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Franchising

Franchising (or commercial affiliation contract):

Franchising is a business development model that manifest itself in a commercial contract with the purpose to define the cooperation between two parties, 1) a large successful company and 2) a small entrepreneur. Through the agreements and common structures, they both collaborate to be in progress and obtain advantages in different markets.

All the technical, strategical and commercial know-how brought by the franchisor are shared with the franchisee, to create the means of collaboration.

In fact, this subject implements the disposal of assets in order to implement a market expanding policy, without taking on particular risks deriving from the increase in the company structure, fixed assets and personnel.

The franchisee, therefore, upon the payment of a fee, acquires the “privilege” to exploit the franchisor’s commercial formula.

According to the dictates of Law 129 of 2004, commercial affiliation is  “a contract between two juridical subjects, economically and legally independent, according to which one party, upon the payment of a fee,  grants the right to the other party to use a set of industrial or intellectual property rights relating to trademarks, trade names, signs, utility models, designs, copyrights, know-how, patents, technical or commercial assistance and advice, by placing the franchisee into a system consisting of a plurality of affiliates distributed throughout the territory, in order to promote certain goods or services “.

Furthermore, the law clarifies the meaning of some terms used in it:

  • know-how as a “wealth of unpatented practical knowledge deriving from experience and tests performed by the franchisor”,
  • the right of entry as a “fixed fee, also related to the economic value and development capacity of the network, which the affiliate pays when signing the commercial affiliation contract “
  • royalties “percentage that the franchisor requires from the franchisee proportionate to the turnover of the good or a fixed quota, to be paid in fixed periodic installments”.

By law, the franchising contract must indicate:

  • the amount of investments and any entry fees that the franchisee must incur before starting the activity;
  • the methods for calculations and payment of royalties, and any indication of a minimum income to be realized by the franchisee;
  • the scope of any territorial exclusivity both in relation to other affiliates, and in relation to sales channels and units directly managed by the franchisor;
  • the specification of the know-how provided by the franchisor to the franchisee;
  • any methods to recognize the contribution of know-how by the franchisee;
  • the characteristics of the services provided by the franchisor in terms of technical and commercial assistance, planning and preparation, training;
  • the contractual conditions for renewal, termination or possible cession of the contract.

Moreover, from the dictates of the CE, there are a series of following clauses:

    • Non-competition obligation: the franchisee has imposed an absolute prohibition “to open during the validity of the contract or during an appropriate period after the expiration of the same, shops for the exercise of identical or similar activities in areas where he may be in competition with traders belonging to the distribution network “
    • Obligation to sell only products supplied by the franchisor. The Court states that “the clause requiring the franchisee to sell only goods supplied by the franchisor or suppliers chosen by the franchisor are obligatory to protect the reputation of the distribution network”.
    • Prohibition to sale the shop: The Court states “the franchisee has an obligation to not sell the shop/activity without the consent of the franchisor “.
    • Obligation to apply the commercial methods developed by the franchisor: this is “the obligation of the franchisee to apply the commercial methods developed by the franchisor and to make use of the knowledge and techniques provided to him”.
    • Obligation to sell exclusively from authorized premises: The franchisee therefore has the obligation to “sell the goods covered by the contract only in the premises set up and decorated according to the instructions of the grantor” and “do not change the location of the store without the consent of the franchisor”.
    • Prohibition to transfer the contract and discretionary choice of franchisees: The Court defines “the prohibition, imposed on the dealership, to transfer rights and obligations arising from the contract, without the consent of the grantor”, as this helps to safeguard “the right to last to freely choose dealers “.
    • Control over advertising: clause “which subordinates any advertising by the concessionaire to the consent of the grantor”, provided that such control refers only to “the nature of advertising”.

The following documents should be attached to the copy of the contract by the franchisor:

  • Data concerning the franchisor and balance sheet for the last three years (if requested by the franchisee);
  • Indication of the trademarks used in the distribution system, with the registration or deposit details, the license or documentation proving the use;
  • A summary of the elements that characterize the activity that is the object of the commercial affiliation;
  • The list of existing franchisers and franchisee’s points of sale;
  • Indication of changes in the number of affiliates with their location in the last three years;
  • The summary of any judicial or arbitration proceedings brought against the franchisor by affiliates, third parties or public authorities and concluded in the last three years concerning the affiliation system, in compliance with the rules on the protection of personal data.

Furthermore, there are two obligations that the franchisee is usually subject to: the invariability of the office and the obligation of confidentiality. Any violation of these rules by the affiliate may result in compensation for the damage suffered and termination of the contract, when the conditions are met.

