– Online Trading and the erosion of territorial exclusivity

For many years a key feature of any franchise has been the designation of a territory by a franchisor to a particular franchisee to operate a franchise business.

Territories are required to be clearly defined giving a level of confidence to the franchisee that he will be able to operate the franchise with certainty and to target the custom of an identified clientele base.

The franchisee ought to be able to safely maximise the returns from the customer base in a demarcated territory, pay the requisite franchisee fees, cover overheads and ultimately earn sufficient income to make a living.

This model is predicated on a reasonably static and easily identifiable customer base within the territory and on a business model where actual trade operates within the designated territory. However, the introduction of online trading has forced franchisors to revisit the assumptions underpinning their particular business model and the marketing and operation of a franchise.

Online trading effectively introduces a level of “fluidity” where the sale and purchase of goods and services may not neatly fit within the fixed demarcation of a territory belonging to a franchisee.  In the online world where the order was initiated and where the order is finally delivered (in for example, a sale of goods) may give rise to competing claims by franchisees. The territorial boundaries become instantly blurred, if not circumvented altogether.

For many long held franchises, the franchise agreements simply did not anticipate the evolution in trade that has been accelerated by online business. This is because historically, “high street” shopping for example, has always anticipated that the sale and purchase fully takes place within the demarcated territory. This is no longer the case. So where does this leave the franchisee?

The franchise agreement needs to be carefully worded to address this issue by providing express wording dealing with which party has the right to claim the online trade – the franchisor, the franchisee in whose territory the order emanated or the franchisee where the order is delivered (or both subject to each party’s contribution or role in the transaction). But, this is being overly simplistic as the initiation of the online sale may be processed through an IT network and servers located in jurisdictions which have no bearing at all to the overall franchise (i.e. offshore). Many franchise agreements need to be updated to cater for these nuances.

A more fundamental challenge for the franchisor is to consider the overall impact that online trade will have to the entire franchise network.

Online trade introduces scale and efficiencies on an unprecedented basis, the impact of which may significantly erode the overall “franchise model” rationale let alone the demarcation of exclusive territories of trade for franchisees.  A franchisor may be tempted to establish a parallel online trade capacity within the business however he cannot plunge headlong into this environment without taking into consideration the potentially prejudicial impact that may have in eroding the franchisee’s investment in a particular territory. To explore these opportunities, the franchisor needs to first investigate the change to the fundamentals of the business and the resulting impact that may be felt by franchisees. The franchisor would need to be wary not to  undercut the franchisee by establishing or advancing a change to the business model which sucks trade from out of the territory exclusively held by a franchisee.

Conversely, the nature and / or scale of the online transaction may be such that the franchisee would not be able to fulfil the order in the ordinary course and may be better satisfied by head office via the online trade portal. A real danger for both franchisor and franchisee is to try and address these complicated factors within a franchise agreement which wholly fails to contemplate online trade.  A franchisor would need to clearly articulate its plans in its disclosure documents before marketing a franchise to a potential investor. For an established franchise network, it would be important for all parties to consult with each other and flesh out the permutations, collectively agree a path forward and then specifically cater for the provision of online trade into the franchise agreement where each party is made keenly aware of their rights, roles and benefits arising from online trade.

For further information or assistance with such issues, please contact Grant Edmundson.