Minimum Performance Levels in Franchising

Many franchisors specify Minimum Performance Criteria (MPC) as an instrument to direct the performance and expectations of their franchisees, and protect the brand. Whether a particular sales level or minimum standard of compliance, the criteria establish the minimum level of franchisee performance acceptable to the franchisor. Failure to achieve the criteria typically sets in motion a framework whereby the franchisee must rectify the situation.

From a franchisors point of view, MPC are a positive. MPC provide a performance backstop and a structure to help maintain a minimum level of performance for each unit. Franchisees understandably regard MPC with less enthusiasm. After all, MPC provide a reason to be performance-managed, and ultimately terminated, depending on their performance and actions. That said MPC can also provide franchisees with a protection mechanism to the extent they help protect their interests from problem franchisees in the group taking shortcuts, failing to perform, and generally bringing the network into doubt in the eyes of consumers, network bankers and accountants etc.

This article addresses a number of areas relating to Minimum Performance Criteria from both a franchisors and franchisees perspective (whether a single-unit operator, multi-unit and/or master franchisee).

Minimum performance levels and criteria

MPC can be identified by a number of similar terms, such as Minimum Performance Objectives and Minimum Performance Standards. The intent is generally the same. MPC establish the base performance level required by franchisees. They establish a performance level which is regarded as below borderline acceptable to the extent that if the particular performance level is not achieved, the franchisor would rather than franchisee were not in the system. From the franchisor’s point of view, the franchisee is just not exploiting the system and territory to a satisfactory level and would rather find a replacement. Furthermore from the franchisee’s perspective, not achieving certain objectives might also indicate to them their talents and energies might be better put to alternative use as well. But not surprisingly, a franchisee might not regard the situation this way.

Who sets the criteria?

Who sets the criteria depends on how the franchise system has been designed. There are three key options. Sometimes a franchisor unilaterally sets MPC for each franchisee. Second, and more commonly, the franchisor and franchise agree upon standards during the business planning process. Third and finally, and very rare, franchisees sometime set their own minimum levels of acceptable performance. Which system is best really depends on the particular business and circumstances.

Many franchisors prefer to work ‘with’ franchisees when setting the MPC as part of an annual business planning process. The business plan provides a positive focus for setting goals and objectives for the year, that should be mutually beneficial to the franchisor and franchisee. The process should be positive and focus on development. Close to the completion of the business plan, the MPC will often be set. And obviously, by virtue of their title, MPC are the minimum acceptable performance level. They are not the level of performance aimed for. Determining the goals and objectives first, working through how these will be achieved, determining the viability of the planned course of action etc, then provides a positive platform from which minimum mutual acceptable levels of performance can be discussed. In this context, it is easier for the franchisor, and importantly the franchisee, to agree upon what level of performance they agree would be unacceptable from their point of view.

Where are they located?

Invariably, the concept of MPC are contained within the Franchise Agreement. The Franchise Agreement will also normally specify the framework for what happens when performance criteria are not met. The actual MPC themselves (whether a level of sales, audit scores etc) can be located in a number of places, ranging from the MPC provision itself in the franchise agreement, to a schedule or annexure to the Franchise Agreement, the Franchisee Manual and/or the Franchisee’s Business Plan. Sometimes, the Franchise Agreement may provide reference to MPC, and the fact there will be MPC to comply with, while the location and form of their final communication is not specified in advance.

It is important to note that Franchise Agreements, and indeed Franchisee Manuals (which should be provided legal status by the Franchise Agreement), contain many related criteria which can be also be regarded as a form of MPC. For example, the aforementioned types of franchise documents invariably require franchisees to promote their businesses diligently, provide customers with good service comply with policies, guidelines and standards, and so on.

What are some examples?

MPC really can come in all shapes and sizes, and conceivably cover all possible areas of the business. Levels of sales and sales growth are quite common. Other sales-related examples include minimum product-service mix proportions, proven levels of prospecting activity, and sales-process conversion rates. Further non-sales related examples include minimum stock levels, approved purchases, minimum levels of qualifications, compliance audit scores, customer service feedback, attendance at a minimum number of group meetings and/or conferences.

