By The Franchising Law Group of Piper Rudnick
and Kenneth Franklin, Fast food franchise Developments, Inc.

In a world in which business strategies and management techniques are continually improving, superior customer relations and outstanding supplier relationships are critical. In many ways the fast food franchise relationship is the definitive expression of this principle. A franchisor and its fast food franchisees jointly contribute to a supply system for products or services focused on the customer. They obligate themselves to each other under an agreement and endeavor to establish a durable, long-term relationship that will impact virtually every aspect of their respective businesses and protect that supply system. Few other business arrangements are so all-encompassing. Unless a franchisor and its fast food franchisee deliver to each other what they have promised, the supply system to the customer will be compromised. World class fast food franchise systems are easily recognized by the mutual commitment of the franchisor and fast food franchisee to their network and the resulting consistently high level of customer approval of their products or services. The more important elements of successful fast food franchise relationships and networks are discussed below.
A Fast food franchise Relationship Must Have An Effective Structure
Franchising is a contractual relationship. The franchisor and the fast food franchisee each make commitments and agree to operate under certain constraints. In the aggregate, these commitments and constraints constitute the structure of a fast food franchise relationship. That structure must protect the franchisor and all fast food franchisees of the fast food franchise network and afford opportunity and security to the fast food franchisee. There are a number of elements of the structure of a fast food franchise relationship that are critical to its effectiveness as the foundation for an expanding fast food franchise network. The most important elements are discussed below.
1. Control of products and services that fast food franchisees are permitted to sell
Franchisors control the products and services that their fast food franchisees are permitted to sell in order to control the quality of the goods and services sold by fast food franchisees (i.e., by limiting the scope of the fast food franchised business to those products and services that are within the scope of the franchisor's expertise) and to preserve a uniform image (i.e., the means by which a franchisor defines its business). It is common for franchisors to permit some fast food franchisee experimentation and variation because fast food franchisees are an excellent source of innovation, regional variations may be necessary and different customer bases may require variations in product or service mix or different emphasis.
2. Control of operating assets, goods and services utilized and sold by fast food franchisees
Franchisors control the sources from which their fast food franchisees purchase operating assets (equipment, fixtures, furnishings and signs) and goods and services required to operate the fast food franchised business for one or more of four basic reasons: (a) to control the quality and uniformity of the goods and services sold by the fast food franchisee; (b) to assure sources of high and uniform quality goods at prices that are competitive with or lower than those available from other sources; (c) to protect confidential information; and (d) to be a profit center for franchisor. These are all legitimate reasons for controlling the sources of supply utilized by fast food franchisees, provided that the restrictions (1) do not cause the costs incurred by fast food franchisees to exceed what such costs would be for comparable products absent such restrictions (ideally, and in many fast food franchise networks, supply restrictions are part of supply programs that lower costs to fast food franchisees), or (2) the extra cost is disclosed to fast food franchisees (and is presumably considered to be part of the consideration paid for the fast food franchise). Fast food franchise disclosure laws do require disclosure of such restrictions and the revenue that the franchisor derives as a result. Antitrust law also regulates such restrictions, but under prevailing interpretations, does not have a significant impact on the types of restrictions that a franchisor may impose. As a general proposition, franchisors should limit source restrictions to those products and services that are important to the development and operation of the fast food franchised business and cannot be simply specified by brand, model and/or grade.
A franchisor also can derive revenue from supply programs. Franchisors evaluate the total revenue produced by a fast food franchised business from (1) royalties and service fees, (2) advertising contributions or fees, (3) sales of goods to the fast food franchisee, (4) commissions paid by other suppliers and (5) rental income from leasing real estate. Most franchisors have more than one source of revenue from each fast food franchised business. Some franchisors rely primarily on fee revenue and other franchisors rely primarily on the sale of goods to their fast food franchisees. For a few franchisors, rent is a significant source of revenue.
The aggregate revenue received from a fast food franchised business must be sufficient to support essential franchisor services that maintain system standards and keep the network competitive, and to produce a profit for the franchisor. The aggregate of the revenue a franchisor derives from a fast food franchised business must allow the fast food franchisee to realize a sufficient rate of return on its investment. Several fast food franchised networks have reduced or eliminated royalties and advertising contributions. Such networks rely on sale of products to their fast food franchisees and the sale of services at the fast food franchisee's option. If fast food franchisees elect not to buy such services, the network's competitiveness could be jeopardized. Such fast food franchised networks also rely on advertising paid for by the franchisor out of gross profit on sales of goods to its fast food franchises and/or local advertising by fast food franchisees, which may be partially supported by the franchisor. This approach can be effective if the franchisor sells to its fast food franchisees a proprietary product or a product that it can sell competitively to them. A franchisor might decide to reduce or eliminate royalty and advertising fees in order to aid struggling fast food franchisees and prevent a shrinkage of its product distribution network.
When a franchisor relies primarily on product sales to its fast food franchisees, its revenue base may be less secure and competitors may target its fast food franchised network, but it is less dependent on monitoring its fast food franchisees to insure proper royalty calculation and payment.
