The primary economic driver that we are seeing is that the shape of the food & drink market is changing at breathtaking pace. Entire parts of the market have disappeared (temporarily, perhaps) whilst new parts are thriving. One striking example of market shrinkage was the sudden dearth of corporate lunches, networking drinks and social events. Whilst that market space has shrunk, the home-delivery and take away market has opened up.

We are fortunate to work with a number of innovative franchising clients and contacts who acted quickly to flex into new markets as others began to dry up. A key differentiator that has allowed some franchise businesses to thrive is diversification – whether that be diversification of products, services, customers or location.

Franchisor considerations when its franchisee is looking to diversify 

Before reviewing any market diversification, the franchisor will be keen to check the franchisee's performance under its contract prior to the COVID-19 outbreak – is this a franchise arrangement it wishes to continue with? Are modifications to performance possible or is this an opportunity to exit? It will then need to consider if the franchisee has a strong business plan that it can implement despite the impact that the global pandemic has had on its cashflows. Is its franchisee robust, healthy and a good bet? Are additional guarantees required?

If the franchisor approves any market diversification by the franchisee then it should check the franchise agreement to ensure that any newly created IP remains protected and that all generated goodwill vests in the franchisor.

Generally, market diversification may lead to an increased risk of IP infringement and potentially challenges to the validity of the franchisor's IP. The franchisor should consider whether this has been taken into account as part of its business model.

Given that the exploration of a new market will likely be outside of the usual course of the franchisor's business, the franchisor should ensure that it has adequate control over the franchisee's operations in that market.  Also, the franchisor should consider whether it has the processes and procedures in place to continue to adequately service its franchisee in the new market space.

Franchisee considerations when looking to diversify

The franchisee should always check the terms of the franchise agreement when looking to diversify. In so doing the franchisee should consider whether the terms of the franchise agreement provide the ability to flex into a new market space (for example, does it have the right to offer take away and home delivery services rather than being restricted to operating out of specific premises). The franchise agreement may require the franchisee to obtain the franchisor's prior approval before taking such action, in which case the franchisee should ensure that it obtains the franchisor's approval in writing.

Regarding IP, the franchisee should check whether the current IP rights granted to it in the franchise agreement are adequate to explore new markets. Also, whether the franchisee has the right to create and/or exploit other IP rights as part of that diversification. 

What is the franchisee expecting to achieve in the long-term? If it is simply to preserve market share or increase revenue then that will be relatively straightforward to facilitate. However, if the franchisee is expecting to be able to independently harvest customer data in the new market space then the terms of the franchise agreement should be carefully scrutinised to check for any contractual restrictions on doing so. 

Both franchisees and franchisors should scrutinise the terms of their franchise agreement before implementing any strategic diversification of their business. Where the terms of the franchise agreement do not align with the parties' commercial strategy the parties may need to enter into a variation agreement in order to amend or vary the terms of the franchise agreement to bring them into line.

Ultimately, it will be much less costly to consider and resolve any IP and contractual issues before the parties begin exploring new markets than to resolve such issues after the event. Our specialist franchising lawyers are here to help and make the process as straightforward as possible.

Our recommendation 

Of particular importance to food & drink businesses during this ongoing period of uncertainty was whether they were tied into operating out of one particular location. The national lockdowns and ongoing restrictions have, of course, changed the way consumers purchased food and drink, at least in the short-term, and businesses that have been unable or slow to move to home delivery or take away have struggled to mitigate the reduction in revenue. Note the closure by Pret A Manger of 30 of its UK stores.  As such, diversification of a franchisee's business structure may allow the franchisee to overcome the challenges posed by having to operate out of one fixed location. 

Market diversification is not as straightforward as it may seem from a franchising perspective. The contractual arrangements between a franchisor and a franchisee often contain restrictions on how the service can be supplied (often with very strict and prescriptive requirements), the geographic locations in which the franchisee may operate, the types of customers it can target and the types of goods it may supply. 

Also, branching into new markets triggers intellectual property (IP) issues for both franchisees and franchisors. For example, the parties should consider whether a franchisee has the right to use the franchisor's IP in a new part of the market. The franchisor may also have concerns with its IP being used by a third-party in a previously untapped market space.

What we are seeing in the market