Micro-franchising: Development of a Micro-franchising Replication Model in Mexico. Small and Medium Sized Enterprises (SMEs) Serie Vector No.

Transcription

1 Serie Vector No. 1 Micro-franchising: Development of a Micro-franchising Replication Model in Mexico Small and Medium Sized Enterprises (SMEs) Author: Abelardo Conde. Special collaboration: Enrique Alcázar, Roberto Blanco, Ferenz Feher and David Lehr. General coordination: Rocío Abud and Magdalena León.

2 Micro-franchising: Development of a Micro-franchising Replication Model in Mexico SMEs Index I. Context A. Introduction B. Background to Micro-franchising 1. Franchising versus Micro-franchising 2. The Value of Micro-franchising 3. Franchising Categories 4. Summary of Case Studies II. Steps for Replicating a Micro-Distribution Model Small and Medium Sized Enterprises A. Overview of Replication Steps Step 1: Identify Concept and Target Market 1.1 Reasons to follow a Micro-franchising Strategy 1.2 Concept and Business Model 1.3 Market Potential and Scalability 1.4 Environment and Infrastructure Assessment Step 2: Business Analysis and Financial Model Development 2.1 Investment per Unit / Total Franchising Operation 2.2 Sales and Sales Margins 2.3 Fees and Margins for the Franchisor 2.4 Profit and Loss Statements (P&L) and Profitability Analysis 2.5 Business Model per Stakeholder 2.6 Taxes and Social Security Step 3: Stakeholders and Relationships 3.1 Social Objective and Vision 3.2 Key Roles and Objectives 3.3 Formalizing the Partnerships 3.4 Vendor Agreements 3.5 Franchise Contracts 3.6 Other Legal Requirements Step 4: Structuring the Company 4.1 For-profit, Not-for profit, Not-for-loss 4.2 Ownership and Governance 2

3 FUNDES Step 5: Selecting Micro-franchisees 5.1 Franchisee Profile 5.2 Franchisee Recruitment 5.3 Retention Strategies Step 6: Micro-franchisee Financing Considerations 6.1 An Adequate Microfinance Institution (MFI) 6.2 Micro-credit Package for the Franchisee 6.3 Guarantee Funds 6.4 Alternative Financing 6.5 Philanthropy Step 7: Establishing Supervisory and Operational Foundation 7.1 Operations Manuals 7.2 Supervisory Structure and Program 7.3 Training Curriculum 7.4 Quality Control Step 8: Establishing a Pilot 8.1 Detailed Pilot Plan 8.2 Reporting Mechanism and Data Analysis System 8.3 Parameters for Go / No-Go Decision Step 9: Development Plan 9.1 Site Selection 9.2 Growth Strategy and Openings Calendar 9.3 Organizational Growth Step 10: Ongoing Operations and Sharing Best Practices 10.1 On-going Planning and Review Process 10.2 Continuous Improvement and Sharing Best Practices 10.3 Meetings with Franchisees APPENDIX 1: Project Checklist for the Franchisor ATTACHMENT 1: Overview of Case Studies 3

4 Micro-franchising: Development of a Micro-franchising Replication Model in Mexico SMEs I. Context A. INTRODUCTION The objective of the following document is to establish a replication methodology for the development of microfranchise enterprises in Mexico. To place micro-franchising in context, a brief overview of micro-franchising will be provided, highlighting its importance as an anti-poverty business approach. Key replication steps will then be detailed encompassing all business activities required in the development of a successful micro-franchise, from market analysis through to the management of ongoing operations. While the guide illustrates best practices and defines steps for setting up a micro-franchise, it is important to note that the steps are simply a guide for replication and not an exhaustive list. There is no one-size fits all model and each micro-franchising system must be evaluated and developed on an individual basis. That said, there are some fundamental factors that should be analyzed and taken into consideration across all systems and these will be the subject of this document. To produce the replication guide, the following research and analysis approach was adopted: 1. Investigators reviewed and summarized published information on 18 case studies of micro-franchise initiatives around the world, broken down by 3 groups depending of the type of franchisor: Large Corporations, Small and Medium Enterprises (SMEs) and Social Entrepreneurs. 2. A methodology coordinator drew common patterns, best practices and conclusions across the 3 types of franchisor, identifying general findings present across all three and summarizing them in a draft document. 3. A micro-franchise expert s panel met to review and complement the draft document in a 2 day workshop. Key participants included renowned international micro-franchising authors Jason Fairbourne and David Lehr, Mexican franchise consultants Ferenz Feher and Enrique Alcazar, among others. 4. Two main sources were used as a reference: the Micro-franchise Toolkit published by Jason Fairbourne et al, and the Franchising Replication Manual developed by the Grameen Foundation USA for their Village Phone initiative. B. BACKGROUND TO MICRO-FRANCHISING 1. Franchising versus Micro-franchising Micro-franchising has its roots in traditional franchising, which is the practice of copying a successful turn-key business and replicating it in other locations by following a consistent set of well-defined processes and procedures. Under a traditional franchising system, the franchisor (who owns the overall rights to the business) sells or licenses its systematized business approach to a franchisee. The franchisor typically controls many of the macro aspects of the 4

