Franchise Compliance

Franchise systems that compromise their compliance put themselves in great jeopardy. The challenges a system could face as a result of non-compliance are far greater than the legal issues. Creating a consistent brand experience requires standards. Look at the McDonald's brand: It has an estimated value of $90 billion (“BrandZ Top 100 Most Valuable Global Brands 2013,” Millward Brown). This value did not accrue because McDonald's let its franchisees do whatever they wanted.

Common Goal

For a brand to be effective, everyone has to be on the same page, support the brand, and act as a unit. When there is little to no compliance, everyone can (and, in most cases, does) act independently. Instead of being a well-oiled machine moving toward a shared goal, the franchise system becomes more like herding cats.

Furthermore, the greatest misconception of franchisees is that a franchisee not in compliance is only hurting itself. Nothing could be further from the truth. Non-compliance of one franchisee hurts the whole system.

Take something as benign as a franchisee not attending the annual conference. Think for a minute about what the franchisor has to do to ensure non-attendees know about everything they missed at convention. The reality is, most franchisors do not have the time or resources to make this extra effort, and, consequently, the franchisee is not kept up-to-date on new policies, new products, etc. Even if the franchisor has the resources, the time spent updating the non-attendees could have been spent in other productive ways on behalf of all franchisees.

So how does the franchisor ensure compliance? The simple answer is to enforce all of the rules in the franchise agreement. But this is easier said than done. What if a franchisee had an accident on the way to the airport to attend the conference? He or she is in the hospital, so it seems fair that he or she would miss the conference. In a franchise system where non-compliance is simple termination, would this franchisee be terminated? It is unlikely.

Reasonable Rules

The better answer is to first make sure the franchise system has rules that the franchisor truly needs to enforce. Any rules that do not serve a real purpose should be eliminated. Also, the importance of those rules needs to be laid out in black and white for the franchisees ' the basic message being that if the rules are included in the franchise agreement or operations manual, then they need to be followed.

Again, back to the example of convention attendance. Because termination is often too harsh, the franchisor rarely (if ever) enforces it, and the lack of enforcement means there really are no rules mandating convention attendance. Consequently, once the right rules are in the franchise agreement or operations manual, the franchisor has to be willing to enforce them. What if the franchisor instituted a fee for non-attendance? An example of this could be a $1,000 fine paid into the national advertising fund, with the fine increasing by $1,000 increments for each missed conference.

In some franchise systems, changing a rule as simple as the one described above can take 10 years, as all the franchise agreements cycle through renewal. To get around these delays, the franchisor can give the franchisee the choice of either paying the fee (not currently in place) or accepting termination (as specified in the agreement). As long as the franchisee has the choice of accepting the fine and the franchisor will enforce what is specified in the franchise agreement if the franchisee chooses not to pay the fine, the franchisor can achieve its goal of having fair rules and franchise compliance.

Reviewing all of the compliance rules and implementing more reasonable and fair fees (in lieu of termination) is a critical part of this process. When the franchisor undertakes this process, it should be done with input from a special committee of franchisees. In a system with a franchisee association, have the association help create the committee. By involving franchisees in the process, the franchise system will develop a thoughtful set of rules that is likely to garner a higher level of acceptance from the franchisees.

Creating a Variance Committee

But remember: Franchisors do not get many calls from franchisees that are happy with the compliance system (I call them “the silent majority”). In fact, franchisors will only hear from franchisees asking for exemptions. Nevertheless, it is the silent majority that believes in the system, understands the benefits of compliance, and tends to be more aggressive in dealing with compliance issues than the franchisor.

This is a major issue in franchise compliance because franchisors do not like to enforce the rules. This happens for two main reasons: 1) they do not want to risk losing a franchisee that is providing the system with substantial income; and 2) they develop personal relationships with franchisees. The fact is, there are franchisees with legitimate exemption requests, but that line becomes very blurry, and eventually the franchisor risks legal liability because it is not enforcing the rules consistently through the system.

The solution is to remove the franchisor from the process of approving variances by creating a variance committee made up of franchisees. This committee can be chosen by management, but with input from either the franchise advisory council or the franchisee association. Like other committees, the membership should rotate over time.

