Dual Franchise Co-Branding: A Cautionary Tale

With the state of the economy, even a strong business like the franchise industry is feeling the proverbial pinch. While still growing and enjoying measures of success, franchisors are dealing with fewer leads and fewer sales of franchises. In such times, franchisors may look to alternative means to increase sales volume while reducing expenses. One alternative franchisors may begin to consider is co-branding.

Co-Branding

The concept of franchise co-branding came into vogue in the late 1990s. It is an idea which in theory could work, but which has had little or no record of proven success. The obvious goal of co-branding is to increase consumer awareness, and ultimately, sales of each franchise's goods or services. However, a successful co-branding arrangement between two franchisors is a rare occurrence. One such attempt was made by D'Angelo's and Steve's Ice Cream. Neither was a particularly strong brand, but the hope was that the combination of the two would somehow increase visibility, marketability, and recognition. Instead, the two brands seemed only to bring each other down. Eventually, Steve's Ice Cream was replaced in an arrangement with Pizza Hut and went out of business.

There are many situations in practice now that might appear to be co-branding, which, in fact, are not. Common settings, where the consumer will see two brands together, include simple retail arrangements (McDonald's and Newman's Own coffee), concessions (Geek Squad kiosks in Best Buy retail locations), or the use of two brands owned by a parent company in one location (KFC and Taco Bell). None of these constitute true co-branding. A true dual franchise co-branding arrangement requires that the two independently owned brands be equally displayed and marketed, both in a marquee position, with both brands getting equal exposure and, ideally, equal consumer recognition.

Little Success

In its very simplest terms, the co-branding agreement is little more than a trademark cross-licensing agreement. This is, in part, why dual franchise co-branding may have found so little success thus far. The principal function of a trademark (or service mark) is to identify the source of the goods or services, and to distinguish these goods or services from those of competitors, often with a stated or implied reference to quality and reputation. To some extent, a trademark licensing agreement corrupts this principle by allowing a third party to be a secondary source of the goods or services. Unless the trademark owner is able to maintain a close connection with the licensee to ensure that the quality standards are maintained, consumer deception or loss of rights in the mark could occur.

Arguably, the concept of franchising is another way to corrupt the principal function of a trademark. Instead of one source, a large franchise will have tens, or hundreds, of “sources” of the goods or services. However, as part of the franchise agreement, the franchisor will ensure, through various elements of control, that the franchisee maintains the quality and other standards in relation to the use of the trademark. Add a second mark and franchisor to the mix, with the need to control its own brand, and it is not hard to imagine why co-branding is rare.

Assuming the market is open to the idea ' and that you have found non-competing franchises with complementary goods or services, each having brands of equal strength that will increase consumer recognition of the other, and targeting and catering to demographics that partially overlap ' what is next? Protect the brand, protect the franchise, and protect the franchise's proprietary information.

Some of the potential issues that can arise from this arrangement are: the exposure and misappropriation of trade secrets and proprietary and other confidential information; missing or unclear terms and expectations; and an ineffective, unclear, or a non-existent exit strategy. At a bare minimum, the following terms must be included in the co-branding agreement: the grant of the cross-license, identification of exactly what marks are to be licensed; use of the licensed marks; the licensed products/services; marketing; royalties, accounting, and reporting; indemnification clauses; confidentiality and non-compete clauses; termination or expiration of the agreement; duties of the parties post-termination or expiration; remedies; a mediation/arbitration clause (if the parties so choose); and typical miscellaneous provisions.

Use of the License Marks

This section should address practical issues such as the format of the marks, how the marks can be used (i.e., on product packaging only, in external advertising, internal advertising, online marketing, etc.) and the level of control that the franchisor will maintain over its own mark(s). Language requiring that each franchise uphold the standards set forth by the other should also be included. Franchisors may choose to include excerpts of their operations manual, specific to standards for offering and selling products/services, as exhibits or as referenced documents to be included with the agreement. Franchisors should be especially careful to provide only such information as is necessary to ensure that the standards and reputation associated with its mark(s) are upheld, without revealing trade secrets or other proprietary information.

