, "We need to build there before a competitor builds there". That's the same thing Mike Quinlain said in 1995.

Proposed new McDonald's store near your patch of stores? Be afraid, Be very afraid.

California is rightly the envy of all for its commitment to public education, consumer protection and sophisticated agribusiness.

However, the current legal franchise model allows franchisors to either deliberately or inadvertently skirt their civic responsibilities.

First, Franchising needs to return to its roots, in which the franchisor set quality control standards for a reason and not just to trap the franchisee into paying for high fees to the preferred suppliers, who then kickback  money to the franchisors.

The standards which protect the food supply chain are too important to leave to the federal government to enforce.  We need the unintended good consequences of brands maintaining quality control and funding the appropriate training and education.  

We don't need, however, a kickback economy.

Second, the current legal franchise model has an unbalanced picture when it comes to information: there is no legal balance between what the franchisor markets the benefits of the system and what the franchisor is contractually obligated to perform.

Private Brand Standards and Public Safety

To understand the first benefit of Bill AB 2305, we have to return to 1950-1970, when McDonald's enforcement of private brand standards were of assistance to the public good and helped maintained a safe food supply chain.

Ray Kroc's franchise model - complete with Hamburger University and passing on volume pricing rebates to the operators- had quality control standard which had a beneficial and unintended good consequence. Kroc's enforcement of private standards produced a safer food supply chain for the public. Sadly, Kroc's vision is not upheld by many modern franchisors.

To see how Kroc's system worked, we have to pay attention to some details.

In the 1970's, Kroc and McDonald's set quality control standards and operating standards. But, the operators purchased food from local sources.

Here is just one clever example of how the private brand's standards had a public benefit. Kroc shipped hamburger buns in package containing enough to make 100 hamburgers. The operating standard was that an operator should go through 100 patties for each package of buns. If the operator went through more, say 110 patties, then:

"Either his meat man was shorting him or someone else was stealing from him."

A meat man who would cheat on weights and measurements is a risk to public safety.  Kroc would have the meat man dead to rights, if he was found to be cheating.  

Today, we have more difficult contamination problems to detect and solve.

But, today many brands set standards for a different reason.  They require the operators to purchase from preferred vendors. Many of these preferred vendors are simply competing on cost - how much money they can rebate to the franchisor? There is no legal requirement for the vendors to compete on value and safety.

To understand why the modern franchise standards don't produce a public good, we have to understand how legal kickbacks work in the franchise industry.

Current Brands - The Kickback Problem

The franchisors you hear from today will tell you how strong their standards are. But, what they will not tell you is is the reason for these strong standards.

Many franchisors have used the current legal model to primarily obtain kickbacks or commercial bribes from their suppliers. The franchisor mandates that the franchisees purchase supplies, at an artificially high price.  The supplier then splits all or some of this extra price with the franchisor. This is perfectly legal as long as it is adequately disclosed.

The franchisor may elect, and many do, to report these kickbacks as essentially royalty income on their intellectual property and transfer the money out of state without paying California state income tax.

But, you will rightly feel uncomfortable with this arrangement, whether or not legal. Kroc was appalled by it.

A supplier who was being richly reward by his business relationship asked Kroc what he might like in return.

"Let's get this straight. I want nothing from you but a good [safe] product. Don't wine me. Don't dine me. If there are cost breaks, pass them on to the operators."

Promises to the Small Business Operator and Consumer

The second benefit of Bill AB 2305 is to protect the consumer, the consumer of information seeking to purchase a franchise. If the brand markets to prospective purchasers by making promises about volume rebates, quality standards, or continuous training, then their legal obligations in the franchise contract will have to match these promises.

Currently, most brands are only contractually required to provide sufficient training to open a location.

Further, the brands are only required to disclose somewhere in the fine print of a 500 page plus "Disclosure" document in legalese that the operator can only expect sufficient training to open a location and there are no price discounts.

