The decision on whether to franchise or not depends a lot on the personality of the business owner. The returns are much smaller but this is balanced by a much smaller risk. There is also no need to find cash for staffing, training, property and so forth. It’s also easier to control: once you get the model right, new outlets become a simple matter of sending out another copy of the rulebook. Even rapid expansion doesn’t dilute management’s focus. It’s much more predictable and the exit routes are much easier.
So the local model represents a low-cost model to growth. It’s ideal for entrepreneurs who would rather not focus on opening a national chain of shops but prefer to concentrate on other areas of the business, such as product development or sourcing.
But franchising won’t work in any environment. Pubs, for example, are notoriously difficult to franchise because of the high element of service involved. In an average retail environment, about 80 per cent of the customer’s perception of value – the ‘brand promise’ – comes from the product itself (including price) but only 20 per cent from the service. So you can still largely fulfil the brand promise even if the service isn’t all there.
Related: Investing in a franchise
In a hospitality business it’s the other way round, so it’s very easy to fail on the brand promise, which in turn impacts on the whole franchise. High-service models are also very dependent on individuals, so they’re not so easy to replicate. The franchise model generally breaks down in these environments.
International franchising involves different considerations to a domestic operation. It’s currently a very hot topic among large UK retail chains, who are seeking to compensate for flat demand at home by seeking new markets such as Eastern Europe and Asia. International franchising operates on a far larger scale: franchisees will often be big businesses in their own right, holding multiple franchise rights and owning considerable property portfolios. They are powerful enterprises and will own the delivery and the perception of your brand.
International franchising offers a relatively easy entrée into a new market. Local franchisees will already have extensive knowledge of the local language, business culture and employment conditions. They will also be equipped with finance teams who can handle the complexities of local regulations and taxes, VAT, customs duties and so on.
The key issue for an international franchiser to establish is the tolerance between a core range of centrally defined products and the need for local flexibility. Some companies are ruthlessly intolerant of any local deviations from the range: for example, it may be a key element in the brand promise that all products come from sustainable sources. It is sensible to allow for a certain amount local sourcing of products, subject to quality approval from the franchise’s own buyers and, where necessary, co-ordination with other items in the range. A clothing brand, for example, might find its own products don’t cover the extremes of climate in all its franchises. Some items might simply be culturally unacceptable, leaving gaps in the range that need to be sourced locally. Most franchises will allow some local sourcing but set an upper limit (such as 15 per cent of merchandise).
International franchisers need to consider the financial model that will underpin the relationship. There can be three elements: wholesale, where the franchise sells branded goods to the franchisees at a margin; licensing, whereby the franchisee pays an annual fee for the use of the brand, logos and signage; and commission, where the franchisee pays a percentage on all sales.
Variations on these themes will depend greatly on the individual preference of the franchiser. Some prefer straightforward arrangements whereby earnings come largely from wholesale margins, thus avoiding much accounting complexity.
Others prefer to incentivise their franchisees with high commission rates. Others use a mixture of licensing and other incentives to take advantage of differential taxation. Establishing a relationship of trust with franchisees is also important, and it is surprising how many franchising relationships operate on a ‘gentleman’s agreement’ basis – a properly set up franchise relationship is mutually beneficial to both sides.
- How replicable is the business model? Can it be delivered ‘in a box’ to potential franchisees?
- What is your level of brand recognition? This is particularly important when moving overseas.
- How easy will it be to control franchises and protect your brand position?
- Do the numbers add up? After taking into account the costs and risks borne by the franchiser, how does the income from franchising compare to your own internal rate of return?
Article by Dan Murphy, a retail director at Ernst & Young
See also: Expansion through franchising