The effective fixed duration of the contract is not defined by the government, but is left to be freely interpreted by the parties, also because different types of franchising correspond to different types of depreciation. As regarding to the causes of termination of the contract, the most frequent are:

  • deadline of the contract has expired
  • right of withdrawal, can be exercised only in the presence of good reason
  • mutual consent
  • failure of one of the parties, such as:
  • the failure or delayed payment by the franchisee, for the products supplied by the franchisor, at the agreed deadlines;
  • the failure / delayed payment of royalties;
  • illicit exploitation and / or different from that granted contractually to the franchisee, the brand and / or the know-how;
  • the violation by the franchisor of the territorial exclusivity contractually recognized to the franchisee;
  • the repeated violation, protracted for a given period, provided in the contract by the franchisor of the obligations of training, assistance and permanent information in favor of the franchisee.
  • default of the franchisee
  • bankruptcy of one of the parties

Advantages and disadvantages for the franchisor:

As regards the advantages, i.e. the subject granting its industrial heritage, we analyze:

  • access to a new source of capital; in fact, each new point of sale uses the financial resources of the franchisee, who invests in the restructuring and image of his shop, adapting it to the franchisor’s style, human resources and management of the business. Therefore, for the franchisee the process involves reduced investments and limited operating costs and, therefore, greater commercial productivity.
  • thanks to the web of the franchisor, franchisee holds the stronger presence on the market in short terms.
    • a more incisive presence on the market, in a relatively short time; thanks to the franchising network, the franchisor establishes a closer and more branched relationship with the market and is able to plan a distribution of its products.
    • better local integration; generally, the franchisee operates in the environment that is familiar to him and therefore is better accepted and integrated than a “stranger”.
    • the creation of new sources of profit is another important advantage: entry fees, royalties, direct sales of products or services are only the leading profit factors. It should always be added the indirect benefits from ongoing collaboration with other companies.
    • the faster expansion of sales, based on the rapid branching of the network and the improvement of the commercial effectiveness of each store allows a widespread diffusion of the brand name and a greater penetration into the market. As the system consolidates and spreads, economies of scale grow: while the franchisor’s fixed costs are spread over an increasing number of affiliates, the prices and conditions of purchase of the assets subject to the franchise decrease in proportion to the increase in quantities purchased by the franchisor.
    • the franchisor has, moreover, fewer problems connected to the personnel, since the latter pertains to the individual franchisee.
    • we shouldn’t forget about the advantages of local advertising, derived from the diffusion of the brand name by the franchisee
    • finally, the franchisor can hold the organizational system and be based on a limited central staff, made up of a few, but valid experts specializing in the various aspects of the commercial sector and operating at a purely strategic level.

Among the disadvantages:

  • Reduction of decision-making autonomy; the franchisee is in fact an independent entrepreneur, often located distantly from the geographical point of view. The franchisor can, therefore, impose less conditions on the franchisee compared to the traditional system of branches owned.
  • The second disadvantage consists of strong barriers to exit and the risk of competition; the affiliation contracts provide for quite long periods and, even in the event of misunderstandings and mistakes by the Affiliate, it is rather difficult to terminate the contract. And we must not forget the possibility that an Affiliate, after gaining professionalism and clientele, decides not to renew the contract and, renouncing the trademark, will continue the activity exploiting the acquired know-how.

Advantages and disadvantages for the franchisee:

Among the advantages:

    • Initial assistance (choice of the location of the point of sale, preparation of store renovation projects, purchase of equipment, recruitment and training of personnel …), consequent reduction of uncertainty and risk, which is one of the main reasons of franchising diffusion. Often the required capital is lower than that required for traditional opening, while the lack of experience and the consequent failure risk are sharply reduced. Furthermore, by assigning the strategic planning to the franchisor’s staff, the franchisee can devote all the time and resources to the commercial development of the business.
    • The benefit deriving from the reputation and reputation of the brand, which avoids long start-up periods and related charges. In addition, the franchisee profits from the advertising and promotion activities carried out by the franchisor even on a national scale.
    • The advantage of using the franchisor’s bargaining power to obtain supplies at lower costs.
    • The franchisee, finally, has continuous assistance and specialized and updated knowledge of the central staff of the franchisor and also enjoys the results of continuous research and implementation of the development programs of the latter.

As for the disadvantages, instead:

  • The loss of commercial autonomy is undoubtedly the main disadvantage faced; the franchisee must comply to the strategic decisions made by the franchisor and depends totally on the ability of the “parent” company to develop a valid franchise system. The franchisee must also comply with the pricing and procurement policies imposed.
  • Another important disadvantage is the risk of competition: at the end of the contract the franchisor can decide to assign the exclusive area to a new affiliate who, automatically, acquires the image and clientele of the predecessor.
  • Lastly, the unilateral nature of the franchising contract, which in major part protects the interests of the franchisor, should not be underestimated. In this regard, it is essential to ascertain that the turnover figures are true: in fact, some franchisers use franchising simply to self-finance and are not able to guarantee development prospects for the network.