Q: I'm looking at three
different franchises, and they are quite different in relation to
the protected territory. One is willing to give me any territory
size I want, one has a specified radius from my location, and the
other has no protected territory at all. I'm confused, because
these are all similar businesses. Wouldn't the one with the
biggest protected territory be the best value?
A: This is an excellent question-it
brings up a topic that has probably been the number-one source of
conflict in franchising over the past 10 years. The issue really
comes down to how much protection a franchisee needs to ensure that
their business is not being encroached on unfairly by another unit
using the same brand and operating system.
What makes this issue so difficult is that there are two schools
of thought coming into play. One argument is based on the idea of
trying to maximize the performance of the individual unit. The
counter argument is based on the concept of maximizing total market
share for the brand in order to maximize the performance of all the
units in the franchise system.
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Most new or prospective franchisees intuitively believe that the
first argument makes the most sense and that they should try to get
the biggest protected territory possible. What's interesting is
that virtually all of the most successful franchise systems follow
the second line of logic in building their chain. Their reasoning
follows the following points:
- Since convenience is a large determinant of shopping choices
for consumers, the greater the number of points of distribution
(units) a franchise chain has, the greater the convenience to the
consumer, and therefore the more total sales volume that will be
done by all units in the aggregate.
- Since the available marketing dollars for promoting the system
to consumers are based on a percentage of total system sales, the
greater the aggregate volume, the greater the marketing dollars
available to promote the brand.
- Since advertising expenditures (for most franchises) are the
largest determinant of sales growth, the larger the advertising
expenditure, the higher the growth rate of aggregate sales
volume.
- Maximizing total aggregate sales volume creates a rising tide
that lifts all boats—in this case, individual franchise units
are the boats.
It's sometimes hard to buy this argument in theory, but the
facts are most convincing. In almost all the successful franchise
chains in the United States, there is a direct correlation between
the markets with the highest density of units and the markets with
the highest average unit volumes. In other words, the greater the
number of units in a market, the more successful each individual
unit is.
There is no question that when a new unit opens close to an
existing unit, there will almost certainly be some cannibalization
of customers from the existing unit to the new one. Customers go to
where the shopping is most convenient. The dynamic that causes
average unit volumes to increase is that the inflation of the
marketing budgets causes the overall demand for the brand to
increase faster than the transfer of customers due to proximity
issues.
Noted that this dynamic takes time to develop, and there are
often short-term volume decreases associated with the addition of
more units in a given market. This short-term effect is the source
of the conflict mentioned above.
Given this, the answer to your question is easy. You should not
assume that the size of the protected territory is a determinant of
value in any franchise. Carefully analyze other factors, like the
average unit volume and profitability in each of these three
systems, as a more dependable indicator of the value of the
franchise investment. Whichever one has the most successful and
satisfied existing franchisees is probably the best bet for
you.
Jeff Elgin has almost 20 years of experience in franchising,
both as a franchisee and senior franchise company executive. He is
currently the CEO of FranChoice Inc., a company that provides free
consulting to consumers looking for a franchise that best matches
their needs. He can be reached at jelgin@FranChoice.com.
The opinions expressed in this column are
those of the author, not of Entrepreneur.com. All answers are
intended to be general in nature, without regard to specific
geographical areas or circumstances, and should only be relied upon
after consulting an appropriate expert, such as an attorney or
accountant.