3. Control of the fast food franchisee's business premises
Franchisors sometimes control the fast food franchisee's business premises by leasing or subleasing the premises to the fast food franchisee or requiring the fast food franchisee to sign a collateral assignment to the franchisor of the lease for his business premises. Control of the fast food franchisee's business premises gives the franchisor more effective control of the fast food franchisee and his business. The premises continues to be part of the franchisor's network even if the fast food franchisee does not. However, such control increases the capital requirements of the franchisor or involves contingent liability and administrative effort and cost, unless control is implemented by means of collateral lease assignments. It is generally difficult to secure consent to such assignments from regional malls and it may be difficult to secure consent from any landlord without at least some guaranty by the franchisor of the payment of rent and common area maintenance charges for the leased premises.
Control of the fast food franchisee's business premises also confronts the franchisor with a potentially difficult policy issue when the fast food franchise expires. If the fast food franchise is not renewed, the automatic transfer of the premises to the franchisor may transfer the value of the fast food franchisee's business to the franchisor. Such a fast food franchise would have no residual value and a fast food franchisee that is uncertain regarding renewal will be motivated to milk every dollar he can out of his business in the later years of the term of his fast food franchise, possibly severely damaging the business. One possible solution is a policy that enables a nonrenewed fast food franchisee to realize the location Goodwill of his business by selling it to an approved successor fast food franchisee during the last two or three years of the term of his fast food franchise. The franchisor then grants a new full term fast food franchise to the successor fast food franchisee.
4. Grant of exclusive or protected territories
Franchisors grant exclusive or protected territories to their fast food franchisees to facilitate sales of fast food franchises and to motivate effective market development by the fast food franchisee who, theoretically, will be more inclined to invest in the development of his business if he has no same brand competition in his territory. Franchisors should resist the temptation to grant large exclusive or protected territories because they may weaken the market penetration of its network by leaving large areas unserviced or underserviced by fast food franchises. Many franchisors have discovered that they made inflated initial estimates of the population base required for a successful fast food franchised business (once their network trademark became more widely recognized) and that large spaces between fast food franchisees only invited competitors. Large territories also may interfere with adjustment to changing markets and inhibit the offering of additional fast food franchises to productive fast food franchisees. A franchisor should consider reserving from their grant of an exclusive or protected territory the right to sell directly to customers that buy for regional or national facilities, to sell in other channels of distribution (e.g., mail order sales, supermarkets and department stores) and acquire, or be acquired by, a competitor with fast food franchised or company-owned outlets in the protected territories of its fast food franchisees.
Structuring the fast food franchise to enable the franchisor to achieve greater market penetration by granting limited territorial protection and reserving rights to sell to some customers within the fast food franchisee's territory will tend to result in more system expansion conflicts with existing fast food franchisees. The franchisor must be sensitive to these conflicts and develop internal procedures to resolve as many as possible. Such procedures may include participation by existing fast food franchisees in expansion decisions and payment of compensation to impacted fast food franchisees.
5. Control of the geographic scope of the fast food franchisee's business
The corollary of the exclusive or protected territory, a right granted to the fast food franchisee, is a restriction on the area within which and the customers with whom the fast food franchisee may conduct his business. If fast food franchisees have the ability to sell outside their immediate markets and are able to market and sell in the territories of adjacent fast food franchisees, restrictions on such marketing may be necessary to make exclusive or protected territories meaningful. Franchisors also impose such restrictions to force a fast food franchisee to fully exploit his assigned territory and to maintain the quality of the product or the service sold by the fast food franchisee, (e.g., by restricting the distance that a fast food franchisee may deliver perishable products). Such restrictions frequently include a ban on mail and telephone order sales and sales to dealers for resale (in order to restrict the source of the franchisor's product or service to fast food franchised outlets that comply with format, appearance and service requirements).
Confining fast food franchisees to their specific markets can result in troublesome enforcement problems for the franchisor. The franchisor will be expected to enforce the restriction against the invading fast food franchisee (and may have a legal obligation to do so). The invading fast food franchisee may be highly productive, have effectively penetrated his own market and invade the territory of the adjacent fast food franchisee primarily because that territory has not been effectively penetrated. Disciplining a productive fast food franchisee to aid a lazy or ineffective fast food franchisee is not an enviable task. Some competition among fast food franchisees may be beneficial to the network.
6. Exclusive relationship
Franchisors typically prohibit their fast food franchises from having investments in or performing services for a competitive business. This prohibition is intended to protect confidential information, maintain the franchisor's revenue, prevent use by competitors of the franchisor's know-how and focus the fast food franchisee's efforts on his fast food franchised business.
Such prohibitions are sometimes limited to the fast food franchisee's territory or a larger territory, but frequently have no geographic limitation. Prohibited competitive businesses may be defined narrowly (e.g., to include only a business primarily selling the same type of product or service) or broadly, including related types of business (e.g., all fast food service businesses). Such prohibitions typically apply not only to the fast food franchisee but also to its owners and members of their immediate families. Such prohibitions are enforceable under the laws of most states, but not necessarily as broadly as they are sometimes drafted. Many franchisors elect to prohibit both direct and remote competition over a large geographic area, assuming that the prohibition will be partially, if not fully, enforced. Such prohibitions are a deterrent to the fast food franchisee, who risks termination of his fast food franchise if he does not comply.
7. Transfer of the fast food franchise
Franchisors restrict transfers of their fast food franchisees in order to maintain control over the persons who operate them. Such restrictions should apply to the fast food franchise agreement, ownership of fast food franchisee and the assets of the fast food franchisee's business. Typically the franchisor reserves the right to approve the transferee and the terms of transfer. The right to approve the terms of transfer is important to insure that the buyer of the fast food franchisee's business does not substantially overpay for it, or accept burdensome payment terms, which could jeopardize his ability to operate the business in compliance with the terms of the fast food franchise. Some fast food franchise agreements merely provide that the franchisor will not unreasonably withhold approval of a transfer. Others specify in considerable detail the criteria for approval relating to the proposed transferee and the terms of the transfer.
