Knowing how to manage franchise owners can be tricky for an expanding franchisor, even without taking into account tricky legal considerations like whether to include an exclusive territory clause in an initial contract. Since 2004, it is a legal imperative for a franchisor to stipulate whether or not a franchisee is granted privileged access to an area. This is known as an exclusive territory clause. Many franchisees find the inclusion of this clause desirable, as it often secures better financial returns. For effective royalty management for a franchisor, it is imperative to explore whether awarding the clause aligns with your business interests, and negotiate with the franchisee on that basis.
Downsides of Granting Exclusive Territory
In recent years, exclusive territory clauses have fallen out of favor among franchisors. Fewer and fewer contracts include an exclusivity clause, as many franchisors are now cognizant of the challenges that exclusive territory poses to continual growth.
Development problems for franchisors associated with exclusive territory agreements include the following:
Stagnation in franchise development can be caused by granting inexperienced franchisees the right to operate in a territory that's too large for them to handle.
Market fluctuation/development in territories in which exclusivity clauses apply can make existing clauses undesirable.
Franchisors may be unable to access new consumer-oriented developments, like malls, that are built in exclusive territory areas, which can stymie franchise growth.
The clause could hinder expansion if the territory contains a larger market than initially estimated.
Exclusivity clauses can be used as leverage by franchisees to stop business development from their franchisor, online or through partnerships in exclusive territories.
Exclusivity clauses can prohibit a franchisor from purchasing other businesses or developing networked enterprises in exclusive territories.
However, although the absence of an exclusivity clause theoretically means that franchisors can expand anywhere — even next door to an existing franchise — in practice, there are legal franchisor responsibilities, such as good faith and fair dealing with the franchisee, that must be upheld.
Benefits of Including an Exclusive Territory Clause
As a franchisor, you'd be wise to employ tools that make your life easier, and an exclusive territory clause may be one of them, despite the downsides detailed above.
If your business model is dependent on the perception of your brand as niche and exclusive, exclusivity clauses often work in your favor. In that instance, they offer no prohibition on expansion, as your brand depends on exclusivity as a favorable characteristic. Furthermore, their inclusion gives you the opportunity to make non-competition a requisite of exclusivity, which guarantees the franchisee will not make an agreement with any competing distributor and protects your market share.
Another time-tested reason for granting a franchisee exclusivity is to increase your brand's desirability for other aspiring franchisees. Many franchisees choose to partner with a franchise because it's a secure way of achieving their financial and business aspirations. However, if franchisees perceive that their franchisor would not be supportive in any number of ways, like denying exclusivity, they may choose to partner with a competitor.
Franchisors must be conscientious about all their expansions, including whether to grant a franchisee exclusive territory. Whether to include an exclusivity clause or not ultimately depends on how the pros and cons align with the aspirations you have for your franchise operation.
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