FRANCHISES

Case Study: How to Handle a Rogue Licensee

George Schenk's largest licensee had his own ideas about running his restaurant. Was it time to cut him loose?

Bob O'Connor

WHOSE PIZZA IS IT, ANYWAY? George Schenk sought more control over his American Flatbread brand.

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Humble would be a good word to describe American Flatbread's headquarters in Waitsfield, Vermont. It's a cluster of buildings surrounding a 19th-century farmhouse and barn, inside of which a crew of shaggy-haired bakers feed uncooked pizzas into wood-fired clay ovens. Outside, the Mad River rushes by. The modest, bucolic setting belies the fact that, by early 2005, American Flatbread founder George Schenk controlled a $3.5 million business selling gourmet frozen pizzas and a burgeoning chain of restaurants.

Perhaps controlled is too strong a term. While Schenk ran the company's two wholesale bakeries in Waitsfield and Middlebury, its eight full-service restaurants were run by licensees. And the largest of those licensees, the owner of seven restaurants, was, according to Schenk, "drifting"--incorporating ingredients and design touches that seemed at odds with Schenk's vision of what American Flatbread should be. Schenk considered ways to rein in his wayward licensee, but soon realized he had little power to do so. Loosely bound by an informal deal struck years earlier, both parties were frustrated, and Schenk wondered if the relationship could be saved--and, more to the point, if it should be.

Schenk had fallen into the food business by accident. After spending a decade as a research biologist, he found himself working in the mid-1980s as an appetizer chef at the Tucker Hill Inn, a popular restaurant in Waitsfield. He spent his time off skiing and perfecting a design he had created for a wood-fired clay oven. Working with a prototype in the inn's kitchen, Schenk started baking flatbreads topped with an eclectic array of local cheeses, meats, and produce. The highbrow hippie pizzas were a hit with guests and Schenk began boxing them and selling them frozen to area markets. By 1991, wholesale demand had outgrown the oven at the inn, and Schenk's operation, dubbed American Flatbread, moved to its current home on a nearby farm, which serves food on weekends.

Almost from the start, American Flatbread attracted interest from would-be restaurant partners. But Schenk was unwilling to take the plunge until 1997, when he met Jay Gould. A Boston insurance executive who skied in the area, Gould said he wanted to open an American Flatbread restaurant near his hometown of Amesbury, Massachusetts. Schenk asked him why and liked Gould's answer: "to bring great food into my community." The two men soon worked out an agreement that gave Gould the right to open restaurants using Schenk's recipes, his oven design, and American Flatbread's distinctive artwork and signage. But not its name. "We didn't want to screw up the frozen business if we didn't succeed," says Gould. He decided to name his restaurant the Flatbread Co.

The agreement between Schenk and Gould focused more on philosophy--local, organic, community-focused--than on business details or operational specifics, and it gave Gould (and his partner in the venture, John Meehan) a lot of room to innovate. Gould opened the first Flatbread Co. restaurant in 1998, in Amesbury. It was a success from the start, and by 2006, there were five more in New England and another on Maui. Along the way, Schenk had granted another licensee the right to open an American Flatbread-branded restaurant in Burlington. And a West Coast licensee, Food Remembers, made frozen pizzas for distribution west of the Rockies and ran a weekend restaurant. By 2005, total revenue approached $4 million.

The expansion had been haphazard, however, and Schenk found managing multiple licensees challenging. Especially difficult was the relationship with Gould. First, there was the issue of "recipe drift." Gould, for example, had begun using a different type of flour, which gave Flatbread Co. offerings a notably different crust. What's more, Gould's restaurants had developed a look of their own--more surf bum than Vermont hippie. Schenk didn't want to stifle anyone's creativity. But with other licensees and an expanding wholesale business to protect, he realized that having a definable core brand was more important than he had expected.

Gould saw things differently. He was proud of the way his restaurants had evolved and how successful they had become. What's more, as his portfolio of restaurants expanded, Gould was becoming increasingly frustrated that he was building a strong restaurant brand without getting credit for it. In fact, he felt he was paying for it with his licensing fees.

The two men knew they had a problem. They just couldn't agree on how to solve it. Their licensing deal was renegotiated in 2000 for a one-year period; from that point forward the companies functioned in an "at will" relationship, voluntarily maintaining the status quo as they searched for a solution. One proposal called for the formation of a new company headed by Gould, with Meehan and Schenk as partners, which would develop all future American Flatbread-style restaurants in the U.S. Another was to keep the existing Flatbread Co. restaurants in New England within the system but allow Gould to independently develop a similar concept in the rest of the country. Neither plan met with the approval of the other licensees in the system.

