Franchising in the Emerging Global Economy

Franchising in the Emerging Global Economy Presented to the National Association of Small Business International Trade Educators (NASBITE) by Elayne P. McClaine, MBA, CGBP New Jersey Small Business Development Center @ Rutgers New Brunswick

Elayne P. McClaine, MBA, CGBP Regional Director, NJSBDC-NB Elayne P. McClaine is Regional Director for the New Jersey Small Business Development Center at Rutgers New Brunswick. She has been involved with the SBDC since 2005 in various roles such as Lead Client Counselor, Instructor, and Assistant Director. She has extensive expertise in the areas of Business & Strategic Planning; Business Financial Management; Market Research; Business Valuation & Franchising. She is a Certified Global Business Professional (CGBP), an Accredited Business Planning Advisor and a Certified GrowthWheel Advisor. She is an SBA and SBDC Global Counselor and Instructor. Prior to joining the SBDC, Ms. McClaine accomplished over 20 years of Brand Management--both domestically and globally ranging from SMEs to Fortune 100 firms. She also has extensive experience as a Business Broker and Management Consultant. Elayne has an MBA-Finance from Regis University and a BA-Economics from Fordham University.

Understanding the Global Consumer: 95% of The World s Consumers Live Outside United States By 2025, more than half of the world s population will have joined the consumer class. This will drive annual consumption in emerging markets to $30 Trillion. McKinsey, 2012 Almost half of the world s GDP Growth between 2010 and 2015 will come from 440 Cities in emerging markets By 2025, 45% of businesses on Fortunes Global 500 list will be based in emerging markets compared to just 5% in 2000. Cross-Border ecommerce is predicted to triple by 2018, with 130 million "major market" shoppers accounting for $307 billion in cross-border purchases--and that's only from the U.S., U.K., Germany, Brazil, China and Australia.

Three Characteristics of an Emerging Market Level of Economic Development Typically measured by GDP per capita Economic Growth Rates exceeding 5% GDP Growth greater than Population Growth Market Governance Extent of free market Government control of key resources (Red Tape, Bribery, Ownership Restrictions, Import Restrictions, capital flows, etc.) Stability of Market System Regulatory Environment

Developed vs. Emerging Markets Developed Markets Emerging Markets Global Position North and West South and East Marketing Orientation Marketing Development Market Channel Marketing Orientation Consumption Emphasis Unified and Integrated Sales Orientation Production Emphasis Fragmented Culture and Society Agreements Formal, Contract Based, Direct Communication, Individualistic Legal Understanding, Disputes Settled Contractually-Binding- Informal, Relationship Based, Indirect Communication, Collectivist/Conformist Mutual Understanding, Disputes Settled by Negotiation-Flexible

Rationale for Global Expansion via Franchising International franchising is a strategic way to reduce dependence on domestic demand and grow new, future revenue and profit centers worldwide. Extending a brand globally through franchising involves a low risk, requires minimal investment and offers a huge upside potential on scaling capabilities. Franchise businesses around the world have seen steady growth in the past decade, particularly in Brazil, China and Mexico. According to the IFA, their members are eyeing overseas expansion as an important way to diversify their portfolios. Over 60% of IFA members currently franchise or operate in international locations, and 16 percent generate between 25 percent and 30 percent of revenue from international activities. Top 200 Franchisors now have 36% of their units outside of United States

Rationale for Global Expansion via Franchising for Small Business According to the International Trade Administration, 281,668 businesses with fewer than 500 employees exported from the United States in 2008, accounting for 97.5 percent of all U.S. exporters. Minority firms are specially attracted to global expansion and Franchising:

The Pros and Cons of International Franchising Opportunities New Revenue Sources Grow Stakeholder Value Less Competitive and Regulated markets Leverage Existing IP Attract Investment to Grow the Brand Challenges Choosing Countries with the Best ROI for your Business Finding the Right Licensee Diminishing focus on Domestic Business High Staff, analysis and travel start up costs Excessive Due Diligence Supply Chain Management

The Pros and Cons of International Franchising in Emerging Markets Among the general characteristics of emerging markets are: Low GNP, but high potential growth Unequal distribution of income, but a growing middle class Limited but growing consumerism Lack of managerial and entrepreneurial talent Lack of capital for economic international franchising expansion Political instability Undeveloped infrastructure High cost of transaction and agency costs-

