How Franchisors Should Deal with the Impact of COVID-19

By Mark Abell

03-2020

The coronavirus (COVID-19) pandemic is fundamentally a human crisis, but its impact upon business in general, and franchising in particular, cannot be ignored. Since 24 February, when for the first time there were more coronavirus cases outside China than in it, and Italy became a centre for the virus in Europe, it has been clear that franchisors cannot ignore it. As the number of confirmed cases of COVID-19 climbs day by day, and governments struggle to develop their strategy to deal with the pandemic, the franchising community must prepare itself for difficult times ahead. Donald Trump’s recent ban on flights into the US from continental Europe is just one example of the challenges that lie ahead.

Although there is a great deal about the virus that remains unknown, two things seem clear: (i) the number of cases is destined to increase and, (ii) that increase, together with the steps being taken to deal with it, will have a real adverse impact upon the global economy. Franchisors must therefore act immediately to put in place a coherent strategy for dealing with coronavirus. The failure of businesses such as Flybe show how serious the economic impact of the virus can be.

How bad can it get?

Bad. Very bad. Even the most optimistic predictions suggest that economic growth will fall markedly through the next two quarters of this year and that recovery will depend on a drop in the mortality rate of the virus and a slowing of its rate of onward transmission. That will most probably be due to “seasonality”, that is a reduction in transmissions similar to that seen with influenza with the onset of summer. The more pessimistic predictions assume that the virus is not seasonal and there is a rapid geographical spread in infection leading to a global recession.

What is the likely impact on Franchising?

The likely impact will be on sales, the supply chain and potentially upon the integrity of franchise networks, with some franchisees using force majeure clauses to abandon their franchises.

It is clear that different sectors will be affected to different degrees. Some franchise chains, like those in the aviation, tourism, F&B and hospitality sectors, will see lost demand which is largely irrecoverable. Other franchise networks in sectors such as retail will see delayed rather than lost demand. Customers are likely to delay their purchases due to fear of the pandemic but in due course will probably buy the product when the pandemic is over or at least anxiety about it reduces. How long these difficult times will last is largely dependent upon how well the government manages to contain the virus, although some sectors, such as hotels and aviation, are likely to be most deeply affected.

In addition to facing the drop in consumer-demand, franchisors will need to deal with significant supply-chain challenges. Many franchisors source a large amount of their products from China. Chinese manufacturers have warned that they will be unable to fulfil orders until at least late summer due to the epidemic. This late delivery will not only affect wholesale orders but individual customer orders, raising a myriad of issues. Franchisors with strong, centralised procurement teams and good relationships with suppliers in China may feel more confident about their understanding of the risks their suppliers face, but many are still grappling with their exposure in China. Despite the devastating impact that coronavirus has had on the Chinese economy to date, it seems as if there will be a relatively quick economic restart in China. This may mean that franchisors with a Chinese supply chain are focusing on stabilising their supply chain rather than moving it out of China, whilst others are bringing forward changes to their supply chain that they had been planning for the longer term.

What should franchisors do to deal with coronavirus?

There is no silver bullet, but there are a number of steps that franchisors should take to ensure that their network is as well prepared as possible for dealing with the pandemic.

Establish a coronavirus task force

 The first thing that franchisors should do is establish a task force that includes some of their franchisees. This will be responsible for dealing with how they and their franchisees deal with the virus. This should be a multi-disciplinary team and cover, amongst other things:

  • Its employees and its franchisees’ employees health, welfare and ability to continue carrying out their functions

  • Supply chain monitoring for the franchise network

  • Financial contingency planning for itself and its franchisees

  • Marketing and sales response

Review the franchise’s supply chain and other third party agreements

 Franchisors need to work to understand the likely supply chain exposure of the franchise network and develop appropriate contingency plans. Likewise with other third parties – such as the operators of shopping malls, train stations and so on where their franchisees have outlets. This will inevitably involve reviewing their contracts with suppliers and in particular the “force majeure” clause. Force majeure provisions typically excuse non-performance due to events outside of a contracting party’s reasonable control, but these boiler plate clauses vary significantly in their detail and there will be differences between the franchisor’s various supply agreements. Many contracts may not specifically include epidemics as a force majeure event. There will be many questions to be asked centring on what constitutes force majeure under the contracts. Closing of manufacturing facilities? Government restrictions on people gathering, including at work? Fear of being in crowds with people who may be infected? School closings that force parents, a significant portion of the workforce, to stay home from work to care for their children? Unwillingness of usual customers to visit restaurants or retail establishments because of fear of being infected?

