The exclusivity of franchise territory is one of the most important factors to be considered when researching a potential franchise. That’s because having a protected, generous, and clearly defined territory will ensure you don’t have to compete for customers with fellow franchisors; your staff will remain loyal; you are going to control your brand’s reputation and perception in your area; you are going to have an easier time getting franchise funding. In this article, we will focus on franchise territory location and how to choose the perfect franchise location.

The prevailing practice when buying or selling a franchise is to define a territory for each franchisor. Both franchisors and franchisees will examine the various methods of allocating franchise territories and choose one that better serves the interests of all parties. The franchise agreement is the primary legal document for the clarification of territorial rights and conditions with details spelled out for both parties. Now let’s take a look at what is a franchise territory location.

What is a Franchise Territory?

A franchise territory location is an area in which a franchisee is allowed to set up and operate a franchised business. The size and scope of a franchise territory are determined by the franchise agreement, and the level of protection offered to a franchisee within the designated territory will vary from one franchisor to another. When referring to franchise territories, franchisors use many different terms, such as “operating territory,” “operating area,” “exclusive territory,” “exclusive area,” “designated area,” and “area of responsibility.”

When you are purchasing a franchise, it is a critical task to evaluate your franchise territory and the protections that you will be granted from the franchisor. Although your franchise agreement will designate your franchise territory and the level of protection that you are entitled to within FDD Item 12, your franchisor is required to disclose the scope, size, and level of protection that they are willing to offer within your franchise territory location.

Understanding the Key Aspects of Franchise Territory

It is not uncommon for a prospective franchisee to concentrate on the size of the territory while negotiating to choose the perfect franchise location with a franchisor, rather than other essential factors. Many franchisees assume that the larger their proposed franchise territory location, the more separated they will be from fellow franchisees, and the greater the potential for growth. There are however a number of issues that need to be addressed.

The territory of a franchisee constitutes the foundation of its business. It is the place from which their customers, revenues, and increased growth are going to be coming from. A territory that is too small can constrain sales growth. A neighboring franchisee may be on the border of another franchise territory in some franchise programs and compete for customers within the same territory.

How to Evaluate Franchise Territory Location?

Under your franchise agreement, the level of protection that you may or may not be given varies from one franchisor to another, and most of the time, it depends on the market and business model.

Some franchise systems provide exclusive territories where other franchisees are not allowed to operate or sell, whereas other systems give you the right to operate and sell within a region but without protection from other franchisees. In other cases, the territorial protections fall in between: some forms of exclusivity of territory come with specific exceptions for certain locations or forms of trade, such as the internet.

Below you can read a summary of important factors to consider when evaluating and potentially negotiating the scope, size, and protections of your franchise territory location:

Fixed Locations vs. Mobile Businesses

The first step when assessing your territorial rights is to understand the franchised business and whether or not you will sell goods or services from a fixed location or on a mobile basis. Examples of fixed-location franchises include mainstream retailers such as restaurants, gyms, and other retail outlets; And service-based businesses, such as spas and center-based tutoring services that operate from one center.

Examples of mobile franchise businesses include the many service-based businesses in which franchisees go out and deliver their services on-site at the location of their customer. Examples of mobile franchised businesses include home-service companies and businesses that retain a physical retail presence but rely on customer delivery for products such as gift baskets.

The “territory question” for fixed-location franchises is whether or not the franchisor will grant you territorial protection around your retail location. Does the franchise agreement, for example, state that the franchisor will not grant franchises within a set radius around your retail store?

The “territory question” for mobile franchises is whether or not the franchisor can provide you with a given territory in which you and ONLY you are allowed to serve customers. Does the franchise agreement, for example, state that the franchisor will not allow other franchisees to serve customers within your designated operation area?

Protection vs. No Protection

Franchisors differ greatly as to whether or not they provide exclusive territorial protection to their franchisees, and even within franchise systems that are providing territorial protection, there is significant variance as to the nature of protection and whether or not the protection is dependent on the success of the franchisee or on the sales.

For a fixed location business, if a franchisor does not offer territorial protection, this means that the franchisor can grant and authorize another franchisee to open another retail outlet next door, or more realistically, a few blocks away. For mobile businesses, this means that the franchisor could authorize other nearby franchisees to serve customers located within their territory.