But, of course these truths make hard marketing. Bill AB 2305 simply requires the brands balance their marketing hype with what the franchise document delivers by not allowing the brands to disclaim or ignore its marketing promises by disclaiming them in the franchise agreement.

The Benefits of Balance

A return to a balance in which quality standards are used to strengthen a brand, and indirectly contribute to public safety, franchisors who live up to their marketing promises will protect the small business operator and consumer.  We can do no better to reflect upon Kroc's view of franchising.

"We are an organization of small business [operators].  As long as we give them a square deal and help them make money, we will be amply rewarded."

Bill AB 2305 provides that square deal for franchisees, and the franchisors, consumers and public will be amply rewarded by its passage.

 

 

One fine day, a franchisor, a preferred vendor, and some franchisees decided to build a franchise system together.

They found many good locations and built a number of great units.

lion fox donkey.jpegThe franchisor asked the preferred vendor to divide up what they had accomplished together.

So, the preferred vendor made up three roughly equal parts and let the franchisor chose.

Angered by the vendor's lack of grace, the franchisor revoked the preferred vendor's status for cause- bankrupting the vendor and acquired all the vendor's confidential information.

After that, the franchisor told the franchisees to propose a division of all that they had accomplished together.

The franchisees put together the vastly greater part of all they had accomplished together in one pile and in the other they put only scraps. When they had prepared the two parts, they called the franchisor and invited him to choose.

The franchisor, quite delighted with this arrangement, took the vastly greater part of all they had accomplished together and said to the franchisees:

"My esteemed colleagues, who taught you to divide things up so well?"

The franchisees answered through clenched teeth:

"None other than the preferred vendor and what happened to him, sir!"

With the scraps, the franchisees rushed off, tails between their legs, to bitterly complain in some small, far off location where the franchisor could pretend not to hear them.

This fable or wisdom story dates back to what Cialdini calls the First Era of Persuasion - which ended badly for the persuaders. It is known as the fable of the Lion, the Donkey and the Fox.

Moral: A partnership with the economically powerful is untrustworthy. If you want to partner with your franchisor, create an modern Independent Franchisee Association working for all of you.

It pays to be a member, both as franchise owner and supplier.

Are you a supplier that wants to get increased exposure to franchise owners?

Do you have a product or service that solves a problem for some, even if not all, franchisees in a system?

And would it help if Franchise-Info made franchise owners more acutely aware that they have this problem?

Then, you need to market directly to franchise owners. Connect me directly on LinkedIn. Ask about "Preferred Vendor Marketing"

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The ABA Forum on Franchisng strives for balance, objectivity, and a focus on legal accuracy. The overall goal is to emphasize collegiality and foster personal relationships between franchisee side and franchisor side attorneys.

Snell & Wilmer's article in The Franchise Lawyer about how Coldstone collaborated with its "franchisee association" is a major blow to the ABA Forum on Franchising's overall goal. The S&W article is a bombshell.

It is hard to believe that the ABA Forum would not carefully vet this piece before it appeared in The Franchise Lawyer, even if the The Franchise Lawyer is a legal newsletter and not a Law Journal.

The role of the ABA Forum on Franchising is troubling for the following reasons.

For more than a decade, the Forum has shied from contentious debate. It has chosen (wisely, in my opinion) to stress civility and a "just the facts" approach.

Essentially, the article is discussing public relations: a franchisor was accused of behaving badly against most of its franchisees in a television show aired on CNBC, citing large franchisee failure rates.  The franchisor sent a fat bank wire to the franchisee attorney on behalf of the non-franchisor controlled franchisee association, whereupon that franchisee attorney went on television to say that only disgruntled franchisees were at  fault for the rash of franchise failures. 

Is there a lesson in there for the readers of The Franchise Lawyer? Umm... it is unlikely that Justin Klein is now going to take a check from Ric Cohen, or Michael Dady will go on the payroll of franchisor The UPS Store. So the article is of rather limited utility in informing franchise attorneys?  There is very little legal point to this article.