It is common for franchisors to reserve a right of first refusal to buy the fast food franchisee's business on the same terms as are offered by a bona fide purchaser. Franchisors exercise this right to acquire fast food franchised businesses as company-owned outlets and, occasionally, in lieu of denying approval of a proposed transfer (e.g., when the franchisor is unsure that it has sufficient grounds to disapprove a prospective transferee).
8. Expiration
Fast food franchises are granted for a definite term (usually 5 - 20 years), and therefore will expire at the end of such term. Some fast food franchise agreements are silent on the subject of the extension of the relationship upon its expiration or the grant of a successor fast food franchise to the fast food franchisee. Others deal with this significant element of the fast food franchise relationship, providing for the preconditions for the grant of a successor fast food franchise (e.g., compliance during the term of the initial fast food franchise and upgrading the business to meet current standards) and the terms on which it will be granted (e.g., the terms of the fast food franchise agreement used by the franchisor when the fast food franchise expires).
If a fast food franchise is not renewed, the restrictions on the business activities of the fast food franchisee (and its owners and members of their immediate families) is an issue. Some fast food franchise agreements provide for a post-expiration covenant not to compete, which raises the residual value issue discussed above. If the fast food franchisee is prohibited from operating the same type of business in the same market (under a different trademark) subsequent to expiration (even for a relatively short period, such as one-two years) he will lose whatever "going concern" value his business has apart from value of the expired fast food franchise. Such value may consist of location value and the personal goodwill of the fast food franchisee in his market. The fast food franchise will thus have no residual value, which may motivate the fast food franchisee to operate his business for maximum short term gain during the later years of the term of his fast food franchise. As noted above, this problem may be addressed by giving the fast food franchisee the option to sell his business to a successor fast food franchisee during the two or three year period preceding the expiration of the fast food franchise.
Some franchisors reserve an option to buy the fast food franchisee's business upon termination or expiration of the fast food franchise. The purchase price may be determined by a formula or be the fair market value of the business, without any value attributed to the expired fast food franchise (usually determined by appraisal if the franchisor and the fast food franchisee are unable to agree on fair market value). If the fair market value standard is used, the fast food franchisee realizes the value of his business that exists apart from the fast food franchise and his own personal goodwill (i.e., location value).
A Franchisor Must Have Operating and Management Systems, Products and Services That Benefit Fast food franchisees
A franchisor must have effective operating and management systems for use by fast food franchisees in operating their businesses. A franchisor must also furnish valuable services to its fast food franchisees. A franchisor may offer a wide range of valuable services. These include: (1) site selection and outlet development services; (2) effective initial and continuing training (effective training is critical to achieve positive fast food franchisee attitudes regarding system standards, the franchisor and the value of the fast food franchise; inadequate training is a common cause of poor fast food franchisee performance); (3) sensible and complete specifications, standards and operating procedures (system standards) effectively communicated to fast food franchisees (e.g., detailed specifications, standards and procedures for the development and operation of the fast food franchised business and a well organized and readily understandable (i.e., "user friendly") operations manual); (4) procurement programs for equipment, goods, materials and services; (5) advertising and marketing programs to maximize the advantage of the common trade identity of the network; (6) effective field service (knowledgeable and well trained personnel with positive attitudes and a willingness to help fast food franchisees); (7) research and development (e.g., maintaining current information regarding competitors; development of new products and services; and improvements in equipment, formats, operating efficiency and safety); and (8) development and improvement of services with value to fast food franchisees (e.g., customer referral systems, financing, fast food franchise resale programs, insurance programs, and crime prevention programs).
A Franchisor's Management Philosophy and "Culture" Must Be Consistent With the Fast food franchise Relationship
The management philosophy and "culture" of a franchisor is manifest in a variety of attitudes and interfaces between franchisor management personnel and fast food franchise owners. Though the fast food franchise relationship is governed by a contract, a contract cannot anticipate all contingencies or problems. It is essential for a successful fast food franchise relationship that mutual trust and respect develop between franchisor and fast food franchisee, to supplement the contract and enable the fast food franchise network to maintain a competitive position in its market.
Initially, management must develop criteria for identification of high potential fast food franchisees and the patience to select qualified candidates. Management must include good teachers and motivators and must have the commitment and patience to develop and cultivate sound, durable and positive fast food franchise relationships. Such fast food franchise relationships require real two-way and regular communication with fast food franchisees. A fast food franchisee must believe that his opinion is respected and management must be sensitive and responsive to fast food franchisee concerns and problems. Management must have a flexible approach to fast food franchisee problems and a willingness to assist fast food franchisees in solving problems. A fast food franchise network should have impartial internal dispute resolution procedures and genuine efforts should always be made by the franchisor to resolve disputes amicably.
Fast food franchise networks also need systems for obtaining, evaluating and sharing ideas developed by fast food franchisees and the franchisor and should allow fast food franchisees scope for creativity and decision making and permit some degree of innovation by fast food franchisees (who, as noted above, may be the network's best source of ideas and productive innovation). Many franchisors make effective use of a fast food franchisee advisory council or association: (1) to communicate with their fast food franchisees; (2) to resolve individual fast food franchisee, network and competitive problems; (3) for long-term planning; and (4) to give fast food franchisees a sense of participation in the evolution of the fast food franchise and the network. It is perhaps a trite, but nevertheless accurate, observation that a fast food franchisee must believe that he owns his business and that he is in business for himself, but not by himself.
