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GLOBAL ECONOMIC DEVELOPMENT THROUGH THE UTILIZATION OF THE FRANCHISE SYSTEM

By CARL J. KOSNAR January 2010

PREFACE Much has been written in recent years extolling the virtues of franchising as it exists in the United States. However, there has been a dearth of information and analysis of the economic impact and potential of franchising, or similar economic expansion systems, in developing countries. Most of what has been written about international franchising has dealt with the legalities pertaining to franchise law, licensing, and trademark and patent law, and their disparities from country to country. In spite of the scarcity of academic and research analysis, the period between the 1970s and the early-2000s witnessed a dramatic increase in international franchising and similar commercial expansion activity. This has occurred not only in Western Europe but also in Asia, South and Central America, Eastern Europe and, to a more modest extent, Africa and the Middle East. In this article, we shall look at some of the benefits and consequences of importing Western (essentially American) franchises and franchising techniques into developing economies. PURPOSE The success of the American franchise business model is well documented through volumes of books and articles, including those written by the author, over the last twenty years. It is not the author’s intent to add to the prolific amount of text that already exists, but rather to put forth the

challenges that he perceives in attempting to transfer the American franchise business model to developing economies in other parts of the world. In order to be successful in many countries outside of the United States, it is his contention that the American version of franchising requires modification in order to be accepted and flourish. One such modification is a related expansion technique that the author has implemented in the United States and Canada with good results which he refers to as the “Franship” system of growth, a composite of elements taken from franchising and joint venture commercial arrangements. The term also may have a connotation that is more acceptable in regions of the world that are reluctant to accept American-style franchising; it proposes a business relationship based on parity. DEFINITION OF FRANCHISING If one analyzes franchising systems worldwide, the structures tend to be hybrid forms of economic organizations that create various hierarchical relationships for the purpose of distributing goods and services. Part of the debate over the precise definition of franchising has revolved around the different business activities which franchising encompasses. The term franchise, in its generic usage, has been used to label business relationships as diverse as the right to broadcast television programs or operate professional sports teams within certain geographic territories to utilizing a complete business-format franchise package such as McDonalds. However, a franchise is probably best defined as comprising a contractual relationship between a franchisee (usually taking the form of a small business) and a franchisor (usually a larger business) in which the former agrees to produce or market a product or service in accordance with an overall “business system” devised by the franchisor. The relationship is a continuing one with the franchisor providing ongoing support and advice, research and development, and help with marketing and advertising. In return, the franchisee usually pays an initial franchise fee and also an ongoing royalty or management service fee normally based on gross sales or a mark-up on supplies purchased from the franchisor. The franchisee provides the capital for the business and is a legally separate entity from the franchisor. Although the franchisor is usually a larger business than the franchisee, most franchise companies do not meet the description of a large, national company. Most franchisors in America and Europe remain small to medium-sized enterprises (SMEs) and are regional in structure and size. The large franchise companies are almost invariably American in origin, and usually qualify as a Fortune 1000 Company, e.g., McDonald's Corporation, ServiceMaster Industries, Coke, Pepsi, Holiday Inn, Burger King, KFC, Pizza Hut, Budget Rent-a-Car and Avis. It has been argued that in the early stages of franchising in the United States, the franchisee was simply a managed outlet of the franchisor. Examples of this theory are the Singer Sewing Machine Company, which started franchising in the 1860’s, and the automobile dealerships and gasoline station franchises started at the beginning of the 20th Century. In these early franchise models, the franchisor exercised enormous control over the franchisee. At the other end of the