The purpose of the variance committee is to review requests from franchisees for variances to the franchise agreement or operations manual. Essentially, the variance committee reviews the application for variance from the franchisee and makes a recommendation to management on whether or not a variance should be granted. Ultimately, the decision to grant the variance is made by management, but in my experience, the variance committee's recommendation is rarely overturned. (Interestingly, the committee ' comprised of franchisees ' tends to be tougher than management on the franchisee.)

Using the initial example to illustrate: When the franchisee called about missing the conference because of a sick relative, I was able to refer the situation to our variance committee. They investigated and learned that the franchisee had never registered for the convention, but claimed he planned to register on-site. The variance committee told the franchisee it would approve the variance if the franchisee could submit the receipt from his airline ticket. But the franchisee had not purchased the airline ticket, either, and the variance was not approved. Without a variance process, I would have approved the variance because I would not have had the nerve to ask for the proof. Because the variance committee was comprised of franchisees, I knew I had the backing of the members of our system.

Conclusion

There are several keys to successful franchise compliance. First, review all of the rules. Those that are not important should be rescinded. Compliance should be about what is important for the entire system. Second, create reasonable fines for lack of compliance. These fines should be strong enough to encourage people to comply, but not so harsh that the franchisor is afraid to use them. Last, use a franchise variance committee to make recommendations on enforcement. This will take pressure off management and increase the likelihood that the rules will be enforced.

Implementing an effective and fair compliance system will transform how a franchise system works with its franchisees. A franchise system that has compliance challenges will be able to create real compliance ' and with that, the entire franchise system will benefit.

Evan Hackel, CFE, is the principal and founder of Ingage Consulting and a board member of the New England Franchise Association. He consults on franchise compliance and other franchise relations matters. He can be reached at 781-281-9390 or [email protected]. Rupert Barkoff, a partner with Kilpatrick Townsend in Atlanta, provided valuable input for this article.

A number of years ago while I was the executive for a franchisor, I was asked for a variance by a franchisee who said he was planning to attend the annual conference, but got called away because of a sick relative. I faced a dilemma because the annual conference was very important to the system, but it is hard to reject a personal request. Also, I realized that if I refused, I might face some blowback if he complained to other franchisees about our seemingly harsh policy.

My situation was not unique. Every franchise system chief executive encounters similar situations in which a franchisee has a good reason for not complying with a rule, or in which the infraction is fairly minor. But how can a franchisor be sure about where to draw the line and how strictly to enforce the rules that are set out in the franchise agreement or operations manual?

After all, we know a franchise system's compliance issues normally start out small; however, within a short period of time, the infractions get bigger. If the franchisor continues to look the other way, before long, the only compliance franchisor will be enforcing is the payment of royalties.

Franchise systems that compromise their compliance put themselves in great jeopardy. The challenges a system could face as a result of non-compliance are far greater than the legal issues. Creating a consistent brand experience requires standards. Look at the McDonald's brand: It has an estimated value of $90 billion (“BrandZ Top 100 Most Valuable Global Brands 2013,” Millward Brown). This value did not accrue because McDonald's let its franchisees do whatever they wanted.

Common Goal

For a brand to be effective, everyone has to be on the same page, support the brand, and act as a unit. When there is little to no compliance, everyone can (and, in most cases, does) act independently. Instead of being a well-oiled machine moving toward a shared goal, the franchise system becomes more like herding cats.

Furthermore, the greatest misconception of franchisees is that a franchisee not in compliance is only hurting itself. Nothing could be further from the truth. Non-compliance of one franchisee hurts the whole system.

Take something as benign as a franchisee not attending the annual conference. Think for a minute about what the franchisor has to do to ensure non-attendees know about everything they missed at convention. The reality is, most franchisors do not have the time or resources to make this extra effort, and, consequently, the franchisee is not kept up-to-date on new policies, new products, etc. Even if the franchisor has the resources, the time spent updating the non-attendees could have been spent in other productive ways on behalf of all franchisees.

So how does the franchisor ensure compliance? The simple answer is to enforce all of the rules in the franchise agreement. But this is easier said than done. What if a franchisee had an accident on the way to the airport to attend the conference? He or she is in the hospital, so it seems fair that he or she would miss the conference. In a franchise system where non-compliance is simple termination, would this franchisee be terminated? It is unlikely.

