Distinguishing between brands might not be as simple (or complicated) as you think
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Distinguishing between brands might not be as simple (or complicated) as you think

I have to confess that I truly admire the creativity of marketing folks. I have very little creativity, and I am impressed that on occasion their creativity has some semblance to reality. On the other hand, I read recently how a marketing consultant was hired to develop some new images for Atlanta's Metropolitan Area Rapid Transit Authority. The consultant's "suggestions" included replacing the typical bench seats we find in subway cars with overstuffed leather sofas. You can write the next sentence for yourself.

In franchising, I haven't seen anything quite so delusional, but the focus in the last 20 or more years on market segmentation, particularly in the restaurant and lodging industries, has similarly raised the question of whether the marketing folks are in touch with reality. There is both a business side and a legal perspective to this question, both of which I will examine in this article.

Let's start with hospitality. Not all hotels are alike. In contrast to the restaurant business, it is not atypical for hotel facilities carrying the same brand to look quite different. The dominance of the real estate factor in the hotel industry makes this almost a fait accompli. Nevertheless, if you read various literature, such as 10-Ks and discussions of the marketplace, the hotel gurus have concluded that there are numerous different markets for hotels.

As is often the case, there is considerable truth in this hypothesis. We will all readily admit that the customer at the Ritz-Carlton will not be the same person looking for a hotel with the characteristics of a Days Inn. However, the hotel gurus have gotten it into their heads that the distinctions between markets within hospitality can be razor-sharply defined. True? Consider the number of brands offered by Choice or Marriott. If you decided you wanted to stay at a Comfort Inn, can you tell me offhand why that would be different from a Sleep Inn? That's one I cannot answer myself.

In most chains, which brand will wear which label will be a function of the quality of the room; whether there are full-time, part-time, or perhaps no restaurant facilities; whether there are meeting rooms or other convention facilities; basic rooms or suite arrangements; indoor or outdoor access to rooms; location (urban, suburban, resort); and so forth. Some of these items may be important to the average consumer. Many of us, however, could care less about many of these factors, especially when the decision where to stay will be made at the last minute.

In the restaurant business, I find similarly amusing the fine lines, or in some cases the not-so-fine lines, the marketing folks are drawing. Again, we can easily distinguish The Jockey Club in New York from Ray's Pizza. When you look at the menus you will realize immediately that the price of the hamburger at The Jockey Club will cost more than the amount of pizza that would feed a family at Ray's. Now look at the so-called steakhouse market. Again, Bonanza does not have many similarities with Smith & Wollensky, but is Smith & Wollensky that different from a Stoney River steakhouse? In the eyes of the marketers, that may be true. Whether the consumer sees things the same way, I find somewhat more questionable.

In the food industry, the most puzzling market segmentation relates to "quick service" and "quick casual" restaurants. Compare, for example, a Taco Bell with a Chipotle restaurant. There probably is a difference, but unless you perform your own marketing survey, it is difficult to find where the lines are drawn, and why. Some say it is price: quick casuals generally have higher prices. But try to get someone to quantify that for you. One can go into a Taco Bell and buy some fancy-priced items.

Others say it may be the level of service attention. Some incorrectly think of quick casual as having more table service. I can cite several examples, however, especially in the Mexican food market, where that is simply not, or to be generous, marginally the case.

A third group suggests that quick casual connotes a healthier line of food products. Sometimes true; often not. I am not sure that refried beans, fried tortilla chips, and chimichangas are that much better for you than a Wendy's grilled chicken sandwich.

The most intriguing answer I received, however, when polling various restaurateurs about the differences between these two markets was that "quick casual customers don't like to eat with quick service customers." In other words, snob appeal! The Joneses will gladly pay a dollar more for a sandwich so that they do not have to sit next to the Clampetts. Unfortunately, I haven't had the chance to empirically test this hypothesis in the marketplace. And probably never will.

The point, of course, is that one must question whether the marketing department's view of the world is seen through the same glasses that consumers wear.

Let's turn a moment to the legal implications of segmentation, for here these distinctions create a multitude of problems for franchisors, franchisees, and their lawyers. Two legal issues come quickly to mind. The first relates to development; the second to non-compete clauses.