5 FUNDES business such as creating and marketing the brand, procuring inputs, continuously refining the model, and recruiting and training franchise operators. This effectively enables the franchisee to operate as part of a network, usually using the name and operating methods of the franchisor, with support from the franchisor in exchange for fees. Franchising is not a new concept, and some historians believe that it may have originated in the Roman Empire as a way to provide municipal services and collect taxes. Others claim that the first retail franchising outlet came from China around 200 B.C., or perhaps even earlier when rickshaw drivers were granted specific routes. Micro-franchising is built on the concept of franchising but is focused on providing opportunities for the poor, who often lack the skills and capital that can lead to success, allowing them to own and manage their own business, while taking into account the local context of the micro-franchisees and their customers. The prefix micro should not be taken to mean that these businesses are not fully developed entities, that they are in any way unprofessional or that the participants lack aspiration to grow. Quite the opposite is true. The term micro refers to the fact that replication requires relatively little capital and that the customer base is comprised of consumers at the base of the pyramid with low incomes that dictate the range of products and services to be provided and the pricing strategy to be adopted. Since micro-franchising focuses on developing sound business models that can be replicated at the base of the pyramid, the start-up costs of micro-franchises are generally quite low. Initial micro-franchisee investments in the microfranchises studied range from almost zero to up to $10,000 US. By contrast, starting a small shop in Mexico may require a minimum investment of $3,000 US with prices for starting a fast food franchise starting from $120,000 US upwards. With respect to the 3 different types of franchisor models detailed earlier (large company, small and medium sized enterprises and social enterprises) micro-franchising success is measured in different ways. With social enterprises in particular, success is measured by both their social and commercial impact. The micro-franchisees themselves and how well they are able to leverage their specific knowledge, reputation, and personal influence within their communities are key determinants of success. Large and medium size enterprises (SMEs) will follow a micro-franchise growth strategy over other forms of business approaches primarily to expand into new geographies, and take advantage of local knowledge without having to bear all the start-ups costs (most micro-franchisees are required to raise start-up capital themselves either through savings or via a loan program). Other benefits of micro-franchising for the micro-franchisor include: Local micro-franchisees are often the key to last mile distribution. Base of the pyramid (BOP) markets can be complicated - micro-franchisees chosen from target communities possess insight and connections that outsiders do not. 5

6 Micro-franchising: Development of a Micro-franchising Replication Model in Mexico SMEs Developing an understanding of the challenges of low income communities and how to address them can lead to innovation in developing markets and also create a useful experience for expanding internationally. Building a network of locals, who are also personally investing in their own success, can enable low-cost scaling and more rapid market penetration for the micro-franchisor. Cross sector partnerships often develop from micro-franchising. These new partners may lead to new market opportunities and business approaches. 2. The Value of Micro-franchising The strength of a micro-franchising approach (and of franchising) comes from its reliance on a business model that has been tested and proven to work. Once the business model has been established, potential licensees (the microfranchisees) can operate copies at lower risk. As part of a network, the micro-franchisor often provides ongoing training and support to help ensure the micro-franchisee s success. Micro-franchises often bring new skills, thinking and services to the community and can help grow the overall local economy. Compared with an individual entrepreneur, the micro-franchisor often has better negotiating power with suppliers and is able to achieve economies of scale in other areas such as product design, use and development of new technologies, and supply chain development. In addition, the micro-franchisor is usually better equipped to focus on marketing, growth, and new product introduction. Furthermore, innovations developed by one micro-franchisee can be quickly implemented throughout an entire network of franchisees. 3. Franchising Categories There are 2 broad categories of franchising: (i). Product distribution franchises simply sell the franchisor s products and are supplier-dealer relationships. The franchisor licenses its trademark and logo to the franchisees but typically does not provide them with an entire system for running their business. This type of franchising is typical with soft drink distributors, automobile dealers and gas stations. (ii). Business format franchises not only use a franchisor s product, service and trademark, but also the complete method to conduct the business itself, such as the marketing plan, site identification assistance, comprehensive training, and operations manuals. Business format franchises are the most common type of franchise. In principle, the overall success of micro-franchising hinges on a high level of standardization. However, the examples studied in this document reveal that modification is often required to take advantage of local nuances and expand into new geographies. Additionally all of the micro-franchising approaches reviewed continue to evolve over time. 4. Summary of Case Studies To enable a deeper understanding of the case studies from which the majority of conclusions in this document were formed, please refer to Attachment 1 for a summary of the key cases analyzed. 6

7 FUNDES II. Steps for Replicating a Micro-franchising System Small and Medium Enterprises (SMEs) A. OVERVIEW OF REPLICATION STEPS The follow section seeks to define the key steps required for the replication of a micro-franchise distribution system in Mexico. The steps are generic in nature and can be applied to any micro-franchising model. As highlighted earlier, it is important to note that the steps are simply a guide for replication and not an exhaustive list. There is no one-size fits all model and each micro-franchising system must be evaluated and developed on an individual basis. That said, there are some fundamental factors that should be analyzed and taken into consideration across all systems and these will be the subject of this section. The following section details 10 steps for replication: Step 1: Identify Concept and Target Market Step 2: Business Analysis and Financial Model Development Step 3: Stakeholders and Relationships Step 4: Structuring the Company Step 5: Selecting Micro-franchisees Step 6: Micro-franchisee Financing Considerations Step 7: Establishing Supervisory and Operational Foundation Step 8: Launching a Pilot Program Step 9: Development Plan Step 10: Ongoing Operations and Sharing Best Practices STEP 1: IDENTIFY CONCEPT AND TARGET MARKET 1.1 Reasons to Follow a Micro-franchising Strategy Companies follow a micro-franchising strategy for various reasons, which may include generating profits, testing a new market or idea, and/or meeting their corporate social responsibility goals. Small and Medium Enterprises (SMEs) tend to follow such strategies to grow and generate profits and social impact is of lesser importance. It is important to understand that the micro-franchise strategy is likely to be essential to the SMEs core business. Given their more limited resources, compared with Large and Social Enterprises, SMEs must have a complete understanding of franchising, as it could become one of their most significant distribution channels. Additionally, more specific reasons may be taken into account, such as taking basic services or products to the target communities, developing the communities in which the large firm operates, working with BOP entrepreneurs to better serve non-bop consumers etc. 7