Wors is the legally ludicrous argument in the pages of an ABA publication. With nary a single citation to law, the article suggests that statements of opinion are defamatory, something a first year law student knows is simply not true, at least not in the United States:

Cold Stone believed the allegations that there are "hidden fees," that Cold Stone profited from subleasing locations to franchisees, and that Cold Stone forced franchisees to buy unnecessary equipment were defamatory and false.

Cold Stone also believed that the allegation that there was a "yet-to-be-filed class action" was false. [emphasis added]

Apart from the matter of what is "hidden" and "unnecessary" is in the eye of the beholder, the article implies that the subleasing markup did not exist. Note the careful use of the word "profited" rather than "marked up":

Cold Stone most certainly did mark up leases by at least 2%, and did not always remit lease payments to the landlord even though Cold Stone debited the franchisee bank accounts.

While it is true that the editors of The Franchise Lawyer are not defamation experts, this is not exactly a tough point of law.

Of equal ethical importance, the editors of the publication are no doubt familiar with some uncomfortable details such as Cecil Rolle's prominent play in the infamous Zarco letter to CNBC and the resulting ethical storm.

The omission of any discussion about Rolle is puzzling, since The Franchise Lawyer lauds the Zarco letter as being the catalyst for CNBC to cave in, and the Zarco letter is less than three pages of type, with more than a full page being devoted to a blistering attack on Rolle. Logically one would think that The Franchise Lawyer would mention that the primary focus of this wonderful strategy is to attack your ex-franchisees.

Did The Franchise Lawyer editors demand a full and balanced article?

Well, read it for yourself. Pay close attention to what is not discussed, in particular any discussion of the actual contents of the Zarco letter, or the legal requirements to pursue a defamation action against a publisher.

(Some time after the BlueMauMau articles appeared, a television executive explained that NBC legal was aware that the program was not defamatory but that the producers just did not want to deal with franchising anymore.The individual indicated that after dealing with the brouhaha, he felt as though he had walked through a sewer. Those familiar with the backstory to the CNBC program may well feel the same way.)

Now, I have the utmost admiration for all the good work that Robert Zarco has done for franchisees over the past decades. I disagreed with him as to how he handled the Cold Stone matter. But I did so publicly. Zarco was a good sport and replied to me publicly.

I also admire S&W because they are doing their job, and doing so in a methodical and devestatingly effective manner.

Snell & Wilmer wrote a clever article for its masterful grasp of the use of publicity to eviscerate a litigation adversary. The tactical brilliance of Snell & Wilmer's litigation strategy is to be admired. When I die, I want to be reincarnated as a S&W litigation associate.

They came not to praise Zarco, but to bury him.

S&W's story in The Franchise Lawyer is intended to inform Zarco's colleagues. S&W placed the story on legal blog sites such as JDSupra in order to ensure that non-ABA Forum on Franchising attorneys did not miss it, and also to ensure that news feeds such as Google would both push the story and ensure search engine users would find it.

That S&W comes out with this publicity at the worst possible time for Zarco is no accident. Not only does the story harm Zarco, but it also reinforces the case, which former franchisee Cecil Rolle is (according to reliable sources close to Rolle) pressing with both Florida's disciplinary body for attorneys and possible direct litigation. Having patiently waited until the story was off the front pages, S&W now puts the story back in the headlines and in a way which Zarco cannot defuse.

And S&W did so with the imprimatur of the "American Bar Association, Fall 2011 Vol. 14 No. 4 " (When was the last time a major law firm could not do a proper BlueBook cite? But then again, it has more impact being published in the "American Bar Association" rather than "The Franchise Lawyer" fall edition.)

However, for the ABA Forum on Franchising to be a part of this is more than not sporting. Wading into an ongoing legal and ethical morass, while avoiding discussion of it is not worthy of the Forum. In confirms suspicions about the ongoing irrelevance of the policy of collegiality.

