In this fast changing world, and heightened globalisation, what are the basic routes to successful international franchise expansion and what are the structures available?
Author: Farrah Rose, Head of International Development at The Franchising Centre
International expansion is the obvious next step for any brand well-established in their home market which wants to tap into highly lucrative overseas markets. After all, there’s a big wide world out there with coming up on eight billion potential customers!
You don’t have to look far to find countless brands who have used the opportunities and tools franchising presents for them to export their tried and tested systems. Big brands like McDonald’s, Subway, and Hertz, Water Babies, Jani King, F45, are the most obvious examples, of course, of businesses that have used franchising almost from day one with incredible success.
However, there are also examples of brands such as Marks & Spencer’s and Costa, Bread Ahead, who are company run in their home turf, but have used franchising to take their systems and concepts overseas.
There are various shades in between these two examples, but all of them have recognised franchising as the best way to bring their products and services to new consumer markets without the risks and demands on capital which opening an owned and managed network overseas usually entails.
Essentially, there are six different structures which brands have used to successfully embrace the power of international expansion:
1. Company-run operations
This model can be very attractive for brands as it allows them tighter control over the establishment of pilot outlets in their prospective territories, and how the brand and systems are implemented. As a result, brands who have been successful in their home markets with company owned branches may feel an affinity for this model, but it can also be fraught with problems and complications.
Cost is the obvious issue, but so is maintaining management and brand standards, and appointing the right people for new leadership roles. Every detail needs to be meticulously planned and overseen, requiring a great deal of capital and time. Organic growth using this model can be slow and expensive, especially if multiple new markets are involved.
Then, of course, there are the many cultural, political, employment and legal differences to negotiate. Every market has its own characteristics, and a company-owned model will naturally be at a disadvantage compared to local brands who already understand exactly how to make things work on their home turf.
Challenges such as how much to pay for sites, how to employ staff and how to make sure the products or services are positioned correctly for the local market, mean there is a very steep learning curve. There will be hard lessons along the way, and the effectiveness of many corporate brands has been blunted by costly, even disastrous, mistakes over the years.
That’s not to say that some brands have not found success using the company-owned model but using a franchising model has been shown time and again to offer faster expansion, and with the benefits of significantly reduced risk and capital expenditure, following a thorough market research and local adaptation. By using franchisees from the local market, you can tap into their knowledge and expertise of the territory to not only drive expansion and development, but also avoid many of the challenges and pitfalls a newcomer to the market faces.
2. Management franchising
In this model, a franchisee buys a licence from the franchisor to use its brand name, and will then invest in setting up the business, but pay the franchisor’s team to run the operations.
This is a very rare way of expanding internationally, and not suitable for most brands’ goals. It is often used for complex and hefty investments such as hotels, schools, and universities.
3. Direct franchising
This is an extension of how a brand might have already expanded in their domestic market, where a franchisor recruits franchisees individually in an overseas territory and manages the entire process directly. Their systems and operations will likely be very similar to those used in the home market, but with a number of adjustments to deal with international issues and modifications to the systems, such as service and products modifications, IT adjustments, pricing and cost structure amendments, currency conversion, taxes etc. The franchisor provides direct support and back-up to franchisees just as it does with its existing domestic franchise network.
Again, on the surface, this is an attractive model as franchisors may see the potential for greater control, but the opposite may be true in practice. Supporting franchisees, driving growth, and maintaining standards can be very challenging over distance, even with modern technology. For example, virtual meetings are all very well, but managing a number of single units/territories, over multiple time zones can be a serious burden. The key question is … How can you be sure the right person is available at the right time to deal with an issue?
Without a solid leadership structure immediately to hand, it is all too easy for franchisees to diverge from the model, which can have a negative effect on growth, productivity, and how the brand is represented in their market. As a result, the cost and impact on the overall franchise structure will likely be much higher than other franchise models.
Without local leadership, and the market specific expertise and experience that comes with it, there will be challenges in co-ordination of development, or consistency in quality. There is a place for direct franchising, but usually on a limited scale, such as in piloting in a new market relatively close to home.
4. Developmental franchising
Often also referred to as area development agreements, this model involves the franchisor granting the rights to an individual, company, or investor group to develop and operate several outlets within a particular territory or region. The most famous example of this is Starbucks and Burger King, who I think we can all agree have done extremely well out of it!
The advantage of this model for the franchisor is that it only has one key franchisee to liaise with in that market, rather than a large network, as with direct franchising. Generally, that franchisee will also have significant resources, and a proven track record of operating successfully within that local market. As a result, they require less support and have the investment capability to build and grow the operation on a scale which aligns with the franchisor’s goals.
As this model is focused around said franchisee, company or group growing a multi-unit network, development agreements typically require that a specific number of outlets must be opened within a prescribed period, say one store to be opened within the first 12 months, with a required openings schedule stipulated over the following years. In return, the investor/franchisee gains long term rights and exclusivity over the new market.
The franchisor will usually charge a significant upfront fee for these rights, often running into six or seven figures. This not only reduces the capital expenditure needed for overseas expansion, but also serves to highly motivate the franchisee to stick to the developmental schedule in order to see a timely return on their investment.
Within this agreement, there will also likely be an initial franchisee fee paid for each outlet which opens, and an ongoing fee based on sales. As with domestic franchising, there will also likely be a commitment to spend a certain amount on marketing, and/or a percentage of sales which should be paid into the global marketing fund. There will also be a set policy in place on how the developer will run the network and infrastructure within their territory.
5. Master franchising
Similar to a development franchise, master franchising is one of the most popular structures in international franchising. Historically, it has been seen most frequently in the service sectors, especially Food & Beverage, but has expanded into a cross section of industries. It is especially effective where the business or service requires the cloning of multiple outlets, each with a hands-on owner/operator.
Like a development franchisee, a master franchisee will usually put down a large sum up front to secure rights in a territory and be committed to paying the home franchisor an ongoing percentage and/or fixed fee for each new outlet. The difference is that the master franchisee themselves is not directly responsible for operating all the outlets themselves (though they may do so in a limited capacity, see below), but rather will act as a sub-franchisor within a country to grow the franchise network with sub-franchisees.
The master franchise agreement will, like the development agreement, usually involve a commitment to open a certain number of outlets within a specified timeframe. This is an essential element in reducing risk for the franchisor that a target market will be underdeveloped. There will also likely be an agreement that the master franchisee must open and operate a number of pilot operations themselves to prove the system works in the culture, market and business environment of the overseas country.
These company-run outlets allow for adaptation of the concept and its operations to the local market and provide a base for training and development as the master franchisee recruits local franchisees to open new outlets. They are also very beneficial for the master franchisee in that they provide a useful source of revenue for their expanding enterprise while new franchisees are being recruited and developed.
On top of this, master franchisees will need to provide the training and support necessary for their franchisees and commit to the franchisors tried and tested systems – within the context of their local market conditions, of course. The master franchisee will also be contractually obliged to monitor sub-franchisees’ performance and, ultimately, to enforce these sub-franchise agreements.
The term of the master franchisee’s agreement must be long enough to allow it to recoup its investment in building a proper country infrastructure, and to issue sub-franchise agreements with a term long enough to attract sub-franchisees and enable them to do the same.
Due to the large scale of the investment, and the substantial up-front fee required, master franchising generally only attracts high-net worth individuals who have considerable experience and ideally, proven skills in running medium to large businesses. This has obvious advantages for the home franchisor but, of course, there is no such thing as completely removing risk from any relationship.
The home franchisor still needs to inure itself against the possible failure of the master franchisee, and have structures to address what will happen if they should decide to sell up, go bankrupt, or if the agreement needs to be terminated due to poor performance.
As a result, there still needs to be significant investment in putting policies, procedures and legal framework at two levels, franchisor to master, master to the sub-franchisees – in place, even if the franchisor has been extremely careful about selecting their master franchisee. It is sensible to include options and pre-emption rights to buy-out the master franchisee which will be triggered both by an impending sale or business failure, and on termination.
Franchisors should also consider ways to recover the existing network the master franchisee has built up, should they move on for any reason, keep the franchisees up and running, and make sure they can still benefit from whatever growth has occurred. There could still be a significant income stream in place that the franchisor will not want to lose.
There is a lot to think about, and requires a good knowledge of local market conditions, availability of suitable master franchisees, local legislation, country demarcation, probably obtained from a regional consultant, market intelligence expert and local legal advisors.
Suffice to say, master franchising is definitely not suitable for a brand which does not yet have knowledge and experience in how to be an effective franchisor, nor has the necessary robust systems in place to pass those onto their master franchisees to support their respective local sub franchisees.
However, for the right brand which is willing to put in the necessary preparation, it can certainly be an incredibly effective route for international expansion.
6. Joint venture
Another variation on the above two models, but in this case a home country franchisor becomes a shareholder in an overseas company to be built and run by a foreign franchisee. In exchange for shares, usually valued at anything from 25% to 50%, the franchisor grants the overseas franchisee developmental or master franchise rights for the territory.
There may be a number of reasons for doing this. Firstly, it allows the franchisor to take a larger share of local profits than they might under a development or master franchise agreement. The profits replace the large upfront fee of the other models, but it may be that the financial projections show this to be beneficial. It also has the added benefit of attracting prospective franchisees who have all the characteristics the franchisor needs, but not the high capital necessary for development or master franchise agreements, or have the capital but are looking for the franchisor’s more indepth involvement and commitment to the market in launching the franchise.
Secondly, laws in certain countries desirable for expansion may simply not allow for classic franchising structures, particularly when it comes to charging royalty fees or foreign ownership. This model allows for share dividends to be paid instead, which is usually more feasible.
While this model has its own pros and cons in terms of revenue that will always be specific to each market, it also has both issues and benefits on a more strategic level. The franchisor will have more control as a shareholder and therefore have more rights over the joint venture company, but it can also mean they have more duties and obligations, and all the resulting extra capital and human resource burdens that come with them deployed in a non domestic country.
So, which is right for you?
After assessing whether or not it is the right time for your international expansion, deciding which model works best for you is likely to be the biggest decision you need to make about your overseas expansion strategy, in both the long- and the short-term. All these models have their benefits and drawbacks, and there is no such thing as a one size fits all. However, the evidence is overwhelmingly on the side of franchising as opposed to company run expansion for most brands who make the effort of conducting thorough market entry study.
You might rightly be very confident and enthusiastic about taking your brand into lucrative new markets, but my biggest piece of advice would be not to rush. You might be keen to see results but spending that extra time and resources now to ensure you are prepared will save you from potentially, very costly mistakes and re-entry attempts, down the line.
Whatever model you choose, here are my top tips for any overseas expansion strategy:
Don’t take your eye off the ball at home
Overseas expansion is going to require a considerable amount of your time and resources. Don’t be so fixated on the goal that you forget what got you to where you are today – which is your home market – and that it still needs looking after. It doesn’t matter how much new growth you enjoy if the foundations it’s built on are starting to shake.
This said however, don’t shy away from periodically assessing whether or not you are ready for internationalisation with genuine experts, who truly understand the necessary steps in the journey you are about to take. Sometimes, a franchisor’s system and concept may be ripe for growth, but fear of unknown may cause inertia which will lead to significant loss of opportunity.
Do your research
This may seem obvious, but don’t forget that not everyone does business in the way you’re used to. There are hundreds of overseas markets, and billions of people to work with, so make sure you know as much as you can about your target market. Will your business concept actually work in your target country, or are there cultural, economic, commercial, or industry-competitive differences that are likely to present barriers?
Eating, shopping, leisure habits, use of technology and working patterns are likely to vary a great deal too, as will taxation and employment law impacting both you and your franchisee as the employer. All may require you to tweak your business model in a different way for each market. Increasingly, many countries also are adopting franchise-specific laws which must be addressed at the very early planning stages.
Plan, plan, plan… and plan again
I know you want to get stuck in, but before you make your move, remember the ‘ticking time bombs’ of gaps or poorly prepared DIY franchise offers, which may have worked domestically because you are situate, in charge but may not work in international, substandard franchise documentation, or drafted provisions of agreements which have been done by those with insufficient experience of international transactions.
You won’t necessarily know something is wrong until later when it is way too late. With the speed of communications and technology these days, failure in one country can go viral around the world in seconds.
On a more strategic level, spend some time analysing and prioritising overseas markets. The world is a big place and you can’t expand everywhere all at once. Discover, and focus on exactly where you want to be in the next 1,5,10 years and beyond.
The devil’s in the detail
When you’re busy focusing on the big picture, it’s all too easy to lose sight of the nitty gritty, and it’s those little details that can come back and bite you later.
Plan for, and resource, your exploratory steps sensibly. Flights, accommodation, key management time away, and finding and evaluating potential partners, adaptation of systems, research, all have a cost. Ensure that the domestic operation can bear it and budget for it realistically.
Carefully work out your franchise offer package in advance. Don’t negotiate on the hoof, and please ensure your fees are realistic. The latter can be especially challenging if you’re considering the development or master franchise route. Put in the time to work them out thoroughly so that they are set at a level which both covers the expenses you will inevitably incur in finding, training and establishing the franchisees in business, as well as permitting a reasonable long-term income stream to flow back to the home country.
They must not, however, be set so high that the master franchisee will feel under pressure, either not to invest sufficiently in its support infrastructure, or to charge sub-franchisees fees which are disproportionate to the scale of their businesses and the profits which they will need to generate to make the proposition attractive.
The same goes for your legal frameworks. Make sure you have structures in place that cover all possible eventualities and are appropriate to the local market without restricting operations too much. The same also goes for your franchise package, documentation and legal agreements. You want to manage expectations and build in certain controls, but still make sure your proposition is attractive. You will also need to consider how you will protect your trademark, patents and intellectual property across multiple legal systems.
Don’t underestimate the power of IT systems in monitoring and supporting your international franchisees – this is now a must for any franchisor.
It’s not how many franchisees, it’s the right franchisees
If you take one of the franchising routes, it is all too easy to see it purely as a numbers game. You might be especially keen to get that master franchisee in place, but getting the right country partner is critical, and a very serious problem if you get it wrong.
Don’t rush in, please take the time to build a robust recruitment procedures and due diligence processes, as well as set out sensible criteria and characteristics for the ideal country or regional franchisee. Set up decent lead channels and seek out the right people for the job – don’t just take anyone who has the cash.
Don’t write anyone off from any unsolicited contact, either. If someone has taken the time to recognise your brand has huge potential for them and their market, and has reached out to you, they are worth spending time with. These could be exactly the characteristics you need.
Don’t be afraid to ask for help
No one person can be expected to be an expert in every single nuance of all 195 countries in the world, and all their various subcultures and markets. Seeking out support from international franchise experts with depth of experience and local experts and consultants is essential in making sure both your brand offering, and franchise package, are optimised for the local market. Experts on the ground who can provide you with the best local commercial data, franchise intelligence and legal advice are worth their weight in gold.
As a wise man once said… there is no one way to franchise a business, but there is the right way for you to franchise your business.
About the author
Farrah Rose has unrivalled experience in international franchising and has been operating in this field since 1984.
Initially working for major corporations, such as Burger King and Arcadia Group Plc, Farrah began advising businesses as a consultant in 1996. During this time she has worked with organisations of all types from family businesses to major Plc companies and high profile brands, helping them to expand their businesses into global markets.
Rose works with 76 associated offices in 103 countries and is now recognised as one of the leading authorities on international franchising and her expertise is sought by companies around the world.
A long standing member of the British Franchise Association, and a Multi Global award winner for ‘The Highest contribution and achievement in international franchising’ IFA 2020 and ‘The Creator’ GNF 2022, she has also worked closely with non-profit making organisations such as the Department of Trade and Commerce in Guernsey, UKTI retail London.
Rose is the senior advisor on international franchising and licensing to Commonwealth Secretariat and the European Bank, has ran significant number of awareness training seminars on franchising for SMEs, Government Heads, and Stake holders across CEE, Central, East Asia and North Africa.
Farrah Rose has unrivalled experience in international franchising and has been operating in this field since 1984.Posted: 13th February, 2023