Entering the U.S.A.: 5 pitfalls for international franchisors | Global Franchise
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Entering the U.S.A.: 5 pitfalls for international franchisors

Insight

Entering the U.S.A.: 5 pitfalls for international franchisors

Where do franchisors go wrong when entering the U.S. market? Ray Hays summarizes the best practices and identifies some of the most common

It’s no secret that numerous international franchisors have tried and failed to enter the U.S. market over the last few decades. In some cases, these franchisors were highly experienced and successful in other international markets. This begs the question: should international franchises simply avoid the U.S. market?

The short answer is no. The numbers demonstrate that the U.S. market is simply too big to ignore if a franchisor is seeking to be a leading global player. According to the U.S. Commercial Service, the American franchise market is more than double the size of any other international market. In terms of operating franchise units (in 2019), the U.S. had approximately 796,000 franchised locations opened. China was ranked second with 330,000, and Japan was third with 270,000.

So, what makes the U.S. market so difficult for international franchise concepts?

This question is not as quick and easy to answer. In summary, the American franchise market presents several challenges for international franchise concepts. Some of these issues are more a matter of perception, and others are very real obstacles to entry. Let’s start with eliminating one of the most common misconceptions about the U.S. market: the fear of high legal risks and legal costs.

The notion of the American ‘legal boogeyman’ is a bit of a myth. While the U.S. franchise market is arguably the most highly regulated in the world, these regulations can actually help decrease the associated legal risks for franchisors, as long as they play by the rules. In fact, litigation in the U.S. franchise market is relatively low. To quote Carl Zwisler, former partner of Lathrop GPM: “According to a recent study of 2,489 franchisors’ FDDs, 54 per cent of franchisors had experienced no franchise litigation, and another 16 per cent reported only one lawsuit over the previous 10 years. 88 of 165 (53 per cent) of franchisors with 500 or more units reported five or fewer lawsuits over the previous 10 years. Only seven franchisors with 1000- plus units reported over 50 lawsuits over 10 years.”

In short, regulatory hurdles and litigation risks don’t pose a significant threat to international franchisors. For international franchisors attempting to enter the U.S. market, failures often come down to several common mistakes that can be easily avoided.

Pitfall #1 – They don’t know the rules, or they disregard them

Unfortunately, on several occasions, I’ve seen international franchise representatives at U.S. franchise expos, who clearly have no clue about U.S. franchise regulations – or worse, they blatantly disregard them. I’ve seen some international franchise reps hand out flyers with unit financial representations, but when I ask them if they have an FDD, they have no idea what I mean, or they simply don’t care.

Granted, most international franchisors who enter the U.S. market are ethical and wish to follow the rules. Some of these franchisors have also done basic research on U.S. franchise regulations. However, I find that many international franchisors are hesitant to retain a U.S. attorney in the early stages of their U.S. market entry planning. They feel that they should hold off on the expense of a U.S. attorney until they are ready to begin selling franchises in the U.S.

I believe this approach is a mistake. In my opinion, it’s critical to have the guidance of a U.S. attorney in the early stages of U.S. entry planning to educate the franchisor on U.S. regulatory guidelines and to address critical issues such as:

  • Which U.S. states to target
  • Identifying possible trademark conflicts
  • Pre-FDD meetings with prospective franchisees or other partners
  • Development of franchise sales collateral
  • U.S. rules for franchises/offering disclaimers on their websites.

Pitfall #2 – They underestimate the capital and time needed

Over the last decade, several international franchisors have commented to me that their U.S. franchise entry “took them twice the time they expected and cost them twice as much.”

Longer U.S. entry timelines and unanticipated expenses are often the result of a lack of understanding of U.S. requirements and costs.

For example, international franchisors entering the U.S. often assume that their largest expense for the franchise launch will be legal fees. This is generally incorrect. My firm has studied the budgets of several franchisors who have entered the U.S. The numbers show that the legal expense is typically less than 20 per cent of the total first-year franchisor expense. (This doesn’t include setting up company-owned pilot operations, which would drive the legal expense percentage even lower).

The legal expense is fairly simple to budget, although it will vary by law firm and type of franchise agreement. Based on U.S. entry projects I’ve seen over the last decade, legal expenses for U.S. entry average about $35,000 to $55,000, which includes trademark filings, creation of the FDD and U.S. franchise agreement, as well as state filing fees in several key target states. A simple single-unit franchise agreement with a basic trademark registration would be at the low end of that price range and the price will go up for a more complex trademark filing, or when the franchise strategy involves an area developer, master franchise or area representative agreement.

It’s the additional 80 per cent or more of non-legal expenses that often results in unanticipated costs for franchisors planning for their U.S. launch. Examples of these expenses, ranked from highest to lowest, include:

  • Franchisor payroll and other personnel expenses
  • Marketing expenses
  • U.S. franchisor office setup and related administrative costs
  • Airfares, accommodation and other travel expenses

The total cost of a U.S. market entry will require a first-year budget of at least $350,000 to $500,000 or more, not including the costs of company-owned pilot locations. Depending on the concept, the addition of one or two pilot locations can increase that figure to over $1m, assuming the franchisor does all the work themselves. To reduce this cost burden, some international franchisors choose to use consultants or other contracted U.S. franchise representatives during the early phases of their U.S. launch, which can cut office overhead expenses by more than half.

