Have you ever wondered why many franchises operate at the location they are? While some franchises are around almost every corner, many appear to maintain a certain distance from each other.
Businesses strive for an ideal location to maximize their individual market potential. While this is true for any business, most franchisors restrict business operations using protection mechanisms. Franchise territory protection is a commonly used and often well-defined rule that any franchisee must comply with. While it is a restriction that potentially holds back earnings at first sight, most franchise businesses benefit from this indirect market regulation.
This article will guide potential franchisors and investors through the use and benefits of franchise territory protection. Each franchisor may have its own point of view, and some essential information must be considered before defining a franchise license. Territorial protection requirements impact site selection, so we will also guide you through the selection process for a successful start.
What is franchise territory protection?
Franchise Territory Protection is a set of regulations by the franchise owner to limit openings and restrict market competition within a given franchise. Franchise licensees must comply with these rules to qualify for a franchise. By limiting competition, the franchisor can assure business performance and steady income from licensing.
Why do businesses need Franchise territory protection?
Businesses face increasingly high competition in local market operations. Too many subsidiaries of a single franchise can threaten business growth and long-term success. (Market cannibalization) Given the licensing fees and initial costs, territorial protection can provide general assurance for both parties, giving them confidence while enabling reliable business planning.
Types of Franchise Territory Protection
Each franchise may have its definition of protection when discussing franchise location protection. However, what are the general options common for franchise territory protection? There are mainly three categories for territory protection:
- Open
This is the most basic franchise protection—little to none. While it is relatively uncommon, few or no protection agreements might be in place, generally ignoring the regulation and providing no limitation for present and new businesses to start in covered markets.
- Protected
A common clause in franchise agreements is the protected type. There is no definitive definition, which leads to varying extents of protection. Most franchisors, however, will follow a geographic approach to limit the number of subsidiaries in a specific area. This type is popular for both partners, allowing flexibility while providing general protection terms. There are still exceptions, which will be presented in the following section.
- Exclusive
Exclusive territory is the highest protection type for franchise businesses. In contrast to the protected type, this form of franchise territory protection will even restrain the franchisor from competing with the licensee in any form. Thus, it provides an exclusive right to conduct business.
Why protection might be misleading
But even if protection is in place, it doesn’t mean franchisees may not face competition inside a protected territory. With franchise territory protection, businesses are generally safe from other franchisees opening the same shop next door. However, the most common type of franchise, the protected, doesn’t necessarily protect from indirect competition through the franchisor.
Businesses may face competition in a protected territory, mainly through alternative business channels. These channels include multi-brand stores, national operating chains, or simply producing and selling off-label products. Therefore, granting protection to a franchisee doesn’t necessarily cut a franchisor’s ability to conduct business in the same market.
Multiple exceptions might allow a franchisor to enter the protected market and indirectly compete with the franchise business, so it is essential to design the FDD specifically. Franchisees and franchisors should be aware of the extent. Thorough research using specialized software is a good starting point.
Reliable software is necessary to map the protection terms from the FDD to present geographic situations. Using the software, franchisors can get an overview of existing territorial markets, enabling verification of FDD compliance. Furthermore, mapping numerous territories simultaneously can help identify gaps in franchise territory protection terms besides new market opportunities.
What is a Franchise Disclosure Document?
A franchise disclosure document (FDD) is an essential document for franchisees. The legal document includes comprehensive information and follows a defined structure (so-called Items). In addition to a franchisor’s financials, initial investment, and obligations, it determines the type and extent of franchise territory protection (see Item 12).
Territorial Protection: How it works
Successful franchise businesses often rely on good franchise territory protection terms. Territorial protection can secure long-term profits for franchisors. While few franchises only grant little protection, these businesses remain the exception. So, how does franchise territory protection work in practice?
A franchisor can define territorial protection in multiple ways. The most popular way is a defined area, a locally restricted market where a franchisee often exclusively conducts business. A protected market can be defined using one or multiple measures:
- Radius
Radius exclusion zones by using distance metrics. These metrics can either be mileage or travel time.
