It’s feast or famine for franchise businesses operating in the food & drink space in the wake of COVID-19. Does market diversification swing the balance?
Penny Rinta-Suksi, Commercial Partner and Ollie Clymow, Commercial Senior Solicitor at Blake Morgan LLP, discuss the effects of COVID-19 on franchise businesses.
As with many sectors of the UK economy, 2020 was a period of great change for both franchisees and franchisors in the food & drink space. How have franchise businesses survived the effects of COVID-19?
What we are seeing in the market
The shape of the food & drink market is changing at breathtaking pace. Entire parts of the market have disappeared (temporarily, perhaps) whilst new parts are thriving. The sudden death of corporate lunches, networking drinks and social events has pulled out a main income stream for many businesses. Whilst that market space has shrunk, the home-delivery and take away market has opened up. Taxi hailing firm Uber, now generates more income from food delivery than their taxi hailing app. Let that sink in.
Diversification was key – whether that be diversification of products, services, customers or location. Innovative franchising businesses who acted quickly to flex into new markets as others began to dry up thrived, whilst others failed.
A key differentiator for food & drink businesses during this ongoing period of uncertainty was whether they were tied into operating out of one particular location. The national lockdowns and ongoing restrictions have, of course, changed the way consumers purchased food and drink, at least in the short-term. Businesses that have been unable or slow to move to home delivery or take away have struggled to mitigate the reduction in revenue. For example, Pret A Manger has had to close 30 of its UK stores. A once staple lunch stop for office workers. Diversification of a franchisee’s business structure may allow the franchisee to overcome the challenges posed by having to operate out of one fixed location.
Market diversification is not as straightforward as it may seem from a franchising perspective. The contractual arrangements between a franchisor and a franchisee often contain restrictions on how the service can be supplied (often with very strict and prescriptive requirements), the geographic locations in which the franchisee may operate, the types of customers it can target and the types of goods it may supply.
Also, branching into new markets triggers intellectual property (IP) issues for both franchisees and franchisors. For example, the parties should consider whether a franchisee has the right to use the franchisor’s IP in a new part of the market. The franchisor may also have concerns with its IP being used by a third-party in a previously untapped market space.
Franchisee considerations when looking to diversify
Before doing anything, franchisees should always check the terms of the franchise agreement if they are looking to diversify and consider whether the terms of the franchise agreement provide the ability to flex into a new market space. For example, does the franchisee have the right to offer take away and home delivery services rather than being restricted to operating out of specific premises? The franchise agreement may require the franchisee to obtain the franchisor’s prior approval before doing so. If that is the case, always obtain the franchisor’s approval in writing to mitigate the risk of a breach of contract claim.
Regarding IP, the franchisee should check whether the current IP rights granted to it in the franchise agreement are adequate to explore new markets. Also, whether the franchisee has the right to create and/or exploit other IP rights as part of that diversification.
What is the franchisee expecting to achieve in the long-term? If it is simply to preserve market share or increase revenue then that will be relatively straightforward to facilitate. However, if the franchisee is expecting to be able to independently harvest customer data in the new market space then the terms of the franchise agreement should be carefully scrutinised to check for any contractual restrictions on doing so.
Franchisor considerations when its franchisee is looking to diversify
Before reviewing any market diversification, the franchisor will be keen to check the franchisee’s performance under its contract prior to the COVID-19 outbreak – is this a franchise arrangement it wishes to continue with? Are modifications to performance possible or is this an opportunity to exit? It will then need to consider if the franchisee has a strong business plan that it can implement despite the impact that the global pandemic has had on its cashflow. Is its franchisee robust, healthy and a good bet? Are additional guarantees required?
If the franchisor approves any market diversification by the franchisee then it should check the franchise agreement to ensure that any newly created IP remains protected and that all generated goodwill vests in the franchisor.
Generally, market diversification may lead to an increased risk of IP infringement and potentially challenges to the validity of the franchisor’s IP. The franchisor should consider whether this has been taken into account as part of its business model.
Given that the exploration of a new market will likely be outside of the usual course of the franchisor’s business, the franchisor should ensure that it has adequate control over the franchisee’s operations in that market. Also, the franchisor should consider whether it has the processes and procedures in place to continue to adequately service its franchisee in the new market space.
Both franchisees and franchisors should scrutinise the terms of their franchise agreement before implementing any strategic diversification of their business. Where the terms of the franchise agreement do not align with the parties’ commercial strategy the parties may need to enter into a variation agreement in order to amend or vary the terms of the franchise agreement to bring them into line.
Ultimately, it will be much less costly to consider and resolve any IP and contractual issues before the parties begin exploring new markets than to resolve such issues after the event. Our specialist franchising lawyers are here to help and make the process as straightforward as possible.
PENNY RINTA-SUKSI – COMMERCIAL PARTNER
M: 07795 495646 | T: 01865 253257
OLLIE CLYMOW – COMMERCIAL SENIOR SOLICITOR
T: 0118 955 3072