International franchisors need to be patient and realistic about the time required to achieve a foothold in the U.S. market. It needs to be seen not as a short-term project, but as a long-term strategic goal with a five or even 10-year horizon. The first year should focus on getting the building blocks in place, such as completing franchise documentation and building a U.S. team, as well as getting a pilot operation up and running.

Pitfall #3 – They don’t hire U.S. franchise experts

International franchisors often choose to send their own team members from overseas headquarters to manage their U.S. launch. Sending non-U.S. staff and managers to the U.S. has several disadvantages:

  • Travel and living expenses: Sending an employee from abroad to the U.S. can involve temporary travel costs, or in the case of a permanent assignment, very costly relocation expenses
  • Immigration laws: Foreign-based staff cannot work in the U.S. for extended amounts of time and obtaining a U.S. work visa is a very complex, time-consuming, and expensive process. Hiring a U.S. immigration attorney will likely be required
  • U.S. team management know-how: Foreign managers easily run afoul of U.S. regulations, such as labor laws. For example, simply asking the wrong question during an employee interview or performance review can result in a very costly labor lawsuit. It’s best to hire U.S. managers, who understand the rules
  • U.S. franchise sales know-how: Non-American franchise managers may inadvertently violate U.S. franchise regulations, which can be a costly mistake. Experienced U.S. franchise salespeople have an understanding of best practices and have established relationships with U.S. franchise brokers and other players in the U.S. franchise world.

Pitfall #4 – They don’t test their concept in the U.S. market

Most international franchisors do basic market research on the U.S. (for example, demographics, industry data, or supply chains), but don’t commit time and capital to testing their concept by opening one or more pilot locations in the U.S.

While a pilot operation can be seen as difficult, costly and time-consuming, the lessons learned are invaluable for the future success of the long-term U.S. franchise project. It is also critical for the international franchisor to document key information throughout the opening process, which will translate into a more efficient and sustainable U.S. franchisee onboarding process going forward.

Common pain-points that international franchisors discover during the pilot phase include:

  • Issues with U.S. supplier sourcing of products or equipment: Often, alternative supplier solutions must be developed for the U.S. market
  • Banking relationships: Setting up a U.S. business bank account can be difficult for a foreign-owned U.S. subsidiary
  • Technology, such as POS or management software: Don’t assume that technology that works abroad will work in the U.S. For example, many foreign-based credit card processing solutions are not accepted by U.S. banks, and an American alternative might be required
  • Licensed intellectual property: Often IP that a franchisor is using in other countries may not include licensing rights in the U.S. Examples may include licensed videos, music, artwork, and other third-party digital content. IP laws are rigorously enforced in the U.S., and going afoul of IP rights can be very costly
  • Differences in labor laws: Employee law, HR processes, and tools like employee handbooks and interview questions not only vary from other countries, but U.S. states have varied and unique labor regulations. The franchisor needs to ensure that their HR processes address these differences across the U.S.

Pitfall #5 – They try to run U.S. operations from abroad

Whether a franchisor chooses to hire their own team or work through consultants, it’s my strong opinion that the head of U.S. operations should be a very seasoned American franchise executive. This manager would typically report to the worldwide CEO or senior VP of international. Having an American franchise executive with autonomy to call the shots on the ground in the U.S. is critical to avoiding major mistakes common with remote decision-making by internationally-based management. thousands of miles and multiple time zones away.

The one exception to this rule might be Canadian franchisors, due to their geographic proximity, same time zones, and cultural similarity. That said, even Canadian franchisors have made missteps when entering the U.S. market (and most certainly vice-versa) due to differences between the two countries’ legal, cultural, and business norms. In many cases, Canadian franchisors choose to hire American franchise management to lead their U.S. operations, and vice-versa.

Success stories

The good news is that numerous international franchisors have successfully entered the lucrative U.S. market in the past 50 years.

These brands include:

  • 1970s (Kumon)
  • 1980s (Tim Hortons)
  • 1990s (British Swim School and WSI)
  • 2000s (Cartridge World and Tutor Doctor)
  • 2010s (Poolwerx, Bodystreet and Eat Gather Love)
  • 2020s (German Doner Kebab)

5 best practices for a successful U.S. market entry

  1. Engage a qualified U.S. franchise attorney as a first step
  2. Create a conservative five-year business plan and budget. Review it every year
  3. Hire experienced U.S.-based franchise managers or contracted experts
  4. Show proof of concept with one or more U.S. pilot locations
  5. Don’t directly manage U.S. operations from abroad

The author

Ray Hays is managing partner at FranLaunch USA, a franchise management firm that facilitates U.S. market entry for international franchisors. He also serves as a member of the District Export Council of Arizona, a volunteer executive advisory group that supports the export promotion efforts of the U.S. Commerical Service

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