- Zip codes
Matching territories to specific zip/postal codes. Franchisees are often required to forward external customers to their corresponding business.
- Population
An indirect measure uses demographic data to define territories. The upsides include a guaranteed market size, while borders are somewhat translucent.
- Geographic
A measure that often defines franchise territory protection in metropolitan areas. Markets may be enclosed by natural (rivers, hills, creeks) or urban (streets, blocks) boundaries.
Franchise Territory Selection in Practice
So, how can franchisors approach franchise territory selection or define protection terms? There are a few steps to finding, selecting, or verifying good territorial protection terms. While the overall process is similar to starting any brick-and-mortar business, aspiring franchisors can use sophisticated tools such as Mapchise to enhance and speed up defining suitable markets using select measures. Specialized tools can save time while reducing risks during this essential business phase.
In the following example, we focus on defining rules from scratch. The overall process also applies to other crucial tasks, such as territory verification (FDD compliance) or identifying market gaps.
Step 1: Research
The first step in franchise territory selection is conducting comprehensive research. Research objectives include researching potential markets and essential customer characteristics such as demographics and psychographics. A spatial demographic data analysis can indicate whether a franchise can succeed at given locations. Mapchise can significantly reduce the complexity and overhead of gathering the required information, especially when planning a nationwide operation.
Step 2: Define FDD
The next step in franchise territory selection is reviewing or defining the franchise disclosure document. After identifying multiple suitable locations and evaluating markets, franchisors can set general rules for their unique FDD. Effective franchise territory protection should generally describe and reflect ideal markets for franchisees. Assuming a franchisor grants standard protection without being exclusive, helpful questions for this process may include:
- What is the extent of franchise territory protection?
- What is an ideal market?
- What does each ideal market have in common?
(Radius, boundaries, demographics, etc.) - Does the market size support alternative distribution through the franchisor?
- How many potential competitors are operating in the area on average?
(rivaling franchises, independent stores, etc.)
A good mapping tool can help identify crucial information while granting franchisors visibility over similar businesses and competing franchises. That is where effective mapping comes into play.
Step 3: Mapping Franchises and Competitors
Using the Steps 1 and 2 findings, franchisors may already have a rough set of rules. Since an FDD (Item 12) must be final and unambiguous, franchisors must define strict yet enabling territory protection terms. Analyzing the direct competition is a good way to achieve this.
Competitive analysis is a standard business practice. In contrast to regular businesses, franchises can utilize territorial mapping to associate competitive insights with geographics. This approach allows franchisors to evaluate appropriate market sizes and revenue expectations, leading to competitive territory protection rules.
Mapchise has built-in features that assist franchise businesses in visualizing numerous protection areas, such as the radius exclusion tool. Available measures are mileage and travel time. However, users can also manually highlight zip codes and geographic regions. The tool enables multi-faceted analysis by blending zonal mapping and competitive analysis using carefully sourced KPIs and insights.
Conclusion
Franchise territory protection is a crucial cornerstone for many franchise businesses. While these protections limit the freedom of choice, they are essential for keeping intra-franchise competition reasonable. The definition and extent of protection types vary between franchisors, making a thorough study of the FDD a priority.
Protections are not always exclusive, meaning that franchisors can still conduct business through alternative distribution models – if they want to. Franchisors can define compliant markets using distinct measures. The most prominent measure is the radius exclusion, either by time or distance.
A comprehensive tool can save franchisors valuable time and reduce the overall complexity of geographic markets. Mapchise is a mapping tool that combines vital components of site selection (demographics, psychographics) and unique requirements for franchise territory selection. Aspiring businesses and franchisors can use this sophisticated tool to assist in crucial research tasks, utilizing trustworthy and up-to-date data and features.
Start your Franchise with Confidence
Starting a franchise often means substantial upfront investments. Reduce the risks and optimize your franchise business using Mapchise. At Mapchise, we provide fine-grained data and insights to assist with defining territories, conducting market research, and more. Contact us today to speed up your research and franchise operations!