Licensed Products and Services

First, the parties must be clear on how the co-branding will occur. Will new brick-and-mortar sites (or Web sites) open under dual marks? Will each franchise's existing stores or Web sites sell each other's products and services under dual marks? Will all of the goods and services offered by each franchise be offered under dual marks, or just select items? Will each franchise simply offer the other's goods and services within their stores or Web sites? Once the manner of execution is determined, it must be addressed clearly within the agreement.

If each franchise is going to offer for sale the products and services of the other, the agreement must specify how the franchisees are to obtain these items. As a measure of protection, and to minimize exposure of confidential information, it would be advisable to transact all wholesale product orders at the corporate level, instead of at the franchisee level, if possible. Exhibits are a preferable way to identify those goods and services that will be offered under both brands or by both franchises. These exhibits should be include accurate descriptions and any identifying information such as SKU numbers, UPC codes, or other common industry indicators; information should, of course, include both the wholesale price to the franchisee who sells the goods and the price at which the goods and services will be sold to the consumer. As these exhibits are updated and amended, each party should sign and retain a copy with the main body of the agreement. When drafting the agreement, be sure to include a definition for “licensed products and services,” which refers directly to the appropriate exhibit.

Marketing

This is the real reason the two parties have decided to come together: to share, and hopefully, increase their marketing. This section needs to address, at a minimum, how the costs of marketing will be shared by each party. The most obvious choice is that costs will be split down the middle. Some description of the strategy could be laid out here, or it could be included as an addendum. The strategy should not just address the technical execution of the marketing plan, but also the expectations of the parties. The plan should also allow for some fluidity because changes in demographics, technology, resources, as well as in each franchise's business plan or model, could affect marketing. If the franchisors have a national ad fund or ad co-op, this may be a good place to use those funds. This keeps the marketing responsibilities at the corporate level.

Royalties, Accounting, and Reporting

Typically, a franchisee uses a franchisor-approved or -required point-of-sale (“POS”) system to keep track of goods and services sold. This system is used to determine royalties owed, and the franchisor most often uses Electronic Funds Transfer to access the franchisee's account and withdraw the royalties due. Commonly, mechanisms are also in place that allow the franchisor to periodically audit a franchisee's account for accuracy.

Add a second franchisor to the mix, and accounting and reporting get a little muddier. Practically speaking, allowing two franchisors access to a franchisee's accounts and records creates a number of problems, not the least of which is the potential for one franchisor gaining access to proprietary information of the other. In co-branding arrangements, accounting and royalty payments are better handled at the franchisor level. This section should clearly delineate the reporting and payment process: How often will royalties be paid? Can the franchisors offset any debts against royalties owed the other? How will the royalty be calculated? Each franchisor also will have to internally determine what percentage royalty its franchisees will owe for the sale of the other franchise's goods and services.

To avoid unintentional disclosure of protected information, this section should be drafted to carefully describe what degree of access each franchise will have to the other's records, and what auditing process will be allowed. The use of a mutually agreed-upon independent third party may be advisable for such audits, with both parties sharing the cost.

Confidentiality and Non-compete Clauses

Although it is not completely beyond the realm of possibility, it is highly unlikely that direct competitors will engage in a co-branding arrangement. “Sharing” customers is unlikely to increase either party's sales or visibility. But an arrangement between franchises whose customer base only partially overlaps in some manner (age, income, etc.) is potentially attractive.

With that said, however, it would not be unwise to treat certain terms of the agreement with such a “non-competitive” franchise as though it was a direct competitor, specifically in clauses addressing confidentiality and non-competition. While the other franchise may not be a competitor now, careless handling and exposure of trade secrets and proprietary information could mean that it may be a direct competitor tomorrow.

All non-compete clauses must be restricted in scope both with respect to time and geography in order to be enforceable. In the case of bricks-and-mortar franchises, the easiest way to restrict the geographical scope is to set a radius around each existing location at the time of termination or expiration of the agreement. For non-physical franchises, selection will likely be based on the demographics of the customer base. In any case, the franchisors will want to carefully consider what “territories” they want to protect.

As for time limits, the parties need to decide what's fair. One or two years may be to short for each to feel adequately protected, whereas, 10 or more years may be deemed unreasonable by a court. In any case, whatever length of time the parties agree to, language should be included that makes it clear that the parties understand the terms of the non-compete, that they arrived at these terms under mutual agreement, and that they both agree that the terms are absolutely necessary to protect their interests and without which, they would not have entered into that agreement at all. While the use of such language is not a guarantee that the non-compete will be held enforceable as written, it will provide a judge with information as to the parties' intent and understanding at the time of the execution, which may be enough for the judge to uphold the clause.