Fair Franchising

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This article will separate the optimists from the pessimists on the important subject of “fairness” in hotel ownership. Hopefully, we will make an optimist out of even the most cynical readers amongst us.

We begin with a simple question: Which of the following is the most likely to occur first?

a) America’s leading hotel franchisors will voluntarily embrace AAHOA’s 12 Points of Fair Franchising.

b) The U.S. Congress will pass comprehensive “fair franchising” legislation (or the Federal Trade Commission will enact a new regulation) that effectively implements the 12 Points and makes further efforts by AAHOA members unnecessary.

c) The U.S. Supreme Court will decide a “fair franchising” case that establishes, once and for all, that liquidated damage clauses (and other contract provisions to which franchisees usually object) are “unconscionable” because they “shock the conscience” of the Court.

d) None of the above.

Obviously, if you answered (a), (b), or (c), you have an optimistic nature, while those that say (d) are probably doomed to spend their lives as pessimists. We respectfully submit that too many observers of franchising are far too pessimistic about the prospects for “fairness in franchising”; in the balance of this article we hope to persuade you to join the optimistic camp as well!

Furthermore, for the optimists, we are going out on a limb to say that the correct answer is (a), that the franchisor community will voluntarily embrace the 12 Points of Fair Franchising long before fair franchising is imposed upon them by law.

That said, the pessimists unfortunately have a lot of history on their side that cannot be ignored. Like a voice in the wilderness, the first known calls for “fair franchising” came nearly 40 years ago when a dedicated Boston lawyer, the late Harold Brown, decried the commonality of franchise agreement provisions that left most franchisees vulnerable to a total loss of equity in their investment. Two obvious examples were provisions that allowed arbitrary terminations, and liquidated dam- ages clauses that make it hard, or impossible, to extricate oneself from a failing brand or a bad deal.

Over the last 40 years, there have been many attempts to “level the playing field”. Among the high- lights, or lowlights, in 40 years of “Fair Franchising” efforts:

1) The FTC in the late 1970’s en- acted franchise regulation, but the FTC Franchise Rule has always been limited to the regulation of what the franchisor must disclose to prospective franchisees, without regulating the contents of franchise agreements or imposing limitations on franchisor conduct.

2) A handful of states enacted their own disclosure laws and some states have legislated against arbitrary terminations, but no state has en- acted comprehensive protection that would come anywhere near the protection for franchisees that AAHOA seeks in the 12 Points of Fair Fran-chising. No new state franchising legislation has been enacted in the last 20 years!

3) Efforts to enact a comprehensive federal fair franchising law peaked in the 1990’s, as the proposed legislation never made it to the floor of the U.S. Congress.

4) Judicial efforts to restrain franchisor conduct have historically centered on both efforts to impose fiduciary duties upon franchisors and efforts to hold certain clauses unconscionable. By and large, franchisors have beaten back efforts to establish fiduciary duties, as most courts see franchising as a two-way business relationship, and not as a fiduciary relationship akin to the relationship between a trustee and beneficiary. Likewise, there have been a handful of cases, mainly from the West Coast, in which courts have found some arbitration clauses in franchise agreements to be unconscionable, but at this time there is not a good precedent in any jurisdiction to argue that a franchise agreement that does not meet the 12 Points is unconscionable.

By and large, the courts have imposed a “good faith and fair dealing” standard on franchisor behavior in performing their contract duties; and of course, the courts remain willing to protect a franchisee from fraud in cases where it can be proved. Thus, it remains possible for individual franchisees to win specific cases, but because most individual, single unit franchisees lack the resources to fight back, the prospects of being defeated in individual cases has not persuaded franchisors to change the terms of their standard franchise agreements fundamentally. Being a good franchisor today remains more a matter of enlightened self-interest among those franchisors that desire “win-win” relationships with their franchisees, more so than any legal mandate.

