Franchises

Uncharted Territories: Understanding a Franchise's 'Territorial Rights'

Uncharted Territories: Understanding a Franchise's 'Territorial Rights'
Image credit: Tim O'Brien | Flickr

The following excerpt is from Mark Siebert's book Franchise Your Business. Buy it now from Amazon Barnes & Noble | iTunes

Mark Siebert delivers the ultimate how-to guide to employing one of the greatest growth strategies ever -- franchising. Siebert shares decades of experience, insights, and practical advice to help grow your business exponentially through franchising while avoiding the pitfalls. In this edited excerpt, Siebert discusses what you must consider when determining whether to offer franchise territories or not.  

An important issue relative to the structure of your franchise offer will be the territorial rights you grant your franchisees, along with any performance requirements you may choose to attach to them. Since granting protected territories will ultimately limit the potential size of your franchise system, one of the most important first questions to address will be whether to grant an exclusive territory at all.

While not all franchisors grant territorial protection to their franchisees, for newer franchisors, a protected territory is often a selling point of the franchise value proposition. Franchisees often expect a protected trade area when they buy from a franchisor. And if your competitors offer a protected territory, failure to do so could put you at a substantial disadvantage in the sales process.

But while an exclusive territory can be a great selling point, doing it wrong comes at a major cost. If, for example, you make your territories too small, you run the risk of franchisee failure and alienated franchisees, which can easily lead to your franchise’s demise. On the other hand, a territory that's too large may provide an advantage to future competitors, who'll develop more units in the same market. Franchisors who make this mistake may find their franchisees operating at a disadvantage relative to competitors who have better saturated the market -- providing them with more advertising dollars to spend, better purchasing economies, more market visibility, and more efficient logistics.

This decision is made even more complicated because the population required to support a business will likely change over time. Increased name recognition and brand awareness should allow a unit to thrive in smaller demographics. Concept changes, such as new product lines or service offerings, may have a similar effect. And, of course, the emergence of new competitors may have the opposite effect. For these reasons, it is always advisable for you to build as much flexibility as possible into any exclusive territory definitions.

This flexibility will require forethought. For example, you'll want to consider exactly what you'll include as part of this territorial exclusivity.

  • Will you carve out an ability to sell product through alternative distribution channels?
  • Will you reserve rights to run competing brands in the same territory?
  • Will you award territories based on a radial boundary (easy, but inefficient) or based on a map (more efficient and more difficult)?
  • Will you have different definitions in different types of markets (large urban areas, suburban locations, etc.)?
  • Will you define your territory based on population or based on a more appropriate variable?
  • Will you have demographic carve outs for certain types of locations (airports, enclosed malls, train stations, etc.)?
  • If you'll be granting exclusive territories, should you attach performance requirements (a barrier in the sales process) to maintain exclusivity? If so, should these requirements be sales-based (perhaps posing an even larger barrier) or performance-based?

If your franchise involves outside sales, you'll have an entirely new set of considerations as well:

  • Will you allow franchisees to market outside their territory?
  • Will they be allowed to market on the internet?
  • Will they be allowed to sell outside their territory if a buyer wants to work with them (perhaps because of a personal relationship) even though they did no marketing outside their territory?
  • How will you handle situations in which the franchisee is selling to a company with offices both inside and outside their territories?
  • What if the franchisee sells something in another franchisee’s territory in any of the above circumstances?
  • If there are both sales and fulfillment/service functions, will one franchisee be allowed to sell and another asked to fulfill? If so, how will that work from a compensation standpoint?
  • If you will have a national accounts program, how will you define “national accounts”?
  • Will you allow your franchisees to call on larger accounts, or will you reserve them for yourself?
  • If you sell them, will you involve the franchisee in their territory?
  • Will you provide a financial incentive to the franchisee if they provide a lead to a national account?
  • If you sell a national account, will you require your franchisee to service it? If not, will you have a right to service it?
  • How will you be compensated for these national account sales—just through the royalty, or will you also be entitled to a national accounts fee?

The list of these questions could go on and on, but for virtually every one of the questions above, there are advantages and disadvantages that you should weigh and decide prior to the sale of your first franchise.

Of course, one of the most pressing questions you'll need to decide as a franchisor will be how to determine the appropriate size of the territory. For the vast majority of new franchisors, their data set is simply insufficient for this type of analysis. While the dearth of customer data makes it more difficult, there are steps you can take to refine your estimate of territorial parameters. Some of the tools you can use include:

Pin-map studies. These studies plot your existing customers on a map in relation to the location of your site or sites. You then determine the size of the area from which a franchisee could earn an adequate ROI by drawing a hypothetical map around the site and measuring the demographics within that site.

Isolated market studies. If you have a unit in an isolated market, you can study the demographics of that market to determine what it takes to generate a certain level of business. Of course, many times there are no appropriate markets to which you can apply this meth­odology.

Competitive analysis. It can sometimes be useful to investigate how competitors design their territories or look at the number of fran­chisees they've placed in various types of markets. Of course, to use this methodology, you'll need to have a relatively similar competitor and some knowledge of how they have defined their territories. And the downside to this analysis is that it assumes your competitor made no mistakes in their own analysis—always a risky assumption.

Market penetration estimates. This method starts by looking at an estimate of your current consumer market penetration and extrap­olating that number into other markets. If, for example, you were achieving about a 5 percent share of the market in the markets you currently serve, you might assume that same level of market penetration (and similar levels of sales per customer) and use that information to reverse engineer a territory size.

For the well-funded franchisor seeking to grow aggressively, we typically recommend you retain the services of a GIS (geographic information system) analytic firm that can undertake a more comprehensive approach to defining territories using a broad range of metrics. GIS companies have access to many different types of data points, often including data on competitor locations within markets targeted for expansion.

If more sophisticated analysis is not an option, you should use some combination of these methodologies to develop a best estimate. That said, savvy franchisors will develop their territorial structure with the kind of flexibility that will allow them to modify the structure (or at least minimize the impact of initial imperfect estimates) as more data allows it to more precisely carve up territories.