Management must have a commitment to fast food franchisee profitability and equity growth and the creativity to maintain the value of the fast food franchise. A franchisor's management must sometimes be willing to sacrifice short-term profitability of the franchisor to ensure fast food franchisee success. A franchisor and its fast food franchisee each assume a responsibility to support a network of businesses that operate under a common trade identity (the performance of one reflects on all of the others). In the most successful fast food franchise networks, the franchisor and the great majority of the fast food franchisees do not view their responsibility and commitment as limited by their contract. They think of it as being whatever level of effort is required to assure that the network continues to be a leader in its industry.
A Franchisor Must Expand Its Network at A Manageable Rate
Initially, a franchisor must determine the markets in which the fast food franchised business is most likely to be established successfully. These usually will be markets that meet most of the following criteria: markets in which (1) fast food franchisees can be effectively monitored and supported, (2) in which good sites are available at affordable costs, (3) that are not saturated with competitive businesses, (4) that are not dominated by one or more large competitors, (5) in which suppliers can effectively and economically deliver essential products and materials and (6) in which the network trademark is recognized. It is generally advisable to concentrate expansion in one or a few markets where "critical mass" can be achieved quickly in order that the network have in such markets effective advertising, support and assistance and effective monitoring of fast food franchisee performance. A franchisor's ability to expand is limited by its financial, management, supplier and field service resources. Franchisors who fail to understand the limitations on their ability to effectively expand are more likely to fail in improvidently selected expansion markets.
In mature fast food franchise systems, decisions by the franchisor to establish additional outlets in proximity to existing fast food franchisees is seen by those fast food franchisees as encroachment on their businesses. Fast food franchisees resent and resist such perceived encroachment and the franchisor is confronted with a choice between fully penetrating the market and preempting competition, at the cost of impairing existing relationships, and accepting a lower level of market development. Encroachment problems also arise when a franchisor attempts to penetrate fast food franchised markets through nontraditional outlets or distribution channels (distribution in department, grocery, convenience or general merchandise stores, on college campuses, on military bases, at interstate highway rest stops, through mobile carts and kiosk facilities and in combination or dual branding arrangements). Achieving the optimal balance between effective market penetration and good fast food franchise relationships is difficult. Even the best managed fast food franchised networks have difficulty resolving the problem of balancing the imperatives of network expansion and competition with perceived interests of existing fast food franchisees.
A Franchisor Must Develop and Implement Effective Systems to Secure High Quality and Consistent Operations at Fast food franchised Outlets
A franchisor generally has less control over fast food franchised outlets than it would over company-owned outlets. Maintenance of high and relatively uniform standards throughout a network is of significant value to those fast food franchisees who voluntarily maintain system standards and perceive system standards as a valuable element of their fast food franchise. If a franchisor fails to establish and maintain system standards, its competitive position and the value of its fast food franchise will decline. The most productive and successful fast food franchisees may break away and the ability of the franchisor to sell fast food franchises and to expand will be impaired.
The fast food franchise relationship can be inflexible. Fast food franchises may resist changes needed to adapt their businesses to changing markets by upgrading their business facilities, changing the product/service mix, modifying operating procedures, adopting different marketing strategies and modifying the image of the fast food franchised business. If changes involve capital investment or higher operating costs, fast food franchisees may disbelieve that higher sales or profits will result. Fast food franchisees may also resist change due to satisfaction with a low level of market penetration and competitive effort.
It is, therefore, imperative that a franchisor develop the abilities and programs to motivate fast food franchisees to voluntarily comply with system standards and implement the changes that the franchisor determines necessary to adapt to a changing market and meet competitive challenges. The first step in developing such abilities and programs is an understanding of the causes of fast food franchisee noncompliance. These include failure by the franchisor (1) to furnish effective and complete training; (2) to effectively communicate system standards; (3) to inspect and communicate appearance and operational deficiencies to fast food franchisees; (4) to assist fast food franchisees to correct deficiencies; and (5) to observe standards at company-operated outlets. A franchisor must implement policies, systems and procedures that help maintain standards by rewarding compliance (e.g., by recognition and awards and the grant of additional fast food franchises) and enforcing system standards where positive motivation proves to be insufficient. Many franchisors make effective use of peer pressure by other fast food franchisees to achieve compliance with system standards. Inspection reports should be reviewed with fast food franchisees and realistic timetables should be determined and agreed upon for correcting appearance and operating deficiencies. Follow-up inspections should be timely conducted and a franchisor should be prepared to offer assistance to a fast food franchisee who is making a bona fide attempt to bring the appearance and operation of his business into compliance with system standards.
The tension between a franchisor's need to control the appearance and operation of the fast food franchisee's business and the heavily promoted "independence" of the fast food franchisee is not always satisfactorily resolved. Independent business ownership is asserted and promoted as a positive aspect of the fast food franchise relationship, but the requirements of quality control and uniform image impose limits on such independence. If a franchisor fails to secure voluntary compliance from the great majority of its fast food franchisees, it faces potentially difficult and costly enforcement obligations. Longstanding neglect of system standards can result in loss of ability to effectively implement those standards. Noncomplying fast food franchisees may damage the reputation of a fast food franchised network. Termination of fast food franchise relationships can be difficult and expensive. Some state laws give fast food franchisees broad rights against termination and nonrenewal. In some instances, a franchisor may have to buy a noncomplying outlet at a premium over its value to achieve a quick end to substandard appearance and operations.