8 Micro-franchising: Development of a Micro-franchising Replication Model in Mexico SMEs Finally, micro-franchising is also seen as a way to improve public image for example by including micro-franchising within Corporate Social Responsibility Programs, a point that will be discussed later. 1.2 Concept and Business Model As a starting point, a product or service must be identified and its attributes, usability and distinguishing qualities that will enable it to succeed against its competitors defined. Where the model involves new ideas, the entire process must be developed from scratch whereas an operational model that is already in existence (whether a single or multi-unit business or concept) will only require adaptation and refinement in preparation for accelerated growth. The latter is the more common method for traditional franchising to develop and carries less risk as consumer tests and operational tests have already taken place. On occasion, however, market inefficiencies or opportunities present themselves without a proven concept already in place. This forces the entrepreneur or franchisor to develop an abstract consumer proposition. In such cases, the franchisor should consider first establishing directly owned units in order to fine-tune and modify the product offering in order to make the business and operational model viable. Once the product offering has been determined, the next step requires the establishment of the business model, or the way in which the franchise will generate money. This must be feasible at 2 levels: i). Micro or unit level profitability of the franchise unit, or a simple description of the profit source (i.e. buying 20 pieces packs of cereal bars at a whole sale cost, and selling them by the unit at a traffic light) less the expenses necessary to operate the individual franchise. Note that the franchise must be able to reach unit level profitability before scaling; if the business model cannot support the individual unit, expansion will just increase overall losses more quickly. ii). Macro or business level profitability of the overall franchise business, or a summary of its franchise income or margin, less the expenses necessary to operate and supervise the new business. 1.3 Market Potential and Scalability The next step is assessing consumer demand or the size of that specific consumer segment, to determine whether the sales volumes generated will be sufficient to set-up a profitable business. Although some companies are experienced at market-sizing in traditional markets, BOP markets can be quite challenging to size, especially when a product / service is introduced that is completely unfamiliar to the target market. A market assessment should focus on identifying the potential commercial demand and the possible distribution channels in the targeted communities, combined with an examination of existing research/models on sales of similar products (or their direct substitutes) both inside and outside Mexico. 8

9 FUNDES The assessment should test willingness and ability and must take into account the earnings and spending patterns of the poor and their spending priorities. In addition, identifying product/service design factors, possible competitors, legal or other risks and the pricing of competitive products and their sales models should also be understood. The scalability of the micro-franchise is also a critical factor and will be addressed in later sections of the document. 1.4 Environment and Infrastructure Assessment Before venturing into a new consumer target or geography, it is necessary to determine if the business and legal environment and the infrastructure are favorable. With respect to the legal environment, in Mexico traditional franchising legislation is also applicable to micro-franchising, as will be seen in section 3. In general, Mexico is well positioned as a business friendly economy. Furthermore, although unknown at the moment of the production of this document, it is widely expected that the Federal government will establish specific SME programs and funds that could be leveraged to make micro-franchising more feasible. Finally, it is necessary to evaluate if the infrastructure needed for the initiative (i.e. roads, distribution systems, financial systems, technology, etc.) already exists and is readily available, or whether it is economically viable to be developed as part of the project. STEP 2: BUSINESS ANALYSIS AND FINANCIAL MODEL DEVELOPMENT This section focuses on the basic steps involved in the development of the financial model. The analysis at this stage is critical, as it will help identify not only the costs of the overall business for the franchisor, but for each individual franchisee as well. This is vital in understanding whether the business is feasible for a potential micro-franchisee, who is likely to have limited savings, in addition to identifying the potential financing needed. Until the business is actually operational, many of the numbers will be generated based on extremely limited information. Due to this, the pilot (as will be discussed later) is a good way to refine the data. That said, best effort estimates should be used where actual numbers are not available. 2.1 Investment per Unit/per the Total Franchising Operation The establishment of a franchise incurs several expenses, including: physical equipment, location development (i.e. does a store need to be built?), initial inventory and pre-operating expenses and franchise fees. In general the franchisee will cover these expenses (or take a loan to do so). 9

10 Micro-franchising: Development of a Micro-franchising Replication Model in Mexico SMEs The franchisor s operating costs are comprised of the cost of staff, office space and equipment, development of operational guidelines and materials, franchisee recruitment, training and training materials development, ongoing management, and perhaps delivery costs. Some of these costs may be borne by the franchisee while on initiating operations, the franchisor may have to spend on getting the first franchises operational. 2.2 Sales and Margins Expected figures for average daily and monthly unit sales, unit price, and blended gross margin, at startup and over time must be determined. This will require developing a ramp-up curve, which outlines how volume will be built up from day one of operations. 2.3 Fees and Margins for the Franchisor The franchisor must describe how it will generate money from the franchise operation. Where the micro-franchisor is also the manufacturer or distributor, their profits can be included in the cost of the product itself. This has many advantages versus collecting a separate royalty fee, such as less paperwork, easiness to change margins, fewer complaints from franchisees over the payment itself, etc. Most micro-franchising strategies tend to avoid up-front franchising costs to make the franchisee s business model more attractive. 2.4 P&L and Profitability Analysis This analysis is essentially the difference between costs and sales revenues over time and determines whether or not the business can be profitable, and when that will occur. Any expected changes over time in margins or economies of scale should be incorporated. The analysis needs to be done both at the unit level and for the overall business and both the franchisee and the franchisor must have sufficient working capital, and funding for initial losses before break-even point is reached. Contrary to traditional businesses, where an entrepreneur needs to make a profit after deducting all costs, including his/her own salary, in the case of micro-franchising the salary of the franchisee should not be deducted; conversely, if the micro-franchisee has employees, their salaries should be deducted. This is due to the fact that micro-franchising can be seen as a self-employment mechanism, hence the final profit becomes the salary or source of income for the franchisee. It is important to note that if the franchisee cannot make a sufficient profit, or get compensated in other ways, it is unlikely that the business will be successful. A sample of generic P&L formats for the franchisor and franchisee are presented below (graphics 1 and 2): 10

