Trends and challenges in the UK Franchise Sector

From a general sector perspective, the headlines include the following:

• Franchising continues to play a pivotal role in the UK economy, contributing a significant £19.1 billion annually. A record high of 1,009 franchise systems, an 8% increase since 2018. 
• The biggest winner is the personal services sector with a rise of 53% in new systems since 2018, highlighting the growing demand for personalised, convenient services in areas such as health, wellness, and education.
• Store retail and vehicle/transport have seen the biggest decline – 25% and 34% decreases in those franchise systems respectively.
• Franchisee profitability remains high: 89% of franchised units, but this is slightly below where it was in 2018.
• 65% of franchisors expect at least one unit within their network to be offered as a resale in the coming year, a significant increase from 51% in 2018. This trend indicates a maturing market, where franchisees are looking to capitalise on the value they have built in their businesses. 
• There has been a dip in the number of new franchisees under 30, down from 27% last year to just 7% this year. It's not clear what has caused this drop-off.
• The pandemic has driven a shift towards digital communication, with a greater proportion of interactions now taking place online. 
• UK franchises are increasingly setting their sights on international markets, with 41% of franchisors planning to expand beyond the UK. Europe remains a top choice due to its geographical proximity and cultural similarities. 

On the overall economic outlook….

• 87% of franchisors anticipate improved conditions for their own companies over the next 12 months. 
• This confidence, however, is tempered by a more cautious outlook on the general economy, with only 53% expecting overall economic improvement.

What does this mean from a legal perspective? 

Speaking from my own experience and client work over the last 12 months, I anticipate the following:

• If profitability is static or declining, then we expect to see more franchisees in financial distress. This could lead to:
  • insolvencies, which franchisors need to be prepared for. Are they monitoring franchisee solvency, is there a plan in place to take action before it's too late (such as temporary changes to the financial model?) and how can a franchisor protect its interests/brand when it is too late? Does the franchise agreement have effective step in rights, rights over leases, rights to acquire assets/ensure business continuity? This issue was brought into focus when the multi-unit franchisee for Itsu went into administration and had to close its stores with a vague notice to customer. Not a good look for the brand.
  • Tension around pricing strategies, as franchisees look to pass on increased costs to customers, but franchisors will want to remain competitive in the market. This needs to be managed carefully, and can lead to competition law issues, and expose gaps in current contractual rights. 
  • Similar to Covid, there may be an increase in temporary waivers of fees, or changes to the system but these need to be time-limited and documented clearly.
• Profit and cost forecasts need to be reviewed carefully and regularly in a time of high inflation, high taxes and high interest rates. We will likely see a rise in claims of misrepresentation in the pre-sale process. If the economic climate is lengthening the overall return on investment, there may be pressure from lenders to extend the usual minimum contract term.
• Many franchise systems are incorporating new tech solutions. Franchisors may be developing software inhouse to then license to franchisees or are engaging third parties to develop/resell their software to franchisees. This is likely to increase costs (in the short-term, at least) which can impact pre-sale projections and business valuations for those looking to exit. It also adds additional layers of complexity to the legal relationship (can it be mandated, can a franchisor procure it on behalf of the network, does this increase liability and can that be limited/excluded?). We wrote an article on this topic in 2023, and we expect these changes to continue to pull at the seams of the traditional franchise agreement in the following way:
  • Increased competition law risks around pricing, online activities and information sharing;
  • Over extension of the manual into contractual issues, such as introducing penalties and quasi contract terms for new services. Doing so risks the enforceability of such terms.
  • Greater reliance on trust and cooperation (arguably) points towards a need for smarter use of franchise councils/associations.
• Finally, with new types of franchisee owners entering the market (the UK master franchisee for Wingstop was recently acquired by private equity for £400 million), and early adopters are looking to exit, franchisors need to take a fresh look at those sections of the franchise agreement which deal with transfers of interest, death and incapacity. 

In summary, franchising continues to grow its share of the UK economy. The market is maturing fast, and the pace of technological change is accelerating. Franchisors therefore need to keep their agreements (and manuals) and the communication channels with franchisees under regular review, to ensure that their systems will be in the "winner" category when the next set of Franchise Industry Survey data is published.

Please contact Gordon Drakes if you have any questions on this topic.