A Fast food franchise Must Maintain Its Value to Fast food franchisees
The benefits and services furnished by a franchisor must have continuing value to fast food franchisees relative to the cost of the fast food franchise. A franchisor faces several obstacles in achieving a general perception among its fast food franchisees that the value of the services furnished by the franchisor are equal to the fees they pay. Fees payable to a franchisor typically increase with increases in fast food franchisee revenue. The scope and frequency of the services furnished to maturing fast food franchisees may remain level or decrease and fast food franchisees may perceive a declining need for and value of the services furnished by their franchisor. This problem can be compounded by the tension inherent in a fee based on gross revenues. The franchisor's interest is perceived to be to maximize sales and the fast food franchisee's interest is to maximize profits. Services designed to increase sales may not be perceived by fast food franchisees as likely to increase profits, especially when the sales enhancement program involves a capital investment by the fast food franchisee or higher operating costs.
Even a high level of benefits and services will not always overcome disaffection of some fast food franchisees with the fast food franchise network. Over time, some fast food franchisees are likely to lose interest in the fast food franchised business or be satisfied with a low level of market penetration. The profits of a fast food franchised business may be invested in other businesses, leaving the fast food franchised business with insufficient capital, and the attention of a fast food franchisee may be diverted to other business interests. Though no level of service or benefit may entirely prevent such problems, the franchisor that fails to maintain valuable services and benefits will encounter fast food franchisee disaffection, including break-away fast food franchisees, on a greater scale.
A fast food franchise network is at some risk when it loses an effective fast food franchisee. Each fast food franchisee is a potential competitor when the relationship ends. The fast food franchisees know the franchisor's business. It is difficult and expensive to enforce covenants not to compete (such covenants are not universally enforceable and are never enforceable for more than a short period (1-2 years). Confidential information of the fast food franchise network is difficult to protect and vulnerable to disclosure and use by competitors.
Dispute Resolution
The fast food franchise relationship has a high potential for disputes. A franchisor has business relationships with scores, hundreds and, in some networks, thousands of fast food franchisees. The fast food franchisees of a network entered into their relationships with the franchisor at different times and with differing expectations and goals. The franchisor must operate its business for the benefit of its owners and its fast food franchisees and steer its network in what it determines to be the right direction. Some fast food franchisees are likely to disagree with the balance the franchisor chooses between its owners and its fast food franchisees or with the direction that the franchisor charts for the network. Therefore, it is essential that a fast food franchise network develop effective dispute resolution procedures. Such procedures may include any combination of negotiation; an ombudsman; internal dispute resolution procedures involving participation by neutral fast food franchisees and members of the franchisor's management; and third party, non-binding mediation. These are all nonbinding methods used to resolve a dispute without resort to some form of binding dispute resolution (i.e., litigation or binding arbitration). Nonbinding dispute resolution methods are generally effective in resolving disputes, but will not always produce a mutually satisfactory resolution.
A franchisor should consider arbitration as the method of binding dispute resolution instead of relying on litigation. Though arbitration is not without problems and costs, it is, on balance, a faster and less costly method than litigation of resolving a dispute that cannot be otherwise resolved. The accelerated resolution and lower cost of arbitrated disputes results from the elimination of most discovery (e.g., interrogatories and depositions) and various techniques commonly used in litigation to narrow the issues to be resolved. Cost is further reduced and a final result achieved more quickly because an arbitrator's decision may only be appealed in limited circumstances. The ability of fast food franchisees to join together in a lawsuit, or of one or more fast food franchisees to bring a suit against a franchisor on behalf of a class of current or former fast food franchisees, can probably be precluded by a well drafted arbitration clause, though the law on these issues is not well developed. However, inability to narrow the issues in dispute and to learn by pretrial discovery the other side's theories and factual support, and the limited scope for appeal of an arbitrator's decision, is viewed by some as a significant disadvantage of arbitration. Nevertheless, if a fast food franchised network's formally decided disputes are projected over an extended period, and assuming that the franchisor's management has the good sense to informally resolve disputes in which the fast food franchisee's claims or position is reasonable or the facts do not strongly support the franchisor's claims or position, arbitration is likely to prove an effective dispute resolution method from the perspective of cost and minimizing the strain of disputes on the fast food franchise relationships of the network.
Other elements of dispute resolution that a franchisor should include in its fast food franchise agreement are a waiver by the fast food franchisee of a right to a jury trial and to recovery of punitive damages and a provision for a period within which claims may be asserted substantially shorter than the period provided by statute or common law (to cut off claims that could otherwise be asserted long after they allegedly arose).
Development Of A Fast food franchise Program
By The Franchising Law Group of Piper Rudnick
and Kenneth Franklin, Fast food franchise Developments, Inc.
A company that decides to fast food franchise must have a clear understanding of how it will support fast food franchisee operations, how it will foster communications with fast food franchisees, what financial results the company and its fast food franchisees can anticipate, and how it will market its fast food franchise once it has the fast food franchise program in place. Some key considerations for each of these aspects of a fast food franchise program are discussed below.