11 FUNDES Graphic 1: P&L Franchisor Directly owned Units 1 Net sales 2 Cost of goods sold 3(1-2) Gross Margin 4 Salaries 5 Occupancy 6 Utilities (electricity, gas etc) 7 Supplies 8 Advertising 9 Maintenance 10 Miscellaneous 11 (SUM:4:10) Total Operating Expenses 12 (3-11) Operating Margin 13 Interest on loans 14 (12-13) Pre-tax income Franchised Units Revenues 15 Franchisee fee (up-front) 16 On-going royalties 17 Margin on product 18 Other Other Revenue Sources 19 Donations & subsidies 20 Other 21 (SUM:14:20) Total Revenues Overhead Expenses 22 Salaries 23 Occupancy 24 Utilities (electricity, gas etc) 25 Supplies 26 Advertising 27 Maintenance 28 Freight and distribution 29 Travel 30 (SUM:22:29) Total overhead costs 31 (21-30) Operating Income 32 Taxes 33 (31-32) Net Income Source: FUNDES 11

12 Micro-franchising: Development of a Micro-franchising Replication Model in Mexico SMEs Graphic 2: P & L Franchisee P & L Franchisee 1 Net sales 2 Cost of goods sold 3(1-2) Gross Margin 4 Salaries 5 Occupancy 6 Utilities (electricity, gas etc) 7 Supplies 8 Advertising 9 Royalties 10 Maintenance 11 Travel 12 Miscellaneous 13 (SUM:4:12) Total Operating Expenses 14 (3-13) Operating Margin 15 Interest on loans 16 Pre-tax Income 17 Taxes Source: FUNDES 18 Net Income 2.5 Business Model per Stakeholder As highlighted earlier, there is no one size fits all business model that applies to micro-franchising. Instead each business model must be developed on an individual basis, taking into consideration local market dynamics. The franchisor in the following example (graphic 3) buys and distributes fast moving consumer goods at traffic lights through a network of micro-franchisees. This model was chosen as it helps illustrate how a micro-franchisor might leverage partnerships and how each partner will either generate income or achieve their social mission. 12

13 FUNDES Graphic 3: Business Model per Stakeholder Project Partner Franchisor Franchisee Vendor Foundation 1 Micro Finance Institution (MFI) Business Model Buys product from the vendor at preferential rates, consolidates and delivers product on a daily basis, keeps a 30% margin against product cost. Needs 200 franchisees to reach B/E. Collects weekly loan repayments on behalf of the MFI Buys product from the franchisor in 20 unit packs, and sells them at a 50% margin at traffic lights. Reaches equivalent to minimum wage selling one pack per day. Manufactures product and sells it at preferential rates to the franchisee in exchange for exclusivity. Margin not disclosed. Support the franchisor in developing the program, sourcing franchisees and finding an MFI. Charge a one time recovery fee. Develops and provides each franchisee with a US$100 loan, payable in 10 weeks at an interest rate of 2% monthly. Source: Adapted from Village Phone Replication Manual, developed by Grameen Foundation USA 2.6 Taxes and Social Security It is necessary to conduct a thorough research of the fiscal implications and costs associated with each business model on a case-by-case basis. Factors to be considered include current legislation, BOP incentives, economic impact, type of product and service, practical considerations on how to comply with local regulations, etc. Access to Social Security, and in particular to a health service plan, is a key topic both with respect to its social impact, and also the guaranteed survival of the enterprise. Where possible, it is recommended that the micro-franchising strategy include a solution for the social security requirements of the franchisee. STEP 3: STAKEHOLDERS AND RELATIONSHIPS The following section is based on the business example detailed above with the objective to clearly establish collective and individual goals of each partner, the role that each plays and the basis for the relationship between them. As in any relationship, clearly outlining vision and responsibilities from the beginning is a pre-requisite for a durable and productive partnership. 3.1 Social Objective and Vision Graphic 3 Business Model per Stakeholder details how each stakeholder in a business model will make money. Equally as important is the definition of the social objectives and vision of the initiative, as this establishes the framework for the majority of decisions that will be taken over time, specifically with respect to balancing social and economic priorities. Failure to clearly define such objectives can generate issues between participants in the project, endangering its existence. 13