Territory Protection Exception

Franchisors often have a legitimate interest in “carving-out” exceptions to the territorial protections that they offer franchisees. You need to examine these carve-outs when buying a franchise and determine how they could affect your business. Examples of specific exceptions to the protection of territories include:

• Captive Markets such as malls, stadiums, college campuses, government agencies, airports, amusement parks, and other places that draw large, captive audiences within your franchise area;
• Web and Alternative Distribution Models such as the Internet, websites, catalogs (to the degree that people still use catalogs), and direct-to-consumer distribution networks where the franchisor may supply goods and, probably, services directly to consumers even if they are not located within your franchise area;
• Private Label Rights which allow the franchisor to sell a competing product or service under a trademark and a name other than the trademark and the name of the franchised business;
• National Accounts allowing the franchisor to directly service facilities and locations which are part of a large national corporation, even if the account being serviced is located within your franchise territory; and
• Performance Contingencies that make your territorial rights conditional on performance criteria, such as minimum sales or gross revenue.

Start with the FDD

Franchisors are expected under the franchise laws to include comprehensive information on the territorial rights that they can or may not provide in item 12 of FDD. Do not just rely on item 12 but it is a great point to get started.

How Is The Size Of A Franchisee Territory Determined?

Franchisors use a variety of criteria to define trade territories, but here is how it should be done. In view of an area containing a certain number of customers for the product or service, an established business will be able to assess its historical performance to determine what its market share has been. Keep in mind that these customers may be defined simply by total population, the population of a certain age group, number of owner-occupied homes of a certain kind, total number of small businesses, number of a certain form of business, or even number of households with gardens, young children or pets.

Once it’s worked out how many potential customers it needs to enable a franchisee to meet its targets, the business will know how many potential territories are available in the country. It is then a matter of defining the boundaries of these territories, and this is often best done by using postcodes, as it is possible for data to be acquired to outlines how many of a certain type of customer exists in a particular postcode. Add enough postcodes together to get the desired number in an area, then repeat the exercise but you need to map the entire country several times. However, note that circumstances change and the method should be kept under periodic review.

What is an Exclusive Territory?

The term “Exclusive Territory” is frequently misunderstood. Many franchisors no longer award exclusive territories and tend to limit the grant of the franchise to the exclusivity of the location itself or to the mall the premises are located in. With established franchisors, this type of exclusivity is more common. In this respect, emerging franchisors may be more flexible.

Franchisees often misunderstand the rationale that applies to the size of a territory and consequently insists on a territory that is too large that can be detrimental to them, rather than advantageous. The size of any sole territory does not dictate the ultimate success of the unit; however, it should be sufficiently large to enable the franchisee to obtain maximum performance from their unit but not so large that it will prevent the franchisor from obtaining optimum market share. Naturally, the franchisor is reluctant to grant any exclusive territory that may hold back its growth.

By granting too many franchises in one region (or too few) a franchising program can be destroyed. Too many franchises in one region will deprive them of business if there are not enough customers to help each franchisee. On the other hand, while a franchisee seeking to choose the perfect franchise location, does not want to be directly competing with other franchisors in their area, the franchise units should be close enough to take advantage of the synergy created when a number of units operate in close proximity.

One choice at the franchisee’s discretion is to seek a negotiation opportunity for an option on any franchise to be granted in an adjacent location. Most of the franchisors would refuse to make such an undertaking because it would be unnecessary for the franchisee to obtain a second franchise when the franchisor wants to expand. This situation has the potential to create conflict because the franchisee could view the franchisor as denying them the opportunity to expand, when the franchisor may in fact be acting in the best interests of the franchisee.

The awarding of an exclusive territory usually prevents the franchisor from opening another franchise within the territory but does not allow the franchisee the right to open another franchised unit within the same territory. Neither does it grant the franchisee exclusive rights to customers within the region. A franchisor can not prevent a franchisee from doing business in a territory of clients within the territory of another franchisee.

When negotiating the size of the territory, the best advice for a prospective franchisee is to be reasonable and assess what is actually in their best interests from a logical, rather than an emotional, perspective. While considering the size of the territory and the effect of another franchise operating in the adjacent territory, it should be noted that the franchisor might position another franchise just outside the limits of an already existing territory.

How To Define An Exclusive Territory?

A number of methods can define an exclusive territory, including a certain radius from the location, postal walks, postal codes, municipal boundaries, and natural boundaries such as rivers. As mentioned earlier, this may be limited to a mall or the location itself. In certain situations, some methods work better than others in order to define and choose the perfect franchise location.

For example, in a situation where there are two distinct trade areas separated by a river, a radius would not be successful. Locating franchises on either side of the bridge may be practical, and even helpful, but a radius would have to be incredibly small, due to the close proximity of the two locations.

Demographic studies can sometimes determine the criteria for the optimum size of the territory, with a provision allowing franchisors to place additional units in the territory if certain events occur e.g. population growth exceeds a given figure or percentage over a specified period of time.

