WHAT IS FRANCHISING? THE POINT OF VIEW OF THE USERS Guy GRAS – IDI Verona, April 17th, 2009

INTRODUCTION For 40 years, Franchising has been developing in Europe. The results are convincing :   We can reasonably estimate "users" of Franchising at more than 10.000 franchisors and 400.000 franchisees, with 4 major countries : France, Germany, The United Kingdom and Italy. But today, after two European Regulations issued in 1988 and 1999, what have we learnt about Franchising ? What is Franchising today for its "users", that is to say for franchisors and franchisees, As professional users of this distribution system, we can make the following observation: All our fundamental principles that are used today in our franchise network, were already contained in the Pronuptia Case of 1986.

I - THE POINT OF VIEW OF THE FRANCHISORS CONCERNING FRANCHISING Why does a Franchisor decide to develop a Franchise network ?   For three of the reasons explained in the Pronuptia Case of January 1986. These can be summarised in 3 key terms : Know-How / investments / development

1 – The know-how indispensable for the distribution of products/services This know-how is absolutely indispensable for the distribution of products and/or services in the network.   For a professional user of a franchise system, two key points need to be stressed : First the know-how, and secondly, the brand or the business name First, concerning the know-how : 1.1 - This know-how must have a specific characteristic : It must increase the franchisees' chances of success by giving them a competitive advantage thanks to the tested methods and commercial techniques developed by the franchisor. As Art. 15 of the Pronuptia Decision specifies : " … the right to establish themselves (franchisees) in other markets using its (franchisor) business name and the business methods which have made it successful"

1.2 - The cost of this know-how is very high for franchisors, because regularly, they have to test it, to improve it, and to develop new methods and techniques. Today, with the fierce competition in markets, this know-how is becoming more and more complicated, expensive for the franchisor and covers a large scope of different expertises (marketing, IT system, communication, …) It must absolutely be protected. As Art. 27 pt 2 of the Pronuptia Decision specifies "Provisions which are strictly necessary in order to ensure that the know-how and assistance provided by the franchisor do not benefit competitors do not constitute restrictions of competition"

Secondly, concerning the brand :   The brand name serves as the umbrella sign for the network It's a rallying sign for the consumer and the general public By using the brand, the Franchisee declares that he is a member of the franchise network. As Art. 17 of the Pronuptia specifies : "The franchisor must be able to take the measures necessary for maintaining the identity and reputation of the network bearing his business name or symbol" As Art. 27 pt 3 of the Pronuptia Decision specifies :   "Provisions which establish the control strictly necessary for maintaining the identity and reputation of the network identified by the common name or symbol do not constitute restrictions of competition …"

As Art. 15 of the Pronuptia Decision specifies And if you don't need this know-how identified by a brand name to develop a successful business, you shouldn't try to develop Franchising. As Art. 15 of the Pronuptia Decision specifies   " Franchise agreements for the distribution of goods differ in that regard from dealerships or … selective distribution systems, which do not involve the use of a single business name, the application of uniform business methods or the payment of royalties in return for the benefits granted"

2 – The decision not to invest in branches. Franchisors don't want to hire salaried employees or to acquire outlets.   Franchising allows small companies to develop their own distribution network, and bigger ones to invest in other fields (R&D for example) As Art. 15 of the Pronuptia Decision specifies "Rather than a method of distribution, it is a way for an undertaking to derive financial benefit from its expertise without investing its own capital"

3 – The will to develop the network with people of our own choice. 3.1 - Franchising is based on the transfer of successful know-how, and on the training of commercial partners.   With the licence of a brand and the indispensable transfer of know-how, Franchising is, in essence, a perfect model of business development in markets, local or foreign. As Art. 15 of the Pronuptia Decision specifies : "… grants (franchisor) independent traders (franchisees) … the right to establish themselves in other markets using its business name as business methods.

3.2 - But, Franchising is more than just a simple licence for using intellectual property rights. Franchisors can't be satisfied only with the transfer of the know-how : They also have to control the application of this know-how by the franchisees in their local markets. This control is necessary to maintain the identity and the reputation of the network. So, Franchisors have the right to freely choose their franchisees as they wish. As Art. 20 of the Pronuptia Decision specifies : "The prohibition of the assignment by the franchisee of his rights and obligations under the contract without the franchisor's approval protects the latter's right freely to choose the franchisees, on whose business qualifications the establishment and maintenance of the network's reputation depend"

II - THE POINT OF VIEW OF THE FRANCHISEES CONCERNING FRANCHISING Why does a Franchisee decide to conclude a franchise contract ?   For three different reasons also explained in the Pronuptia Case. These can be summarised in 3 key terms : Independence / know-how / reputation

1 – The will to be an independent partner - The Franchisee wants to be an independent trader. He is legally and financially independent of the franchisor.   - The Franchisee is the owner of his franchised business. As Art. 15 of the Pronuptia Decision specifies " In a system of distribution franchises of that kind, an undertaking … developed certain business methods grants independent traders, for a fee, the right to establish themselves in other markets …"

2 – Benefiting from the know-how reserved for the members of the network 2.1 - The Franchisee wants to benefit from know-how which outside competitors don't have. He commits himself to keeping this know-how confidential. As Art. 15 of the Pronuptia Decision specifies "The system gives traders who do not have the necessary experience access to methods which they could not have learned without considerable effort… " As Art. 27 pt 2 of the Pronuptia Decision specifies "Provisions which are strictly necessary in order to ensure that the know-how and assistance provided by the franchisor do not benefit competitors do not constitute restrictions of competition"  

2.2 - The Franchisee agrees to pay to have access to this know-how.   As Art. 15 of the Pronuptia Decision specifies "… grants independent traders, for a fee, the right … " As Art. 24 of the Pronuptia Decision specifies "… paying a relatively high entry fee and undertaking to pay a substantial annual royalty.."

3 – Benefiting from the reputation of the network 3.1 - The Franchisee wants to benefit from the reputation of the network identified by the Franchisor's business name. As Art. 15 of the Pronuptia Decision specifies "The system … allows them to benefit from the reputation of the franchisor's business name"   3.2 - In becoming a member of the chain, the Franchisee accepts the power of control of the franchisor. The Franchisor must be entitled to verify the right application of the know-how transmitted . "The franchisor must be able to take measures necessary for maintaining the identity and reputation of the network."

IN CONCLUSION, AS PROFESSIONAL USERS, we have a wish for the next Block Exemption Regulation.    The wish is to see clearly defined and recognized in the new Regulation what exactly Franchising is, as is the case with other channels of distribution. We can find an indication in the Regulation of 17th June 2008 concerning the law applicable to contractual obligations.   In its article 4, the "franchise contract" is clearly distinguished from the "distribution contract", in order to determine the law applicable in the absence of choice by the parties concerned.  

So, I think we need to clearly read this extract of the article : "(e) a franchise contract shall be governed by the law of the country where the franchisee has his habitual residence" "(f) a distribution contract shall be governed by the law of the country where the distributor has his habitual residence"

Why was it necessary to make this distinction ?   Perhaps because Franchising is, in essence, different from other distribution systems and has a real specificity, as we saw in the Pronuptia Decision. Perhaps also because a "franchise contract" is a contract of local reiteration/ application of the know-how by a franchisee who is duty bound to apply the methods and the techniques developed by the franchisor. This could explain why it was decided to take the law of the country where the franchisee has his habitual residence.