Termination or Expiration

This is the exit strategy. By anticipating issues at the start, while the parties are in the pleasant stage of beginning a new relationship, a great deal of legal wrangling can be avoided on the back end. It is far easier to agree to terms of a break-up when all the parties are still happy and satisfied than it is after the failure of business deal and the parties' relationship has soured.

It is critical that termination and post-termination language be clear, concise, and cover both parties with respect to the cessation of the use of the marks in connection with any and all goods and services, removal of the other franchise's marks, assignment of liability (which by its nature will extend beyond the termination/expiration of the agreement), the final accounting and reporting requirements for each party, and the assignment of any common debts or losses (most commonly with marketing and advertisement expenses). This section should cover the process by which each term in the agreement will conclude, and what rights, responsibilities, or restrictions (including reference to any confidentiality and non-compete clauses) will be assigned to each party with respect to these terms.

Miscellaneous

This section should cover choice of law, choice of forum, severability, assignments, notices, and similar matters. Language should also be included that clearly indicates that this agreement is not a franchise agreement, partnership, or any other such arrangement that may create a fiduciary duty or agency relationship between the parties.

Each co-branding agreement will, naturally, need to be tailored to the needs, goals and expectations of the parties involved. However, being sure to address the issues, as discussed above, is a good place to begin when drafting the agreement. Ultimately, a franchisor contemplating a co-branding arrangement will likely find that it is not the legal protection of the franchises that will be the most difficult aspect of the arrangement ' the biggest obstacles will be within the marketing arena.

Conclusion

Before even drafting and entering into a co-branding agreement, prospective partners will need to carefully assess the value of such an arrangement from a marketing perspective. Are the brands compatible? Are the target demographics attractive? Will the brands raise each other's status, recognition, and reputation? If these and other questions are answered in the affirmative, then franchisors may be on their way to a successful venture in co-branding.

With the state of the economy, even a strong business like the franchise industry is feeling the proverbial pinch. While still growing and enjoying measures of success, franchisors are dealing with fewer leads and fewer sales of franchises. In such times, franchisors may look to alternative means to increase sales volume while reducing expenses. One alternative franchisors may begin to consider is co-branding.

Co-Branding

The concept of franchise co-branding came into vogue in the late 1990s. It is an idea which in theory could work, but which has had little or no record of proven success. The obvious goal of co-branding is to increase consumer awareness, and ultimately, sales of each franchise's goods or services. However, a successful co-branding arrangement between two franchisors is a rare occurrence. One such attempt was made by D'Angelo's and Steve's Ice Cream. Neither was a particularly strong brand, but the hope was that the combination of the two would somehow increase visibility, marketability, and recognition. Instead, the two brands seemed only to bring each other down. Eventually, Steve's Ice Cream was replaced in an arrangement with Pizza Hut and went out of business.

There are many situations in practice now that might appear to be co-branding, which, in fact, are not. Common settings, where the consumer will see two brands together, include simple retail arrangements (McDonald's and Newman's Own coffee), concessions (Geek Squad kiosks in Best Buy retail locations), or the use of two brands owned by a parent company in one location (KFC and Taco Bell). None of these constitute true co-branding. A true dual franchise co-branding arrangement requires that the two independently owned brands be equally displayed and marketed, both in a marquee position, with both brands getting equal exposure and, ideally, equal consumer recognition.

Little Success

In its very simplest terms, the co-branding agreement is little more than a trademark cross-licensing agreement. This is, in part, why dual franchise co-branding may have found so little success thus far. The principal function of a trademark (or service mark) is to identify the source of the goods or services, and to distinguish these goods or services from those of competitors, often with a stated or implied reference to quality and reputation. To some extent, a trademark licensing agreement corrupts this principle by allowing a third party to be a secondary source of the goods or services. Unless the trademark owner is able to maintain a close connection with the licensee to ensure that the quality standards are maintained, consumer deception or loss of rights in the mark could occur.