Reasonable Rules

The better answer is to first make sure the franchise system has rules that the franchisor truly needs to enforce. Any rules that do not serve a real purpose should be eliminated. Also, the importance of those rules needs to be laid out in black and white for the franchisees ' the basic message being that if the rules are included in the franchise agreement or operations manual, then they need to be followed.

Again, back to the example of convention attendance. Because termination is often too harsh, the franchisor rarely (if ever) enforces it, and the lack of enforcement means there really are no rules mandating convention attendance. Consequently, once the right rules are in the franchise agreement or operations manual, the franchisor has to be willing to enforce them. What if the franchisor instituted a fee for non-attendance? An example of this could be a $1,000 fine paid into the national advertising fund, with the fine increasing by $1,000 increments for each missed conference.

In some franchise systems, changing a rule as simple as the one described above can take 10 years, as all the franchise agreements cycle through renewal. To get around these delays, the franchisor can give the franchisee the choice of either paying the fee (not currently in place) or accepting termination (as specified in the agreement). As long as the franchisee has the choice of accepting the fine and the franchisor will enforce what is specified in the franchise agreement if the franchisee chooses not to pay the fine, the franchisor can achieve its goal of having fair rules and franchise compliance.

Reviewing all of the compliance rules and implementing more reasonable and fair fees (in lieu of termination) is a critical part of this process. When the franchisor undertakes this process, it should be done with input from a special committee of franchisees. In a system with a franchisee association, have the association help create the committee. By involving franchisees in the process, the franchise system will develop a thoughtful set of rules that is likely to garner a higher level of acceptance from the franchisees.

Creating a Variance Committee

But remember: Franchisors do not get many calls from franchisees that are happy with the compliance system (I call them “the silent majority”). In fact, franchisors will only hear from franchisees asking for exemptions. Nevertheless, it is the silent majority that believes in the system, understands the benefits of compliance, and tends to be more aggressive in dealing with compliance issues than the franchisor.

This is a major issue in franchise compliance because franchisors do not like to enforce the rules. This happens for two main reasons: 1) they do not want to risk losing a franchisee that is providing the system with substantial income; and 2) they develop personal relationships with franchisees. The fact is, there are franchisees with legitimate exemption requests, but that line becomes very blurry, and eventually the franchisor risks legal liability because it is not enforcing the rules consistently through the system.

The solution is to remove the franchisor from the process of approving variances by creating a variance committee made up of franchisees. This committee can be chosen by management, but with input from either the franchise advisory council or the franchisee association. Like other committees, the membership should rotate over time.

The purpose of the variance committee is to review requests from franchisees for variances to the franchise agreement or operations manual. Essentially, the variance committee reviews the application for variance from the franchisee and makes a recommendation to management on whether or not a variance should be granted. Ultimately, the decision to grant the variance is made by management, but in my experience, the variance committee's recommendation is rarely overturned. (Interestingly, the committee ' comprised of franchisees ' tends to be tougher than management on the franchisee.)

Using the initial example to illustrate: When the franchisee called about missing the conference because of a sick relative, I was able to refer the situation to our variance committee. They investigated and learned that the franchisee had never registered for the convention, but claimed he planned to register on-site. The variance committee told the franchisee it would approve the variance if the franchisee could submit the receipt from his airline ticket. But the franchisee had not purchased the airline ticket, either, and the variance was not approved. Without a variance process, I would have approved the variance because I would not have had the nerve to ask for the proof. Because the variance committee was comprised of franchisees, I knew I had the backing of the members of our system.

Conclusion

There are several keys to successful franchise compliance. First, review all of the rules. Those that are not important should be rescinded. Compliance should be about what is important for the entire system. Second, create reasonable fines for lack of compliance. These fines should be strong enough to encourage people to comply, but not so harsh that the franchisor is afraid to use them. Last, use a franchise variance committee to make recommendations on enforcement. This will take pressure off management and increase the likelihood that the rules will be enforced.

Implementing an effective and fair compliance system will transform how a franchise system works with its franchisees. A franchise system that has compliance challenges will be able to create real compliance ' and with that, the entire franchise system will benefit.

Evan Hackel, CFE, is the principal and founder of Ingage Consulting and a board member of the New England Franchise Association. He consults on franchise compliance and other franchise relations matters. He can be reached at 781-281-9390 or [email protected]. Rupert Barkoff, a partner with Kilpatrick Townsend in Atlanta, provided valuable input for this article.