Area Development: a contract increasingly used in Italian franchise practice
The Multi-Unit franchise model is increasingly widespread in the world, including Italy. According to the MUF model the franchisor has relationship with franchisees which in turn own several points of sale. Within the MUF model, a role of primary importance is played by the Area Development Agreement. The Area Developer is a franchisee to which the franchisor grants the right to open its own franchise units in a specific area, for a specific period of time and according to a specific development plan, on an exclusive basis. The Area development scheme offers many advantages to both parties. Crucial aspects for success of an Area Development agreement are a careful selection of the Area Developer and a realistic drafting of the Development schedule.
1.Multi-unit franchising in Italy
As is known, the Multi-Unit franchise (MUF) model is increasingly widespread in the world; Italy is not an exception.
Unlike the traditional Single-Unit Franchisee (SUF) – according to which the franchisor has contractual relationships with individual franchisees – according to the MUF model the franchisor has relationship with franchisees which in turn own several points of sale (POS), thus essentially acting as intermediaries between the franchisor and the individual POS.
The reasons for the success of the MUF formula are many: in fact, compared to the traditional SUF model, it allows for a higher and more accelerated rate of development and penetration, greater financial and risk sharing, faster cash flow, etc.
It is estimated that, in the world, over 60% of POS belonging to a franchising network are managed by MUF; in Italy, around 40% of franchises are based on a MUF model.
MUF is particularly used in the initial phase of a franchise network development; but it is also used in its maturity phase, often in combination with the traditional SUF model and with the Master Franchising.
2.Area development: structure and characteristics
Within the MUF model, a role of primary importance is played by the Area Development Agreement (ADA), which is increasingly used in Italy as well.
The Area Developer is a franchisee to which the franchisor grants the right to open its own franchise units in a specific area, for a specific period of time and according to a specific development plan, on an exclusive basis.
Unlike what happens in the Master Franchising, the Area Developer does not have the right to sub-franchise the franchise package, but only to open franchise units (or POS) it owns, thus acting as an intermediary between the franchisor and individual points of sale.
The opening of the various franchise units by the Area Developer in the given territory takes place according to a specific development schedule, regulated in detail in the area development agreement. It includes the geographical dimension of the territory, the opening time schedule, the scope of exclusivity, the consequences of non-compliance with the program, etc.
The franchisor may contractually reserve the right to open its own units in the territory reserved for the Area Developer, in certain strategic areas (for example, airports, stations, sports fields, parks, etc.). In any case, the franchisor’s consent is generally required for the opening of the various franchise units, albeit on the basis of predetermined criteria.
Typically, the Area Developer pays the franchisor a development fee at the signature of the contract, which represents the consideration for the granting of exclusive development rights in the territory and is generally lower than the fee paid by a Master Franchisee. Additional franchise fees are also envisaged at the time of the opening of the individual franchise units, generally to a proportionately reduced extent compared to the entry fees and royalties paid under a traditional SUF model.
3.The advantages of the Area development
The advantages that the Area development scheme offers to both the franchisor and the Area Developer are many.
Firstly, if the POS are controlled by an Area Developer, the levels of uniformity and adherence to the network standards are generally higher than if the franchisees remain completely independent from each other.
Furthermore, the Area Developers, although not as easily replaceable as an area manager, generally give greater guarantees of reliability to the franchisor, as their remuneration is strictly linked to their performance, and therefore having a direct involvement in the network.
Finally, the franchisor can in this way optimize and reduce the costs of selection, training, marketing and supply chain, entrusting this task to the Area Developer who knows the Italian market and is generally more experienced and reliable than a single unit franchisee.
On the other hand, the Area Developer can count on exclusivity in the territory (which allows it not to suffer the competition of other franchisees, at least as long as the ADA is in force) and on fees and royalties lower than those that would correspond. for individual franchise units or as part of a Master Franchising.
4.How to optimally structure an Area development agreement
Two aspects are crucial to ensure success of an Area Development agreement and minimize risks.
Firstly, it is necessary to proceed with a careful selection of the Area Developer, which must provide adequate guarantees to the franchisor not only in terms of capacity and experience but also in terms of financial capacity, in accordance with the agreed program for opening franchise units.
For this reason, the Area Developer generally is an investor (often a company) of considerable size, organizationally and financially well structured, with experience and who has already been successful in the Italian market and/or in the reference sector (for example, the owner of a restaurant chain).
Secondly, it is necessary to prepare the Development schedule in a very precise and realistic way, avoiding in particular to grant the Area Developer too large a territory for a substantial period of time, with the risk of delaying the development of the network and/or jeopardizing the image of the brand.
In this regard, it will obviously be advisable to carefully study the Italian market and plan the development by providing a series of subsequent steps, in order to verify the progress of the Area Developer and provide appropriate remedies.
In fact, if, for various reasons, the opening program of the franchise units should not be respected by the Area Developer, before termination of the relationship it will be appropriate to provide for various intermediate steps in the contract, such as the reduction of the territory granted exclusively or the loss of exclusivity.
Conversely, if the Area Developer completes the development plan in advance of what is expected or in any case is in line with the contractual provision, option or pre-emption rights may be envisaged for the exclusive extension of the territory.
Avv. Valerio Pandolfini
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The information contained in this article is of a general nature and is not to be considered an exhaustive examination of the various issues, nor is it intended to express an opinion or provide legal advice. Specific legal advice must be provided with regard to individual cases.