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pendulum are those that argue that the franchised small business may be viewed as an emerging form of independent small business whose distinguishing characteristic is its independence to operate, and profit, under the guidelines of the usually larger franchisor. As such, franchising, or in some cases modified versions, can be viewed as a means of nurturing and developing entrepreneurial talent in developing countries, and it is in this context, that the author feels the Franship program can accelerate economic growth. DEFINITION OF FRANSHIP SYSTEM The Franship system is a comprehensive commercial joint venture in which one party (the grantor) grants to another party (the grantee) the right to operate a business selling products and/or services produced or developed by the Franship entity under the grantor's business format and identified by the grantor's logo and trademark. The Franship entity is owned jointly by the grantor and the grantee and receives a license to operate by the grantor in the grantee’s country. The grantor is usually a large franchise company and provides the training, support, and the entire business format. The grantee is a business group, company or governmental agency domiciled in the country where the Franship is located and operated and, in most cases, provides the majority of the funding to establish the Franship business activities. The Franship system can also be thought of as a pooling of resources and capabilities. The grantor contributes the know-how and experience and the grantee contributes the initial capital investment, or supplemental capital investment, motivated effort, and operating experience within the country and its variety of markets. The Franship, like the franchise model, includes a format for the conduct of a business, a management system for operating the business, and a shared trade identity. The Franship system is a business expansion method and joint venture relationship, not a franchisor-franchisee relationship, nor is it a buyer-seller relationship; it is a partnership with equity shared by both parties, and, in the opinion of the author, is an acceptable business expansion model for countries that do not accept the Western “Mc Donaldization” of their economies.

THE FRANSHIP SYSTEM AS A MEANS OF IMPORTING ENTREPRENEURIAL ACTIVITY INTO DEVELOPING COUNTRIES To date, franchising has been developed to a greater extent in the United States than anywhere else in the world, despite the fact that the concept had its early origins in Europe. The last 10 years, however, have witnessed an unprecedented spread of franchising across international frontiers prompted almost exclusively by American franchise companies wishing to cope with problems of market saturation and monopoly legislation at home. Exports by European franchise companies, by way of comparison, range from modest to trivial depending upon the country in question. Countries such as France, are becoming involved in international franchising activity but appear to be currently concentrating on ex-colonies and are geared towards serving expatriates.

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Franchisor internationalization began initially by establishing a presence across industrialized nations with developed economies and language/cultural proximity and affinity to the United States. As markets began to become saturated in America, and as the export potential of franchising became more evident, the growth rate accelerated and global expansion has broadened. In an increasing number of countries, escalating urbanization, rising disposable incomes, and expanding consumer markets provide conditions favorable to the growth of franchising. U.S. ATTITUDES TOWARDS FRANCHISE GLOBALIZATION High profile American involvement in international franchising is looked upon favorably at the highest levels in the U.S. because of the strong benefits to the U.S. economy. From a balance-of-payments perspective, international franchising is considered (in the U.S.) as a safe and rapid means of obtaining foreign currency with a relatively small financial investment abroad. It is notable that it neither replaces American exports nor exports American jobs. These reasons make this business arrangement one of the most preferred and government-supported forms of international involvement. The same argument can be made for the Franship system. The advantages of a global Franship, or franchise, program to an American company may be summarized as:

Fewer financial resources are required as the Franship entity incurs the majority of the costs involved. Raw materials can often be produced internally in countries under the Franship structure where direct imports may be limited under the franchising system. There is less susceptibility to political, economic and cultural risks if the ownership is local under the Franship program. Property is less likely to be expropriated since the grantees are local nationals. Grantees under the Franship program are more familiar with local laws, language, culture, and business norms and practices of the country. And, having ownership in the parent company creates more motivation rather than just owning an American franchise.

The Franship program also helps to avoid some of the following risks of employing franchising as a vehicle to international expansion from the franchisor's viewpoint:
• • •

Possible difficulties in repatriating royalties Difficulties in protecting copyright and intellectual property rights Difficulty in policing quality standards, unfamiliar laws, regulations, language, and business norms

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• • •

Difficulties in servicing franchisees Difficulties in terminating contracts because of local laws Creation of local competition as the franchise concept is mimicked

