Franchise Frenzy

Booming industries and landmark court cases put franchising in the fast lane.

Magazine Contributor

January 1, 1997 10 min read

This story appears in the January 1997 issue of Entrepreneur. Subscribe »

Someday in the future, when people look back on the time line of franchising, they'll likely recall 1996 as a turning point. New trends, concepts and ways of operating were springing up left and right; meanwhile, in the legal arena, franchisors and franchisees alike were rocked by a series of surprising events. Here, a look at what's new . . . and what the future may hold.

Now that rotisserie chicken, bagel and coffeehouse franchises have gone from new kids on the block to industry staples, what concepts will emerge in 1997? After spending considerable time combing through industry data, compiling a massive database and going to sleep with visions of franchise trends dancing in our heads, we've chosen a few concepts that are emerging from the pack:

Internet franchises. "Companies are getting involved in franchising from the standpoint of home page development or other services," says Mark Siebert, president of Francorp Inc., an Olympia Fields, Illinois-based management consulting firm specializing in franchising. And the timing for these cutting-edge franchises is impeccable: About 40 percent of large companies and 25 percent of medium-sized and small businesses have either developed or plan to develop Web sites, according to market research firm O'Reilly & Associates.

Senior services. Surely we needn't tell you again about all those baby boomers turning 50 last year. Franchises are already targeting the 50-plus crowd--services such as financial planning for retirement and care facilities for Alzheimer's patients should mature in 1997. Meanwhile, residential elder-care facilities, which have been cropping up since the late '80s to provide an apartmentlike alternative to traditional retirement homes, are starting to catch on with franchisors.

Juice bars. After hitting it big in California, juice franchises are starting to branch out to the rest of America. They are, however, expected to do well only in regions that boast young and affluent consumers, and, in most cases, they require a warm climate to ensure availability of produce.

Water stores. With consumption of bottled water hitting $3.4 million in sales last year, some believe water is the only beverage strong enough to rival coffee franchises in the future.

Specialized staffing franchises. According to the National Association of Temporary and Staffing Services, receipts in the specialized staffing industry rose to $20.8 billion in the first half of 1996, offering franchises a ripe market. Many staffing franchises have also added employee leasing to their repertoire.

Children's activities. Franchises that blend education with fun are still hot, as are a variety of cutting-edge child-related businesses, ranging from baseball camps to Victorian tea parties. Children themselves are proving to be no minor market--they make or influence almost $150 billion in purchases each year.

Ways And Means

Trends in franchising are extending beyond mere products to include systemwide changes in ways of doing business. Among the most promising changes taking place are:

Internet franchising. "It's the beginning of the franchisor Internet explosion," says Siebert. "We're seeing a significant increase in both intranet pages as a means of communicating within franchise organizations and Internet advertising by franchises."

Globalization of franchising. Many franchisors overseas are either expanding vertically (growing rapidly in certain narrow industries such as fast food or retail) or horizontally (when many smaller U.S. franchisors enter the market).

Homebased franchises. Siebert calls growth in this sector "explosive," more than doubling in the past two years. Many of these franchise opportunities exist in business-to-business services, which are usually direct-sales franchises.

Rural franchises. "These smaller markets have been ignored for years and are fertile ground if you can develop a concept that works there," says Siebert. The key to success in rural markets, he believes, is the ability to provide quality services combined with lower start-up costs so the franchise can prosper even with lower levels of unit volume.

Infinite distribution points. "Years ago, we never dreamed you could purchase pizza over the Internet or be served a McDonald's hamburger on an airplane," says Janet Sparks, publisher of the Continental Franchise Review newsletter. "There are so many nontraditional ways of franchising now, there's no telling what the future might bring."

Legal Eagles

When it comes to legal and regulatory issues, 1996 was "a watershed year," says Robert Purvin, chairman of the board of trustees of the American Association of Franchisees and Dealers (AAFD).

This year, the traditionally franchisor-friendly courts warmed up to franchisees and set out to tackle the big stuff: encroachment, franchisee termination and advertising funds. "Suddenly this summer, we saw a spate of franchisee-sensitive court decisions," says Purvin. "It was unprecedented in terms of the number of significant cases, which is an indication of the shifting of public opinion and increasing empathy for the franchisee's perspective."

Here's a rundown of some of the landmark decisions in 1996:

Perhaps the noisiest was the case involving Naugles Inc ., which struck a nerve in the always sensitive area of encroachment. The 9th U.S. Circuit Court of Appeals ruled that Naugles, a Mexican-restaurant chain, breached the good faith and fair dealing clause in its franchise agreement when it opened a restaurant 1.4 miles away from a location owned by franchisee Vylene Enterprises Inc. (see "Franchise News," November 1996). The case succeeded in injecting the phrase "good faith and fair dealing" into the vocabulary of everyone in the franchising industry and left many franchisors trying to figure out exactly how that seemingly broad standard could be applied to the territorial clauses of their franchise agreements.

