International Franchising

Franchising is a form of licensing in which a company (franchisor) licenses a business system as well as other property rights to an independent com­pany or person (franchisee). The franchisee does business under the franchi­sor’s trade name and follows the policies and procedures laid down by the franchisor. Essentially, therefore, the franchisor licenses a way of organizing and carrying on a business under this trade name. In return, the franchisor receives fees, running royalties, and other compensation from the fran­chisee.

Franchising grew explosively in the United States during the 1960s, and is now common in diverse business fields: fast-food restaurants, car rentals, construction, soft drinks, hotels and motels, and several services ranging from real estate brokerage to the preparation of tax forms. In the decade 1965-1975, more than 200 U.S. franchisors took their business systems into foreign markets by establishing 11,000 franchise outlets, mainly in Canada, Europe, Japan, and Australia.¹⁴ Holiday Inn, McDonald’s, Ken­tucky Fried Chicken, and Avis (to name only a few) have become house­hold names in scores of countries. Much earlier, Singer Sewing Machine, Coca-Cola, Pepsi-Cola, and Hilton Hotels showed the way. Although non- U.S. companies have also become international franchisors (such as Wimpy’s, Bake ‘n’ Take, and Benihana), U.S. companies have dominated this form of enterprise in both numbers and sales volume, so much so that franchising has a distinctly American flavor.

As with any other mode of foreign market entry, franchising offers both advantages and disadvantages to a company. The principal advantages are the following: (1) rapid expansion into a foreign market with low capital outlays, (2) a standardized method of marketing with a distinctive image, (3) highly motivated franchisees, and (4) low political risks. Key disadvantages of franchising resemble those of traditional licensing: (1) limitations on the franchisor’s profit, (2) lack of full control over the fran­chisee’s operations, (3) the possible creation of competitors, and (4) restric­tions imposed by governments on the terms of franchise agreements.

International franchising is particularly attractive to a company when it has a product that cannot be exported to a foreign target country, it does not want to invest in that country as a producer, and its production process (business system) can be easily transferred to an independent party in the target country. Thus physical products whose manufacture requires sub­stantial capital investment and/or high levels of managerial or technical competence are poor candidates for franchising. The same is true of service products (which must be produced at the foreign point of sale) that involve sophisticated skills, such as advertising, accounting, banking, insurance, and management consulting. That is why international franchising is most popular in consumer service products that can be created with compara­tively low levels of capital and skills.

For companies with franchisable products, therefore, the critical choice is between franchising and equity investment in a joint or sole venture. This choice is another illustration of the trade-off between control and risk, which was discussed in Chapter 1. When a company is starting its penetra­tion of a foreign market, it may choose franchising as an entry mode because of its lower risks. But as the company gains experience in that market, it may replace its franchisees with joint or sole ventures, which give it more control. Many companies have done that at home in the United States, and the same transformation is also under way in several foreign countries. One survey of 85 U.S. franchisors found that only 68 percent of their foreign outlets were entirely owned by franchisees; 15 percent were minority and majority joint ventures with local investors, and 17 percent were wholly owned by the franchisor.¹⁵ For many companies, therefore, franchising may prove to be a transitional entry mode that takes them into joint or sole ventures at a later time. This transition will occur, of course, only when it is the most profitable way to exploit the target market. For that reason, it is least likely to occur in developing countries that place constraints on foreign ownership. Also for internal reasons, some firms will choose to stay with franchising, just as many companies have chosen to stay with exporting.

The steps to establish franchising systems abroad resemble those of traditional licensing: (1) assessing sales potential in the target market, (2) finding suitable franchisee candidates, (3) negotiating the franchise agree­ment, and (4) building a working partnership with the franchisee. Franchis­ing differs from ordinary licensing mainly in a greater emphasis on control over the franchisee’s operations. The franchise contract usually stipulates that the franchisor can terminate the contract after a one- or two-year trial period, and later for the franchisee’s failure to perform to agreed standards and sales volume. Other provisions cover the franchisor’s right to inspect all aspects of the franchisee’s operations, his right to prohibit any activities of the franchisee that harm the product/service image, and so on. The contract may also include an operating manual, to which the franchisee must conform if he is not to lose the franchise. As in licensing, some governments may not allow certain provisions intended to protect the fran­chisor’s interests, such as territorial limitations or fixing the prices at which the franchisee must sell. Especially in developing countries, it may be dif­ficult or impossible to terminate a franchise agreement for poor perform­ance or to buy out a franchisee.

Franchising will not work unless the franchisor offers continuing sup­port to the franchisee. One kind of support is logistical: supplying equip­ment, signs, promotional materials, products, and other physical inputs needed by the franchisee. Other support—such as training, financing, and technical, accounting, merchandizing, and general management assist­ance—is necessary to achieve a desired level of franchisee performance. A third kind of support is promotional, particularly mass advertising to spread the company name and presell franchised products and services. The franchisor may also need to adapt his franchise package to the political, economic, and sociocultural environment of the target country. For exam­ple, Kentucky Fried Chicken in West Germany was not allowed to import cooking oil used in the United States, because it contained antifoaming agents prohibited by German health authorities. The additive was required because the oil had to be used in special pressure-frying equipment, and a substitute additive approved by the authorities drastically changed the taste of the product.¹⁶ To cite another example, when the fast-food chain Beef-A- Roo went into Australia, it was forced to change its trade name to Beef- Ranch because “Roo” means kangaroo meat, which is disdained by urban Australians.¹⁷ The Hackett survey, referred to earlier, reported that one- third of the franchisors had altered logos, promotional and color themes, and architecture in foreign markets.¹⁸

In conclusion, franchising emerged in the 1970s as a powerful entry mode for products and services that can be reproduced by independent franchisees. For U.S. companies that can overcome new management and political problems, international franchising bids fair to rival the earlier franchising boom in the United States.

Source: Root Franklin R. (1998), Entry Strategies for International Markets, Jossey-Bass; 2nd edition.