The Franchise Agreement with International Company - Case Study Example

? Summary Auchan, the French retailer plans to enter India through franchising. India has huge untapped potential in the retail sector but the Indianregulations do not permit direct FDI. Auchan plans to enter into franchise agreement with Landmark Group, which is set to terminate its agreement with SPAR in India. The macro-environment in India is conducive to investment and the chosen mode of entry has been justified because of low capital investment with shared risks. This mode of entry would enable Auchan to derive competitive advantage while having the capability to cope with the risks in the venture. 1. Introduction The French food retailer Groupe Auchan S.A. (Auchan) is one of the world’s top retail and distribution groups and the fourth largest food retailer in France with a market share of about 12 percent (Standard & Poor’s, 2011). It competes with European giants such as Carrefour and Casino. Auchan has a strong position in the hypermarket segment which contributes about 80% of the group’s revenues. In addition to intense competition, rising inflation has been holding back consumer spending in Western European markets. Auchan has expanded into several Asian countries and also in Central and Eastern Europe. India has a huge retail market but it has FDI restrictions and does not permit foreign companies into multi-brand retail. Auchan has been attempting to enter into India through a franchise agreement with Dubai-based Landmark Group. The Landmark Group, founded in Bahrain with a single shop, has grown into one of the largest retail organizations (Landmark Group, 2012). Currently, the Landmark Group operates the SPAR hypermarkets and supermarkets in India but their agreement with SPAR is set to come to an end. Auchan Groupe intends to enter into a franchise agreement with the Landmark Group until India amends its FDI policy. As of now India does not permit FDI (Foreign Direct Investment) in multi-brand retailing. 2. Rationale for choosing India India offers huge potential for the retail sector as the disposable income of the middle-class has been growing. FDI in different sectors has been increasing in India and the Indian currency (Rupee) has become strong in the international market. However, PEST analysis would help in evaluating if Auchan’s decision to enter India is a viable proposition. Political The political situation in India is unstable as it has a coalition government since no single party has clear majority. The industrial sector also faces opposition and the growth in agriculture has been slow. However, the role of the central government as the intermediary of the state governments is now ending (Mohan, 2006). This indicates that states now have autonomy while the growing middle-class favours liberalization. The business conglomerates in India have turned their attention to retailing (Deloitte, 2008). The Ministry of Commerce and Industry, Government of India, is the nodal agency for monitoring and reviewing the FDI policy in India on continued basis (Tyagi, 2010). Economic The Indian economy has undergone tremendous change. The Indian economy has recorded high growth rates and is an attractive destination for investments (IBEF, 2011). The Indian economy is expected to grow at 7.5% and is expected to contribute to the recovery of the world economy. The Gross Domestic Product (GDP) was 8.5% during 2010-11 against 8% in 2009-2010. Over the next two years India is expected to attract FDI worth USD 80 billion according to a research report by Morgan Stanley as cited by IBEF. India’s retail sector is expected to grow to $635bn by 2015 (Sengupta, 2008). At the same time, food retail is expected to grow to $1.6bn over the next five-year period (Srivastava, 2008). Social The modern cities such as Delhi, Mumbai and Bangalore show evidence of modernization and adaptation to western standards under the influence of globalization (Pick & Dayaram, 2006). Growth and development in communications technology, development of transport infrastructure, widespread availability of western goods and rising real estate prices have challenged the traditional habits and practices in India. Consumerism has influenced the buying habits of the Indian consumer. India has become the “next big thing” for the world’s leading retailers (Deloitte, 2008). Consumer spending in India is expected to be strong. Technological India uses advanced telecommunications technology and is much advanced in different modes of communication such as broadband and mobile technology. The retail sector uses advanced technology globally and India offers the necessary infrastructure to handle this. Analysis India offers immense potential in the retail sector despite government constraints and regulations. Consumer spending, technology, the economic situation and the political environment are all conducive to the growth of the retail sector in India. Thus, Auchan could consider expansion into India. However, Auchan should not focus on the mass market as margins have reduced as found by Deloitte (2008). The mass market has become saturated and fierce price competition has driven down margins. Auchan should focus either on the affluent consumer or the low income consumer. 