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Copyright © International Chamber of Commerce (ICC). All rights reserved. ( Source of the document: ICC Digital Library )
by Emily O’Connor
Once the Franchisor has decided to move forward with international expansion, a first step should be to develop country by country a concrete business strategy (business plan). To minimize the chance of failure abroad it is essential that a Franchisor thoroughly evaluate and understand the target markets and understand financial/investment necessities. Market research in the target markets as well as financial planning are the additional steps to be taken to this stage.
To prepare a business plan for a specific target market a thorough market analysis is essential. The Franchisor must understand beforehand if, how and why its business model could be successful in the target market — or not.
In addition, the market analysis is not only the basis for making critical financial and investment decisions but also a good source to decide at a later stage a reasonable Franchise Fee. The amount of the Initial Fee usually relates to the market potential that can be derived from the results of the market analysis.
The market analysis can be based on field research as well as desk research. Field research, which is by its nature more expensive, is rarely undertaken. Desk research is common. The Franchisor can start a desk research project with internal resources by reviewing publicly available data on the Internet, such as that from local chambers of commerce, embassies, foreign commercial services, trade representations, franchise associations and other commercial, trade and franchise publications, either general or industry-related. Local assistance might become necessary because of language barriers and is recommended at least in less developed countries. Local franchise consultants as well as industry-related business advisors with franchise experience might also be a good source of information. National franchise associations, internationally experienced legal counsel and foreign commercial services might be particularly good sources for finding an appropriate business consultant.
In addition to identifying potential industry-related or service-related competitors, the market research will also answer the question of whether franchising is a known and marketable distribution strategy in the target market. In some, usually well-developed, franchise markets there is an unwritten but still common understanding of what typical[Page31:]Initial Fees could be. The Franchisor’s market research must uncover such unwritten thresholds so as to keep its fees within the generally accepted range.
The market research should also evaluate the end customer behavior (consumer or business-to-business (B2B)) and reaction to the Franchisor’s products or services, distinguishing Sub-Franchisees as customers of the local Master Franchisee from consumers buying products or services from Unit franchises. Consumer evaluation must identify soft factors such as cultural behavior, language, religion, tradition, age, trends, etc.
Understanding the market potential in the target market is essential for the success of an international franchise expansion. Typically, three or more parties plan to make profits through the franchise concept: the Sub-Franchisee, the Master Franchisee or Area Developer, the Franchisor, and, where applicable, suppliers of the System. At the end of the day, all of these parties’ profit margins must be generated by the market potential, in other words, be paid by the customer in the target market. The System will likely fail if one or more of these margins cannot be generated due to a lack of customers, a non-competitive price range in the target market, or other reasons for non-acceptance of the System in the target market.
Once the market potential is assessed, the market research should distinguish the eventually differing target groups of the Franchisor’s international expansion strategy. These include:
General factors such economic and political climate, wealth, market situation and others apply.
Product-related Franchisors have to analyze if and how the future supply of products in the target market will be obtained or secured. Not all products can be delivered across borders at reasonable cost. If so, the market research should identify potential local producers and logistics applicable to the sales process. In this case it will be essential that the Franchisor assist actively and eventually personally in the target market during the process of analyzing, testing and selecting local suppliers.
In other cases, Systems have used suppliers acting globally, e.g. in the bakery or logistics industries, which might be of great help in installing new procurement and logistic mechanisms for the System in the target market. In this situation, the Franchisor might wish to legally secure its ties to the global supplier. Especially after cessation of the MFA, it might prove helpful to prevent, as far as legally possible, the System’s suppliers from continuing to work with the former Master Franchisee in the target[Page32:]market. In some cases, it will be necessary for the Master Franchisee to establish and continuously operate a logistics center and/or warehouse in the target market as intermediate or direct supplier of the Sub- Franchisees. The MFA should clearly regulate such duties of Master Franchisee, which usually do not fall within any applicable principles of good faith. In addition, the parties should estimate realistically the investment and ongoing costs for establishing and operating a warehouse, supply chain, etc. And again, such additional investments and costs must be generated through sales to customers in the target market.
