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Franchising's underperformance in the EU and the role of the Regulatory Environment

01/05/2012

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United Kingdom

Franchising's underperformance in the EU and the role of the Regulatory Environment

This article was first appeared in Intellectual Property Magazine, 1 May 2012.

Business format franchising is a specific, distinct and uniform way of exploiting intellectual property rights that has a significant economic impact in the European Union.  It comprises a "basket" of trade marks, copyright material, designs and trade secrets, which together form the blue print for a successful business.  This enables the franchisor to grow its business in an exponential manner.  It also allows franchisees to access a proven business format.  As a result, franchising stimulates economic activity by offering significant advantages to all those involved, improving market penetration and giving business increased access to other member states.  It comprises nearly 10,000 franchised brands in the EU, which account for over €215 billion (US$300 billion) turnover per annum.  However, compared to its scale in the USA and Australia, franchising is not realising its full potential in the EU.

 A comparative law analysis drawing upon member states’ existing laws, shows that this underdevelopment of franchising in the EU is, in part, due to the regulatory environment it is subject to.  This is primarily because of two distinct factors.  Firstly, a failure by the EU's regulatory eco-systems to properly govern franchising.  It fails both to adequately reinforce the economic drivers that attract franchisors and franchisees to franchising and to reduce to an appropriate level the inherent consequential risk to which both parties are exposed.  Secondly, there is a lack of homogeneity between the national legal eco-systems which amounts to a barrier to trade between member states. 

An appropriately drafted directive would not only harmonise the approach of the EU’s legal eco-systems towards franchising but will also re-enforce the relevant economic drivers and reduce the inherent consequential risks to an appropriate level. 

Poor Economic Data

There is no up to date uniform and complete set of economic data for franchising in all or even the majority of EU member states.  This in itself suggests that franchising is not achieving its full potential in the EU.

The most recent figures published by the European Franchise Federation are in respect of 2009, but they only deal with 18 member states(1) and the information given for them is incomplete(2) and in places incorrect(3).  A careful consideration of these figures and a selection of other sources suggest that franchising in the EU currently accounts for approximately US$300billion.

An Uneven Spread Within the EU

Franchising is not well established in many of the newer and less economically developed EU member states.  The figures show that franchising is heavily focused in around a quarter of the EU member states which account for US$250.4 billion (€180 billion) out of a total estimated turnover of US$300 billion - the UK, Germany, France, Spain and Italy.  In other words less than 25% of the EU member states account for an estimated 83.5% of franchising’s turnover in the EU.

A Poor Comparison

The EU has a population of around 500 million(4) compared to the USA’s 310.9 million(5).  The EU’s Gross Domestic Product(6) in 2010 was US$16,106,896,000,000 (16.1 trillion) compared to the USA’s GDP of US$14,624,184,000,000 (14.6 trillion)(7).  One might therefore expect the estimated turnover of franchising in the EU and the USA to be similar.  However, this is not the case.

The estimated 405,000 franchised outlets in the EU and the estimated turnover of US$300 billion are dwarfed by the equivalent figures in the United States, where in 2010 there were an estimated 901,093 business format franchise outlets employing 9,558,000 and accounting for an output of US$868.3 billion(8).

Even Australia, with a population of only 22.5 million and a GDP of US$1.2 trillion has an estimated franchise turnover of US$130 billion(9). 

 

Population

GDP 2010

Estimated turnover of franchising

Franchising as a percentage of GDP

Turnover of Franchising per head of population

EU

500 million

US$16.1 trillion

US$300 billion

1.86%

US$600

USA

310.9 million

US$14.6 trillion

US$868.3 billion

5.95%

US$2,792

Australia

22.5 million

US$1.2 trillion

US$130 billion

10.83%

US$5,777


 

The figures are very stark.  Although the USA has only 60% of the population of the EU and a lower GDP, franchising’s estimated turnover in the USA is considerably more than double that in the EU. Compared to both the USA and Australia, (both of which are federal states and have sophisticated and well developed franchise laws), franchising in the EU is markedly underdeveloped. 

Why do Companies become involved in Franchising?

The economic drivers that lead franchisors and franchisees to become involved in franchising differ.

Improved access to both appropriately qualified managerial resource and capital and other economic drivers such as bulk purchasing, economies of scale and enhanced product development explain why businesses use franchising as a way to exploit their intellectual property. A number of economic incentives resulting in an increased chance of success (such as access to a proven format, a nationally recognised brand, ongoing support, economies of scale and so on) supported by various situational, personality and economic correlatives explain the attraction of franchising to franchisees.  Franchising is therefore a win-win relationship.  Franchisors use it to exponentially grow their businesses – particularly into regions and countries which are otherwise beyond their reach.  Franchisees use it to access a "turn key" business format. 

What are the Risks of Franchising?

There are a number of different risks inherent in franchising for franchisors and franchisees. Franchisors are exposed to risks arising from information asymmetry and moral hazard (such as underpayment, in-term competition, abuse of the franchisor’s brand and non compliance with the business format).  Whilst franchisees are exposed to the risk of misrepresentation, encroachment, poor quality business formats and inadequate support.

How Successful is Franchising's Regulatory Environment in the EU?

Franchising is a symbiotic relationship between two legally independent businesses that is used in a wide range of sectors and on a broad spectrum of scale and value which can be differentiated from Trade Mark Licensing, commercial agency and distribution.  The main difference is the business format and the ongoing support. These features are not impacted by either economic or sectoral contextualisation. 