3. Justification for the entry mode The choice of entry mode has an impact on international marketing but often the regulations prevailing in the host country influence the entry mode. Foreign investors are free to invest in India except for a few sectors where prior approval of Reserve Bank of India (RBI) is necessary. Retailers have been entering India through different modes before 2006 as FDI was not permitted in the sector. They used entrance routes such as franchise agreements, cash-and-carry wholesale trading, strategic licensing agreements, and manufacturing and wholly-owned subsidiaries (Tyagi, 2010). Under the cash-and-carry wholesale trading FDI up to 100% is permitted under the automatic route. However, for retail trade for ‘single-brand’ products FDI is permitted only up to 51% with prior Government approval. Multi-brand retailing is not permitted in India. Auchan plans to enter India through franchise agreement with Dubai-based Landmark Group. A SWOT analysis of the chosen entry mode would help evaluate the justification for the chosen entry mode. A franchise is a business agreement where the franchisor permits the franchisee the licensed right to own and operate the business based on the concept of the franchisor while also using the franchisor’s trademark (Sinha, 2012). Strengths Franchise agreement is the easiest method to enter the Indian market. Franchising is a form of vertical contractual relationship which literally means to grant the rights (Grunhagen & Dorsch, 2003). This form of venture is based on mutual trust and support. Franchising is an efficient means to control the problems while also eliminating the constraints that could arise during expansion (Inma, 2005). Investments by the franchisor are minimal because the responsibility of maintenance, construction and management of the local operations lie with the franchisee. Most importantly, while Indian regulations do not permit multi-brand retailers to enter India, under franchising FDI is permitted with the approval of the Reserve Bank of India under Foreign Exchange Management Act (Tyagi, 2010). Brands such as Lacoste, Nike and Marks and Spencer have entered India through this route. Weakness Franchising requires regular monitoring and control but emerging markets pose a challenged because of the cultural and geographical distance (Welsh, Alon & Falbe, 2006). Even small retailers such as Body Shop and Benetton have entered India and other emerging markets through franchising. Brand and image building is essential before entering an emerging economy (Alon &McKee, 1999). Other retailers such as Wal-mart and Tesco are known to the Indian consumers but Auchan is not such a familiar name. Hence Auchan would need to establish large distribution networks. The rules for royalties and franchisee fees in India are not liberal under franchising agreement (Tyagi, 2010). This would require innovative restructuring to maximize returns. Opportunity The Indian retail sector is still is the nascent stage and the Indian government realizes that FDI can be a powerful catalyst in the retail industry. The franchise industry in India is the second largest in the world with the growth expected at 30-40 percent (Sinha, 2012). Currently there are nearly 800 franchisors operating in India with only 10% being foreign owned. After the tier I cities, retail is now entering the tier II cities as well which demonstrates huge untapped potential. Moreover, compared to the country’s market size there is low presence of international brands in the retail sector (Sinha, 2012). Since direct entry is not permitted in FDI retail in India, franchising is the best option. Bata, Coca-Cola and Nike have all entered India through franchising. Auchan would be able to charge up to 1% for domestic sales for use of their brand name and trade mark without transfer of technology. The size and diversity of the population in India, the growing economy, changes in lifestyle and the advent of modern retailing provide tremendous opportunity for franchisors in the retail sector. Retail sales in India through franchisees constitute about 2% of the total retail sales against almost 50% in the US which indicates the huge potential that exists in India. Threats There is lack of investments in the logistics of the retail chain which can result in an inefficient market mechanism. The chain is fragmented and the storage infrastructure is also insufficient. The public procurement and distribution system is a matter of great concern. Moreover, there is absence of legislation regulating the franchise agreement (Sinha, 2012). Often the foreign franchisor is confused as several laws such as intellectual property, taxation, and foreign exchange control regulations govern the franchise agreement. Moreover, the financial institutions do not consider soft expenses as part of the project cost. SWOT analysis An analysis of the strengths and weaknesses demonstrates that to expand in India the only option for retailers is through franchising. Auchan plans to enter into franchise agreement with Landmark Group that already has a presence in India. As such they would be having knowledge of the local economy, regulations, local culture and customs. Landmark would also be familiar with the pitfalls of poor infrastructure and logistics in the retail supply chain. 4. Competitive advantage through entry mode The entry mode is chosen based on the level of control and investments desired. If a high level of control is required the investments too have to be high. This in turn translates into higher risks. In franchising the risks are shared between the franchisor and the franchisee. Franchising as a mode of entry is viable for developing economies as it enables the franchisor to receive support and motivation. It works as a source of competitive advantage. It helps businesses to adapt to different cultures and lifestyles, different regulation across nations (Hoffman & Preble, 2004). Franchising is the most viable mode of entry in the current global economic environment. Franchising requires regular monitoring but this has become possible due to advanced telecommunication technology. Franchising would help Auchan to achieve competitive advantage because through franchising it is possible to obtain human resources at low cost. India still has unsaturated markets in urbanized populated cities. The demand for western products is high and hence Auchan could obtain competitive advantage. Besides, risks are low and costs are shared in franchising. Own distribution system is not required when market entry is through franchising. This helps in rapid market penetration at comparatively lower costs. Moreover, Landmark Group already has knowledge of the local markets, culture, of the local regulations, customs and norms. 