Franchise or selective distribution: which contract to choose?
The choice of a distribution network is a major strategic decision for any company wishing to develop the marketing of its products or services. Among the options available, the franchise agreement and the selective distribution agreement are two of the commonly used mechanisms, but they respond to distinct economic logics and legal frameworks. While both aim to organise a network of independent business partners, their purposes, criteria of validity and obligations deriving therefrom differ substantially.
The purpose of this note is to detail the legal regime of each of these contracts, before summarizing their fundamental differences in a comparative table. This analysis aims to clarify the choice between these two models according to the objectives pursued by the network head.
The FRANCHISE AGREEMENT REGIME
The franchise agreement is a mode of collaboration by which one company, the franchisor, grants another company, the franchisee, the right to exploit a business concept it has developed, in exchange for financial compensation. This contract is based on the reiteration of a commercial success.
To become a franchisor, you must:
- First, having know-how:
- sufficiently experienced
- identified
- secret
- substantial
- Secondly, having rights:
- on a valid and registered trademark
- on the elements used to identify your concept (e.g. logo, etc.)
The three pillars of the franchise agreement
The validity and qualification of the franchise agreement are subject to the meeting of three essential cumulative elements:
- The provision of customer rallying signs: The franchisor grants the franchisee the right to use its brand, its sign, and other distinctive signs (logo, graphic charter) that allow the public to identify the network.
- The transmission of know-how: This is the central and determining element of the franchise. “know-how” means a package of non-patented practical information, resulting from experience and testing, which is: To be qualified, this know-how must be secret, substantial and identified.
- Secret: It is not generally known or easily accessible.
- Substantial: It is important and useful for the franchisee, likely to give it a competitive advantage.
- Identified: It must be described in a sufficiently complete manner to make it possible to verify that it meets the conditions of secrecy and substantiality. This description is most often materialized in an operating manual or “bible”.
- The provision of commercial and technical assistance: The franchisor has the obligation to accompany the franchisee throughout the duration of the contract. This assistance is manifested by initial training, assistance with opening up, and then ongoing support (marketing, management, technical, etc.) to ensure the proper application of the concept.
The obligations of the parties and the legal framework
The franchisor’s main obligation is to provide the franchisee with the means to replicate its commercial success. This is broken down into three basic duties: conceding the right to use customer buy-in signs, passing on know-how, and providing ongoing technical and commercial assistance.
On the regulatory level, the franchisor is subject to a strict pre-contractual information obligation (Doubin law, codified in Article L. 330-3 of the Commercial Code), requiring the submission of a Pre-contractual Information Document (PID) at least twenty days before the signing of the contract.
The franchisee, although an independent trader, is required to scrupulously respect the standards of the network to maintain its homogeneity and reputation. In return for the right to join the network, they generally pay an entry fee (or initial flat fee) and then periodic fees (royalties), often calculated on their turnover.
The SELECTIVE DISTRIBUTION REGIME
Selective distribution is a system whereby the supplier undertakes to sell its products or services only to distributors selected on the basis of defined criteria, and where these distributors undertake not to sell to unauthorized resellers. This model is particularly suitable for luxury products, high-tech or requiring a particular sales environment to preserve their brand image.
The interest of distribution contracts is to strategically organize the commercial circuit of the products and services that are the subject of them. The effectiveness of such a commercial policy generally does not go well with a very large number of distributors and requires that they be selected on the basis of criteria that the network promoter will have specifically defined for the marketing of its products and services.
Approval
criteria
To create a selective distribution network that complies with competition rules, the supplier must define qualitative and/or quantitative criteria for the selection of its members.
These criteria must be objective, indispensable and suitable for the distribution of the contract products and must make it possible to improve the technical and commercial performance of the distributors and consequently the quality of the service offered to consumers.
These criteria can therefore be:
-
qualitative
- in nature (for example, the characteristics of the retailer’s store location in some attractive neighborhoods, the nature of the facilities and interior design, the training of salespeople)
- and/or quantitative in nature (application of a numerus clausus in a given territory).
The selection criteria must:
- be applied in a non-discriminatory manner by the supplier,
- be justified by the nature of the products (brand image, high technicality, luxury, etc.),
- be proportionate and necessary to ensure the proper marketing of the contract products, and
- be applied evenly.
In theory, whenever a candidate for the selective distribution network meets the qualitative criteria set, the network promoter cannot refuse approval.
Sometimes, the rejected candidate challenges the rejection. Several foundations are available to him:
- the refusal of approval may constitute a cartel prohibited by French and European antitrust regulations, if the refused applicant demonstrates that the criteria have been applied in a discriminatory manner and that they are likely to eliminate competition or allow this elimination;
- where the supplier’s market share is significant, refusal of authorisation may also be sanctioned on the basis of abuse of a dominant position,
- finally, the non-renewal of the selective distribution contract may be a source of liability when the circumstances surrounding it are abusive.
The obligations of the parties
The main obligation of the supplier is to supply only authorized distributors. It is the responsibility of the authorized distributor not to resell the products to professionals outside the network, in order to guarantee the waterproofness of the latter.
Unlike franchising, selective distribution does not imply the transmission of know-how or the obligation to provide ongoing assistance. The relationship is centred on the sale of products and compliance with the quality standards imposed by the network manager. The distributor does not have to pay royalties: his remuneration comes from the margin he makes on the resale of the products.
COMPARATIVE
TABLE: FRANCHISE VS. SELECTIVE DISTRIBUTION
Please find below a table comparing the main elements of the two contracts:
Franchise
| Criterion |
Selective Distribution Agreement
Primary |
|
|---|---|---|
| Objective | Replication of a commercial success and a global concept. | Preservation of brand image and distribution quality for specific products. |
| Core Element | Know-how and ongoing support. | Objective, qualitative and non-discriminatory selection criteria. |
| Transmission of Know-How | Yes, essential and constitutive obligation of the contract. | Yes, essential and constitutive obligation of the contract. |
| Ongoing Support | Yes, essential obligation of the franchisor. | No, the relationship is mainly commercial (buy/resell). |
| Selection of Members | selection (intuitu personae) by the franchisor. | Selection constrained by objective criteria. Any candidate who completes them must be approved. |
| Remuneration | Entry fee and periodic fees (royalties). | Margin realized on the sale of its products to distributors. |
| Obligations of the Member | Payment of an entrance fee and royalties. | Purchase of products from the supplier. No royalties. |
| Exclusivity | Frequent but not essential. Can be a development tool. | Possible, but the principle is freedom of sale within the network. |
| Justification of Competition Restrictions | Protecting know-how and maintaining the network’s identity and reputation. | Need to preserve the nature of the product (luxury, technicality) and the integrity of the network. |
CONCLUSION
The choice between franchising and selective distribution depends fundamentally on the company’s strategy and the nature of its offer.
Franchising is a powerful integration model, suitable for companies that have developed a comprehensive and proven business concept (products, services, marketing, management) and want to duplicate it on a large scale by relying on independent but closely supervised partners. Emphasis is placed on the transmission and replication of an economic model.
Selective distribution, on the other hand, is a quality control tool for the sales channel. It is preferred for products whose value and attractiveness depend strongly on their image and the conditions of their marketing. The objective is not to replicate a business model, but to ensure that the sale is carried out by professionals meeting precise specifications.
Ultimately, if the franchisor sells a “recipe for success”, the head of a selective distribution network sells products to selected resellers. A thorough analysis of the concept, products and development ambitions is therefore an essential prerequisite to direct the network manager towards the most relevant and legally secure contractual structure.
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