14 Micro-franchising: Development of a Micro-franchising Replication Model in Mexico SMEs For social organizations participating in a micro-franchising project, it will be critical to understand if the business owner (whether it be a SME, Large Corporation, or Social Entrepreneur) has a social objective for the new venture, and whether the fundamental objectives of each party are compatible. When the franchisor is an SME, the social objective is far less relevant that the economic one. This is due to the fact that SMEs are often in an earlier stage of development than large companies. As most micro-franchisees live in poverty and have very limited education, permanent contact between franchisor and franchisee provides a natural platform to transfer more than business related knowledge. For example, many franchisors generate additional social impact via training and education on hygiene and health practices, self-esteem, values, etc.; some of them take it a step further, with mandatory primary studies or mandatory savings. Many of these value added services cannot be charged for and the costs for them must either be recouped from the business model or provided on a subsidized basis (by the business itself, or by one of their partners). 3.2 Key Roles and Objectives Each entity that commits to participating in the micro-franchising strategy must have a defined role and responsibilities. It is also important that each party openly states its own individual objectives, to ensure that they fit with the common social objective and vision. Graphic 4 provides an example of how roles and objectives can be established for a particular business model: Graphic 4: Roles and Responsibilities per Stakeholder Stakeholder Franchisor Franchisee Vendor Role Champion and Leading Orchestrator of the Project: - Gathers and coordinates other partners - Operates and develops the whole network - Provides the logistics, purchases and resells the product and uniforms - Negotiates with MFI, helps facilitate the loans and retains repayments Micro-franchise Owner and Operator: - Undergoes the initial training and buys the start-up kit financed by the MFI - Every morning buys and picks-up the product at the franchisor satellite distribution center - Sells the product at traffic lights in the assigned area - Repays the credit via weekly installments to the franchisor Product Manufacturer - Manufactures and sells the product to the franchisor - Delivers the product at the franchisor s DCs - Subsidizes the uniforms in exchange for brand presence - Extends a conventional credit line to the franchisor Objective To generate a social impact by creating micro-entrepreneurs that support an improvement in living conditions for their communities and for themselves. Profits are only necessary to ensure sustainability, and will likely be reinvested instead of being distributed to the owners. To establish their own business and improve living conditions for their communities and for themselves. To increase revenues and profits by incorporating a new sales channel 14

15 FUNDES Foundation 1 Micro Finance Institution (MFI) Source: FUNDES - Supports the franchisor in developing the program, sourcing franchisees and finding an MFI - Holds a seat on the board - Developed a tailor-made loan plan for the franchisees - Provides a loan to each new franchisee, and collects repayment via the franchisor To generate new, self-employed entrepreneurs from the BOP To provide a new service or product in the target communities To generate profits and have a social impact by creating microentrepreneurs that improve living conditions for their communities and for themselves 3.3 Formalizing the Partnerships All parties involved must formalize their agreement in a non-binding Letter of Intent or an equivalent document. Such documents often evolve into standard contracts with the responsibility usually assumed by the franchisor. 3.4 Vendor Agreements In order to ensure quality assurance and operational consistency it is important that the franchisor maintains strict control over the supply chain. This is particularly true when the franchisor does not manufacture the goods that the franchisee will distribute. In addition, the franchisor often places a mark-up on the product so it is imperative that the franchisor is the exclusive provider of such products for the franchisee in order to ensure profitability. Franchisors include exclusive provider clauses in the franchising contracts and sign exclusive purchasing agreements with their key vendors. They are therefore not permitted to sell directly to the franchisees. 3.5 Franchisee Contract The contract that will regulate the relationship between franchisor and franchisee should be as straightforward and clear as possible. The objective must be to ensure that the franchisee fully understands the contract and is comfortable with all the terms. The contact should include the following: Duration of the contact Geography Economic terms: fees and margins for the franchisor Commercial, legal, and financial policies established by the franchisor 15

16 Micro-franchising: Development of a Micro-franchising Replication Model in Mexico SMEs Obligations of the franchisor such as training, supervision, providing systems and operations manuals Obligations of the franchisee such as the requirement to operate in a specific way; paying the fees or products; using the uniform and brand related items; conducting purchases directly from the franchisor or from authorized vendors Mechanism for dispute resolution Reasons for termination Wherever possible it is advisable that a Self Help Group is available to sign the contract in addition to the franchisee. In many emerging markets, due to limited enforceability of legal contracts, additional measures are often employed to ensure compliance such as peer-pressure, the involvement of local leaders and incentives to act and perform in line with expectations. 3.6 Other Legal Requirements The franchisor is obligated by Mexican law to deliver the Franchise Offering Memorandum, or COF (Circular de Oferta de Franquicia) to the franchisee, 30 working days prior to the opening of the franchise unit. This document includes detailed information on the franchisor, market, business model, and other information relevant to the new venture. The franchisor must also be aware that: Intellectual Property: Mexican law mandates that a brand is registered, or is in the process of registration, prior to the granting of a franchise. The franchise contract must license brand usage, know-how and technical assistance so it is imperative that these three elements exist prior to the contract being issued. IMPI (Instituto Mexicano de la Propiedad Industrial): It is the responsibility of the franchisor to renew and maintain the brand guidelines and to defend the brand against any possible cases of piracy. In such cases, it is the responsibility of the franchisor to inform the franchisee of any potential infringement. Private Information Law: This law regulates treatment of potential franchisees personal information and should be considered by the franchisor. Additional legal steps: Particular industries require specific legal steps such as the financial services, education and health care industries. STEP 4: STRUCTURING THE COMPANY The decision as to the best way to structure the company will depend on a number of factors related to its social and business objectives and the way in which these objectives can be achieved. The potential structures and their implications for any one particular company are beyond the scope of this document and the following are guidelines only. All franchises should seek legal advice prior to embarking on an initiative. 16