Arguably, the concept of franchising is another way to corrupt the principal function of a trademark. Instead of one source, a large franchise will have tens, or hundreds, of “sources” of the goods or services. However, as part of the franchise agreement, the franchisor will ensure, through various elements of control, that the franchisee maintains the quality and other standards in relation to the use of the trademark. Add a second mark and franchisor to the mix, with the need to control its own brand, and it is not hard to imagine why co-branding is rare.

Assuming the market is open to the idea ' and that you have found non-competing franchises with complementary goods or services, each having brands of equal strength that will increase consumer recognition of the other, and targeting and catering to demographics that partially overlap ' what is next? Protect the brand, protect the franchise, and protect the franchise's proprietary information.

Some of the potential issues that can arise from this arrangement are: the exposure and misappropriation of trade secrets and proprietary and other confidential information; missing or unclear terms and expectations; and an ineffective, unclear, or a non-existent exit strategy. At a bare minimum, the following terms must be included in the co-branding agreement: the grant of the cross-license, identification of exactly what marks are to be licensed; use of the licensed marks; the licensed products/services; marketing; royalties, accounting, and reporting; indemnification clauses; confidentiality and non-compete clauses; termination or expiration of the agreement; duties of the parties post-termination or expiration; remedies; a mediation/arbitration clause (if the parties so choose); and typical miscellaneous provisions.

Use of the License Marks

This section should address practical issues such as the format of the marks, how the marks can be used (i.e., on product packaging only, in external advertising, internal advertising, online marketing, etc.) and the level of control that the franchisor will maintain over its own mark(s). Language requiring that each franchise uphold the standards set forth by the other should also be included. Franchisors may choose to include excerpts of their operations manual, specific to standards for offering and selling products/services, as exhibits or as referenced documents to be included with the agreement. Franchisors should be especially careful to provide only such information as is necessary to ensure that the standards and reputation associated with its mark(s) are upheld, without revealing trade secrets or other proprietary information.

Licensed Products and Services

First, the parties must be clear on how the co-branding will occur. Will new brick-and-mortar sites (or Web sites) open under dual marks? Will each franchise's existing stores or Web sites sell each other's products and services under dual marks? Will all of the goods and services offered by each franchise be offered under dual marks, or just select items? Will each franchise simply offer the other's goods and services within their stores or Web sites? Once the manner of execution is determined, it must be addressed clearly within the agreement.

If each franchise is going to offer for sale the products and services of the other, the agreement must specify how the franchisees are to obtain these items. As a measure of protection, and to minimize exposure of confidential information, it would be advisable to transact all wholesale product orders at the corporate level, instead of at the franchisee level, if possible. Exhibits are a preferable way to identify those goods and services that will be offered under both brands or by both franchises. These exhibits should be include accurate descriptions and any identifying information such as SKU numbers, UPC codes, or other common industry indicators; information should, of course, include both the wholesale price to the franchisee who sells the goods and the price at which the goods and services will be sold to the consumer. As these exhibits are updated and amended, each party should sign and retain a copy with the main body of the agreement. When drafting the agreement, be sure to include a definition for “licensed products and services,” which refers directly to the appropriate exhibit.

Marketing

This is the real reason the two parties have decided to come together: to share, and hopefully, increase their marketing. This section needs to address, at a minimum, how the costs of marketing will be shared by each party. The most obvious choice is that costs will be split down the middle. Some description of the strategy could be laid out here, or it could be included as an addendum. The strategy should not just address the technical execution of the marketing plan, but also the expectations of the parties. The plan should also allow for some fluidity because changes in demographics, technology, resources, as well as in each franchise's business plan or model, could affect marketing. If the franchisors have a national ad fund or ad co-op, this may be a good place to use those funds. This keeps the marketing responsibilities at the corporate level.

Royalties, Accounting, and Reporting

Typically, a franchisee uses a franchisor-approved or -required point-of-sale (“POS”) system to keep track of goods and services sold. This system is used to determine royalties owed, and the franchisor most often uses Electronic Funds Transfer to access the franchisee's account and withdraw the royalties due. Commonly, mechanisms are also in place that allow the franchisor to periodically audit a franchisee's account for accuracy.

