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FRANCHISE COMPLIANCE: A Light at the End of the Tunnel

For a brand to be effective, everyone has to be on the same page, support the brand and act as one.

By Evan Hackel, CFE

 

Compliance issues in a franchise system tend to have a snowball effect — it can start with something fairly minor like not attending convention, but it doesn’t take long before the infractions get bigger. And, if the franchisor looks the other way, eventually it will be enforcing only compliance on royalty payments.

Franchise systems that compromise their compliance put themselves in great jeopardy. The system-wide challenges they could encounter as a result of non-compliance are far greater than the legal ones. Creating a consistent brand experience requires standards. Look at a brand such as McDonald’s Corp. that holds its franchisees to high standards — it has an estimated value of more than $92 billion, according to Yahoo! Finance on Aug. 5.

Acting as One

For a brand to be effective, everyone has to be on the same page, support the brand and act as one. When there is no compliance, franchisees have the opportunity to act independently. The result is a fragmented system, not one that is aligned and moving toward the same goals.

Some franchisees believe that when one franchisee isn’t in compliance that franchisee is only hurting himself. This couldn’t be further from the truth. Non-compliance of one franchisee hurts the whole system.

Take the minor infraction of not attending the annual convention. Consider what the franchisor needs to do to ensure non-attendees know about everything they missed at convention. Reality is, there isn’t enough time or resources available in most systems to make this extra effort, and consequently, the franchisee isn’t kept up to date. Even if the franchisor has the resources, the time spent updating the non-attendees is taken away from those franchisees attending the conference.

Steps to Ensure Compliance

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. Consider the convention non-attendee. What if he was in a major car accident on the way to the airport? Missing the convention seems fair (and legitimate). In a franchise system where non-compliance is simple termination, this franchisee would be terminated, a little severe considering the circumstance and the reason most franchisors are unwilling to use it.

The better answer to ensuring compliance is to first ensure the franchise agreement has rules the franchisor needs enforced. Any rules that don’t serve a real purpose should be eliminated. The rules need to be black and white for the franchisees — if it’s in the franchise agreement it needs to be followed. Period.

Once you have the right rules, you need to have reasonable penalties. Think about termination as the penalty for not attending convention. Because the franchisor rarely enforces such a harsh penalty, there really aren’t any rules enforcing convention attendance.

What if the franchisor instituted a reasonable penalty for non-attendance? An example could be a $1,000 fine paid into the national advertising fund, with the fine increasing by $1,000 increments for each missed convention. This penalty is more appropriate, and thus, likely to be enforced by the franchisor.

Changing a rule in some franchise systems can take 10 years — you add the new rule into franchise agreements as franchisees renew. There is a way to work around this issue: the franchisor can give the franchisee the choice of either paying a fine or accepting termination. As long as the franchisee can choose to accept the lower penalty, and the franchisor will enforce the actual penalty if the franchisee doesn’t pay the fine, you achieve your goal of having a lower penalty.

Reviewing all of the compliance rules and developing more reasonable and fair penalties is a critical part of this process. To be successful and have franchisee support, you need to make them part of the process. To accomplish this, create a special committee of franchisees, or in a system with a franchisee association, have the association help create the committee. The franchisees will help you develop a thoughtful set of penalties that are likely to garner a higher level of acceptance from the franchisees.

Don’t kid yourself, franchisors won’t get calls from franchisees who are happy with the compliance system. These franchisees believe in the system and understand the benefits of compliance; and they are ultimately more aggressive in dealing with compliance issues than the franchisor.

Enforcement Consistency

Now we’ve circled back to the major issue in franchise compliance: franchisors don’t like to enforce the rules. This happens for two main reasons: one, they don’t want to risk losing a franchisee who is providing the system with substantial income; and two, they develop personal relationships with franchisees.

Failure to enforce the rules consistently can create legal issues for the franchisor. The lines between a franchisee’s legitimate exemption request and the franchisor playing favoritism can become very blurry, and the franchisor can eventually be at risk for legal liability.

The solution is to create a variance committee of franchisees. The franchisor’s management chooses the committee members with input from either the franchise advisory council or the franchisee association. Like other committees, the membership should rotate over time.

Essentially, the variance committee reviews the franchisee’s application for variance to the franchise agreement and recommends to management whether or not a variance should be granted. Ultimately, the decision to grant the variance is made by management, but from my experience, the variance committee tends to be tougher than management on the franchisee and management rarely overturns the committee’s recommendation.

Let’s go back to the example of franchisees not attending an annual convention. The franchisee said he was planning to attend the annual conference, but had to return on the way to the airport because of a call about a sick relative. The variance committee conducted a deeper investigation. The committee learned the franchisee hadn’t registered for the convention. The franchisee claimed to plan to register on-site. The variance committee then asked for a receipt from the airline ticket. If the franchisee could produce the receipt from the airline ticket, the committee would approve the variance. The franchisee wasn’t able to produce the airline ticket and the variance wasn’t approved. Sadly, without a variance process I would have approved the request, because I wouldn’t have had the guts to ask for the proof.

There are several keys to successful franchise compliance. First, review all of the rules. Rules that are not important should be rescinded. Compliance should be about what is important — and the entire system should be focused on those things. Second, create reasonable penalties for lack of compliance. You need to find the right balance between encouraging compliance and desire to enforce. Lastly, 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, a member of the IFA Franchise Relationship Committee and a New England Franchise Association board member.  Find him at fransocial.franchise.org.

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