Expanding Your Franchise Internationally
In last month's column , I urged new franchisors to exercise caution when it comes to their initial growth strategy. With such a strong domestic market, one might rightly ask why any but the largest U.S. franchisors should consider going global. For some U.S. franchisors, the U.S. markets are relatively saturated. But for most, the promise remains largely unfulfilled. Why then, go global?
In a word, timing.
In today's global marketplace, never before has the timing been so good for U.S. franchise concepts. And when a non-U.S. investor decides to buy a franchise, where do they go shopping?
Consider the following: The U.S. is home to the vast majority of the world's brand-name franchisors. It's the heart of capitalism and entrepreneurship. In many countries, U.S. concepts carry a certain cachet simply because they're from the U.S. The retail and service environments in many countries are simply not as competitive as they are in the U.S. And in the Darwinian world of business, that type of environment produces the strongest survivors.
The fact is, the U.S. is the shopping mall of the world when it comes to franchise opportunities. And more international investors are shopping today than ever before.
So while international expansion is clearly not appropriate for the neophyte franchisor, neither should it be confined only to franchisors with thousands of units in operation.
How to Expand Internationally
Many franchisors initiate their global franchise efforts through serendipity. Perhaps a foreign investor looking for a franchise came across their listing at Entrepreneur's FranchiseZone , and that chance encounter leads to an international franchise opportunity. But encounters like this aren't an effective strategy for international growth.
Unless you're one of the lucky franchisors that have a strong international candidate fall into their laps, you'll need to do some proactive marketing to generate your international prospects.
Franchisors targeting international growth are well advised to start by targeting a specific country or group of countries in which they would like to expand. To do so, the first step is to identify the best countries for your particular concept. Factors such as franchise climate, the market for your particular product or service, competitive factors, proximity, language barriers, culture, political climate and relevant legal concerns should all be factored into the decision.
Countries outside the U.S. that currently have franchise regulations are:
- Some provinces of Canada
- South Korea
Once you've targeted an appropriate market, prospective international franchisees can be generated in a number of ways: trade shows, franchise shows, trade missions, the internet, targeted public relations, print advertising, direct mail and the use of brokers are among the most popular means.
Perhaps the most difficult method is to try to go it on your own. This involves the creation of an international lead generation strategy with all the complexities of the international sale. Unless you have a strong knowledge of a particular market, this strategy is likely to generate a substandard partner or fail entirely.
One alternative to the strictly do-it-yourself approach is the Gold Key program available through the U.S. Chamber of Commerce. Simply contact the appropriate U.S. embassy and, for a modest fee, they'll assist you in researching the market and identifying potential partners. They'll even set up meetings with these partners. All you have to do is show up and negotiate the deal. Still, this strategy has some substantial drawbacks--not the least of which is the amount of time and energy you'll need to expend in order to effectuate a deal.
One popular means of targeting prospects is the use of international trade missions. Sponsored by groups such as the International Franchise Association, trade missions attempt to provide franchisors with introductions to a number of qualified candidates in each country. The franchisor is typically responsible for its own expenses (which can run upwards of $10,000), their own follow-up and their own negotiations. The sponsoring organization is responsible for the logistics and providing the introductions.
But the most effective approach for franchisors that are really committed to their international expansion efforts involves the use of brokers specializing in international development. Their knowledge of specific markets, combined with resources in those markets, allows brokers to effectively promote your franchise within a particular market.
Brokers will generally start by networking within a country and directly contacting the best potential partners in a specific market to determine their level of interest. Brokers usually won't ask the franchisor to visit the country until they've generated some serious interest, and often the candidates will visit you as a first step, thus minimizing the time you spend in this process. More important, this direct contact approach will generally result in the best candidates and the best follow-up, as the broker will derive a substantial portion of their compensation based on "success fees," which often range upwards of 20 percent of the initial fee.
While some brokers are willing to work on straight commission, the best brokers generally require you to offset out-of-pocket expenses, underwrite the development of market research (which may cost $10,000 or more per market), and pay them a stipend while they're involved in the search.
Regardless of the means used to generate your international prospects, unless you're relying entirely on serendipity, you should plan on spending money in the sales process. Travel costs alone will likely run in the tens of thousands of dollars before the deal is finalized.
Structure of the International Transaction
Once you've identified qualified candidates, remember: The strength of your partner is even more integral to your success internationally than it is domestically. As a franchisor, you may have significant difficulties that you would not encounter domestically. And you will be dealing with a franchisee that has substantially greater responsibilities than your typical domestic franchisee. Not only will your franchisee be responsible for developing and adapting your foreign prototype, but he or she will also be responsible for implementing your expansion plan for an entire country.