17 FUNDES 4.1 For Profit, Not for Profit, Not for Loss Micro-franchise systems can be structured as for profit, not for profit or not for loss entities depending on the ultimate vision of the company. In addition to the vision of the company, other factors that should be taken into consideration include the fiscal and labor environment, the ability to receive donations from foundations and companies, participation in government programs and subsidies and whether credit can be obtained from micro-finance institutions. SMEs tend to enter the micro-franchising arena as for profit organizations. They often have fewer resources than large companies and, therefore, it may be harder for them to explore or incorporate a different type of structure. 4.2 Ownership and Governance It is necessary to determine who will own the micro-franchise system and who will guide and govern its strategic direction. SMEs traditionally do franchising directly; sometimes as their core business and sometimes as a promising diversification strategy to allow them to grow more rapidly with the limited resources that they have. The legal ownership structure must be addressed although every venture is different and there is no one size fits all rule. In Mexico, legal advisors tend to favor those that limit the responsibility of the company and owners, such as the S.A. (Sociedad Anonima), S.A.P.I. (Sociedad Anonima Promotora de Inversion) or S. de R.L. (Sociedad de Responsabilidad Limitada). Consequently, these organizations tend to employ a more straightforward structure where governance is concentrated with the owners and fewer stakeholders are involved. If there is a formal board then it is mainly formed of and controlled by the owners. It is not common for social organizations to be involved in SME projects and if they are then it is predominately in a secondary role. STEP 5: SELECTING MICRO-FRANCHISEES It is widely acknowledged that franchisee selection is one of the most crucial tasks in the franchising process. The franchisor-franchisee relationship is often quite complex and it takes a great degree of compatibility, cooperation, communication, trust, and hard work to make it succeed. In terms of micro-franchising, significant cultural and educational differences can make the recruitment process even more challenging. 5.1 Franchisee Profile Franchisors must define their own ideal franchisee profile based on a number of factors including the nature of the product, the physical work involved and implied workload and the economic commitment and cultural differences within communities. Additional factors to consider include education levels and literacy, prior knowledge / skills and business experience, reputation and motivation. 17

18 Micro-franchising: Development of a Micro-franchising Replication Model in Mexico SMEs Potential franchisees are often people who are respected and hold some form of leadership role within their communities. In some cases, micro-franchise systems require that the franchisees have a good credit history with a microfinance institution (MFI) and indeed, often use the client base of such institutions as a source of potential franchisees. In general, however, franchisors tend to look for individuals with common characteristics: disciplined, willing to take direction and adhere to a system, enthusiastic, honest, ambitious, and the ability to work well with people and in teams. 5.2 Franchisees Recruitment Despite the existence of franchising schemes for over 50 years, the process for recruiting franchisees is constantly evolving as organizations continue to seek ways to improve their methodology. NGOs, Self Help Groups and micro-finance institutions that already operate in the community are often involved in the selection process. This is particularly true with micro-franchising as these organizations are familiar with the local people and can select those most suitable / qualified. These organizations are also in a position to help build reciprocal trust. A brand with a well-established reputation generates good will up-front and may help to increase interest among potential franchisees. Some micro-franchisors leverage successful micro-franchisees in their recruiting efforts, especially when they are attempting to enter an area where their brand or business is unknown. Given how risk adverse many people can be, seeing someone in similar circumstances that has been successful can be a powerful source of motivation. Other successful approaches include asking community leaders for their recommendations and support, holding competitions and establishing referral programs. 5.3 Retention Strategies One of the most common problems in micro-franchising is the turnover of franchisees. Consequences of this include stalled operations (resulting in a negative image), accounts owed and an increase in the cost for recruitment. Regular turnover of franchisees can be managed a number of different ways: Implementation of a sound business model Improvement in the recruitment process A requirement that the franchisee invests some of its own money upfront Ensure quick break-even point, either via the use of subsidies or salaries Deferred benefits such as elementary education, mandatory savings accounts Provide greater support and implement motivational programs 18

19 FUNDES STEP 6: MICRO-FRANCHISEE FINANCING CONSIDERATIONS As previously discussed, both the micro-franchisor and micro-franchisee are required to have start-up capital in addition to ongoing funds to enable the franchise to develop and grow. The following section only covers financing for the micro-franchisee. Financing for the micro-franchisor is beyond the scope of this document. The following section outlines the basic funding options currently available. Micro-franchises may use more than one of these mechanisms and they may also evolve over time. 6.1 Appropriate Micro Finance Institutions Micro Finance Institutions (MFIs) are organizations that provide financial services to micro-entrepreneurs and small businesses that traditionally lack access to banking and related financial services due to the high transaction costs associated with serving these client categories. Given that the micro-finance sector involves multiple participants, each with different social missions, social and financial goals, credit policies and preferred economic and geographical regions, it is vital that the appropriate MFI is selected in order for the micro-franchising strategy to succeed. Moreover, it is important that the chosen organization operates in a manner consistent with its internal goals. The MFIs most suited are those that have adopted a holistic approach and seek to support their clients via additional services such as employment training classes, or business development assistance. Less suitable are those MFIs that are simply interested in making loans and are focused on increasing the size of their loan portfolio - where performance metrics are based primarily on the number of loans granted. 6.2 Large Corporations as Creditors The credit product offered to the franchisee has to be tailor-made for the specific project and must take into consideration the amount of funding required, cash flow and payback time, and specific franchisee characteristics, among other factors. This requires a significant joint effort between the franchisor and the MFI. Due to this, those financial institutions that offer off-the shelf loan packages may not find micro-franchise initiatives attractive. In terms of payment, it is generally recommended that small, frequent payments are collected by the franchisor at the time of delivering goods or paying the franchisee for their products / services. Self Help Group and community involvement are potential sources of peer-pressure to ensure loan repayments. 6.3 Micro-Credit Packages for the Franchisee Guarantee funds are often established to ensure that the MFI recoups the loan in the event that the recipient is unable to repay it. This removes the collection risk from the MFI and transfers it to the fund. This cost can be absorbed by a government or an NGO. 19

