It’s fundamental to the success of all franchise networks that franchisees maintain certain standards; and there is a basic level of performance that all franchisees need to exceed. This month’s article for Elite Franchise Magazine takes a look at the minimum performance clauses typically found in franchise agreements.
Minimum Performance Clauses
There’s a very strong commercial incentive for franchisees to perform at their best. After all, the franchisee owns his own business and reaps the rewards of his efforts. Equally, the franchisee will suffer in a very direct way if his business under-performs. You may therefor wonder why minimum performance clauses are used in franchise agreements. This month’s article looks at what they and how they’re used.
Purpose of Minimum Performance Clauses
Minimum performance clauses were rarely seen in older agreements but are now common place. One reason for this is that a franchisor needs to be able to take action against an under-performing franchisee to protect the brand, the wider network and occasionally, the franchisee themselves.
Many networks also use a performance review process as an added layer of motivation for franchisees – no one likes to come last! On a more constructive note, performance monitoring means there is a process of continual improvement across the network as everyone strives to move up the rankings.
Types of Clause
Minimum performance clauses do as the name suggests. They are clauses that require the franchisee to achieve a certain level of performance with sanctions if the required standard is not met. The exact nature of the requirements differ widely from network to network but generally clauses fall into two categories: quantitative requirements which require the franchisee to achieve quantified targets, such as a minimum monthly turnover, or minimum annual sales growth; or qualitative requirements which tend to be more subjective and relate to wider, operational issues.
Sanctions for Failure to Achieve the Minimum Standard
The specific sanctions imposed for failing to achieve the minimum performance standards will be set out in the franchise agreement. Typical sanctions might include:
- Losing the right to renew at the end of the current term unless performance improves;
- Financial sanctions (such as paying a minimum fee);
- A requirement to undergo additional training or be supervised by the franchisor; or
- In a worst case scenario, termination.
Importantly, the franchisor’s reaction should be proportionate to the franchisee’s breach, so if a franchisee narrowly misses a target, sanctions should not be as severe as a franchisee who falls a long way off.
In a well-run franchise, failure to achieve a minimum performance target will trigger a process through which the franchisor supports the franchisee and helps them to improve. Termination should always be a last resort and only used after the franchisee has been given time and support to try to do better.
How to Set Minimum Performance Targets
Minimum performance targets should be set with extreme care, both in choosing the areas that will be assessed and then setting an appropriate minimum level for each area. A good starting point is to consider the factors that are most fundamental to the successful operation of the business and set performance targets for those functions.
Once the area(s) for monitoring have been chosen, thought needs to be given to where to set the bar. Comparing franchisees to other franchisees in the network is tempting, but may not be appropriate if either there are relatively few franchisees to compare overall; or if there are significant differences between franchisees’ local businesses. For example, a new franchisee would be expected to have a very low turnover but very high sales growth compared to a franchisee who has been operating for many years and has a high turnover but low growth; or there may be significant differences in local market conditions or size or spread of the territory that make drawing direct comparisons difficult.
If there are large differences between franchisees, then any performance measuring process will need to take account of those differences, for example, new franchisees could be granted an initial grace period whilst they establish themselves during which time the minimum targets won’t apply.
Averaging performance across the network as a whole is one way to mitigate the differences between franchisees, but in that case the target must be set at a level which is well below the average; otherwise, by definition, there will always be some franchisees who are performing below the average, but who may still be successful in their own right and who may not be able to match performance of the best franchisees due to reasons beyond their control (such as local market variations). Also be mindful that franchisees at the extreme ends of under or over performance may distort the average.
It’s also important to remember that the targets for these clauses are intended to be set at a level which represents the absolute minimum for the business to be viable. The franchisor may well set other higher performance targets in business plans or as part of a programme of mentoring and motivating franchisees, but these should be separate to the minimum performance clauses and fall outside the franchise agreement.
Minimum performance clauses are a valuable weapon in the franchisor’s armoury for protecting both franchisees and the brand; however they must be chosen with extreme care. It’s important that the target is set at an absolute minimum, not at a level that the franchisor would like franchisees to achieve in an ideal world. Failure to achieve a target should result, in the first instance, in the franchisee being given extra help and support to improve. More serious sanctions, and ultimately, termination, should only be used as a last resort.