Match Your Brand to the Best International Market
March 2010 Franchising World
“If you don’t know where you are going, any road will take you there.”
Lewis Carroll, Alice’s Adventures in Wonderland.
By Carl E. Zisler and Katherine L. Wallman
If your company has a successful brand and you want to expand it into other countries, but you aren’t sure why, how, where or what it takes to do it successfully, you either can seize “opportunities” that present themselves, or you can plan for future opportunities and seize those which are most likely to be profitable.
Although some companies begin international franchising because it seems impressive to be known as a “multi-national company,” or because a prospect appears at a trade show booth or establishes contact via the Internet, experienced international franchisors have learned to be more methodical in deciding whether and when to expand.
If a company understands its reasons for international franchising, it can do a better job of planning for foreign expansion. Some companies look to international franchising as a way to hedge against domestic economic downturns. During the current recession, several foreign markets have outperformed the U.S. economy. Franchisors often target countries or regions for growth after analyzing the likely market for their business, the likely number of customers, the number of units each market could support, the investment required, the return on investment which they can generate from a market and the likely speed of the return on investments. Often they target markets which are similar to their home markets or they are attracted by overtures from a strong prospective franchise partner.
For years, U.S. franchisors have expected that a significant portion of fees paid by franchisees for rights to a country would be profit. They often have failed to appreciate the transaction costs they would incur, such as the cost of translating their concept into one which is workable in a foreign market, the support required from every department within their organization, and the need to train and support master franchisees in recruiting and supporting unit franchisees. Sometimes both franchisors and franchisees have underestimated the capital foreign franchisees will need to successfully adapt and grow franchises in new countries.
According to Kay Ainsley, CFE, managing director of Michael H. Seid & Associates, “There is a difference between selling a master franchise and developing an international market. Long-term and sustainable growth can only be achieved if the franchisor is prepared to invest the time and money and to delay their return on investment to properly develop a market.”
No Two Markets the Same
Many franchisors have locked themselves into initial and ongoing fee structures which are based upon a “rule of thumb” or what a competitor has charged, rather than upon an analysis of the costs of providing franchise services in a new market.
Experienced franchisors recognize that no two foreign markets are the same. Expenses and returns differ depending upon the expansion strategy a franchisor selects for use, the nature of the market and the capabilities of the franchisee. International franchise candidates are naturally interested in setting financial terms early in negotiations and memorializing franchise fees in a letter of intent. However, until both parties have researched the market and their costs of fulfilling their duties under a franchise agreement, they should refrain from committing to a fee structure which may bind them for 20 years£if the relationship can survive that long. Franchise relationships are only successful when all parties involved achieve a level of profitability which warrants their investment and risk.
John Dring, CFE, president of Instant Imprints Franchising, Inc., and veteran international franchisor says: “It is essential for franchisors to prove the concept will work in a country before offering franchises there.” His company is investing in a test of its concept with an Australian partner before allowing franchising to commence.
Care must be taken to structure a foreign franchising program that will create and support successful franchised outlets. Market research, supplemented by a foreign franchisee prospect’s own effort, should be undertaken to evaluate differences between a proposed market and the franchisor’s home market or other foreign markets in which it has had experience. Every item of expense, gross income and net income should be analyzed before committing to a market or a transaction. If building costs are higher, rents are higher, available sites are smaller than in the franchisor’s home market, and businesses in the proposed market are closed on Sundays, will the franchisor’s business model work? If government approval is required to pay more than 5 percent in royalties, and if 25 percent of royalty payments must be withheld to pay income tax in the franchisee’s country, can a franchisor realize its minimum cash flow requirements? Can high import duties on equipment be overcome through local sourcing?
Which franchising strategy should franchisors use in new markets? Cafe2U Pres. Andy Simpkin, who is expanding his Sydney, Australia based mobile coffee franchise to the United States and the United Kingdom says “selecting the proper franchising concept is critical to a company’s success. When planning to enter a foreign market, a franchisor has to understand what effect the selected franchising system will have on profitability of the franchisor and for its franchisees.”
Excellent Expansion Strategies
Master franchising used to be the strategy almost all U.S.-based international franchisors used. It permits the collection of relatively high initial fees, permits the fastest growth of any franchising strategy and typically requires master franchisees to bear most of the cost of translating and implementing the concept to a market. Although the “too good to be true” characterization of master franchising has resulted in many unfulfilled expectations, a well-planned and executed master franchising program can be an excellent expansion strategy.
Area-development franchising is attractive to franchisors because they can rely upon a single individual or entity to build and operate an agreed number of outlets over a defined period of time. Because of the capital required to fulfill development schedules, few area developers are willing or able to commit to the development pace which is generally expected of master franchisees. Franchisors tend to like being able to collect significant initial fees from developers, as well as their full “standard royalties,” as opposed to sharing royalties with a master franchise.