Franchising needs to be regulated as the regulatory environment in the EU (both self regulatory and legal) within which franchising operates does not adequately protect and re-enforce the economic drivers that attract franchisors and franchisees to become involved in franchising.  Nor does it adequately reduce the consequential inherent risks.  In some cases it over protects the franchisees, so increasing the risks to franchisors and eroding the economic drivers that attract them to franchising in the first place.

Self regulation of franchising fails to deliver all it promises and is not transparent, consistent, accountable or proportionate.(10)  There is a lack of suitably experienced, authoritative, fully representative and sufficiently resourced franchise associations.

The inevitable conclusion is that franchising needs to be legally regulated in the EU. Voluntary regulation will never be able to provide franchisees, potential franchisees or indeed franchisors with the level of protection that they require.

The Current Law

The current franchise specific regulatory environment in the EU comprises franchise laws in eight member states(11). They focus predominantly upon pre-contractual disclosure and fail to present a homogenous approach to key issues.  This one dimensional approach does not reduce the risks of informational asymmetry and moral risk to which the franchisor is exposed or the risks of misrepresentation, encroachment, poor quality formats and inadequate support to which franchisees are exposed.  It does not ensure that the economic drivers which attract franchisors and franchisees into franchising are supported. The lack of a homogenous approach between the different EU member states reduces franchising's cross border potential.

Non franchise specific laws in member states impact upon the pre-contractual regulatory environment in the EU in five distinct ways.  They impose a duty not to misrepresent facts, an obligation to disclose relevant information to potential franchisees, an extra contractual obligation to disclose relevant information to potential franchisees, an extra contractual obligation of confidentiality, an obligation to enter into the franchise agreement once negotiations have passed a certain point and a right to withdraw from

the contract within a limited time period.  Each member state takes a different approach to these issues, resulting in a lack of any homogenous approach. 

The ongoing franchisor/franchisee relationship in the EU is impacted by a regulatory environment that comprises a duty of good faith, anti-trust, unfair competition and consumer law.  Again there is a complete lack of harmony between the various non franchise specific regimes seeking to regulate the franchise relationship in the EU.  

This heterogeneity substantially weakens the ability of businesses to use franchising as way of entering other EU member states.  It creates a technical barrier over which many franchisors simply cannot climb.

Conclusion

The European Commission is unequivocal in its belief that a regulatory environment comprising harmonised legal eco-systems is necessary to ensure that businesses can operate across borders efficiently.  Despite this clear view of the need for a harmonised approach to the regulation of cross border commerce in the EU, there is a complete lack of homogeneity on the way that franchising is regulated in the EU.  This current heterogeneous regulatory environment for Franchising creates obstacles that hinder franchisors from taking full advantage of the single market.

In addition to this, the EU's regulatory environment also fails to adequately reinforce the economic drivers that attract franchisors and franchisees to franchising and to reduce to an appropriate level the inherent consequential risk to which both parties are exposed.  This further hampers the ability of franchising to fully exploit the single market.

The comparative underperformance of franchising in the EU when compared to its performance in the USA and Australia is a clear consequence of this lack of homogeneity and the failure of the EU regulatory environment to support the economic drivers which encourage the use of franchising and reduce the consequential risks.

Franchising's disproportionate concentration in the UK, Germany, France, Italy and Spain further exacerbates franchising's failure to promote trade between member states as much as it could and should do.

An appropriately drafted directive would not only harmonise the approach of the EU’s legal eco-systems towards franchising but will also re-enforce the relevant economic drivers and reduce the inherent consequential risks to an appropriate level.  This would in turn help to increase both the number of businesses involved in franchising in the EU and their turnover.

Dr Mark Abell, joint head of the franchise and licensing team at law firm, Fieldfisher.


(1) Austria, Belgium, Croatia, Czech Republic, Denmark, Finland, France, Germany, Greece, Hungary, Italy, Netherlands, Portugal, Poland, Slovenia, Spain, Sweden, Turkey and the UK.  Turkey is not a member of the EU.  However four of these (Belgium, Denmark, Finland and Germany) are estimates and the gross total of 11,731 is arbitrarily discounted by 15% to take into account the fact that brands that exist in several countries may be costed more than once in these statistics.  The figure for Turkey is given at 1,640 and so that must be removed.  Consequently the estimated figure of 8,330 is deemed to be unreliable.  The statistics do not give details of even estimated turnover for franchising. 

(2) For example, no turnover figures are given for 12 member states.

(3) The turnover figure for the UK in 2009 is given as €9.42 billion rather than the €11.8 billion given by the BFA

(4) International Monetary Fund.  World Economic Database, October 2010

(5) Ibid

(6) The market value of all final goods and services from a nation in a given year.

(7) International Monetary Fund, ibid

(8) “Price Waterhouse Coopers 2010 Franchise Business Economic Outlook” – The International Franchise Association’s Educational Foundation
http://www.franchise.org/ (viewed 29/12/2010).

(9) Franchise Council of Australia
http://www.franchise.org/ (viewed 29/12/2010)

(10)  
www.berr.gov.uk/whatwedo/bre/index.html, accessed 08.10.2009.

(11) France, Spain, Italy, Sweden, Belgium, Romania, Estonia and Lithuania

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