20 Micro-franchising: Development of a Micro-franchising Replication Model in Mexico SMEs Guarantee funds have proven to be an effective mechanism to increase credit availability and reduce the cost for base of the pyramid (BOP) initiatives in general. 6.4 Alternative Financing Alternative financing schemes that may be useful are merchandise provided on consignment by the franchisor and fixed assets provided by the franchisor on bailment. Other financing schemes are not recommended owing to their complexity. These include earn-out models, where the franchisee is originally hired as a manager and purchases the unit from the store earnings; partial ownership, where ownership moves gradually from original franchisor to the operating employee; and the buy-and-lease-back model, where the franchisor buys and remodels the store and leases it to the franchise. 6.5 Philanthropists Philanthropic organizations can play a significant role by providing not only operational funds and much needed subsidies, but also support for building organizational capacity, bringing in outside expertise and assisting on an as needs basis. This may be advising on specific issues, contributing to the business plan, helping to develop metrics for success or assisting in negotiations with partners. Philanthropists are traditionally more involved in Social Entrepreneur models but they can also be found in Large Corporations and SME micro-franchising projects. STEP 7: ESTABLISHING SUPERVISORY AND OPERATIONAL FOUNDATIONS 7.1 Operations Manuals As with traditional franchising models, an Operations Manual must be developed to ensure efficient and consistent operations across different regions, stores, shifts and ultimately individuals. The Operations Manual contains the policies, procedures, preparation methods and best practices to ensure that the business operates successfully. It describes the minimum level of operations and explains the step-by-step tasks that must be performed on a daily, weekly and monthly basis. It traditionally includes several check-lists, guides and illustrations that allow it to be a self-explanatory working guide, which is key when users are illiterate or speak a different mother tongue. An Operations Manual for the franchisee traditionally includes the following components 1 : Accounting and Financing Systems Marketing Manual Customer Relations Employee Relations 20 1 Brad H. Wales, chapter 14 of The Microfranchise Toolkit, by Jason Fairbourne et al

21 FUNDES Products and Services Physical Facilities Management Administrative Functions An Operations Manual for the franchisor is also necessary. This should contain all aspects of the day-to-day working relations with the franchisee. 7.2 Supervisory Structure and Program As previously discussed, the micro-franchising initiative usually represents the core business of SMEs. As such, the support structure tends to be shared in order to minimize the duplication of efforts and costs. Regardless, a full time micro-franchising supervisor is required to perform the following 3 basic functions: Conducts store visits, applies an operational audit form, and provides general assistance. The person responsible usually leaves a detailed written action-plan that forms the basis for the following visit Monitors the financial and operational performance of each franchisee and shares the results and rankings Answers and addresses any questions or needs that the franchisee may have. Owing to the ethnic diversity in rural Mexico, it is preferable that the supervisor belongs to the same group, or at least speaks the same language, as the franchisees. 7.3 Training Curriculum A training curriculum must be developed based on and similar to the Operations Manual. This document contains the same chapters as the Operations Manual in addition to an Orientation chapter that all new employees or franchisees receive. This Orientation chapter includes the history, mission, vision, philosophy and key operational principles of the enterprise. SMEs usually provide training through the supervisor. Training is sometimes performed in situ or it can be carried out during the periodic meetings of franchisees or employees. In some cases, training can be done remotely, which can generate significant savings. In some specific industries, such as health services, training and certifications are mandatory by law and therefore must be included in the training curriculum. As previously discussed, all the manuals and training materials must be illustrated and clear enough to ensure that the franchisee is able to understand them. 21

22 Micro-franchising: Development of a Micro-franchising Replication Model in Mexico SMEs 7.4 Quality Control Establishing a quality control process is critical when different individuals (micro-franchisees) are the final point of contact for delivering goods and services. This is even more vital in areas such as health services and food distribution, common to the micro-franchising arena. The type of product or service being sold largely determines how much control is required over the micro-franchise and delivery to the customer. If the key value is based on quality then much more control will be required to ensure this. This, in turn, means a strong emphasis on branding, recruiting, training, retention and consistency. The most common and efficient way to implement a quality control process is to include the task in the supervisor s visit or audit form. This ensures that the supervisor runs a quality check of the finished goods or service provided during their operational visit. This is the primary reason for ensuring that at least some of the supervisor s visits are unannounced. An additional method is to seek direct contact and feedback from the community leaders. STEP 8: ESTABLISHING A PILOT A pilot program serves to collate the necessary elements to operate a franchise on an on-going basis. In addition, it allows for those involved to collect the necessary data required to validate and correct financial and operational assumptions upon which the original project feasibility was based. The program can also be a valuable tool for recruiting new stakeholders as it provides a tangible example of the concept. 8.1 Detailed Pilot Plan A detailed plan of the pilot project must include the following elements: Objective of the pilot Pilot phase prerequisites: legal requirements, business model, operational plan, marketing plan, micro-franchising in place, suppliers and product Test phase itself: calendar, launch activities, marketing support, reports Resources required Costs and budget It is important that the timing allocated for the test period is sufficient in order to provide quality information. Owing to the lean structures and the direct involvement of the decision makers, SMEs traditionally require less time and take between 6 and 12 months. In addition, the franchisor needs to establish a minimum number of successful units before considering that the concept is validated. The costs associated with the pilot project are usually covered by the franchisor. 22

