International Franchising - Essay Example

Franchising Introduction Franchising is frequently associated with service firms, such as hotels, retail outlets, and quick service restaurants. These firms often have strongly identifiable trademarks and try to guarantee the customer a uniform and consistent level of service and product quality across different locations and over time1. However, the high degree of standardized operations makes the replication of the format across diverse markets difficult. Differences in things such as key ingredients, labor, and physical space can force significant modifications to the service formula. Franchising Defined Following to Dicke (1992): Modern franchising can perhaps best be thought of as a method of organization that combines large and small business into a single administrative unit. In a franchise system one large firm, often called the parent company, grants or sells the right to distribute its products or use its trade name and processes to a number of smaller firms2. The use of contracts in franchising also varies from the standard approaches used in domestic operations. Because of the importance of consistency across outlets (both franchised and corporate-owned), the primary research focus of franchising has been on understanding how best to ensure that the franchisee delivers the business format service as specified by the franchisor. Typically, it is believed that this can be achieved through well-designed contract mechanisms such as fees and royalties. However, contracts become more difficult to monitor and enforce in the international environment as a result of time and distance3. The use of standard contracts that is common in the domestic setting is less common internationally where contracts are usually modified for host country laws and cultural differences. Even the use of a contract often takes on a different meaning in the diverse cultural and legal environments of international business4. (Table 1). International Franchising Finally, the importance of the foreign franchisee to overall operations relative to that of most individual domestic franchisees is often greater as well. First, in international franchising, the foreign franchisees are often major multinational firms rather than small, independent entrepreneurs. This may be a result of greater awareness by the larger host country firms regarding the franchisor’s business concept5. Such firms also are attractive franchisees due to their strong financial position and longevity in business making them less ‘risky’ partners in an unfamiliar business environment. In Japan, Burger King’s franchise partner is Japan Tobacco, one of Japan’s largest firms and reflects JT’s efforts to diversify its business portfolio. Many of the international agreements also involve either a joint venture or a strategic alliance, as in the case of Japan Tobacco and Burger King6. This type of relationship typically is more extensive in its contract terms than a simple franchise agreement and places additional responsibilities on both the franchisee and the franchisor (Table 2). Second, the importance of the foreign franchisee is also increased because of the number of units for which it may hold development rights. International franchising often makes extensive use of different types of multi-unit franchising agreements. Generally, multi-unit franchising refers to either master franchise arrangements or area development agreements. In these agreements, franchisees are assigned the rights to larger blocks of units covering a specific geographic area. Additionally, the master franchise agreement allows the franchisee to recruit and enter into contracts with additional sub-franchisees. The use of multi-unit franchising internationally has been an important method for franchisors to be able to expand their operations without the need to monitor and evaluate numerous distant franchisees7. The popularity of this approach is reflected in the findings by the 1995 IFA survey of 169 international franchisors who indicated that they heavily used master franchise agreements (81 per cent) for their international operations. The use of area development agreements had also increased and was used by 71 per cent of the surveyed franchisors. The implication of this expansion approach, however, is that a single franchisee may hold the rights to all development for several countries and can become a powerful actor in the franchise system8. Partnership Relations Taken together, these differences regarding partner size, contract type and quantity of units in international franchising fundamentally affect the relationship between the franchisor and the franchisee9. The bargaining power between the two parties becomes more equal than has been true domestically. Franchisees are in a position to demand a greater role in the local decision-making and are also more interested in receiving information from and sharing information with the franchisor. Franchisees become more than simply a method to run distant outlets and can provide important access to resources and contacts in foreign markets. A firm needed a substantial advantage over host country firms in order to compensate for the time, distance, and cost incurred through foreign market investment. This firm-specific advantage might include a specific resource as well as the capabilities to more efficiently organize transactions10. For example, McDonald’s extensive experience and marketing has built a global brand name and operational system which results in a substantial firm-specific advantage over the lesser known Bob’s Hamburgers of Rio de Janeiro.. This explanation can also be applied to franchisors such as McDonald’s Corporation. As awareness of foreign opportunities increased and home markets became more competitive, McDonald’s has expanded its world-wide operations to include more than 8,500 foreign franchised and affiliated outlets. The critical element of this approach, however, is the perspective that FDI involves a system of relationships that are needed to attain specific resources that are not otherwise available11. This explanation captures the final, critical element of international franchising as a method for foreign direct investment. It involves the complete system of relationships among the franchisor and franchisees that are crucial for developing and transferring resources, including ideas for new products and services, and technologies for improved service delivery. The system of relationships also serves as an important mechanism for gathering information regarding new opportunities or partners for outlet expansion and development. For example, the ideas for the original Eg McMuffin and the Big Mac came from franchisees in the McDonald’s network and now are two of the best selling items on the system’s menu12. Because of the fundamental business contract, the primary relationship is clearly between the franchisor and each franchisee firm. In practice, all of the franchisees are connected and interdependent, both informally and formally. The ‘informal’ ties occur through participation in the franchise business in which the reputation and success of each franchisee has the potential to impact the reputation and success of all the other franchisees. Poor performance by one franchisee can sour customers on the general business and discourage them from purchasing from another unit, regardless of ownership13. The franchisor has sued the franchisee for termination of the franchise contract for degradation of the franchise concept and failure to uphold standards. Although the franchisee only operated in that geographical area, the resulting publicity can affect the reputation and sales of other outlets as well. The formal relationships