Some suppliers may seek to invoke force majeure clauses to defer fulfilment requirements to franchisor networks. This leaves the franchisor with three options:

  • Agree that coronavirus is a force majeure event and accept the consequences;

  • Dispute that coronavirus is a force majeure event under the dispute resolution provisions of the supply contract, which will take time to resolve and, even if a judgment is awarded in the franchisor’s favour, enforcing the judgment will be difficult; or

  • Negotiate a compromise. Such a compromise may include temporarily rerouting orders through other countries less affected by the outbreak, such as Bangladesh and Vietnam, negotiating to be the first retailer to receive orders once business resumes, or covering the cost of delay through the supplier’s insurance.

Franchisors should also consider:

  • Taking advantage of applicable force majeure provisions to enable them to cancel current orders and source the goods elsewhere;

  • Reviewing contracts with wholesalers to determine options for credit and payments for existing orders;

  • Making a claim on their business disruption insurance

If franchisors find that the force majeure clauses in their agreements are suboptimal they should consider redrafting them for future agreements.

Look after your franchisees

Force majeure claims are not only an issue with third parties outside of the franchise network. It is also possible that franchisors find that some of their franchisees look to invoke the force majeure clause in its franchise agreements to avoid the need to pay ongoing franchise fees or, depending upon how the clause is drafted, even walk away from the franchise altogether. Again, the franchisor can either: accept this, contest it, or seek to find a compromise. Franchisors should be very much alive to this possibility and develop a clear strategy as to how it will deal with such claims. Franchisors should also be aware of the risk that a number of their franchisees work together to justify a mass walk-out on the basis of force majeure. The best way to avoid these types of claim is not to look at taking legal action, but to pre-empt such claims by taking appropriate proactive steps. Prudent franchisors should review the force majeure clause in their franchise agreements and plan how they will react to any claims made under it by franchisees.

Protect the franchisees’ customer base


Franchisors must invest in their customer and try to anticipate their likely behaviours in reacting to coronavirus. For example, it may be that while consumer demand is down, it doesn't disappear and customers move to online shopping and home delivery. This would suggest that franchisors should support franchisees to build their omni-channel distribution capability. This could even be an opportunity for more creative franchisors and their franchisees.

Ensure that franchisees take steps to ensure that they have sufficient liquidity

Franchisors should be working with their franchisees to help them model the appropriate financial response to the impact of the virus, perhaps by helping to define input numbers and identify appropriate models, benchmarking KPIs and likely trigger points.

Ensure that franchisees look after their employees


It is important not to underestimate the disruptive impact that the virus will have upon existing ways of working and the emotional impact that it will have upon the workforce of both the franchisor and its franchisees. Franchisors should be working with their franchisees to draft and implement a plan that is based upon conservative predictions and government guidelines. They should benchmark themselves against their peers. Franchisors must show leadership so that franchisees and their employees have confidence in the franchisor and its coronavirus strategy. That will mean implementing a strong communication strategy.

Conclusion

As coronavirus continues to wreak havoc globally, long-term business implications are likely for franchisors in terms of their supply chain, consumer demand and franchisees.

Franchise networks which operate in the F&B, leisure, hospitality and retail sectors are particularly at risk, with those which sell goods manufactured in China probably being most impacted. Chinese suppliers’ ability to perform under supply contracts and hence the franchisor’s ability to keep its franchisees fully stocked is becoming more and more of an issue as an increasing number of Chinese factories close their doors to stop the spread of the virus. This supply problem is likely to other countries such as Vietnam, in due course.

Consumer demand will also badly suffer and so creative consumer facing strategies need to be developed by franchisors. It may even be that some franchise networks start to lose some of their franchisees taking advantage of force majeure clauses.

It is at times like this that franchisees really do look to their franchisors for strong leadership and ready-made solutions. In order to keep the confidence of their franchise network franchisors must develop a strategy as to how they will deal with the impact of coronavirus. Those that do may even find that they obtain a competitive advantage in what will be a very volatile and robust market.

Last reviewed 12 March 2020