It is important to note that while MPC can conceivably cover every area of the business, they rarely do – nor should. Clearly minimum standards covering countless areas of the business will do little more than drive franchisees M.A.D. From all points of view it makes sense that MPC are limited to the most essential, non-negotiable critical and core areas of the business. What is actually appropriate, and fair, should depend on the specifics of the business and the objectives of the owners. But ultimately, it makes sense if MPC address key drivers of the business. After all the success of many franchise systems is strongly influenced by a consistent focus on executing the fundamental drivers of the business.

Any MPC must be operationalised clearly. There can be no room for doubt in respect to performance outcomes and whether or not performance has been met.

MPC may be specified separately according to a variety of time periods, such as monthly, quarterly or annually. The timing of MPC is essential for many criteria, especially when measured infrequently or affected by factors such as seasonality.

MPC and different levels of franchisees

Minimum performance requirements are a structure and framework that can be applied, like a pattern, to all levels of franchisees. MPC can be applied to a single-unit lawn-mowing owner, a multi-unit owner of two or three restaurants, a master franchise holder for a region, and an investor securing exclusive rights to expand an overseas franchise concept in a target country.

For a particular individual franchise system, many of the criteria associated with a single-unit operator, will also likely apply to a multi-unit and/or master franchisee. As you can imagine, for example, sales and compliance related criteria will be of equal relevance to all outlets associated with different franchisees controlled by a single-owner or multi-outlet owning franchisee.

As the level of franchise type or opportunity increases so to does the range of criteria that may be appropriate. For a sequential franchisee, for example, wanting to secure rights to an additional outlet, the franchisor may specify minimum criteria relating to sales, compliance and store upgrades of an existing outlet/s that must be bettered before additional units are proffered.

Multi-unit franchise agreements, such as area development, area representation and sub franchising agreements, often add the concept of a development schedule. A development schedule typically specifies the expected number and rate of unit or outlet openings required by a multi-unit franchisee in order to fulfill their obligations. For example, an area developer, with rights to establish six restaurants in a city/region might be required to open two per year over a three year period. Similarly, an investor investigating an overseas master franchise for particular country might need to establish more than 30 units before 2016. These could be either franchised or company-owned. Either way, the successful master franchisee will need to establish 30 in order to retain their franchise agreement and associated business. Other examples pertaining to multi-unit franchise agreements include total sales levels, average sales and compliance audit scores.

Minimum performance criteria – a reality check

Minimum performance criteria should not only be limited to important areas of the business, they must also be realistic. After all, minimum performance criteria are designed to address a minimum acceptable level rather than expected (or target) level of performance.

It is the author’s view that minimum performance criteria are often misused. Examples include a franchisor (whether intentionally or not) requiring criteria that will be hard, notwithstanding the franchisee’s best endeavors, to achieve. Oftentimes, this situation arises because the franchisor assumes a level of performance to be achievable based on a false assumption. An example may be a franchisor unilaterally specifying minimum acceptable sales levels for a Greenfield unit where there is no trading history. A related example relates to an overseas franchisor requiring a minimum number of outlets to be opened in New Zealand when the concept has never been tried or trialed here. There’s a fine line between protecting a franchisors interests and providing an unfair requirement upon a well intentioned and qualified franchisee. Furthermore, the author is also of the view that unilaterally set minimum performance requirements, where no prior trading has been experienced, could be interpreted as a form of performance projection. After all, if they are minimum performance criteria, and I work diligently, surely I could have expected more sales and/or more stores in return for my investment? For this reason, some franchisors will hold off setting MPC until a particular franchisee has been trading for a year or more. That trading then establishes a history upon which certain criteria can be more safely set.

What happens when criteria are not met?

The concept of MPC is often accompanied by a framework specifying what happens if MPC are not met. What happens will be unique to the specific way the clause or framework has been drafted. For example, some criteria might be absolute and failing to achieve them will be outright critical to the agreement. Conversely, some frameworks may allow the franchisee to miss performance criteria once or twice, but if it happens three times in consecutive months, or say three times in a six month period, then the situation needs to be rectified.