5) Franchisees in a minority of systems formed independent franchisee associations in an attempt to engage in collective bargaining with their franchisors. There have been some notable successes on this front, but so far, the independent franchisee association movement has not gained serious traction toward the goal of negotiating agreements that are more palatable to the franchisee. Moreover, efforts by associations to bring system-wide litigation or arbitration to redress franchisee grievances have had mixed results, as it remains difficult to establish association “standing to sue” (or to obtain class action certification) in any case that depends on proof of franchisor conduct with respect to specific individual franchised locations.

6) Efforts to establish national umbrella franchisee associations (such as the American Franchisee Association and the American Association of Franchisees & Dealers) have achieved limited success as these organizations are perennially out- funded by the International Franchise Association, which speaks for franchisors.

7) The Federal Trade Commission in 2007-08 adopted the first serious amendments to its franchise rule since the late 1970’s. However, to the disappointment of most franchisee advocates, the FTC declined again to go beyond the regulation of the franchise sales process. Efforts to extend regulation to the contents of franchise agreement — or to franchisor conduct during the relationship or upon termination — were considered but rejected.

8) One bright spot, however, is that in the amended FTC Franchise Rule, franchisors must now disclose whether the franchisees in its system have created an independent franchisee association and whether the franchisor recognizes the association as legitimate. Other highlights/low- lights of the amended FTC Rule are that:

[T]he amended Rule requires more extensive disclosures on: lawsuits the franchisor has filed against franchisees; the franchisor’s use of so- called “confidentiality clauses” in lawsuit settlements; a warning when there is no exclusive territory; an explanation of what the term “renew- al” means for each franchise system . . . In a few instances, the amended Rule requires less than the UFOC guidelines — for example, it does not require disclosure of so-called “risk factors,” franchise broker in- formation, or extensive information about every component of any computer system that a franchisee must purchase.

9) Last but not least, AAHOA has adopted the 12 Points of Fair Franchising, but so far, the major hotel franchisors have been slow to embrace them.

Against this history, I remain very optimistic that franchisees — whom AAHOA correctly refers to as “hotel owners” — have a future that is much brighter than the past. How- ever, the question that we posed at the beginning of this article was a trick question. No great change in the direction of “fair franchising” will simply occur but instead this important goal must be achieved. Furthermore, franchised business owners in general and AAHOA members in particular have much greater odds of success in striving to achieve voluntary compliance with fair franchising standards for the simple reason that “self-help” is al- ways better than waiting for charity from others. To wait for the courts, the legislatures, or the regulators to rescue hotel owners from “unfair” contracts is to place your fate in the hands of others, who have much more funding, and to abdicate personal responsibility for your own future. That would be a tragic mistake, especially since all the ingredients for hotel owner success are readily at hand. Specifically, hotel owners will win the struggle for fairness when three things happen:

1) Enlightened hotel owners will decline to sign contracts that do not meet the standards established by the 12 Points of Fair Franchising. You would not buy a car that was unsafe and place your family in physical danger. Why would you buy a hotel on terms that are legally unsafe and thereby place your family in economic danger?

2) Taking advantage of the amended FTC Franchise Rule, hotel owners will create single-brand independent franchisee associations and demand recognition, and will demand the opportunity to collectively bargain the franchise agreement. Future hotel purchasers will scrutinize the Franchise Disclosure Documents that must now comply with the amended FTC Rule (replacing the old Uniform Franchise Offering Circulars or “UFOCs”) to see whether the particular brand has recognized its association.

3) Savvy hotel owners will explore alternatives to being franchisees. Two alternatives come readily to mind: Establishing cooperative associations, and becoming franchisors instead of franchisees. Both of these alternatives are very viable from a legal standpoint. The question is not whether these developments will occur, but when, and whether AAHOA members will be at the forefront.

Each of these three actions are steps to independence, and hence to fairness. As more and more hotel owners take these steps, there will very quickly come a tipping point at which the established hotel brands either will have to get on board with the 12 Points of Fair Franchising or lose franchise sales. By taking the steps outlined herein, hotel owners will change the game in their favor. Am I optimistic? You bet! 