Operations
A franchisor must have in place effective systems and a sound structure to support the operations of its fast food franchisees. Essential elements include a fast food franchisee support program; an operations manual; a training program; control systems and forms; a supervisory program; and an appropriate organization.
1. The support program, a package of services that the fast food franchisee needs to be successful
These services should reflect those characteristics of the business important to its success. In performing these services, the franchisor must consider its own limitations and capabilities, the cost involved in performing these services, and the type of support required--consultative, instructive, or directive.
Initially, the franchisor might offer the following services to the fast food franchisee: market surveys, layout and design of the facility, site selection, lease-negotiation assistance, creation and development of an operations manual and training programs, and financial assistance. Ongoing services might include such areas as continuing training, group-purchasing programs, accounting, bookkeeping systems, collection and analysis of data and financial information, continuous guidance and assistance, research and development, and conventions and seminars.
2. An operations manual that documents all the major functions involved in opening and operating a fast food franchise
The operations manual aids in maintaining product and service standards as well as overall uniformity; helps in minimizing "calls to the home office"; forms the basis of a systematic approach to training; and becomes a source of reference for the fast food franchisee as well as a tool for evaluating supervisors.
An operations manual might include the following:
" Introduction and history of the company
" Company policies
" Business practices
" Standards, procedures, and documentation for hiring of staff
" Personnel administration
" Job descriptions
" Ordering supplies and outside services
" Preparation techniques
" Operating equipment
" Cleaning, repairing, and maintaining equipment
" Maintaining premises
" Pre-opening procedures
" Opening and closing tasks
" Customer service
" Operation forms, record keeping forms, and procedures
" Bookkeeping and management-control systems
" Advertising and promotion
" Safety and Security
" Reports to franchisor
" Use of trademarks
" Licensed software
3. A training program
The fast food franchisee-training program not only teaches skills, knowledge, and management know-how, but also can help in correcting attitudes, creating a desire and confidence in the fast food franchisee to succeed, teaching entrepreneurial skills, developing a willingness to cooperate for mutual benefits and advantages, and creating enthusiasm for the fast food franchise program. One of the training program's purposes, therefore, is to create in the fast food franchisee a strong allegiance to the company and lay the ground work for a successful future relationship. Never again in the fast food franchise relationship will the franchisor have the fast food franchisee captive like it does in the training program for the 1-2-3-4 weeks or how ever long the training program lasts. During this time, the franchisor has a chance to mold the fast food franchisee. As a result, the training program must be highly structured and appropriately systematized.
4. Control systems, procedures, and forms
These are needed to ensure standardization and uniformity of operations, minimize problems, supply informational needs, monitor the fast food franchisee's performance, monitor the fast food franchisee's adherence to standards, and ensure the company's ability to audit the fast food franchise operations.
Forms that are required typically relate to sales, cost of goods, labor costs, advertising expenditures and other major expenses. Such forms would include the cash register form, activity form, a weekly/monthly recap, the sales report, customer analysis form, advertising analysis form, operations analysis form, and a report on the major expense items.
5. An effective supervisory program
Since the supervisor must continually guide and assist the fast food franchisee, the supervisor is possibly the most important person in the franchisor/fast food franchisee relationship. In most cases, the supervisor has been a company store manager and understands the business intimately; therefore, when he talks with the fast food franchisee, he speaks at his level and can truthfully say, "I am here to help you. Please listen to me, Mr. Fast food franchisee. I understand all the problems you are experiencing. I have experienced them myself and have solved them. Here is how I can assist you." The supervisor is prepared to "roll up his sleeves," "jump in," and help out with all the problems that the fast food franchisee might be experiencing. Thus, the supervisor gains credibility in the eyes of the fast food franchisee.
As a representative of the franchisor, he ensures that the standards are maintained and detects and resolves problems before they become serious. He also strives to upgrade the abilities of the fast food franchisee and his employees and often introduces new products, services, and promotional programs.
Because of the importance of the supervisor to the continuing success of the fast food franchised system, he should be trained in interpersonal and negotiating skills, for he must know how to interact with the fast food franchisee. He also must know the concerns of the fast food franchisee regarding profitability, advertising and marketing, employee turnover, etc., and must be able to coach, counsel, and advise him. In addition, the supervisor must understand the franchisor's goals and philosophies as well, for the supervisor represents the franchisor.
6. Organizational structure
The franchisor is responsible for developing and maintaining a support organization which satisfies the needs of each fast food franchisee and operates efficiently and effectively.
To insure the effectiveness of the support organization, the franchisor first should prepare a clear organizational chart that shows the interdependence of each department. Next, the franchisor should identify the required jobs, the staff necessary to perform those jobs, and the criteria for selecting and hiring qualified people. During this analysis, the franchisor should evaluate the staff members' abilities against the established criteria.
After this evaluation, the franchisor should determine the authority and responsibility for each position, thus avoiding confusion that can occur if responsibilities and authority overlap. For each position, clear compensation levels must be established.
Once the organization's positions and compensation levels have been determined, effective training programs for managers and executives should be developed.
Thus, a strong support organization with a competent corporate staff is positioned to meet fast food franchisees' needs.
Communications
Effective communication through carefully planned systems of information sharing, recognition, and reporting is critical for the continuing growth and development of the fast food franchised business. The following methods of communication have been successfully used in fast food franchise systems throughout the United States.