Single-unit franchising is used internationally in different circumstances. Some franchise concepts only require one or two points of sale in a country. Some markets, e.g. small island countries, only can support a few units. Some concepts require such large investments, e.g. luxury hotels and resorts, that unit franchising is used by their franchisors rather than other formats. Unit franchising also may be used for complex businesses where a franchisor believes that it requires a direct relationship with a franchisee.
Joint ventures are sometimes used for expansion into new markets. However, this form of partnership in which the franchisor is an investor is not a strategy most franchisors routinely use. Besides requiring investment beyond what is required for a traditional franchise, a joint venture can create conflicts of interest between the franchisor and its foreign franchisee partner, expose the franchisor to taxation in a foreign country, complicate financial statement reporting requirements and generate disputes over management of the business. Joint ventures, however, can give the franchisor more control over how its franchise concept is adapted in a new country and give the joint venture organization greater credibility in negotiations with prospective unit franchisees and with suppliers.
The franchising strategy selection usually depends upon an evaluation of multiple factors, including: the resources and commitment of the prospective franchise partner; the size of the market; whether a master franchise can be profitable for unit franchisees, master franchisees and franchisor; the investment required to adapt and establish the concept in a new market; how franchised outlets are to be supplied; the existence of franchise sales laws; and the resources a franchisor has to invest in a given market. When selecting a franchising format for a transaction or territory, an understanding of the differences in investment, cost and profits also should be explored. For example, the costs of establishing a single-unit franchise in a country with a language, culture and legal system which differ from a franchisor’s may be so high that neither a franchisor or prospective franchisee could recoup that investment from a single outlet.
Plan and Budget
What type of “platform” is needed for successful international franchising? Franchisors should develop a business plan and a budget for dealing with each of the following:
1. IP protection in territories planed for expansion, including trademark and domain name registrations.
2. Prototype international franchise agreements and disclosures.
3. An international franchise recruiting process.
4. If master franchising is to be used, manuals and training programs designed to support master franchisees in functioning as franchisors.
5. Manuals and training programs to support different practices outside the United States.
6. An overview of business, legal and tax issues in each market which is identified as a priority. Before expending resources for a deal, a franchisor should know whether its business model can be lawfully and economically conducted in a market.
7. Commitments from each operational department and allocated resources to support franchisees in different countries, at different times of the day, and sometimes, in different languages.
8. A business promotion plan for launching new franchised businesses in foreign markets where the franchise concept may be unknown.
9. An understanding of how foreign franchisees can be supplied with equipment, supplies and inventory on a cost effective basis outside the franchisor’s home market.
If these issues are addressed in advance, a franchisor is poised to move quickly when an opportunity arises. Rather than creating or recreating resources for each new deal, a franchisor will have documents and processes which will require relatively little modification from country to country. That is not to suggest that significant changes do not exist when taking franchises to different countries. Translating documents, obtaining government approvals, modifying legal documents to be lawful and enforceable in the new country each will require time, patience and money.
Picking the Best Markets
How do franchisors select the best markets for their international growth? By considering the following factors:
Proximity: Expanding into nearby markets requires less of a strain on resources than traveling far away. Franchisors are more likely to be somewhat familiar with doing business in neighboring countries.
Language and culture: In countries which share the same language, similar cultural heritage and similar legal systems, franchisors feel more comfortable than when franchising into countries where these factors are all “foreign.”
Surveys of best places to do business: Useful publications include the World Bank’s annual publications listing the best places to start and carry on business, “Doing Business In,” the Economist Intelligence Unit (www.eiu.com) and Transparency International (www.transparency.org).
Countries with similar market characteristics: The greater similarity between consumers of two countries, the greater the likelihood exists that products will be equally appealing to consumers of both.
Countries with a rapidly growing economy and middle class: China and India are examples.
The criteria for multi-unit franchisees who will be granted significant territories in foreign countries may differ from what a franchisor uses in its home market. This is especially true if the franchisor is using a franchising strategy internationally which it does not use at home. Many franchisors look for successful, sophisticated business people. U.S. franchisors expect franchisees to speak English and to have the financing needed to execute their business plans (including development schedules). Many franchisors prefer to do business with established companies. Some are especially fond of granting franchises to companies which already are involved in a related business in the country or which already operate franchises there. Many franchisors believe that it is very helpful for their foreign franchisees to have political connections which can help them cut through bureaucratic obstacles. A sound reputation and an open mind are also sought-after characteristics.
As franchising is growing in popularity throughout the world, franchisors which want to access new markets must be prepared to cope with the uncertainties and costs of entering foreign markets and be prepared to face competition from other international franchisors as well as franchisors based in the markets they target. More than ever, planning is required for successful international franchise growth.
Carl E. Zwisler, a principal, and Katherine L. Wallman, an associate, practice international and domestic franchise law in the Washington, D.C. office of Gray Plant Mooty. Zwisler is a former IFA General Counsel and author of Master Franchising: Selecting, Negotiating, and Operating a Master Franchise. He can be reached at 202-295-2225 or firstname.lastname@example.org and she can be reached at 202-295-2223 or email@example.com .