Published in AAHO Lodging Business Magazine March 2009, by Carmen Caruso.

Franchisees have long term contracts, sometimes as long as 20 years. Franchisor executives in C suite might not last more than 5 years.

The franchisor may be sold, merged, or go into a reorganization. How does this time difference effect their views?

View this highly informative and short video and find out the difference between franchisee and franchisor time.

Steve Memorial.jpg

Steve Ellerhorst was a firm believer in the value and necessity of franchisee associations.  Steve's entire working life was spent in franchising: franchisor executive, franchisee operator and as a franchisee association leader. 

Steve, along with others in the Hardee's system, was instrumental in forming the Independent Hardee's  Franchisee Association. 

The  Independent Hardee's Franchisee Association exists today because of the foresight of Steve, his deep appreciation of the three different views and needs of the franchisee, franchisor, and supplier -and how to reconcile those needs within the business framework.

Steve was a master of finding great ideas, presenting them to the right person in the franchise system - then stepping out of the way so that person could get their necessary credit and applause.  He created the best audience for great ideas, which then got implemented because of the audience's enthusiasm.

Steve was also instrumental in the growth of a number of franchisee associations: the Meineke Dealers Association, the American Association of Franchisees and Dealers,  the Curves Association,  and the Coalition of Franchisee Associations.

Steve was also one of  the founders of the International Association of Franchisees and Dealers.

The IAFD is a testimonial to Steve Ellerhorst's grand vision of how franchisee associations exist to strengthen, help and promote the franchise brand through member benefits, communication, advocacy and education.

A great organizer, with a keen and penetrating mind peering out of a loveable soul, Steve will be dearly missed by all his family, friends,  franchisees, suppliers, and franchisors.

Please feel free to add your own remembrances of Steve in the comments section.   (You will have to register by providing your name and email.)

 

Memorial Notice

 

Beloved husband of Lisa Krummen Ellerhorst; loving father of Elizabeth 
(Matt) Yingling and Katie Ellerhorst

Loving grandfather of Micah Yingling;  dear son of Margie and the late 
Jack Ellerhorst;  dear brother of John (Julie), Dan (Lucy), Tom (Vicki), 
Scott and Patti;  dear uncle of many nieces and nephews.

Died May 30, 2011 in Indianapolis, Indiana.  Graduated from Purcell High 
School in 1975; was CEO/Executive Director at International Association 
of Franchisees and Dealers;  


Memorial service to be held Saturday, June 
4 at 11:00 am at Holy Trinity Church, 201 Clark Street, Middletown, Ohio 
45042.  

If sending flowers, please send by Friday, June 3, 2011 to Holy 
Trinity Church;  In lieu of flowers, family asks that donations be made 
to the American Cancer Society.

At the 2009 ABA Forum on Franchising held in Toronto, mediators Peter Klarfeld, Michael K. Lewis, and Peter Silverman "KLS",discussed the advantages, disadvantages and benefits of mediating instead of litigating a franchise dispute.

By popular vote, their program was selected as one of the best programs from the recently completed 32nd Annual Forum on Franchising.

Their program covered some of the most interesting aspects of mediating franchise disputes.

Topics covered included:

    • Benefits of mediation, when it is effective and when it is not;

    • Use and drafting of mandatory mediation clauses and controlling the mediation process;

    • Dispute versus Deal mediation;

    • Strategies and tactics used by mediation participants, including the mediator, and;

    • Ethical issues that arise in mediation, and evolving trends in collaborative law.

There is a general feeling of dissatisfaction with both litigation and arbitration in the franchise community.

Rubert Barkoff, one of the Deans of Franchising, puts it this way:

Litigation is a lousy way to resolve disputes, and arbitration is, in my opinion, not much better. We can try to give meaning to phrases like "good faith" and "unconscionability," but in the end all we accomplish is to create more legal battle fields on which the parties can feud.