5. Risks and risk mitigation In international retailing competition is fierce but as competition increases, so do risks. Financial and investment risks are minimal in emerging economies when franchising is chosen as the entry mode. Limited infrastructure and unstable political climate are other factors that Auchan has to be prepared for while entering India. To overcome the political and economic risks, having a local franchisee can promote political and cultural acceptability. Auchan would be able to gain knowledge of the local regulations, cultural customs and norms. India is a land of diversity with many different languages spoken in different parts of the country. This could pose challenges in monitoring and in understanding the business norms. The economic risks arise as retailers source produce globally and hence are vulnerable to the uncertainties in the global economy. The volatility of the exchange rates, the oil prices and trade restrictions can lead to fluctuation in prices. Currency risks also impact franchising activity but since the franchisors receive the royalty as a percentage of the revenues, this risk to some extent is mitigated (Fladmoe-Lindquist & Jacque, 1995). Besides, the franchisors must have a contingency plan ready to cope with the changes in the global economy. Emerging markets such as India have poorly functioning institutions thereby leading to severe agency and information problems (Khanna & Palepu, 2000). India also demonstrates weak corporate governance and control. However, since Auchan intends tying up with Landmark, they would be able to benefit from the management skills, political connections and internal processes. Another risk that could arise is from poor enforcement of labor laws in most states in India. Labor regulations in India’s retail sector fall under the jurisdiction of the state governments which define the working hours, the pay structure, the working conditions and also the leave that needs to be granted to employees (Amin, 2008). The Landmark Group would be familiar with these laws and regulations and would be able to handle such issues. Conclusion The retail sector is still in the nascent stage in India compared to global standards. However, saturation has been reached in the metro cities and retailers are now tapping the huge potential that exists in the retail sector in tier II cities. Besides, compared to the country's size there is low presence of the international brands. Auchan would face several constraints during expansion and franchising would help the retailer to combat them. Moreover, this entry mode requires low capital investment, low risk and fair returns. Franchising requires regular monitoring and control and since the Landmark Group is already familiar with India, these would be taken care of. Auchan would however need to create its brand image before it enters the Indian market. While tying up with the Landmark Group would give it some advantage, its own brand image is equally important. However, India has poor infrastructure and market mechanism to handle the supply chain in the retail sector. Franchising is the only option available to Auchan, but the company would be able to achieve competitive advantage because this mode of entry ensures minimum capital investment with low risks. They would not require to build their own distribution system and market penetration would be rapid. Foreign exchange risks too would be minimal as Auchan would only need to receive the franchise fees. The Landmark Group, having experience of operating in India, would be able to cope with the challenges and risks involved. Thus, the mode of entry chosen by Auchan is justified based on the country and the sector analysis. References Alon, I. and McKee, D.L., 1999. The internationalization of professional business service franchises. Journal of Consumer Marketing, 16 (1), pp. 74-85 Amin, A., 2008. Labor regulation and employment in India’s retail stores. Journal of Comparative Economics Deloitte, 2008. 2008 Global Powers of Retailing. [Online] Available at: [Accessed 16 February 2012] Fladmoe-Lindquist, K. and Jacque, L., 1995. Control Modes in International Service Operations: The Propensity to Franchise. Management Science, 41 (7), pp. 1238-1249 Grunhagen, M. and Dorsch, M., 2003. Does the franchisor provide value to the franchisee? Journal of Small Business Management, 41 (4), pp. 366-384 Hoffman, R.C. and Preble, J.F., 2004. Global franchising. Journal of Services Marketing, p.101-113 IBEF, 2011. Indian Economy Overview. [Online] Available at: [Accessed 16 February 2012] Inma, C., 2005. Purposeful franchising: re-thinking of the franchising rationale. Singapore Management Review, 27 (1) Khanna, T. and Palepu. K., 2000. Is Group Affiliation Profitable in Emerging Markets? The Journal of Finance, 5 (2), pp. 867-891 Landmark Group, 2012. SPAR India opens its first Hypermarket in Mangalore at the City Centre Mall. [Online] Available at: [Accessed 16 Feb 2012] Mohan, R., 2006. Recent Trends in the Indian Debt Market and Current Initiatives, [Online] Available at: [Accessed 16 Feb 2012] Pick, D. and Dayaram, K., 2006, Globalisation, reflexive modernisation, and development: the case of India. Society and Business Review, 1 (2), pp.171-183 Sengupta, A., 2008. Emergence of modern Indian retail: an historical perspective. International Journal of Retail & Distribution Management, 36 (9), pp.689-700 Sinha, A. 2012. Franchising in India. Chilli Breeze. [Online] Available at: [Accessed 16 February 2012] Srivastava, R.K., 2008. Changing retail scene in India. International Journal of Retail & Distribution Management, 36 (9), pp.714-721 Standard & Poor’s, April 29, 2011. Groupe Auchan S.A. [Online] Available at: [Accessed 16 February 2012] Tyagi, E., 2010. Foreign Direct Investment in Indian Retail Sector – An Analysis. Legal India. [Online] Available at: [Accessed 16 February 2012] Welsh, D.H.B., Alon, I. and Falbe, C.M., 2006. AN EXAMINATION OF INTERNATIONAL RETAIL FRANCHISING IN EMERGING MARKETS. Journal of Small Business Management. 44 (1), pp. 130-149 Read More