TECHNOLOGY TRANSFER The transfer of franchise know-how across national boundaries can be viewed as a process providing local franchisees with access to value-added businesses as well as the marketing techniques and managerial support implicit to firms developed in industrialized economies. However, not all countries and cultures readily accept Western franchising concepts. Franship-type joint ventures have traditionally been a more popular method for international development because the franchisor receives financial assistance with the costs of globalization. Sharing the equity with a local partner also assists the franchisor with the sensitivity needed to cope with cultural, political and administrative norms, and behavior patterns in the franchisee’s country. In some Asian and Middle East countries there are relatively few, if any, foreign (or indeed home-based) franchise companies registered. There were, and are still, stringent foreign investment laws and a preference for Franship-type joint ventures rather than outright foreign ownership. In other countries even joint ventures were restricted to sectors specifically targeted by the national government. GLOBAL UTILIZATION As the major American franchise companies grow more competitive in the United States, the large chains have looked to overseas markets for their future growth. A dozen years ago, Mc Donald’s had approximately 3,200 restaurants outside the United States; today it has 20,000 restaurants in over 125 foreign countries. It currently opens approximately 6 new restaurants every day, and at least 5 of them are overseas. The economic values and industrial practices of American franchises are being exported to every corner of the globe. American franchising systems have not only become symbols of Western commercial advancement, but have proven successful in helping to grow foreign economies as well. American franchise companies are often the first multinationals to arrive when the country has opened its markets, serving as the pioneers in the reconstruction of the local economy. Seventeen years ago Mc Donald’s opened its first restaurant in Turkey, no other foreign franchisor or chain did business there. Turkey, now has hundreds of franchise outlets, including 7-Eleven, Nutra Slim, ServiceMaster, Industries, Re/Max Real Estate, Mail Boxes Etc, (now owned by UPS), Ziebart Tidy car, plus many others. The anthropologist Yunxiang Yan has said that in the eyes of Beijing consumers, U.S. franchises represent, “Americana and the promise of modernization.” Thousands of people wait patiently for hours to eat at the city’s first Mc Donald’s in 1992. Two years later when a Mc

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Donald’s opened in Kuwait, the line of cars waiting at the drive-through window extended for seven miles. About the same time, a Kentucky Fried Chicken (KFC) restaurant in Saudi Arabia’s holy city of Mecca set new sales records for the chain, earning US$200,000 in a single week during Ramadan. In Brazil, Mc Donald’s has become the nation’s largest employer. Many international franchise businesses have become the center of commerce, and disperse economic benefits throughout the foreign city or country. Classes at the Mc Donald’s training facility in Oak Brook, Illinois, are taught in more than two dozen languages. As the American franchise chains move overseas, in order to diminish the fears of American domination, the chains purchase as much food and supplies as possible in the country where they operate. Instead of importing food and supplies, they import their systems and procedures so that local businesses can learn and prosper by providing the needed products and services. Seven years before Mc Donald’s opened its first restaurant in India, the company began to establish a supply network there, teaching Indian farmers how to grow iceburg lettuce with seeds specially developed for the nation’s climate. A Mc Donald’s restaurant is just the entry point of a much larger system comprising an extensive food-chain, leading back to all the local suppliers and eventually back to the farms. CONCLUSION The Franship system, as a modification of the Western franchise business model can have a useful “role-model” effect in encouraging local entrepreneurs in countries with developing economies to set up their own franchises and even consider expanding these “home-grown” franchise models outside the country. An implicit feature of a Franship, and/or franchise system, is the concept of technological transfer to the learning organization or country, where technology refers to skills and know-how rather than just machinery and hardware. This broader process relates to methods of organization and operation, quality control, and various other manufacturing procedures. Notwithstanding the author’s recommendation to utilize the Franship system rather than conventional franchise structures in some developing economies, there will be circumstances that exist within other countries that nevertheless warrant the use of master franchise relationships. For governments of developing countries that wish to tap the potential of franchising and concentrate on promoting local businesses while resisting the downside factors of imported Western franchise know-how, the Franship model has proved effective. However, it may well be that, in exchange for exposure to managerial, marketing and consumer know-how which imported franchise systems bring with them, there may a price to pay. The cultural homogeneity which exposure to Western tastes may bring, the loss of economic diversity, the possible displacement of existing local businesses, the repatriation of fees and profits, plus the notion of control from a distance, all need to be taken into account by policymakers in developing economies before deciding to either embrace or reject this source of technology transfer and know-how.

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Whatever posture governments of developing economies decide to adopt on franchising, one thing appears fairly certain: franchising as a business expansion concept cannot be indefinitely ignored. ******

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