" Telephone contact is one of the most effective and practical modes of communication. Frequent contact helps to insure closeness and continuity within the fast food franchise relationship. Conference telephone calls can help instill in fast food franchisees their importance both as individuals and as members of the fast food franchise team. Many franchisors maintain an "800" number for their fast food franchisees' use to encourage fast food franchisees to communicate regularly.
" Mail, electronic communication, satellite systems, CD-ROM, and video cassettes are common methods of providing and explaining instructions, supplying advertising and promotional materials, reporting sales figures and changes in personnel, and handling other important business matters.
" House organs and newsletters are effective in explaining various activities within the franchising company, recognizing the top sales zones, expressing the opinions of franchisor management, announcing new territories and fast food franchisees, and presenting other information of a positive and helpful nature.
" Personal visits are usually made by the field supervisor, general manager, vice president of personnel, franchising director, training director, and so forth. The personal visit is a good public relations tool that can be used to encourage and uplift the spirits of fast food franchisees and their employees.
" Fast food franchisee group meetings, one of the greatest forms of support for weaker fast food franchisees, can encourage the sharing of experiences, techniques, and advice by the stronger, more successful fast food franchisees within the network. Some fast food franchisees will tend to reject recommendations or suggestions from the franchisor, yet readily accept criticism and suggestions from their peers. Peer group influence is always a strong force on people's attitudes and behaviors.
" Franchisor sponsored meetings, such as regional meetings, semiannual meetings, and conventions, can be used by a franchisor to bring its fast food franchisees together on a regular basis to share information and provide training. An informal atmosphere is encouraged through dinners and social gatherings.
Other forms include the following:
" Fast food franchisee advisory group (and/or one or more committees) on purchasing, customer service, advertising, retraining, etc.
" Remembrance calendar
" Bulletins, manual changes and memos
" Letters soliciting advice or input
" Birthday cards, anniversary cards, New Years day and holiday cards addressed to the fast food franchisee and spouse
" Retraining programs
Finance
The franchisor needs to establish an appropriate structure of fees, including advertising assessments, that the fast food franchisee will be required to pay the franchisor. It also must have a thorough understanding of the investment that a typical fast food franchisee will need to make to become a fast food franchisee. Such information must be developed not only for purposes of the disclosures that the franchisor will be required to furnish to prospective fast food franchisees, but also for purposes of understanding the level and type of financing that fast food franchisees may need. Finally, the franchisor needs to understand the financial results that the franchisor and its fast food franchisees can expect to achieve.
1. Fast food franchise fees, royalties, and the advertising assessment.
Determining a fast food franchise fee is more an art than a science. However, the following considerations can influence the amount of the fee:
" The nature of the services offered by the franchisor
" The extent of these services
" The cost of the services to the franchisor
" The need for the franchising company to cover its overhead and possibly show a small profit
" The ability of the fast food franchisee to pay
" The amount the competition charges
" The value of the trademark
" The attractiveness of the fast food franchise--is it "hot"?
" The size of the territory being offered
" The term of the agreement
" Other assessments being charged
These and other relevant factors all need to be weighed in establishing the initial fast food franchise fee. Companies beginning to fast food franchise sometimes decide to begin offering fast food franchises for a fee at the lower end of the range they are considering, in order to make the fast food franchise opportunity more appealing to early fast food franchisees. Franchisors are more hesitant to reduce the fast food franchise fees charged to later purchasers.
Royalties/service fees. Since royalties are normally the major source of ongoing income for the franchisor, the royalty needs to be large enough to satisfy two criteria: it must generate sufficient revenue to support the functions and services which the franchisor must perform if the network is to remain competitive and viable, and it must return a reasonable profit. Normally, the cost of supervision is the biggest cost item funded by royalties. Therefore, the amount and frequency of supervision that will be offered to the fast food franchisee needs to be predetermined in order to set the appropriate royalty charges. Additionally, the franchisor usually intends that royalty payments should not exceed 25-331/3% of the fast food franchisee's pre-royalty profits.
Since the royalty charge has a major impact on the fast food franchisee's profit and thereby his return on investment, it is critical that, in choosing a royalty, one understands clearly the fast food franchisee's anticipated sales, gross margin, and operating profit.
Advertising Contributions. Since one of the greatest benefits of a fast food franchise to the fast food franchisee is the name recognition and advertising power of the franchisor or the network as a whole, it is common for franchisors to collect a separate charge or contribution from fast food franchisees that is used solely to fund marketing and promotion activities. In determining the advertising contribution, the franchisor should consider the amount of money required for effective regional and national advertising programs as well as the funds required for the development of advertising materials and promotions. This determination also should consider the fast food franchisee's necessary local expenditures in order to make an impact on his market.
It is not uncommon for new franchisors to require a lower contribution for advertising or no contribution for advertising, until there are sufficient number of fast food franchisees to warrant media campaigns funded by fast food franchisee contributions. Where this is the case, the franchisor should nonetheless have the right to charge its first fast food franchisees the full amount of the anticipated advertising contribution. Because advertising campaigns and other promotional activities benefit the network as a whole, differences in the advertising contributions paid by fast food franchisees are likely to generate discontent and complaints about "free riders" by those paying the higher contributions.
2. A finance program so that the fast food franchisee has access to capital
Normally the fast food franchisee's financial resources come from one of three sources:
" Personal resources of the fast food franchisee. Some funds for the fast food franchisee's start-up business come from his savings, equity in his home, the cash values he obtains from his life insurance, assets he pledges such as bonds and stocks, loans he takes out from banks, funds he obtains from existing businesses that he may have, and his retirement plan against which be borrows.