Once you've identified the best possible international franchise candidate, the next question you must deal with is the structure of the transaction. One of the first questions that any company new to international franchising will face involves whether to expand by direct franchising, joint venturing or master licensing.
In direct franchising, the franchisor organization sells franchises and attempts to directly support those franchises in the market. In essence, the U.S. franchisor would attempt to directly duplicate its domestic success in the foreign market.
This form of entering any foreign market is probably the most difficult, unless the market in question is in close physical proximity and is relatively similar from an economic and social perspective. While some U.S. franchisors favor this method of expansion in Canada and Mexico, it's extremely cumbersome when it comes to more distant foreign markets.
From a definitional perspective, a franchisor could be said to be entering a foreign market through the use of a joint venture if that franchisor maintained an equity interest in the company that was established to expand the concept in that market. This strategy has the advantage of allowing the franchisor to participate in the equity appreciation of the foreign entity while providing it with an ongoing revenue stream, generally based on gross sales.
Given the increased risk and capital demands of this strategy, however, it's estimated that fewer than 12 percent of U.S. franchisors opt for variations of this structure. Typically, only the largest and best-capitalized franchisors can afford a long-term investment of this nature.
By far, the most popular method of entering new international markets is through the use of a countrywide master franchise or area developer. Typically called a master licensee, this company (these are generally not sold to individuals) will be much more sophisticated and better capitalized than the average individual franchisee.
As a starting point, you're probably looking at selling the entire country, or at least a substantial territory within a larger country. While some of these arrangements are structured like area development agreements, most resemble subfranchise arrangements, in which the partner would not only develop units, but will sell franchises much the same as you would as a franchisor. Franchisors typically are compensated in these arrangements through a combination of initial territory fees, a percentage of ongoing fees and a percentage of individual franchise fees.
Before deciding on a fee structure, it's important to get an understanding of the services required to establish a successful international venture. Fees can then be determined only after estimating associated expenses. Bear in mind that the costs of closing an international transaction can be significantly higher than a domestic transaction. Brokerage fees, international franchise attorneys, travel costs and substantial training commitments both at home and abroad can easily give you a six-figure headache.
For this reason, initial fees for most countries generally range between $100,000 and $1 million, depending on the size and maturity of the market involved and the overall demand for the franchise in question.
Similar to domestic transactions, most franchisors look to their international franchise fees primarily as a cost recovery tool and only secondarily as a profit center. The franchisor would, obviously, like to maximize franchise fee revenue. However, knowing the importance of establishing the channel (and its associated royalties and/or product sales), most franchisors price their fees low enough to avoid erecting substantial barriers to the franchise sale.
Unlike domestic transactions, in which a fee is generally specified in advance for inclusion in the Uniform Franchise Offering Circular and isn't subject to negotiation, international franchise fees are often subject to negotiation based on what each party is "bringing to the table." (Note: U.S. franchisors aren't required to comply with U.S. disclosure laws for foreign transactions, but may be subject to foreign disclosure laws.) Moreover, since the costs incurred in a transaction might vary substantially, there's often an economically justifiable reason to raise or lower fees.
In a master franchise relationship, both royalties and franchise fees are generally a fraction of what they are in a direct franchise relationship, with the licensee generally receiving the lion's share of the revenues from both. The U.S. franchisor generally receives between 20 percent and 50 percent of the franchise fee upon each unit opening, and between 25 percent and 40 percent of royalty revenues. These fees should not be determined based on the country in question, but rather on detailed financial analysis and an understanding of specific support services required.
In structuring these transactions, two additional points are of critical importance: performance requirements and expenses. The speed with which you're able to establish the foreign franchise organization will be a critical element in determining when you'll achieve positive cash flow. If your licensee isn't willing or able to commit to an aggressive development schedule, be sure that you write provisions into your agreement requiring them to cover all direct expenses until a certain number of franchises have been established.
Lastly, be sure that you or your U.S. franchise attorney retains an attorney familiar with franchising in the host country prior to finalizing any agreement. Peculiarities relative to allowable royalties, intellectual property, trademark, employment and anti-trust laws may have a profound impact on your structure.
The Decision to Go Abroad
International franchising isn't a venture to be entered into lightly. Aside from complex international legal and regulatory environments, the prospective international franchisor must be prepared to make a substantial commitment of time and resources to its international business. And to be successful, the franchisor must be highly selective--working only with the right partner and choosing only counties in which the concept will be well received.
Not all franchisors are ready for this level of commitment. But for those that are, the "export opportunities" can be quite rewarding.