23 FUNDES 8.2 Reporting Mechanism and Data Analysis System Before starting the pilot program, the data collection and analysis system must be fully operational. The required information, both financial and operational, must be clearly defined and a preliminary test on the system capacity to deliver these results must be conducted. 8.3 Parameters for the Go / No-Go Decision The decision to roll out the business or not will be determined by the results of the pilot. It is important, therefore, to be clear from the outset what the scope, duration, goals and criteria for success will be. The operational and financial goals must be as specific as possible: clients served, units sold per week, ramp-up curve, margin, operational costs, operational Key Performance Indicators, customer satisfaction metrics, etc. While social impacts may take longer to realize, the expected impacts should be defined and also be measured during the pilot. STEP 9: DEVELOPMENT PLAN Once the concept is fully operational, a phase of accelerated growth is usually needed to reach profitability and gain economies of scale. Unit or store growth needs to be well planned, as the organization and support function growth needs to occur simultaneously. 9.1 Site Selection The franchisor needs to determine the site selection criteria or the list of characteristics that an ideal location should possess. This is based on the product or service offered, the target consumer profile, consumption patterns, etc. Such criteria will need to be flexible, particularly with respect to young ventures with a limited number of units in operation. Typically, the franchisee submits a recommended location and the franchisor conducts the analysis and has final approval. This is due to the fact that it has more experience than a new franchisee with respect to the performance of existing locations. 9.2 Growth Strategy and Openings Calendar A comprehensive growth strategy must include geographical criteria defining which areas to target first and how to enter new geographies over time. Growth must be determined by a careful market assessment and prioritization plan and not derived from the demands of franchisees. After the strategy has been validated, it must be translated into an Openings Calendar that specifies how many units will be opened by month and year. 23

24 Micro-franchising: Development of a Micro-franchising Replication Model in Mexico SMEs 9.3 Organizational Growth As units grow the organization must ensure that it is well structured to keep control of the increasingly complex operations. This will often require more and better people, better systems, processes and controls, and overall more sophisticated management practices, which the large organization can leverage from their established structures. STEP 10: ONGOING OPERATIONS AND SHARING BEST PRACTICES Following the pilot the original financial assumptions in the business plan must be updated with more specific projections including more realistic revenue and cost numbers. The new financial plan will set the basis for decisions on resources, staff hire, capacity building, etc. From an operational perspective, some adjustments will probably be necessary and must be implemented before starting the roll-out phase Ongoing Planning and Review Process The planning process and ongoing review of results must become an everyday activity for the franchisor. Review meetings with the franchisee need to be established on a weekly, monthly, quarterly or annual basis, as needed. It is important to develop specific reporting templates that incorporate the financial and operational information that should be reviewed every week or month. This practice generates historic comparable data, makes the organization focus on key strategic indicators, and ensures the development of the systems to obtain and track such information Continuous Improvement and Sharing Best Practices As the organization develops, specific processes will be implemented to solve issues and increase operational efficiency across the value chain. This should include a review of processes on a regular basis and regular feedback sessions with micro-franchisees, as often they will have the best insight into where improvements can be made. After the new solutions or best practices are developed, mechanisms should be put in place to gather data on their effectiveness. Operations manuals and audit forms may also need to be updated Communication with Franchisees Periodic franchisees meetings must be organized in order to communicate new initiatives, share best practices, recognize the best performers in financial and operational terms, and gather feedback from franchisees. Meetings are often a more efficient way of communicating a consistent message, discussing common issues and maintaining a positive working relationship with the franchisees. 24

25 FUNDES Appendix 1 PROJECT CHECKLIST FOR THE FRANCHISOR - SME Step 1. Concept and Target Market 1.1 Validate concept and business model 1.2 Assess market potential and scalability 1.3 Assess environment and infrastructure available Step 2. Business Analysis and Financial Model Development 2.1 Calculate investment per unit 2.2 Sales and margins forecasting 2.3 Define fees and margin for the franchisor 2.4 Profit and loss statements (P&L s) and profitability analysis 2.5 Define business model per each stakeholder 2.6 Assess social security implications Step 3. Stakeholders and Relationships 3.1 State social objective and vision 3.2 Define key roles and objectives 3.3 Formalize the partnerships 3.4 Negotiate vendors agreements 3.5 Elaborate franchise contract 3.6 Conduct other legal duties Step 4. Structuring the Company 4.1 Define for-profit, not-for profit, not-for-loss structure 4.2 Establish ownership and governance 4.3 Organize an advisory council Step 5. Selecting Micro-franchisees 5.1 Define ideal franchisee profile 5.2 Develop a Franchisees recruitment strategy 5.3 Develop a Franchisees retention strategy Step 6. Financing Considerations 6.1 Select an adequate microfinance institution (MFI) 6.2 Define if they can provide financing by themselves 25

26 Micro-franchising: Development of a Micro-franchising Replication Model in Mexico SMEs 6.3 Develop a micro-credit package for the franchisee 6.4 Consider securing guarantee funds 6.5 Evaluate alternative financing 6.6 Consider participation of philanthropists Step 7. Establishing Supervisory and Operational Foundations 7.1 Develop operations manuals 7.2 Define supervisory structure and program 7.3 Develop a training curriculum 7.4 Establish quality control mechanisms Step 8. Launching a Pilot Program 8.1 Develop a detailed pilot plan 8.2 Define reporting mechanism and data analysis system 8.3 Pre-establish parameters for Go / No-Go decision Step 9. Development Plan 9.1 Define site selection criteria and process 9.2 Develop growth strategy and openings calendar 9.3 Establish an organizational growth plan Step 10. Ongoing Operations and Sharing Best Practices 10.1 Set-up on-going planning and review process 10.2 Set-up continuous improvement and best practices mechanism 10.3 Define franchisee meetings structure 26

27 FUNDES 27

28 Serie Vector No1 Summary Sheet Program Name: Typology: Location: Abstract: Key Players: Building a Micro-Franchising Replication Model in Mexico Microenterprise Sector Mexico Replication methodology for the development of micro-franchise enterprises in Mexico. Key replication steps will then be detailed encompassing all business activities required in the development of a successful micro-franchise, from market analysis through to the management of ongoing operations, focused on a Small & Medium Enterprises. FUNDES Inter-American Development Bank, IADB Support Fund for micro, small and medium enterprises, Ministry of Economy, Mexico.