Factors to Consider When Selecting Countries Country Stability Viable Consumer Market Intellectual Property Protection Rule of Law Good GDP Growth Indicators Potential to Generate Adequate Profit and ROI

Franchisor Must Have These Qualities A Brand that will attract Demand globally Excellent Business Model in their current country Strong, replicable unit franchise results Proven Margins in a competitive environment Consistent growth based on repeat customers not market stimulation Strong training, support, marketing and Internet Resources Financial model that offers licenses the potential for a consistent ROI

In-Country Franchisee Partner Must Have These Qualities Clear understanding of your business Good business reputation and connections in-country Successful knowledge of the industry and sector Successful knowledge of cultural mores Access to suitable real estate Adequate capital to grow your franchise in-country Experienced management to put into the franchise

less INVESTMENT JOINT VENTURE AREA LICENSE MASTER FRANCHISING IMUFA DIRECT UNIT FRANCHISE more CONTROL less

Pros Control: Franchisor is able to retain control Revenue: No Sharing of the royalty stream Testing Markets: Franchisor can validate one unit at a time Tiered Expansion: Minimal Risk Direct Unit Franchising Cons Limits on Growth Rate: Few franchises at a time Lower Fees: In line with slower growth, lower fees in short term Increased Due Diligence and Research: Franchisor totally responsible Capital Resources and Time: Franchisor Manages franchises and expansion costs, legal risks, compliance Disclosure Laws: Franchisor must comply with all local laws Taxes: Reporting and payment obligations; Franchisee may be required to withhold on amounts paid to Franchisor Exposure: Local laws may favor franchises

Joint Venture Pros Ownership and Control: Allows Franchisor to maintain actual ownership over expansion and operations while requiring foreign partner to invest the most resources and capital Flexibility: Can be Master Franchise or Area Development Model Tax Benefits: Entity may be eligible for tax benefits or incentives available to permanent establishments in the foreign market Potential Greater Share of JV s Profits: Franchisor may also receive greater royalties/license payments and profits via dividends and distributions Cons Potential for Loss of Control: Local partner may be a partner and have more say in operations and expansion Exposure: Franchisor may be exposed to more liability stemming from laws of foreign markets franchise laws, general, corporate law and taxes, and ownership structure Disclosure Laws: Franchisor must comply with all local laws. Prolonged Negotiations: Negotiating the terms of the JV Partnership may involve complex issues

Area License Pros Same as Direct Franchising Control: Entering into unit franchise agreements in addition to area development agreement provides franchisor with control over growth and operation Upfront Capital Infusion: Franchisor will receive an upfront payment with creation of area development agreement with the developer may also mean deferred or reduced royalties Leverage Local Knowledge and Expertise: Franchisor will benefit from developers knowledge of local market conditions, culture, political, legal and economic issues Cons Same as Direct Franchising Constrained by Capital Resource of Developer: Growth of Franchisor s Brand and system in foreign market will be limited by funds available. Franchisor reliant upon developer s track record and financial position Local Disclosure Laws: Franchisor must comply with all local obligations to supply a disclosure document for not only the development agreement but also each unit franchise agreement which may be a financial and administrative burden Administrative Ease of Termination: Easier to terminate and/or replace an area development agreement within a specified territory as compared to a master franchise agreement

Pros Master Franchisor Cons Fast Avenue to Growth: Fast path to growing Franchisor s Brand and system in foreign Market Risk Management: Master Franchisee will bear the larger risk of loss and legal risks as it is the party contributing the majority of capital, HR resources and recruitment Leverage Local Knowledge and Expertise: Franchisor will benefit from the master franchisee s knowledge of local market conditions, culture, political, legal and economic conditions Reduced Investment of Franchisors Time and Resources: Less time, capital and human resources are required from Franchisor Economies of Scale for Sub-franchisees: Franchisor can scale up franchise operations quickly, master franchisee can pass on efficiencies to sub-franchisees helping them to operate profitably Upfront Capital Infusion for Franchisor: Non-Refundable fee paid at outset Disclosure Laws: The Master Franchisee, not the Franchisor would be responsible for complying with disclosure laws Liability to Sub-franchisees: Franchisors can be insulated from liability by limiting direct involvement and contracts Unrealistic Development Schedules Territory: Franchisors must be mindful of granting too large a territory to a Master Franchisee who cannot adequately service. Smaller territory with first right of refusal would be better option Risks from Heightened Reliance on Master Franchises: This model can give rise to the downside risk of connecting with the wrong local partner. Poor choices can negatively impact brand and goodwill Risks for Future Re-Entry to Market: If the Master Franchisee is unsuccessful or cannot deliver expansion goals, it will be difficult for the Franchisor to re-enter with a failed brand. Unavailable in Certain Markets: Certain jurisdictions will not permit a Franchisor to enter into a Master Franchisee agreement without ownership or skin in the game Failure to Handle Pilot Units and Administration of System: Master Franchisee may fail as a result of inability to focus on pilot operations and administration which requires legal and regulatory expertise Disclosure Laws: Franchisor may still be required to comply with respect to the grant of the Master Franchisee. Liability to Sub-franchisees: Franchisors cannot assume that lack of contractual inclusion will exempt them from local laws and franchisee recourse

