Years ago, the international expansion of a franchise system was the preserve of only the mega-brands with lots of human and financial resources. This is no longer the case, and over the past 10 to 15 years many emerging franchisors have been experimenting with expansions into other countries. The results have been decidedly mixed, but with many more failures than successes.
This is so, not just because of the inherent challenges in such expansions, but often because of poor planning and/or poor execution. This article will highlight a few of the most common mistakes made in international expansions and some suggestions about how to avoid them.
Get the timing right
The common wisdom in bygone eras was that a franchisor would want to saturate their home country before attempting an international expansion. The modern thinking is that the decision to expand internationally has more to do with the quality of the system and its ability to support foreign franchisees than simply the size of the system domestically.
This raises so many questions. Does the franchisor have the financial and human resources to investigate:
- The acceptability of the concept in the target country?
- What adaptations need to be made to the concept?
- Challenges with the supply chain in the target country?
- Potential financial rewards from the expansion to justify the additional expenses?
- Whether there are enough qualified franchisees (unit, area or master) to make a success of the expansion?
The answers to these questions, and many others, require an initial investment of money and time, which is all too often overlooked or underestimated. The end-result is, at best, a failed expansion, or at worst, damage to the system in the home country, as leadership is distracted and resources are stretched too thin.
The answer is to research, research, research and research some more. Take your time and make sure you can find the money and people to provide you with accurate, reliable and sufficient information to answer the main question: is your system ready for an international expansion?
Get the right countries at the right time
Regrettably, failed international franchise expansions often result from bad choices about the target countries into which to expand. There are many reasons for this, but commonly the root problem is that the franchisor reacts to an overture from a resident of a foreign country, rather than doing the necessary research and considering the available options and cost benefits of each country.
From an international franchise expansion perspective, not all countries are created equal. The factors that need to be investigated and considered include:
- Proximity to the franchisor’s home country
- Common language and culture
- The prevalence of similar businesses in the target country
- The availability of critical supplies and inventory
- The availability of needed labor
- The legal system for the protection of the franchisor’s rights.
The choice of target countries, especially at the beginning of an international franchise expansion program, should take into account geographical regions and not just single countries (for example, the META region, Scandinavia, Europe, Asia, North America or Latin America).
Many franchisors have found greater success expanding internationally by concentrating on one region at a time, instead of spreading their resources too thinly across a number of countries. Sometimes, this is accomplished by recruiting a single master franchisee for a region, or simply by the franchisor concentrating on and learning from experiences by taking things one country at a time.
Choose the right franchise vehicle
There are a number of choices for franchise vehicles or structures open to a franchisor interested in expanding internationally, including unit franchises, multi-unit franchises, area agency franchises, master franchises and joint venture franchises. Making the right choice is very important and can result in a successful international expansion or an unmitigated disaster.
The counsel of perfection in this area is to start with one or a few corporate units. This way you can test drive the concept in a foreign country, allowing for more flexible fine-tuning of the concept, and to create a proof of concept locally for prospective franchisees. Once the corporate units are running well, the franchisor can either begin franchising new units or dispose of the existing corporate units to new franchisees.
Unquestionably, the structure of choice for international expansions has typically been master franchising, with the right of the master franchisee to sub-franchise. The goal is to find a well-financed master franchisee, who is knowledgeable about the industry and with franchise experience. Unfortunately, there are not a lot of unicorns out there, and many an ambitious master franchise program has failed miserably.
The chance of failure increases significantly when the franchisor leaves too many of the critical decisions about the franchise expansion to the master franchisee, under the mistaken belief that local knowledge trumps research. To avoid many of these problems, you can grant multi-unit rights to a small number of franchisees in a country. While resulting in slower growth and increased franchise development costs, this approach gives you a much greater chance of achieving sustainable and enduring growth of the system in a country or region.
Don’t go for the largest territory
Invariably, an international franchise expansion program involves a consideration of the size of territories. Prospective franchisees often try to secure the largest possible territory, which frequently is an entire country or even a number of countries within a specific region.
Franchisors new to international franchising tend to grant unnecessarily large territories, mainly through a lack of knowledge of the potential of the system in the territory – and because the franchisor feels it would be easier and more cost-effective to deal with just one master franchisee in a larger area. However, the franchisor is more likely to gain a stronger and more profitable system if initial territories can be kept as small as possible, allowing franchisees to gain more or larger territories over time as they prove themselves capable.
Additionally, it’s psychologically (and sometimes legally) easier to reward good performance than to punish bad performance.
One of the most difficult numbers to ascertain in all franchising is the amount that should be charged for the front-end franchise.
This number will be influenced by many factors, including the length of the term of the grant, the franchise system’s history of success, the amount of training and initial support to be provided by the franchisor, and the level of additional investment required of the franchisee. If this number is set too low, the franchisor may find the exercise too expensive to do a proper job of helping the business reach profitability. If set too high, it may impair the franchisee’s ability to achieve financial success or to operate the business at an acceptable level.
Similar considerations arise when setting the continuing royalty rate. There are additional factors here to consider if the chosen vehicle is master franchising. In this case, the franchisor has to determine how fees from unit franchisees will be shared between the franchisor and the master franchisee. In this situation, responsibilities for the development and administration of the system should be determined first between the franchisor and master franchisee. The division of the various fees should then be based upon the costs of discharging those responsibilities – and only after that should the parties divide the remaining profits.
While not easy to accomplish, the benefits from an international expansion of a successful franchise system can be rewarding in so many ways – certainly financially. However, the best advice is encapsulated by the words of Benjamin Franklin: failing to plan is planning to fail.
Edward (Ned) Levitt is a partner in the Canada/U.S. law firm Dickinson Wright LLP, and co-chair of its Franchise and Distribution Law Group. Ned is recognized as one of Canada’s leading authorities in franchising and distribution law