As for development: Will building a new unit with a different brand affect a sister brand within close proximity? Again, I don't think we need to worry about Marriott's Ritz-Carlton chain affecting the Fairfield Inn, also a Marriott product. But go back to my Sleep Innâ€"Comfort Inn example. If Choice elects to franchise a Sleep Inn next to a Comfort Inn, will, or to what extent will, the new unit impact the old? (Let me note that the hotel industry has developed a whole line of impact experts who have developed what appear to be sophisticated models that measure both intra-brand and inter-brand impact.)

The consequences of such a decision may have legal impact on the parties, depending upon the precise language of the contract. Franchisor advocates would go so far as to say that with the right language, these expansion decisions cannot be challenged, absent bad faith. Franchisee advocates would argue that the covenant and good faith should prevent this from occurring, especially if the result of opening the new facility would be to force the existing franchisee out of business because of sales transfers from the old to the new. I am not sure I would go quite so far as either group's advocates. But let no franchisor forget juries and even judges are human, and if an expansion decision is unreasonable, a Houdini judge or jury will find a way to work itself out of handcuffs.

We saw this in the famous Scheck v. Burger King Corp. case, which in fact was not such a case of extremes. But then, again, we saw the precisely opposite result in Burger King Corp. v. Weaver. A franchisee who prevails at trial may lose on appeal, or, as the whole history of Scheck shows, subsequent precedents might limit the viabilities of any victory the franchisee advocates achieve; but it may take several years for franchisor advocates to secure the position that gives protection against encroachment claims.

By proving or being able to prove market segmentation (i.e., the hotels don't compete in general irrespective of how close together they may be), one might enhance the likelihood of deflecting an encroachment claim in the first place. Even though the law has been franchisor-favorable over the last 14 years on the subject of encroachment, it still takes one part reality (i.e., Is there really a market distinction?), one part favorable contract language, and one part good lawyering for a franchisor to prevail on this issue.

As for non-competes, the issue is how broad can the scope of the non-compete be in order for the franchisor to limit the ex-franchisee's future activities? In some states, where the courts are very pragmatic, it may not make much of a difference what the precise wording of the non-compete may be. The non-compete provision might say "steakhouse" or "white tablecloth restaurant featuring steaks," or, to use a different market segment, it might say "fast-food restaurant serving Mexican-style food."

Blue penciling by courts, coupled with good expert witnesses, may make greater precision unnecessary from the franchisor's perspective. ("Blue penciling" means that even if the non-compete is overly broad, the court will, under appropriate circumstances, come to the franchisor's rescue by rewriting the overly broad non-compete to be narrower in scope or time or in the breadth of territorial protection.) A good witness will look at the actual facts and demonstrate, for example, that even though Taco Bell and Chipotle might for marketing purposes fall into two different segments, there is nevertheless a significant amount of crossover between the two as to customer base, and therefore using a phrase like "Mexican-style food" should not prevent a court from enforcing the non-compete.

On the other hand, following the policy that post-term non-competes are disfavored, other states will go out of their way to point out where the non-compete is broader than is necessary, and if so, throw it out altogether. Some of these states refuse to blue pencil. The fate of the non-compete lives or dies upon the words on the paper only. Other courts might show greater leniency, but nevertheless a greater reluctance to protect the franchisor interests if a wide paintbrush is used where a narrower one would have sufficed.

One issue these courts will look at carefully is the scope of the non-compete. In these jurisdictions, the use of precise language may be very important. If "fast casual" is not a precise term, the court might throw out the non-compete that uses this as the basis for scope because of vagueness. Similarly, stating that "involvement with a restaurant serving steak, ribs, and seafood" may be challengeable because the description cuts off competitive activity in too many markets where, arguably, the concept under scrutiny allegedly does not compete in any significant manner. Use a of a term describing a well-defined market segment, for non-compete purposes, will give the franchisor more ammunition to defend itself against the proposition that the scope of its non-compete is unreasonable.

But getting back to one of the original questions: What does the consumer think? Suppose you have been driving for 10 hours; night has fallen; the three kids in the back seat are cranky, but you are hell-bent to complete half the journey in day one. There is only one goal here: peace and quiet. And the primary, and probably the sole, question regarding hotel selection is simply, Is there a vacancy? Price, convention facilities, and chocolates on the pillows all become secondary when the misbehavior of the less-than-18-years age bracket is the primary concern.

Rupert Barkoff is a partner in the Atlanta office of Kilpatrick Stockton, LLP, where he chairs the firm's Franchise Practice Team. He is a past chair of the American Bar Association's Forum on Franchising.

Published: March 6th, 2007

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Franchise Update Magazine: Issue 4, 2006
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