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Franchise Tutorial 17: Intro to Territories and Protected Areas

Franchise agreements will typically address the issue of territories and/or protected areas. Protected areas may be defined by distance radius, postal codes, municipalities, cities or simply outlined as within the four walls of the franchised location. The territorial boundaries are defined in the franchise agreement and will often state that no other franchisee shall be licensed or a corporate store opened to operate under the same brand within the territory, provided that your franchise license is in good standing and you are living up to all terms of the franchise agreement.

The intent of the exclusive territory is to protect your business sales from being cannibalized by other locations offering the same products and services in close proximity to your location. Such encroachment could detract from your business sales.

It should be understood that not all franchise agreements have exclusive territories and one should read the franchise agreement carefully to fully understand the implications. Some franchise agreements will clearly state the territory is non-exclusive or simply defined as the address of the physical franchised location. Franchisors are becoming more and more reluctant to grant exclusive territories or protected areas as it restricts the franchisor's ability to grow the brand. Over time, new retail projects are built that provide great opportunities to build market share. The population may have substantially increased and now supports the brand having two locations. If the franchisor does not take advantage of the opportunity to expand, their competition will often do so. This may cause harm to the existing franchise location.

The Right of First Refusal is often a way that the franchisor addresses this issue. In the event that the franchisor determines that the demographics have changed and a second location is justified within the territory, you are provided the first opportunity to open the second location. If you choose not to do so, the franchisor is free to open the new location or franchise it to someone else and your original territory size is reduced accordingly.

Some franchises are sales- and marketing-driven, not location-driven. Examples of these are those specializing in home renovations, window washing and other services. They may be home-based businesses or operating out of a vehicle. The franchisee goes to the customer rather than the customer coming to a location. In these circumstances, an exclusive territory would provide you with the benefit of not having to compete directly with other franchisees offering the same service and/or product. However, your growth becomes restricted and limited to the size and potential of your territory. If you are referred business outside of your territory, you are required to turn the business over to another franchisee servicing that area. What if the sale is based on long-term relationships that you have developed? This has often been addressed by the franchise agreement stating that the territory is your primary market of responsibility and the only market that you can directly advertise in, but that you can service customers outside of your territory that have been referred to you or are generated through networking and advertising done within your defined territory.

From a franchisor's perspective, it has been learned that some franchisees are more sales- and marketing-oriented than others. This results in some territories being fully capitalized and generating strong sales and brand recognition, while other territories remain underdeveloped and not generating the revenues they should. Franchisors are addressing this by setting policies and defining minimum sales quotas within the franchise agreement. If sales quotas are not met, then exclusivity may be lost, allowing the franchisor to enter the market or license other franchisees within the area. There is also a common practice when the franchisor is looking to establish a location in close proximity to an existing location. The franchisor will usually conduct a study to determine the potential impact on sales of the existing location. If encroachment is determined to be a significant possibility, the franchisor may abandon its plans for the new store opening or provide some kind of revenue sharing with the existing location.

The franchise agreement may have other restrictions, restraints or permissions that further define and clarify your territory rights. Examples of these clarifications include:

Restriction of sales regarding national or institutional accounts. These may be handled by the franchisor.
Prohibition on the solicitation of sales from other franchisees of the franchise system so as to prevent franchisees from cannibalizing each other, usually when there are no protected territories.
Reservation of the franchisor's right to franchise different brands within the territory, which may or may not be a direct competitor to you.
Restriction and restraint of Internet or mail sales, which have no definite boundaries. Sometimes franchisors will reserve these sales for themselves and share the revenue with franchisees or will have the orders filled by the nearest location.

Reputable franchisors are as concerned about encroaching upon and cannibalization of locations as the franchisee. The franchisor also has a legal responsibility to act in good faith and conduct fair dealings. The specific territory and protected area policies and terms should be outlined in the franchise agreement. As a complex issue, it requires careful reading of all terms and conditions so that you have a full understanding of exactly how protected your territory is. Have a lawyer who is familiar with franchising assist you in understanding your franchise agreement and talk to existing franchisees to learn how territory issues have been dealt with by the franchisor in the past.

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Posted Date: January 2011