The PIP v. Sealy case got to the core of the franchisee termination issue. Steve Sealy, a franchisee who left PIP to start his own business when he had seven years left on his 20-year franchise agreement, was sued by PIP. But courts ruled to free him of the responsibility of paying future profits to the franchisor.

"Franchisors in the past could confidently go into court after terminating a franchisee for whatever reason and receive as part of their monetary reward the future royalties they would have received had the franchisee stayed in business," says Erik Wulff, a partner with Hogan & Hartson, a law firm in Washington, DC.

The case that some 2,400 present and former Meineke franchisees brought against their franchisor, Meineke Discount Muffler Shops Inc., introduced yet another overhaul to the franchising relationship: the class action suit. "In these cases, franchisees have redress in court by bonding together and, as a group, challenging the [franchisor's] practices," says Wulff. "It really underscores the power franchisees have to effect change."

And while courts once feared to tread into contractual relationships, they are now boldly pursuing what Wulff calls a judicial activism. "Courts are increasingly looking beyond franchise agreements and looking into [franchisor] practices," he says. "If judges sense something is wrong, they're going to find a way to right that wrong."

Though the courts are not likely places in which to seek peace, Wulff hopes "the end result of [the court decisions] is that the industry will be more effective at self-regulating and that franchisors will opt for more balanced franchise agreements and greater inclusion of franchisees in critical decision-making. If that happens, it will be wonderful for the industry."

David J. Kaufmann, a senior partner at Kaufmann, Feiner, Yamin, Gildin & Robbins LLP, a New York City law firm that counsels franchisors, believes tough court battles may be the exception rather than the rule in the future. "Franchising has already reached a certain level of maturity such that disputes are actually diminishing, not expanding," he contends. "The modern franchisor understands the benefits of mediation, and both sides understand that the money and time and antagonism engendered by litigation is [rarely] worth it."

Future Forecast

In many ways, 1997 will be even more crucial than 1996. How the groundwork laid last year will be refined remains to be seen.

"In 1997, we'll see franchisors reassessing the way their franchise systems operate, if for no other reason than to stave off the possibility that a franchisee association may form and force [change] upon them," says Wulff. "They'll become proactive and make necessary changes, which is a healthy development."

For several franchisors, those ideas are already being backed by action. Burger King's newest franchise agreement explicitly recognizes its franchisee association, and the company has made a commitment to periodically discuss a number of specific issues with the association. Carl's Jr. brought in one of its largest franchisees to help set its system straight, making most franchisees happy for the first time in years. And Pepsico, long embroiled in a tug of war over units, has settled a long-term contract dispute and renegotiated its franchise agreements.

A recent breakfast meeting between Purvin of the AAFD and Don DeBolt, president of the International Franchise Association, may not have made any headlines in this headline-laden franchising season. But it symbolizes a certain calm in the storm and hints at a time of future--dare we say it?--cooperation.

"We're working behind the scenes to develop a stronger franchising community, one in which everyone comes out a winner," says Purvin. "Two years ago, I said we were entering the golden age of franchising. And now it is upon us."

Legislation

For the past two years, while other franchising venues bustled with activity, the once-controversial House Small Business Committee remained almost silent. This was no surprise, because then-Committee Chair Rep. Jan Meyers (R-KS), who retired at the end of the 104th Congress, announced at the beginning of her reign that franchising hearings would not be a priority.

But a turnaround could be in the offing this year, as Rep. John J. LaFalce (D-NY), who was once in the eye of the storm surrounding franchisee rights, plans to reintroduce his franchise bill.

"In the last Congress, the [bill] was [whittled] down to a point where it's now focusing on basic rights and legal remedies," says LaFalce's spokesperson Dean Sagar. The bill does not bring government into the franchise relationship, says Sagar; it simply "eliminates some of the roadblocks in contracts [that prevent] franchisees from going to court to protect their investment."

SBA Loans

In July, the Small Business Administration (SBA) proposed setting new terms franchisors would have to meet for their franchisees to obtain SBA-guaranteed loans. With a requirement that franchisors designate a specific territory for franchisees, as well as provisions regarding management control, renewal, termination, default and transfer issues, the proposal hit on many touchy subjects.

At an October conference called by the SBA, equal numbers of franchisees, franchisors and lenders got together to talk about fair and appropriate terms for financing. "Debate is such a healthy thing," says attendee Robert Purvin of the American Association of Franchisees and Dealers. "The fact that it happened is a terrific development."

The SBA plans to finalize the new lending rules this month. "We are not looking to favor one side or another," says the SBA's Ronald Matzner. "The only way we fulfill our mission is to provide more financing for small business. Whatever this final draft looks like in the end, we will do nothing to harm the ability of small businesses to get the financing they need."