Michael K. Lewis is an Adjunct Faculty member for the Harvard Program of Instruction for Lawyers Mediation Workshop and his colleague, Robert H. Mnookin, in his book "Beyond Winning" has an explanation for why litigation is lousy, costly and unsatisfactory:


"In litigation it can sometimes seem as if each side is frantically preparing for a trial that will never take place.
One side drafts a complaint, files motions, takes depositions, goes through document production, prepares for trial --all with the knowledge that it will probably settle the case.
And each side knows this.
It is like an arms race: each side builds up an arsenal, hoping never to use it.
Each needs the arsenal to signal a readiness for battle. But each would also benefit if both sides could agree to reduce the weapons stockpile.
The problem is that neither side wants to disarm first."
How can we move beyond the limitations of litigation or arbitration as the sole method of solving franchise disputes? KLS's ABA program on mediating franchise disputes discussed a number of useful topics.
BENEFITS OF MEDIATION

KLS argue for six (6) benefits of mediation over litigation: low cost, informed risk management, creative solutions, preservation of relationship, mutually advantageous, and high success rate. KLS believe that in a number of disputes, parties are more likely to live with their agreed upon settlements than find satisfaction with a Court judgment which may not speak to all of their business priorities.
They also point to four (4) benefits of mediation even if there is not a settlement: reduced trial preparation, possible future settlement, more tempered appreciation of strength and weakness of case, and an overall reduction in misunderstandings and clarification of priorities.
But mediation is not without its risks. Some parties use the mediation for pure delay, and there are times in which one party needs to make a statement through the trial process that certain behaviors will not be tolerated.
In sum, mediation is likely to be more effective than litigation if: a) the parties wish to preserve their relationship, what KLS called "in-term disputes", b) the dispute depends on business judgments rather than simple contractual analysis, and c) there is either a unilateral or mutual misunderstanding about positions which a mediator can reasonably dissolve.

MEDIATION PROCESS AND TERMS

No mediation process is constructed from thin air. People don't simply show up at the mediator's location and sit around the table trading offers back and forth.

KLS have a thoughtful list of issues to consider when drafting a mediation agreement for the franchise system.
1. Should the mediation be mandatory or not? Peter Silverman points out one advantage for the franchisor to mandatory mediation: settlements reached through mediation need not be disclosed under the new Section 3 of the FDD. Even confidential settlements reached as the result of litigation or arbitration have to have material terms disclosed. This disclosure is not required for mediated settlements. This is a benefit also for franchisees as they are not obliged, even in a mandatory mediation process, to agree to a settlement.
2. How wide should the mediation clause be? Should a specific mediation service provider be selected before hand? One difficult question is whether the mediator should have any specific franchise or industry experience. Extensive franchise experience can be seen as a bias by either party and may result in the mediator simply substituting his or her judgment for the group's collective judgment.

3. Time, limitation period tolling, and costs should be dealt with in the mediation provision.
KLS raise other issues to consider, but one that they don't talk about is the possible effect of the Fair Arbitration Act on the availability and use of mediation. Is franchising moving away from both litigation and arbitration? Will the passage of the Fair Arbitration Act make mediation a more attractive option for franchisors?
DISPUTE VERSUS DEAL MEDIATION

Peter Silverman in his wonderful book A Client's Guide to Mediation and Arbitration made a useful distinction between dispute mediation and deal mediation. Most attorneys when they think of mediation think of it as version of alternative dispute resolution - an alternative to litigation.

However, mediation is a useful tool to help a party with negotiating a deal. Most franchisors engage informally in deal negotiation with their franchisees, attempting to get either compliance on the existing standards or compliance with a new standard. The standard franchise agreement allows for the termination of a franchisee who is not in compliance, but this is usually the last step that is taken.

Unfortunately, in my opinion, not enough time was taken in the ABA Forum to flesh out how deal mediation might help franchisors engage with their franchisees to enact structural changes for the benefit of the franchise network.