Pros International Multi-Unit Franchise Agreement Cons Reduced Administrative Burden and Costs: Less time and capital and human resources required once an IMUFA is executed Fast Avenue to Growth: As administrative burdens are reduced, resources can be placed towards the growth and expansion plan Leverage Local Knowledge and Expertise: Franchisor will benefit from local partner s knowledge of local market conditions, culture, political, legal and economic conditions Economies of Scale for Franchisees: By scaling up franchise operations quickly, economics can be passed onto unit franchisees helping them to operate more efficiently and profitably Upfront Capital Infusion for Franchisor: Generally a large non-refundable master franchise fee is paid to Franchisor at outset of the relationship Loss of Control: Compared to the development agreement model, the Franchisor has less control over individual franchise outlets once the IMUFA is executed. Unrealistic Development Schedule: Difficult to set realistic, rather than overly aggressive development schedules, especially upfront. Upfront Heavy Lifting: Significant foresight and heavy investing in initial drafting is required to consider how the franchise relationship will be governed over time. Forms of Agreement: Unlike area development model developers typically agree to open outlets signing them at then current form of franchisee agreement. Since all rights are granted up front in the IMUFA, there is no opportunity for the Franchisor to require new outlets to be operated pursuant to the then current agreement. Disclosure Laws: The Franchisor may still be required to comply with disclosure laws with respect to the grant of the IMUFA. If the Franchisor has not previously granted an IMUFA, it will have to undertake the cost and expense of dong so as part of its first expansion.

Co-Branding Pros Concept especially designed for Small Business: Low investment level on two or more franchises that are related may be matched with a local franchisee, i.e. a gas station Leverage Local Knowledge and Expertise: Franchisor will benefit from local partner s knowledge of local market conditions, culture, political, legal and economic conditions. Economies of Scale for Franchisees: Lower overhead and operating costs. Shared space, equipment and cross trained employees. Leverages complimentary or compatible brands or concepts in a single location Diversifying Risk: Expanded customer base under one roof. Reduced investment and operating cost. Cons Limits on Growth Rate: Match and opportunity may take time Increased Due Diligence and Research: Franchisor totally responsible Capital Resources and Time: Franchisor Manages franchises and expansion costs, legal risks, compliance Disclosure Laws: Franchisor must comply with all local laws Taxes: Reporting and payment obligations; Franchisee may be required to withhold on amounts paid to Franchisor Exposure: Local laws may favor franchisees

Small Business Impact Global expansion impacts small businesses both domestically and abroad Contributes to company growth, expansion and profitability Improves competitive stance for brand and for business Strengthens local economic development Generates lending and funding impact Increases job Global marketplace access via Internet supports domesticsales and growth Small Franchisor can capitalize on native country/regional connections

Small Business Impact US and SBA Global Support for Small Business Franchising SBDC and NASBITE CGBP Consultants SBA Franchise Registry 7(A) International Trade Loan Program Export Working Capital Program SBA Export Express Resumption of Exim Bank

For A Free Consultation Elayne P. McClaine, Regional Director New Jersey Small Business Development Center at Rutgers New Brunswick Livingston Campus Rutgers Business School 94 Rockafeller Road, Piscataway, NJ 08854 Office: 848-445-8790 Direct: 848-445-8788 Fax: 732-445-2239 http://www.business.rutgers.edu/njsbdcnb Request for Counseling, Calendar and Evaluation Forms