For those Franchisors who will supply products or services cross-border themselves, it will be necessary to comply at all times during the term with the applicable import/export, tax and customs regulations as well as other applicable laws, e.g. labelling, consumer protection or hygiene. For example, within the European Union minimum labelling requirements for products are harmonized by EU law, but certain elements may vary from country to country. In addition, for certain product categories, such as electronics, language requirements may apply (e.g. for the manuals).
For Franchisors providing equipment, local architectural, construction and product safety regulations apply. The Franchisor might need the assistance of local planners, contractors and/or architects to comply with local laws, which tend to be mandatory in most countries and may trigger damages claims in case of breaches.
Instead of purchasing products, materials or equipment locally, the Franchisor may decide to import them from abroad. This may pose yet other challenges, which again may affect the Franchisor’s economic model, in the guise of import duties put in place to protect domestic production of products against foreign imports at lower costs. In the absence of treaties favoring certain categories of imports, duties can amount to 40%, 50% and even 60%, which can have a disastrous effect on the Franchisor’s economic model and thus act as a detriment to the development of the concept in a specific country. For example, a tea shop concept based on strict supply of Franchisor-owned tea may fail in a country, such as Turkey, where import taxes on foreign tea are high enough that either the price for customers will be too high or the margins generated by the System too low for all participants to survive economically.
Most franchise business models need adaptation to the local market requirements. It starts with translation but goes deeper into the necessities, traditions and values of the potential customer, especially if it is a consumer. Internet-based service Systems might have to do less adaptation work than restaurant or food service franchises. But legal requirements can also complicate the home market business model especially in highly regulated industries, such as senior care or medical services.
While the operational adaptation may be started by the Franchisor, many Franchisors wait for a Master Franchisee to be selected in order to use its local Know-how in the adaptation process.[Page33:]It is crucial to define clearly steps, responsibilities and costs related to the adaptation process in the MFA. Usually adaptation will not end with the provision to the local Master Franchisee of the operations manual but will continue during the Master Franchisee’s pilot phase.
When target market potential, customer groups, investment and adaptation necessities are defined, the Franchisor must evaluate the investment needed to enter the target market. The Master Franchisee should demonstrate its financial capabilities for several years, as it takes considerable time before the System is locally installed, adapted, piloted and rolled out to enough sites and/or Sub-Franchisees. Satisfying return on investment should not be expected too quickly by the Master Franchisee.
The Franchisor and the Master Franchisee should make sure that, even after the split of any fees, royalties, or earnings among Sub-Franchisees, the Master Franchisee, and the Franchisor, and after paying all suppliers, the profit margins are sufficient for all parties involved to pay all investments and costs and to earn a satisfying profit.
Until the first revenue from the target market arrives, usually through the Initial Fee, many investments will be financed by the Franchisor. Adaptation, travel, communication, translation and other costs apply as well as eventual brokerage fees, service-related expenses for business advisors, the above-mentioned market research and other costs.
Moreover, financial planning should estimate the budget in order to implement and operate the business model in the local market after the MFA is signed. Hard costs such as retail/office space, staff, equipment, marketing costs, local taxes and logistics may need to be taken into account.
While the Franchisor needs financial resources to expand internationally, the potential partner in the target market must also understand its own potential investment in order to sign, understand, be trained on, pilot and sell the concept in the local market. The Master Franchisee needs sufficient financial resources to survive the pilot phase without revenues from franchise sales.
Upon entering a new market, a Franchisor must establish and implement a support structure for its Franchisees. Not every System will use the same structure. It must be tailored to the capabilities of the Franchisor, needs of the Franchisees, and the business and cultural practices in the Territory. The following key components should be considered for the international support platform.
[Page34:]
These manuals are the essence of the System. They detail the unique and proprietary aspects of the System and define the brand standards. Unless the Franchisor has already modified its concept for an international market, it should be able to leverage its domestic manuals. The Franchisor should be prepared to make its manuals “country agnostic,” as most countries use the metric system for measurement.