And as Silverman points out, this is an "exciting new field for managing franchise relations."

STRATEGIES AND TACTICS

KLS outlined the basic mechanics of mediation and had some thoughts on the strategy and tactics to use at the mediation table.

This is a very large field and many of the participants wanted Mr. Michael Lewis, who is decidedly less evaluative than many former judges, to justify his lack of evaluation. Lewis argues that many times in the rush to judgment about which story is to be preferred, former judges miss the important nuances that may result in a settlement.

KLS did put to rest a number of mediation myths. First, asking for mediation is not a sign of weakness or a signal of willingness to compromise. Second, the common method of selecting a mediator by each side developing a list of candidates from 1-5 in ranking may result in a choice of the less objectionable as opposed to the most qualified mediator. KLS suggest that one party develop a list, and if the other party is satisfied with the credentials of the mediators, simply say "choose one" on the theory the mediator chosen is likely to be persuasive.

How much information should be disclosed before the mediation? This depends upon where parties are in the dispute, but the goal of mediation is to reach a settlement before significant costs of discovery are incurred by both parties. Trial lawyers will feel uneasy about this, but their clients may thank them.

In developing the negotiation strategy, KLS rely upon the well known devices of BATNA and WATNA, best alternative to a negotiated agreement and worst alternative to a negotiated agreement, in their analytic framework.
My own sense, confirmed in conversation afterwards with Michael Lewis, is that attorneys are not very good in general at employing these analytic devices. Indeed, I have had franchise attorneys tell me that their client's business interest in this dispute was the enforcement of their contractual rights! This is an analytical area in which some attorneys ought to specialize in, in my opinion.

KLS highlighted other important strategic issues: whether to disclose to the mediator "any personality quirks, or irrational thinking" on the part of any party; the goal of your opening statement, if any; understanding that the goal of mediation is not arrive at the truth, but at a settlement which allows the parties to go forward; and the usefulness of mediator proposals.
A mediator proposal is one made by the mediator of the form: would you concede X if I can get the other party to drop Y? A mediator proposal is different but related to the mediator's device of bracketing, which transforms a dispute with a potential loss of $X and gain of $Y to something like a potential loss of less than $X, but a gain of less than $Y.
It was Lewis' opinion that mediator proposals are antithetical to the spirit of mediation as it interjects the mediator's evaluation into the process which should be owned by the parties.

Finally, literally at the end of the day, the parties should sign a term sheet, if not an actual settlement agreement. "Seeing one's signature at the bottom of a clear term sheet tends to reduce next day second guessing", avoiding post settlement regret at not getting better terms.

ETHICAL ISSUES AND EVOLVING TRENDS IN COLLABORATIVE LAW
The most relevant ethical requirement binding an attorney in a mediation is the extent to which during the negotiation the attorney can bluff, mislead or deceive. Most rules of attorney conduct, in the ABA's Model Rules of Professional Conduct, prohibit tactics like lying, puffing, or bluffing in a mediation.

There is a distinction between lying about material fact, and not giving the other party the truth about a fact that they have no right to. Most attorneys are careful about treading this line, but clients may feel that they have greater leeway to stretch their demands at a mediation.
It may be permissible for an attorney to state that the "Board of Directors does not wish to settle this dispute for more than $100,000", signaling an acceptable upper range, but impermissible for the attorney not to correct his client who lies at the mediation and says that the Board had formally rejected any offer for less than $100,000.
Finally, KLS pointed the franchise legal community to developments in another legal field intimately connected with maintaining relationships - collaborative family law. "The key to the process is that parties hire attorneys who have subscribed to collaborative law process and are training in the principles of cooperative negotiating."

In collaborative law, the parties and their attorneys agree to resolve their differences using cooperative measures, and should that fail the attorneys agree that they will not be able to represent their clients in litigation or arbitration process.
Another important development is the use of settlement counsel, who work with the trial lawyer but are hired specifically to pursue settlement during the litigation process.


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