Licensing agreements: Considering the relative merits of constraints and flexibility


Apr 11, 2024

Licensing agreements: Considering the relative merits of constraints and flexibility

The lawsuit recently filed by 16 Tim Hortons franchisees [1] has raised an interesting question related to the relative merits of constraints and flexibility in licensing agreements. It has often been said that franchises work because the system is clearly defined and constraints are in place to secure advantageous contracts. However, what this lawsuit is demonstrating is that an element of flexibility is necessary to ensure that all parties are able to prosper.

Why constraints exist

Franchise licensing agreements are necessarily constrained to ensure that customers will receive the same experience every time they visit a franchise, regardless of where that franchise is located or who is operating it.

It is of paramount importance that brand familiarity is nurtured and that franchisees operate in a consistent manner, delivering products and services that always meet or exceed a customer's expectations.

Franchisees may be required to source their stock via defined suppliers or through a centrally managed contract. They may be required to make targeted investment decisions to ensure that their premises and staff training always remain at acceptable levels. They may also be required to abide by set pricing to remain attractive to consumers.

Where flexibility is required

When operating in unstable market conditions, franchisors may need to embody a level of flexibility to ensure that their franchisees are not financially disadvantaged. If the imposed constraints limit their ability to comply with their contractual requirements, conversations must be held at the earliest opportunity to identify the cause of the compliance issue and implement an appropriate remedy.

In cases where set pricing or defined sourcing mechanisms are limiting a franchisee's ability to turn a profit, franchisors must explore sourcing options with them to determine whether efficiencies can be made to enable them to hold the set pricing yet make enough money to remain afloat. If the franchisee's claims of unfavorable profitability are upheld, the franchisor should work closely with them to identify other efficiencies or process improvements that may allow them to increase their profit margins and support them in returning to a profitable position.

The ideal solution

Franchisors should always want their franchisees to do well because successful businesses enhance brand awareness and overall profitability. It is essential that franchisors regularly revisit their licensing agreements and consider them in terms of current market conditions to ensure that they are fair to all parties, support the brand in achieving its objectives, and contain sufficient flexibility to satisfy franchisees who may otherwise struggle to deliver against their targets.