One factor to consider is the effect caused by latent market demand, which increases the potential of a marketplace as consumer awareness of a given product or service gains recognition. Typically, franchisors want to award the kind of exclusive territories which retain some flexibility for modification if market conditions were to change.

Gray Areas

‘Gray Areas’ are regions that are not part of any other franchisee’s territory, nor are they areas served by ‘company-owned’ operations of the franchisor. A number of franchise agreements require franchisees to service customers in Gray Areas; however, that privilege is typically subject to the sale of the territory in the Gray Area to another franchisee.

The franchisee is not entitled to the right of first refusal or other rights of any form to a Gray Area by virtue of its activities in that Gray Area. Moreover, the franchisor usually has the right to sell any territory placed in a Gray Area at any time, without notifying the franchisee beforehand. In case the franchisors receive notification from the franchisor, all marketing activities within the Gray Area must be ceased immediately. The franchisor may issue the notice to cease marketing without regard to whether or not another franchisee has bought a territory in the Gray Area.

The bottom line is that a franchisee can offer services to consumers in a Gray Area but they do not have any goodwill and are on the verge of losing those rights at any time.

Why should you take territories and exclusivity seriously when establishing a franchise?

Questions about territory, along with earning potential are at the top of the minds of franchisee candidates. After all, territories help determine the potential to earn, because they contain the desired customers of a franchisee. However, as franchising has become so competitive, with similar franchises attracting the same consumers, franchisees do not have to compete with other franchise owners within their own brand.

When emerging franchisors are thinking about establishing territories, they must think through offering them exclusive rights as well. ‘Exclusive territory’ is a particular protected area where the franchisor can run their company under their own system without interference from the franchisees within their own system.

This is an enticing opportunity for potential franchisees to seek investment in the brand and will help their customer base expand. Here are several other ways to sell exclusive territories that both franchisees and franchisors will benefit:

Maintain The Peace

Exclusive territories may help foster harmony among franchisees and franchisors. In case two or more of the same brand outlets are in the same territory, franchisees have the opportunity to start competing for the same customer base, depending on the market model. Providing separate and exclusive territories protects their consumer base and the annuity revenue stream they generate from attracting loyal customers and holding them.

Plus, bad blood can form between competing franchisors without exclusive territories. This is not ideal in any case, but it is challenging particularly for emerging franchisors who are trying to develop a strong, reliable franchisee network. When it comes to helping and enhancing, franchisees also rely on each other for guidance or assistance. If there is tension between franchisees because they are competing against each other, there will not be any camaraderie and support.

In addition to developing a possible ill will against each other, franchisees can often look unfavorably at their franchisor for failing to provide them with the protection that exclusive territories are offered in a network. This will almost definitely occur when franchisee applicants do their due diligence by talking to current franchisees and will ultimately delay the growth of the franchise.

Create a Positive Reputation

The franchisee has the opportunity to develop the brand in an exclusive territory and set it up for success in that region. There are also exclusive territories for your franchise system that protect your brand in each region.

For instance, if you have two franchisees in the same territory, and one provides sub-standard service, does not maintain a clean location, or is a lousy neighbor in the community, the reputation of the other franchisee and their location might suffer. Your brand ultimately will suffer in that entire territory. With several locations in one territory, the impact can be even bigger.

Nonetheless, before you sell potential exclusive territories to franchisees, you will need to establish them as fairly and equitable as possible.

Develop a Territory

You will decide where the territories will be located, after some thorough planning. Typically, franchisors determine territories that are based on zip codes, geographic size, population size, natural boundaries, or other criteria.

Zip code, radius, and population are the most common methods of determining a territory. But not all of these methods are created equally and can be advantageous to some and disadvantageous to others depending on where they operate.

For example, a zip code-based territory is usually composed of a cluster of zip codes. That is perfect for urban areas where populations are dense but this sort of territory does not always fit well for rural areas where the population is typically small and spread out in vast areas. A similar argument can be made, based on the radius, or physical distance, for the area. It might seem fair to base territories on population, where each has the same number of people/potential customers. Nevertheless, the demographics of each region may vary, with some not being a total fit for the franchise label.

Determining a territory also requires a mix of metrics to make things as equitable as possible. Regardless of criteria, the franchisee should have growth potential across all territories. By analyzing the success of the current territories, a market research company can help broaden the growth parameters, and a consultant can conduct a territorial optimization review.

Maintain the Right to Change Status

As a franchisor, when drafting the franchise agreement you will have to include stipulations for exclusivity. Try adding a provision that allows you to adjust the status of the territory from exclusive to non-exclusive for a variety of reasons, including whether demand for the franchise is growing in the territory or if the variety of prospects for franchisees is growing.