Multinational companies are seeking alternatives to foreign direct investment to improve access to other world markets. Survey finds two-fifths interested in Brazil, India and China expansion.

By Priyanka Kher and Ramprakash Sethuramasubbu

The nature of business transactions is continuously evolving to respond to new technological and economic realities. Traditionally, multi-national corporations (MNCs) are engaged in cross-border business, either through direct ownership of foreign affiliates in host countries or by arm’s length trade. Over the past few years, with the emergence of global value chains, this trend gradually started changing and companies increasingly began considering alternatives to foreign direct investment in order to gain efficiencies or access to foreign markets. These alternatives or less traditional forms of investment include contract manufacturing, services outsourcing, franchising, licensing and management contracts. Since these alternatives entail investment in a form other than “equity,” they are often referred to as non-equity modes of investments. Foreign direct involvement (FDI) and non-equity modes of investment (NEM) are not mutually exclusive, therefore multinationals that enter a host country using NEMs, often, over time decide to invest more directly through full or partial ownership creating foreign subsidiaries or joint ventures. The decision to either internalize or externalize production of goods, services and flow of information ultimately depends on the relative costs and benefits, as well as the associated risks. Thus, cross-border investment today can take two forms: direct equity investments and commercial contractual arrangements between foreign investors and local enterprises. 

In case of the latter the foreign investors’ investment consists of making available its brand name, intellectual property, know-how, technology, skills or business processes or other intangible assets. Given this, in addition to FDI and trade, NEMs can be another vehicle to integrate developing countries into global value chains, potentially address unemployment, increase productive capacity and increase local value added.

International Survey

To understand this phenomenon better, specifically with respect to franchising, the Trade and Competitiveness Global Practice of the World Bank Group and the International Franchise Association partnered to conduct a survey of international franchisors. The objective of the survey was to better understand the motivations of companies to enter into franchising arrangements in emerging markets, main policy and regulatory impediments in entering such arrangements, the scope and nature of current franchising operations and growth markets.

The survey was conducted in 2016 and covered 30 companies, the majority having operations in the Latin America and Caribbean, East Asia and Pacific and Middle East and North Africa regions. Information was collected through telephonic interviews; 57 percent of the respondents were operating in more than five developing countries. Respondents had operations in sectors such as business services, quick service restaurants, personal services and residential services.

The survey sought to assess the level of contribution of respondents to key development indicators such as employment, local sourcing, training and skills and technology transfer. Thirty percent of the respondents mentioned that their franchisee units cumulatively employed over 1,000 people. 

Training is Key

Increasing absorptive capacity of the local partners or entrepreneurs depends on the nature of training provided by the franchisors. Success of some of the top franchise systems is attributable to the training and support provided. For example, franchisors such as 7-Eleven, in addition to providing store equipment, provide field consultants who often meet with the franchisees to help them maximize store performance and profit.

All respondents provided training to franchisee units in developing countries before they started operations. Respondents also mentioned that training was provided in both industry specific professional skills and general managerial skills which include financial, marketing, sales and management capabilities to enable franchisees to run their franchises efficiently.

Further, the survey explored the role of franchising in setting quality standards. Ninety-seven percent of respondents indicated that they required franchisee units to comply with private quality standards set by the franchisor. Respondents emphasized that an insufficiently trained franchisee can result in poor quality of service or other operational errors, and the negative effects caused can be irreparable, resulting in the loss of customers and dilution of the brand.

Nearly two-thirds — 63 percent — reported that they transferred technology, in the form of equipment or software to produce goods and provide services, that was new to the local market. The survey also aimed to learn more about the experience of the respondents in sourcing locally. Ninety percent of the respondents mentioned that they preferred sourcing locally, largely because it greatly reduced costs and allowed for greater scalability of operations. This preference was only if sufficient quantity and quality of inputs were available locally. 

Constraints on Expansion

A key aspect covered was the types of constraints that franchisors typically faced in entering or expanding operations in emerging markets. Respondents were asked to rank in order of priority a set of commonly reported constraints. The leading constraint or impediment identified by the respondents was finding the right franchisee, followed by protection of intellectual property, repatriation of funds, registration or approval process, political stability and contract enforcement (Figure 1).

Finding the right franchisee was reported to be difficult not always for the reason of lack of availability of suitable local partners, but often because of information asymmetry and gaps, due to which international franchisors are unable to even identify appropriate candidates to partner with.

The survey also identified repatriation as a top constraint, especially in certain African and South Asian countries where franchisors needed to receive additional approvals from the Central Bank and other agencies, prior to transferring funds. Other respondents reported cumbersome approval procedures, and ambiguous and complex disclosure requirements.

It is critical for international franchisors to be assured that if there is a need to use judicial means to have their contract enforced, the host country’s legal framework recognizes the sanctity of the contract and has the systems to enforce contracts. On the contrary, when procedures for enforcing contracts are cumbersome or when disagreements in contractual arrangements cannot be resolved in a timely manner, the foreign partners can find themselves frustrated and sometimes even pushed to exit a country. This finding was also confirmed by the survey respondents.

The physical absence of inputs and raw materials in a country is indeed a constraint. In addition, some countries impose policy and regulatory requirements which make it very difficult to access inputs and raw materials both within and from outside the countries. For instance, high duties and tariffs may be imposed or customs procedures may delay availability of critical resources (perishable inputs in the food sector). To make things even more challenging, countries impose mandatory local sourcing requirements, as high as 80 of raw materials and business equipment being used. Respondents reported that such unreasonable requirements negatively impacted their ability to access the right quantity and quality of raw materials.

Targets of Expansion

Finally, respondents were also asked which potential developing and emerging markets they would be interested in entering or expanding their operations in (Figure 2). Over 40 percent indicated that they were interested in expanding into Brazil, India, China. In addition, interest was also expressed in entering or expanding in Indonesia, Mexico, Vietnam, Philippines or Chile. These and other emerging markets can improve their overall competiveness to attract more FDI and NEMs by addressing some of the reported constraints systematically, and potentially generate development benefits domestically.

Priyanka Kher is a Private Development Sector Specialist for the World Bank Group and Ramprakash Sethuramasubbu is a consultant for World Bank Group. This article may contain advice, opinions and statements of various participants of the survey. The findings, interpretations and conclusions expressed herein are those of the authors and do not reflect the views of the World Bank Group, its Board of Directors or the governments they represent. The World Bank Group does not guarantee the accuracy of the data included in this work.

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