Add a second franchisor to the mix, and accounting and reporting get a little muddier. Practically speaking, allowing two franchisors access to a franchisee's accounts and records creates a number of problems, not the least of which is the potential for one franchisor gaining access to proprietary information of the other. In co-branding arrangements, accounting and royalty payments are better handled at the franchisor level. This section should clearly delineate the reporting and payment process: How often will royalties be paid? Can the franchisors offset any debts against royalties owed the other? How will the royalty be calculated? Each franchisor also will have to internally determine what percentage royalty its franchisees will owe for the sale of the other franchise's goods and services.

To avoid unintentional disclosure of protected information, this section should be drafted to carefully describe what degree of access each franchise will have to the other's records, and what auditing process will be allowed. The use of a mutually agreed-upon independent third party may be advisable for such audits, with both parties sharing the cost.

Confidentiality and Non-compete Clauses

Although it is not completely beyond the realm of possibility, it is highly unlikely that direct competitors will engage in a co-branding arrangement. “Sharing” customers is unlikely to increase either party's sales or visibility. But an arrangement between franchises whose customer base only partially overlaps in some manner (age, income, etc.) is potentially attractive.

With that said, however, it would not be unwise to treat certain terms of the agreement with such a “non-competitive” franchise as though it was a direct competitor, specifically in clauses addressing confidentiality and non-competition. While the other franchise may not be a competitor now, careless handling and exposure of trade secrets and proprietary information could mean that it may be a direct competitor tomorrow.

All non-compete clauses must be restricted in scope both with respect to time and geography in order to be enforceable. In the case of bricks-and-mortar franchises, the easiest way to restrict the geographical scope is to set a radius around each existing location at the time of termination or expiration of the agreement. For non-physical franchises, selection will likely be based on the demographics of the customer base. In any case, the franchisors will want to carefully consider what “territories” they want to protect.

As for time limits, the parties need to decide what's fair. One or two years may be to short for each to feel adequately protected, whereas, 10 or more years may be deemed unreasonable by a court. In any case, whatever length of time the parties agree to, language should be included that makes it clear that the parties understand the terms of the non-compete, that they arrived at these terms under mutual agreement, and that they both agree that the terms are absolutely necessary to protect their interests and without which, they would not have entered into that agreement at all. While the use of such language is not a guarantee that the non-compete will be held enforceable as written, it will provide a judge with information as to the parties' intent and understanding at the time of the execution, which may be enough for the judge to uphold the clause.

Termination or Expiration

This is the exit strategy. By anticipating issues at the start, while the parties are in the pleasant stage of beginning a new relationship, a great deal of legal wrangling can be avoided on the back end. It is far easier to agree to terms of a break-up when all the parties are still happy and satisfied than it is after the failure of business deal and the parties' relationship has soured.

It is critical that termination and post-termination language be clear, concise, and cover both parties with respect to the cessation of the use of the marks in connection with any and all goods and services, removal of the other franchise's marks, assignment of liability (which by its nature will extend beyond the termination/expiration of the agreement), the final accounting and reporting requirements for each party, and the assignment of any common debts or losses (most commonly with marketing and advertisement expenses). This section should cover the process by which each term in the agreement will conclude, and what rights, responsibilities, or restrictions (including reference to any confidentiality and non-compete clauses) will be assigned to each party with respect to these terms.

Miscellaneous

This section should cover choice of law, choice of forum, severability, assignments, notices, and similar matters. Language should also be included that clearly indicates that this agreement is not a franchise agreement, partnership, or any other such arrangement that may create a fiduciary duty or agency relationship between the parties.

Each co-branding agreement will, naturally, need to be tailored to the needs, goals and expectations of the parties involved. However, being sure to address the issues, as discussed above, is a good place to begin when drafting the agreement. Ultimately, a franchisor contemplating a co-branding arrangement will likely find that it is not the legal protection of the franchises that will be the most difficult aspect of the arrangement ' the biggest obstacles will be within the marketing arena.

Conclusion

Before even drafting and entering into a co-branding agreement, prospective partners will need to carefully assess the value of such an arrangement from a marketing perspective. Are the brands compatible? Are the target demographics attractive? Will the brands raise each other's status, recognition, and reputation? If these and other questions are answered in the affirmative, then franchisors may be on their way to a successful venture in co-branding.