often emerge through membership in franchisee associations. As a result of the their mutual dependence on the business format and their relationship with the franchisor, many franchisee systems have developed franchisor independent organizations.14. Franchising and Foreign direct Investments (FDI) Within this broad agenda of the network perspective, research has tried to more finely examine different aspects of network relationships under various conditions. Different features that have been investigated include the density of the ties, collaborative routines, structural change, and social capital. In addition, collective identity, collective learning, partner status, and network culture have received substantial attention. It is proposed here that these last four particular elements of network systems are especially important to understanding international franchising as a form of FDI15. These dimensions—shared identity, collective learning, franchise partner status and franchise network culture—contribute to the ability of franchisors to access distant resources in the global expansion and internationalization process. Although a franchise system requires a shared identity among the franchisor and the various franchisee units for the system to be successful. The identity that binds the system is a unique combination of the brand name, the service, and the operational system. The requirements of a business format system demand that this shared identity be carefully cultivated and guarded. Deviations from the standards of the identity are grounds for franchise contract termination16. These relationships have the potential to provide important sources of suppliers, customers, and ideas that can greatly facilitate the management of the business from remote locations. In domestic franchising, partner status and social capital are of less importance because the franchisor already has significant knowledge of key markets and industry participants. The international arena is a very different matter17. The political, market, and cultural systems may vary significantly from the domestic context. Well-positioned and connected franchise partners can make the difference between success and failure for franchise FDI. Status and social capital are important to international franchisors for several reasons. First, they can provide access to a national network that may otherwise be difficult to enter. In many countries, FDI is an involved process that requires many different governmental agencies and local firms. High status partners with significant social capital can help facilitate the approval process18. Network Relations Network theory’s primary concern with examining relationships among actors makes it particularly appropriate for franchising. Broadly, network theory focuses on understanding the set of ties between parties and the role that such linkages play in the actions and decisions of particular groups. The general proposition is that the connections between parties provide an important mechanism for understanding several key issues. The status of the franchisee, as well as its broad set of relationships and social capital within its own national network, also affects international franchising. In network research, the concept of status refers to a superior position within a specific social group based on prestige or economic and political power. Affiliation with such a partner is often an important mechanism for improving one’s own position19. Within international business, the status of a local partner in its national network can have a major effect on the foreign direct investment efforts of a firm. Partners with greater status can provide significant access to political and business systems that might otherwise be difficult to enter. This is broadly supported by the finding that partner status is an important element in the creation of successful strategic alliances and joint ventures20. The ability of a foreign partner to access resources derives from the larger set of relationships and social capital that it holds. In network analysis, social capital involves the complete set of existing and possible resources that result from the relationships among the actors within the network21. The main disadvantages of franchising are lack of control and contractual obligation, regular checks and price limits. Second, international franchisors may also use high status partners to increase their own standing within a national network. For example, in Bolivia, Burger King is owned and operated by an individual who is also the largest shareholder of a major cement manufacturing firm. In Bolivia, the cement industry is among the five most important industries in the national economy. Consequently, the local franchisee holds a significant position in the Bolivian market through his broader business connections. In Japan, the smaller space of the Tokyo outlets forced KFC to reconfigure its cooking equipment from a wide, horizontal design that worked in the free-standing US style of restaurant to a narrower, more vertical design that saved space. Consequently, in international franchising, the fundamental service may be similar to that of the home country, but details in the delivery of the service are often altered. The challenge is to adapt the format in response to the local market without affecting the overall image and service of the franchise22. Conclusion In sum, franchise partners can provide access to host country resources that may not be as easily available if a franchisor pursues FDI with a lower status, less connected partner. This suggests that an important aspect of international success in franchising may depend on the franchisor’s ability to transfer its collective culture, learning, and identity through its organizational systems. Furthermore, the value of identifying partners with position and status in the national network may be a fundamental requirement for long-term success. This is particularly true given that most franchise agreements run for a minimum of ten years, and an inadequate partner could adversely affect the franchise’s development for a long time as well as adversely impact other franchisees. For researchers within the franchise literature, it is important to begin to examine alternative theories such as the network perspective. Just as many of the larger manufacturing multinationals have discovered that the network of relationships provides important sources of information and know-how, so too may the franchisors. As a result, it is important to not only develop a set of relationships, but also to develop the routines that support and integrate ongoing collective learning, identity, and culture. Such systems will be necessary to retain a competitive position at home and abroad. This allows both opportunities and threats to be more quickly and easily identified because there is a common language along with a set of norms and beliefs that allows both information and knowledge to be transferred. Fundamentally, franchise network culture is necessary to create the linkages that allow access to international resources. This would be particularly important in pursuing the integration aspect of FDI that focuses on the co-ordination of positions in different national networks and will be critical as franchisors move from an ‘international’ to more of a ‘transnational’ type of strategy Bibliography Bai, C. and Tao, Z. 1999, “Contract Mixing in Franchising as a Mechanism for Public Good Provision, ” Journal of Economics and Management Strategy, 9 (1): 85–113 Brickley, J. A. 1999, “Incentive Conflicts and Contractual Restraints: Evidence from Franchising, ” Journal of Law and Economics, 42: 745–74. Blair, R.D., Lafontaine, F. 2005, The Economics of Franchising. