Retail Global Expansion Determining your method of market entry

As the global economy continues to stumble, retailers are struggling to achieve growth domestically. While there are pockets of opportunity, many retail sectors in the United States are saturated and not expected to grow much, if at all. Growth may be heavily dependent on winning share from competitors, typically a taxing effort. Consequently, many retailers are looking beyond their borders for potential growth. Foreign markets offer attractive growth rates fueled by burgeoning middle classes, lower competitive intensity, and greater pricing flexibility. Additionally, a global presence may help retailers lessen their risk exposure to an economic downturn in any one market. Some of the biggest historical barriers to entering foreign markets have eroded. Many foreign governments have opened their countries to outside investment. Technological advances have revolutionized consumers and companies ability to communicate and share information. Similarly, enhancements in infrastructure around the world have made producing and transporting goods considerably more feasible. However, entering new countries is not as simple as signing a lease and opening the doors. Market entry requires careful consideration of external risks and internal parameters in order to understand market dynamics, requisite competencies, and financial implications. There is no one size fits all model. Based on these considerations, retailers should select a method of entry that balances two critical but often conflicting interests: speed and control.

The trade-off between speed and control There are three primary market-entry methods: franchising, joint venture, and owned expansion (see Figure 1).
Figure 1. Market-entry methods

Method of entry Franchising

Definition An agreement to allow a partner to operate stores under the retailers brand

Illustrative models Area development Master franchise Individual franchise Hub and spoke

Joint venture A shared Joint venture ownership Franchise agreement agreement with through a joint venture a partner Owned A companyowned and funded expansion Acquisition Multichannel (e-commerce) Brand statement store Shop-in-shop Pop-up-shop

Each of these methods presents trade-offs between speed and control. To contrast the relative differences, we developed The Control Continuum. As Figure 2 illustrates, international expansion typically entails an inverse relationship between speed and control the faster a company wants to expand, the less control the company can exercise, and conversely, the more control they want to retain, the slower expansion is likely to proceed. At one end of the spectrum, franchising typically enables the fastest expansion, but often with less control. At the other extreme, owned expansion typically allows retailers to retain the most control, but usually at the slowest pace. In the middle of the continuum, franchising may offer the most significant flexibility, and joint venture permits a blended agreement.
Figure 2. The Control Continuum

Parameters for selecting a method of entry The relative importance of external and internal parameters influences the level of control and pace of expansion retailers want to achieve (see Figure 3). To develop an effective international expansion strategy, retailers should prioritize these parameters. The choices will reflect relative preferences for speed or control. Similarly, the trade-offs among parameters are likely to shape retailers decisions about method(s) of entry and the types of markets to enter. For example, a capital-constrained retailer who is intent on rapid expansion is likely to pursue a method of entry with less control rather than organic growth. Conversely, a retailer with a valuable, iconic brand will likely place greater emphasis on maintaining strong controls rather than achieving aggressive growth targets. Taken individually, each parameter may suggest multiple potential methods of entry. However, taken in aggregate, the parameters will likely lead retailers to a preferred answer.

Speed Franchising Joint venture Owned expansion

Control

While The Control Continuum depicts the trade-offs between speed and control for each method of entry, deciding which model to employ, when, and where, requires an assessment and prioritization of specific external and internal considerations.

Figure 3. Method of entry parameters

Parameters Level of investment Time to payback Brand image and customer experience Risk level Product freshness

Effect on level of control and pace of expansion Financial position and access to capital will affect retailers choices. The more material the investment, the more control the retailer usually wants to retain. Expected return on invested capital, investment time horizon, and anticipated valuation multiples influence the pace of expansion and level of control retailers want to exercise (particularly relevant in owned versus nonowned decision). Retailers with a strong brand image and/or unique customer experience requirements tend to exercise higher level of controls. Typically the amount of control (and thereby exposure) a retailer retains is inversely correlated to the risk of the market (the greater the market risk, the less exposure the retailer wants to bear). Retailers for whom product freshness is a key component of their value proposition tend to favor greater levels of control. Higher control allows them to closely monitor products freshness and effectively manage the product life cycle. Level of control exercised by a foreign retailer may be dictated by local laws and regulations. Retail concepts that are fairly formulaic generally require less oversight and, therefore, can rollout more quickly. Conversely, retailers with a highly technical concept may exert greater supervision. Available competencies, resources, and infrastructure within the organization will play a critical role in determining the level of control the retailer can take on. This parameter is particularly important in joint ventures and franchising as the retailer assesses what they can bring to a collaboration. Some markets necessitate or warrant bringing in a partner. In those cases, the competencies, resources, and infrastructure of the partner will shape the level of control the retailer wants to retain.
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Local laws and regulations Business model complexity Internal capabilities

Partner capabilities

Selecting a method of entry Different retailers use different methods of entry to enter new markets. Though a small minority of retailers employs one method of entry, in all markets, many retailers employ multiple methods of entry, varying them by market. For example, Zara has company-owned stores in Spain, China, and Russia, joint ventures in Mexico, India, and Australia, and franchised stores in the United Arab Emirates, Columbia, and Indonesia. In some countries, retailers do not have much of a choice as local laws dictate permissible forms for foreign direct investment. Figure 4 presents an illustrative sample of retailers and their selected method(s) of entry by region.
Figure 4. Method of entry by retailer

different countries, maintains strong controls over their brand, assortment, and pricing. Conversely, some retailers craft franchising agreements to designate many of these responsibilities to the franchisee. Franchising contracts can even vary by market and partner. Franchising is also an appealing method of entry as it allows the retailer to moderate capital investments. Typically, the franchisee partner may be responsible for providing some, if not most, of the money required to build and expand the business. The flexibility of franchising agreements allows retailers to reach acceptable trade-offs on specific considerations such as level of investment, market risk, and local laws. As a result, retailers can enter markets that otherwise might have been inaccessible. The primary challenge for retailers is determining the amount of control to retain over each area of the business. Retailers essentially need to categorize all responsibilities into three groups: 1. Responsibilities retailers must own; 2. Responsibilities the franchisee partner must own; and 3. Responsibilities that one party or the other will own depending on the partner and the market. 1. Responsibilities the retailer has to own (internal assessment). Retailers should first look internally to assess the competencies, knowledge, and experience they must own in order to remain distinctive. These attributes often undergird their value proposition and competitive differentiation. For example, Zara retains strong controls over product development and merchandising, which allows them to quickly respond to consumer demand. Likewise, brand-conscious companies such as Nike, tend to maintain control over almost all aspects of marketing and advertising. Decisions about where to preserve control are comparatively easy at a strategic level, but more difficult at an operational level. For example, on a strategic level, a retailer may want to assert strong controls over merchandising, but what exactly does that mean for specific responsibilities such as markdowns, competitive shops, and inventory ownership? The internal assessment is a vital, if arduous, process to determine precisely where to draw the line. 2. Responsibilities the franchisee partner has to own (external assessment). The success or failure of a franchising agreement rides on the selection of a franchise partner. In many ways, picking a franchisee partner is like choosing a spouse: get it right and years of marital bliss will likely follow. Get it wrong, and divorce lawyers will be carving up the relationship. Fortunately
3

Retailer Mango

Asia Companyowned Franchise

Middle East/ Western Africa Europe Franchise

Eastern Europe

Americas Companyowned Franchise JV n/a

Company- Companyowned owned Franchise Franchise Joint venture (JV) Companyowned Franchise JV Companyowned Companyowned Franchise Franchise JV

Marks & Spencer

Companyowned

Franchise

Nike

Companyowned Franchise Companyowned Franchise

Franchise

Companyowned Companyowned Franchise

Companyowned Companyowned Franchise

Zara

Franchise

Franchising The ability to customize franchising agreements is what makes this type of entry attractive. It is also what makes them so challenging. As depicted on The Control Continuum (Figure 2) franchising offers more flexibility to customize the level of control and pace of expansion. Franchising agreements can be written to ensure very high levels of control. Spanish fast-fashion retailer Mango, who has over 1,000 franchised stores in about 100

The ability to customize franchising agreements is what makes them so attractive. It is also what makes them so challenging.

for many retailers, there has been an onrush of attractive partners with the proliferation of sophisticated franchisee businesses. Historically, franchising was only palatable to quickservice restaurants. The traditional franchising model was built on two foundational requirements which aligned well with quick serve restaurants: an easy-to-replicate business model and an owner/operator franchisee partner. As other retailers pursued opportunities in foreign markets, a new, more knowledgeable breed of franchisee partners emerged. These modern franchisee partners are generally large, well-capitalized organizations, possessing deep local market knowledge, with business models predicated on franchising multiple brands in a given market. These highly developed and experienced franchisee partners can add considerable value. These franchisees typically offer operational capabilities and infrastructure that can be leveraged to deliver functional services more efficiently and effectively than a stand-alone retailer could. Figure 5 below summarizes some common responsibilities franchisee partners own and the value they typically provide. Figure 5. Typical franchisee responsibilities and value Common franchisee Description competencies and value

3. Responsibilities that will vary by partner and market (external assessment). After identifying the central responsibilities of the retailer and the franchisee, respectively, there will likely be other areas where the locus of responsibility will vary depending on factors such as the competencies of the franchisee partner and the dynamics of the market. For example, a retailer may designate field oversight as a flexible responsibility. In safe, mature, and saturated markets like Western Europe, the retailer may rely on employee company-owned resources to provide field oversight. Conversely, in less stable and more remote locations, such as Indonesia, the retailer may push the franchisee partner to provide most of the field oversight responsibilities. While the ability to customize franchising agreements makes it an appealing method of entry for many retailers, it is most applicable to retailers with branded or exclusive products and/or services. For example, many vertically integrated apparel retailers have used franchising as means for international expansion. On the other hand, franchising in commoditized sectors such as consumer electronics and books has been more limited. Franchising may be unsuitable for retailers that want to expand operations in heavily regulated industries such as grocery and drug stores. Franchising requires a specific set of management capabilities. Running a franchising business is very different from running a retail business. A franchising business requires greater account management to fortify and maintain strong working relationships with franchisee partners. From an operational perspective, traditional roles and responsibilities are only partially applicable. For example, a buyer in a retailers franchising group may not be in charge of selecting product, but rather serves as a coordinator to facilitate orders from the franchisees. Joint venture Joint ventures are a less common method of entry. Conceptually, retailers and partners can be drawn to joint ventures as they effectively align both parties financial interest and risk. Joint ventures also offer higher levels of control than franchising and a single, typically mature, local partner. While joint ventures are fairly rare in the global context, they are more frequently used in markets with legal restrictions such as India. As the Indian government vacillates on opening their retail market to foreign direct investment, current laws limit ownership opportunities for many retail formats. Presently, multibrand retailers that sell more than one brand of products are barred from India.
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Capital

Contribute capital specifically funding new store openings and paying up-front and/or ongoing fees Own and/or have access to preferred real estate sites Have existing supply chain and information technology systems Have experience running and overseeing stores Understand local consumers, competitors, rules, and regulations

Real estate Infrastructure Field and store operations Local market knowledge

Running a franchising business is very different from running a retail business.

Single-brand retailers are allowed 51 percent ownership through a foreign direct investment. Consequently, joint ventures are the preferred (and/or only) method to enter one of the worlds fastest growing markets. For example, Marks & Spencer entered India through a joint venture with an Indian retail ownership group. However, many retailers avoid joint ventures as they can be troublesome to manage and administrate, especially in the fluid and fast-paced retail environment. Joint ventures may encounter bureaucratic decision making, which can limit managements ability to rapidly and efficiently respond to market demands. Similarly, joint ventures can encounter board-level issues such as unclear governance procedures, processes, and accountabilities. Partners can start to disagree over which party is bringing value to the entity. Owned expansion Historically, owned expansion has been a favored method of entry for retailers. Owned expansion offers a higher degree of control. The speed of expansion tends to be more measured for organic growth. Applying the parameters for selecting a method of entry to owned expansion shows which types of retailers are best suited to use it. One particularly relevant parameter is the complexity of a retailers business model. For example, major electronics retailers who sell technical products and services need a well-educated sales staff. The importance of attracting, training, and retaining the right store associates drives big box electronics retailers to retain a higher level of control over store operations. Additionally, the major electronics model requires a sizeable up-front investment to fund each new store opening, a strong relationship with a consolidated supply base, and a flexible pricing model to maintain product freshness. The relative importance of these parameters makes owned expansion an effective method of entry.

Another important parameter the power of the retailers brand plays a significant role in shaping which method of entry they use. Retailers with iconic brands favor methods of entry that provide for the most significant control. The long-term risk of damaging the brand, in an increasingly transparent global marketplace, overrides the short-term need for growth. It is a lesson some pioneers of global retail expansion learned through experience. For example, one luxury apparel manufacturer used lower control methods of entry to penetrate selected foreign markets. However, this company decided to buyout many of its partners and assert full ownership (and control) over its retail presence in these foreign markets. While organic owned expansion typically yields measured growth, acquisitions may allow retailers to more rapidly achieve a sizable presence. Acquisition is a particularly attractive means of expansion for retail models, such as mass merchants, that require scale in order to drive operational efficiencies. For example, Target bought leases from a Canadian mass merchant as a way of establishing an immediate presence in the country. From a market perspective, retailers tend to pursue owned expansion as a means to enter markets that are geographically proximate to their current operations and have similar consumer and competitive dynamics. Many American retailers select Canada for their first foray into international expansion. Owned expansion into nearby markets with familiar dynamics requires fewer investments in and changes to the organization and infrastructure and, therefore, has great appeal. In contrast, entering markets that are far removed from existing operations and/or have different dynamics can require expensive investments in resources and infrastructure, thereby decreasing the attractiveness of owned stores. The retailer may need to extend existing core competencies in customer-facing functions into these new markets. For example, merchants may need to understand local consumer preferences, competitive intensity, market trends, and price elasticity. Retailers will also have to develop the necessary knowledge base to manage effectively other critical customer-facing elements such as evaluating real estate site selection, hiring and managing local store labor, and customizing marketing messages. Owned expansion presents additional implications, beyond investment in and modifications to customer-facing functions. Usually entry with company-owned stores is likely to require adding capabilities and costs in back-office functions such as finance and human resources. Retailers
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Owned expansion is appealing to retailers with a complex business model, an iconic brand, adequate access to capital, and an appetite for measured growth.

entering distant and different markets may be challenged with unfamiliar tax issues and labor laws. From an infrastructure perspective, owned expansion may demand new supply chain channels for efficient product flow, and, to plan and manage the business effectively, retailers may need to add, convert, or augment technological software, hardware, and capacity. While some of these market specific laws, regulations, and services can be purchased from local or regional third-party providers, appropriate oversight at corporate is still required. Summary There is a palpable sense of urgency for retailers to expand globally, especially as the U.S. economy continues to struggle. While some of the biggest historical barriers to entering foreign markets have eroded, there is now far more transparency. Successes, and failures, quickly ripple across the globe, producing more impact on a retailers financial performance and the perception of their brand than ever before. A larger stage means greater risks and greater rewards. Though there is no one size fits all guide to success on a global stage, many retailers are likely to face a similar set of decisions. Retailers should choose how to maintain strong controls over their value proposition while managing the pace of their expansion to obtain sustainable growth. Balancing speed and control, two critical and often conflicting factors, offers retailers with a blueprint for international expansion.

Authors Thomas F. Quinn Principal Deloitte Consulting LLP +1 313 324 1265 tquinn@deloitte.com Jean-Emmanuel Biondi Principal Deloitte Consulting LLP +1 404 631 2503 jebiondi@deloitte.com Adam Chait Senior Manager Deloitte Consulting LLP +1 404 220 1841 achait@deloitte.com Researchers Whitney Young Senior Consultant Deloitte Consulting LLP +1 617 437 2424 whyoung@deloitte.com Elise Xu Consultant Deloitte Consulting LLP +1 617 437 2557 yuxu@deloitte.com Visit Deloitte.com To learn more about our services, visit us online at www.deloitte.com/us/retail-distribution. Here you can access our complimentary Dbriefs webcast series, Deloitte Insights podcast program, innovative and practical industry research, and a lot more about the issues facing retailers and distributors from some of the industrys most experienced minds.

Retailers who want to enter lower risk markets, defined as geographically proximate with similar consumer and competitive dynamics to their domestic market, tend to favor owned expansion.

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