The Franchisor needs to establish the necessary infrastructure to support the business and create the conditions for success in the Territory. In the Franchisor’s home market, it has developed a way of doing things and a Know-how which is part of its success. In some areas, it may have identified this Know-how as one of its “key factors for success”; however, it is very unlikely that all of this Know-how has been documented in a way that can be readily shared. The Franchisor, therefore, will need to create new tools to train its Franchisees in all the areas which it has identified as critical to success. The idea here is to focus on what is distinct and mission critical and to leave more general areas and local adaptations to the Franchisee. As the Franchisor focuses on the core processes which are most important to its business, the Franchisor will need to clearly define the roles and responsibilities of the Franchisor and Franchisee and provide the Franchisees with clarity as to its level of involvement in the Territory. Questions the Franchisor must address are: What does the Franchisor want to approve and how? How does the Franchisor wish to be kept informed? How will the Franchisor add value to the plans of the Franchisee? How does the Franchisor envisage the on-going business relationship? This is the purpose of the Manuals.
Sourcing and distribution may be one of the more complex parts of the Franchisor’s international expansion, and while the supply chain will often be the topic of one of its Manuals, some of the key questions a Franchisor will face as it expands internationally are:
[Page35:]The answers to these questions will vary depending on the business and the Franchisor’s strategy. However, a robust supply chain will be critical to success and this is an area where the Franchisor and Franchisees have to be prepared to invest.
The timely investment in the right resources to support the international business is a critical component of the Franchisor’s support platform. The resources a Franchisor deploys will reflect its strategy and the level of involvement it wants to have in the Territory, as well as the level of support it wants to provide to its Franchisees. The Franchisor’s goal is to maximize the chances of success and it does not want to start on the wrong path and later spend its energy fixing what is broken. A Franchisor’s growth in the market depends on its brand being successful. A Franchisor’s success will set a precedent as it considers expanding into other markets.
It is important that the people the Franchisor selects have the right skill set and leadership to support international markets. Cultural sensitivity and the ability to work in cross-functional teams will help build a productive working relationship with Franchisees. In addition, it is important to have people with strong business acumen and a “general management” perspective. Beyond their own functional expertise, it is the ability to problem-solve, connect the dots, and provide holistic solutions that will make the difference.
Finally, a Franchisor should seriously consider how it can leverage technology to enable more effective communication and collaboration with its Franchisees. Technology can help streamline access to information and make sure people have access to the most current information. File-sharing and work-flow can help with collaboration on projects and with key approval processes. The Franchisor and Franchisees must think about how the information and communication flows can be organized and managed to facilitate and improve the quality of the interactions between the Franchisor and the Franchisees.
When taking a business international, a Franchisor will need to arrange training for its partner on the commercial concept and Know-how developed by the Franchisor. When using a Master Franchising format, it will also be important to agree on the training of the Sub-Franchisees to standardize practices across sites and promote the image of network unity. At the same time, it should be borne in mind that training may need to be adapted to accommodate differing commercial methods used in the local market. Franchisors often start with several weeks of initial training and provision of an operations manual, followed by occasional field visits and ongoing training.
The Master Franchisee’s training may be organized in different ways to meet various policy and administrative needs. Nevertheless, the organization of this training should not jeopardize the integrity of the[Page36:]System. For example, French jurisdictions appreciate the organization of and support for training events on disputes related to re-classification of a contractual relationship as a salaried one.
Consider carefully the fact that the establishment of a management structure in a target region may be so expensive that it militates against the particular internationalization.
Franchisors will find that financing for individuals in some countries can prove quite challenging. Potential Franchisees typically will be called upon to provide 30% to 50% of the total investment from their own personal liquid assets, which may come from savings, an inheritance, a gift or a loan from family or friends. Traditional banks will typically fund the balance of the investment if the bank is convinced that the proposed franchised business is viable and profitable. Government loans or subsidies are available but more difficult to secure. In some countries, private banks have installed special franchise financing mechanisms, such as UBS in the United Kingdom or Deutsche Bank in Germany.
Franchisors may also opt to help their individual Franchisees with financing to lower the requirement for significant personal funds, e.g. in the form of a loan or participation in the franchised business, or of a lease-management agreement where the Franchisor remains the owner of the business. Moreover, leasing companies increasingly offer specific solutions for financing Franchisees’ store equipment, machinery, trucks and the like.
16 This section is based on After the Agreements are Signed. See Footnote 9.