Comedian Louis Black once claimed that he discovered the end of the universe when he saw a Starbucks across the street from another Starbucks. I suppose we’re now in the post-apocalyptic world, as I’ve seen a number of shopping centers featuring both a stand-alone Starbucks coffeehouse and a supermarket that contains a Starbucks kiosk. Starbucks Corporation apparently views this arrangement as a “win-win” for it, as it receives revenue from both its corporate-owned locations and the kiosks that it has licensed to third party retailers like Safeway. Safeway Inc. apparently likes the arrangement as well, as the practice has existed for a number of years.
A typical, non-Fortune 500 franchisee, however, probably should be wary of a nearby intra-brand competitor – whether that competitor is the franchisor itself or a fellow franchisee. A McDonald’s franchise owner, for instance, might have a legitimate beef (no pun intended) if McDonald’s Corporation allowed another franchisee to open next door to it and dilute its customer base. One reason we don’t normally see this type of occurrence, of course, is the existence of protected territories. Unfortunately, some franchisors are more scrupulous than others when it comes to truly protecting franchisees from competition.
When presenting a franchise opportunity, a franchisor might downplay the importance of a protected territory (especially if it does not offer one) or offer assurances that the territory being offered is sufficient. A stock explanation sounds something like this: “You’ll be representing our brand and paying royalties based on your revenue. We only succeed if you succeed. Why would we want to saddle you with a nearby competitor who could hurt your business and therefore hurt us?”
That rhetorical question can be answered in at least two different ways. First, the franchisor might actually be on the level and view itself as a strategic partner that wants the general public to associate its brand with quality and success. (If so, you still should seek the necessary contractual protections.) Second, the statement that the franchisor “only succeeds if you succeed” and would itself suffer injury if your sales were lost to a fellow franchisee could very well be incorrect. Assuming that you and a fellow franchisee pay the same royalties on your respective sales, does it really matter to the franchisor which one of you pays those royalties? On the other hand, might a franchisor feel motivated to offer franchises to both of you in order to (i) receive duplicate “initial franchise fees”; (ii) placate the other franchisee, with whom it hopes to become a multi-unit franchise; and/or (iii) increase the number of locations or franchised providers viewed by the public? Or what if the franchisor decides that it is more profitable to operate through company-owned sources – such as corporate stores and/or the internet – than to rely solely on franchise fees in your market? These possibilities are all too real.
If offered a franchise opportunity, you must determine whether, in light of the product or service you’d provide, territorial protection is needed. If so, you need to determine the appropriate size in light of your market’s demographics. (A two-mile exclusive territory might work well in a heavily populated urban area but not too well in a sparsely populated rural area.) Then, compare the size of any territory offered by the prospective franchisor with those needs.
Perhaps as importantly, know that much of the territorial “protection” offered by today’s franchisors can be illusory. For example, the franchisor might do one or all of the following:
- Agree not to offer franchises in your territory but reserve to itself the right – or stay silent regarding its right – to compete through company-owned locations.
- Reserve the right to offer competing franchises or open company-owned locations in nearby mall food courts.
- Allow certain retailers such as supermarket chains to sell the same products being offered by franchisees.
- Reserve to itself the right to compete with you through unconventional methods, such as internet sales.
- Expressly or implicitly reserve the right to operate or offer franchises of competing, but different, brands in your territory.
- Promise to protected territory unless and until you commit a “material default.” The problem with such an open-ended condition is that the franchisor probably has the means to “manufacture” a default if it’s looking for an excuse to pull your territory.
The issue of territorial protection is not that a franchisee should lightly consider. It’s better to start considering before purchasing a franchise – not once the competition has begun.