How the situation is rectified will depend again upon what strategic decisions were made when designing the franchise system and how the specific clauses in the franchise agreement have been drafted. We advocate, where there is a breach, that a franchisor representative meets with the franchisee to discuss, plan and agree upon a required active course of action and initiatives to be undertaken by the franchisee in order to rectify the situation within an agreed upon time period. The actions and initiatives the franchisee undertakes will depend on the criteria requiring rectification. As examples, additional training maybe required in order to help resolve a compliance problem. If the issue is related to sales performance, a more active focus on prospecting and sales activity maybe required. Again, this may require some training, and it may also require increased marketing activity and investment on the part of the franchisee.

From a franchisors viewpoint it is essential that the franchisee does take active steps to rectify the situation. It is possible of course that the franchisee fails to meet some minimum performance criteria for valid reasons – such as the opening of a competitor across the road. Such circumstances need to be taken into consideration.

The bottom-line underpinning MPC is termination. The franchisee, by failing to meet MPC as required in the franchise agreement signed by both parties, risks losing their investment in the franchised business.

Why are MPC important? What do they aim to achieve?

From the franchisors point of view it is important to have franchisees who maximize the potential of the concept in their territories. This is because the market size, particularly in a country like New Zealand, is limited. The difference between a two, five or ten percent change in sales can have a dramatic impact on the profitability of both franchisees and the franchisor. For a franchisor, in a market as small as New Zealand where there is limited overall scope for royalties, this can be of vital importance.

To ensure a level of performance achievement by franchisees the franchise network must have a performance management mechanism. Part of the performance management mechanism flows through the initial strategy and requirements for recruiting franchisees, related performance management infrastructure for existing franchisees (e.g., franchisor and franchisee business planning cycles, performance reviews, call cycles, field visits, action plans etc) and a culture whereby high performance is encouraged (e.g., consider rewards and recognition programs) at both the franchisor and franchisee level, including the staff of both entities. MPC can provide an important structural element within this wider performance management framework. They can provide a bottom-line protection for the franchisor in the event a franchisee underperforms.

From a franchisees point of MPC make clear minimum acceptable levels of performance. In addition, MPC help protect incumbent franchisees from other non-performing or sloppy franchisees within the network.

Conclusion

MPC are an important structural element employed by many franchise systems. Whether a particular level of sales, or number of outlets opened within a specified timeframe, the minimum performance criteria outline the bottom-level of performance acceptable to the franchisor. How the MPC are structured depend on how the franchise system is designed. As outlined above, there are many different ways MPC can be structured and work.

From a prospective franchisor's point of view there are important decisions to make during the strategic planning process prior to launching a franchise system. In addition, the prospective franchisor needs to ensure MPC are located within an infrastructure that more generally fosters and encourages the performance development of franchisees. After all, it is not positive to always focus on MPC because they are the ‘minimum acceptable’ rather than ‘expected level’ of performance. Important questions to address include the following. What do I do if MPC are not met? What tools and guidance do I have available to assist the franchisee to rectify performance? How do we measure whether performance has improved? What if agreed upon actions have not been taken or implemented by the franchisee? How are we going to record and evidence this if required?

A prospective franchisee or investor on the other hand needs to take care when evaluating a particular franchise opportunity, regardless of whether it is for a single unit, multiple-unit or master franchise. The criteria and framework associated with MPC need to be clearly understood. The prospective investor must also ensure that any criteria individually specified are reasonably achievable. To that end, in addition to normal due diligence the prospective franchisee should also talk with existing franchisees about their experiences with MPC in the franchise system.

MPC are important but they must exist within a culture supporting the ‘development’ of franchisees. The ‘development’ focus may include compliance but should also focus on the business development of franchisees. The point is that the focus of the relationship should be a positive, which is the development of franchisee performance. The focus for relationship should not be on minimum levels of acceptable performance .