And while the relationship between Gould and Schenk remained cordial, Schenk was getting edgy. In April 2005, he hired some outside help. Joan Painter had been advising young companies about franchising since leaving Ben & Jerry's (NYSE:UN) in 2003. "Flatbread Co. and American Flatbread were becoming two distinct entities," she says. Painter suggested that American Flatbread replace its licensing agreements with a formal franchising program. Schenk agreed and charged Clay Westbrook, a local food consultant, with creating the systems and documentation that franchisees would need. None of the licensees, including Gould, was eager to become a franchisee. But American Flatbread was most concerned about Gould. The message presented to him, by Schenk and Westbrook as well as Painter, was that it was time either to come aboard or to part ways. Gould balked at what he calls "a hard sell." By the beginning of 2006, the companies were again deadlocked.

The Decision

In spring 2006, American Flatbread and Flatbread Co. decided to part ways. Schenk wasn't happy about it, but he saw no alternative. "If working with us is no longer satisfying," he says, "then I think it's healthier for both parties to move on." Adds Gould: "We've had a lot of fun together, but the situation had become unsolvable."

Under the terms of the separation, which are still being hashed out, Flatbread Co. will pay American Flatbread an undisclosed amount for exclusive development rights in New England (except Vermont), where Gould hopes to build a strong regional brand. Schenk and Gould remain friends, and both are curious to see how their new relationship will develop. There's little question that the two brands will have strong similarities. Neither intends to abandon the commitment to buying organic and local supplies, and many of the recipes will remain similar. Westbrook concedes American Flatbread has a limited ability to protect recipes and menu items. Instead, the company is focused on protecting its rights to the exclusive use of its distinctive names for signature flatbreads--such as the popular Punctuated Equilibrium flatbread (with kalamata olives, sweet peppers, feta cheese, rosemary, red onions, mozzarella, and garlic).

American Flatbread also will work to expand its wholesale business and leverage the name recognition it has as a result of selling frozen pizzas in supermarkets nationwide. "Statistically, where the frozen product is available, the restaurants have had quicker start-ups, and the frozen product does better where stores are located," Schenk says. In May, a new American Flatbread franchise will open in Ashburn, Virginia, near Washington, D.C., and the company has received a few dozen inquiries from other would-be franchisees. But it's moving slowly for now.

The two parties also are discussing an agreement about not competing in certain markets, says Painter. However, she adds, "there are many flatbread concepts"--such as Urban Flats and Arizona Flatbread--"and we see everyone as competition." Gould's attitude seems a bit more laid back. "What we do and what they do are both really good," he says. "Hopefully, the sun shines on everyone."

The Experts Weigh In

Choose franchisees wisely

If a licensee or franchisee wants to go, he has to go. But just becoming a franchiser isn't going to solve Schenk's control problems. Franchisers are never in control, no matter what the agreement says. That's why you need to select the best franchisees. American Flatbread was right to focus on people with shared values in the beginning. It needs to continue doing that in selecting franchisees. When you have great franchisees who share your values, you won't be spending money on attorneys' fees.

Doug Ducey
CEO
Cold Stone Creamery
Scottsdale, Arizona

One or the other

I'm impressed with the company's move to franchising for more control. But I'd be concerned about having licensees and franchisees in the same system. It would be one thing if it was using licensing appropriately--for example, if it wanted to give a licensee the right to make an American Flatbread clothing line. But now you have one person who is a licensee and another who is a franchisee, but both are running restaurants. The different programs can create a first, second, and third class within the organization, and that can create ill will.

Patrick Callaway
President
Francorp
Olympia Fields, Illinois

Protect the IP

It's a good move to get all the restaurants using the same name and adopting a uniform look. Moving forward, American Flatbread needs to perform an intellectual property audit to identify anything, such as techniques or devices it has developed, that is patentable. It should copyright anything it hasn't already, particularly its artwork and distinctive typeface, and make sure it owns all the rights. Then if Flatbread Co. uses something that's quite similar, American Flatbread will have a basis for saying it's trying to confuse consumers.

D. Peter Harvey
Trademark Attorney
Harvey & Siskind
San Francisco

Last updated: Apr 1, 2007

ADAM BLUESTEIN

Adam Bluestein is a frequent contributor to Inc., writing about health care, innovation, and new technology. He lives with his wife and two children in Burlington, Vermont.




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