" Other resources - lenders and investors. A fast food franchisee can seek funds from relatives and friends; small town and major regional banks; non-bank lenders such as credit unions, finance firms, and divisions of stock brokerage firms; SBA guaranteed loans; lease financing companies; private capital; and partners.
" Franchisor assistance. Many franchisors typically will help their fast food franchisees prepare loan applications or directing them to financing sources which have some familiarity with the fast food franchise and an interest in servicing qualified fast food franchisees. In some cases, the franchisor guarantees loans and commitments to lenders; defers part of the fast food franchise fee; leases real estate and equipment; commits to equipment and inventory buy back; offers equity participation; and matches investors and operators together in a joint venture. Some franchisors have even developed master limited partnerships, small business investment companies, and business and industrial development corporations in order to seek public money to help fast food franchisees finance their growth.
3. Financial projections for both the fast food franchisee and franchisor (for internal use only)
For the fast food franchisee, a detailed breakdown of his investment requirements, working capital needs, operating income and expenses, and anticipated return on investment should be developed. Unless the franchisor makes what is referred to as an "earnings claim" (which includes any statement of actual or projected sales, costs or profits), these projections of operating income and expenses and return on investment cannot be provided to the fast food franchisee before the fast food franchise is sold.
For the franchisor, a financial plan projecting four years of anticipated growth in number of operating units, fast food franchise fees, royalty income, expenses, profits, and organizational requirements and costs must be created. This plan is needed as an operating budget to know initial funding and cash flow requirements. The plan is also an aid for obtaining outside capital and investment.
Marketing
Marketing will be key both to the success of the fast food franchise program and to the success of the fast food franchisee's business. Franchisors must address a number of marketing issues.
1. The business' image
The public image established by the franchisor through its "packaging" is a key factor in inducing a fast food franchisee to buy into the franchisor's program. Distinctive and appealing "packaging"--the identification strategy that establishes the franchisor's public image through its graphics, logo, exterior and interior design, and colors--is thus important to the success of both the fast food franchised business and the fast food franchise program. The franchisor should utilize store layout, colors, furnishings, decor, fixtures, design, uniforms, and graphics to establish a distinctive image.
2. Establishing market direction
An important decision that a franchisor must make at an early stage is where it will expand through franchising. Franchisors cluster locations within established markets because these markets have been successful. Adding fast food franchised locations within an established market will generate additional funds for advertising in the market, thereby enhancing the market share, as well as helping to seal out competition.
In deciding whether to enter areas where there are no existing units, franchisors are often influenced by: (1) the ability to service and supply locations in the new market area; (2) the "run-off" value of the franchisor's trademark or reputation that might proceed the fast food franchisee in the new locale; (3) the sales potential of the new market area; (4) the level of competition that exists in the new market area; and (5) the evaluation of population, income, retail sales, and other factors that may influence the likely success of a market area.
3. Grand opening and ongoing advertising programs
Providing advertising programs is one of the most important services that the franchisor can offer its fast food franchisees. While a fast food franchisee might be able to create, on his own, other programs offered by the franchisor, he will never be able to duplicate the sophistication of the franchisor's advertising programs because these programs are funded by the combined contributions of all operating units. Usually, a national advertising program is funded by fast food franchisee contributions and the fast food franchisee has a contractual obligation to spend a minimum percentage of sales or dollar amount on advertising on the local level using promotional material supplied by the franchisor. The franchisor will monitor the fast food franchisee's expenditures on the local level by reviewing P & L statements, advertising expenditure reports, and the fast food franchisee's use of cooperative advertising programs.
4. Recruitment of fast food franchisees
A start-up franchisor, in order to use its time, resources and money most appropriately, must determine the profile of its likely fast food franchisee, particularly documenting the skills and talents required. The characteristics of the fast food franchise business dictate the kind of fast food franchisee needed.
After the franchisor has established the profile, it must establish a budget and goals for recruiting fast food franchisees, in order to determine the most effective place to use its advertising dollars. Should the franchisor promote in a business magazine? If so, which one or ones? Should it use newspapers? Would direct mail, trade shows, seminars, public relations, or broadcast media prove effective?
To attract excellent prospects and sell them, the franchisor must determine the business' unique features and benefits and then express them through cleverly worded ads, appropriate sales brochures, and effective phone and mail follow-up programs. All this effort is intended to obtain an interview with a qualified prospective fast food franchisee.
The salesperson who will meet personally with prospective fast food franchisees must be well trained in the franchisor's business and in effective sales techniques. Thus, the salesperson's personal presentation must be well structured, for the salesperson must ferret out information about the prospective fast food franchisee's interests, while providing the prospect with information that will help in the decision-making process. The salesperson must use appropriate interviewing and qualifying techniques in order to identify and sell qualified fast food franchisees.
The franchisor should also put into place a system for monitoring the effectiveness of, and refining, its fast food franchisee recruitment process. For example, the franchisor should analyze the media used to determine which provides the most qualified leads, and should evaluate leads to determine which leads produce the most interviews and sales.

Part I: Introduction to Franchising
Part II: In What Ways Is Franchising A Superior Expansion Method?
Part III: When Is A Company Ready To Franchise?
Part IV: Buying A Fast Food Franchise
Part V: Elements Of Successful Franchising

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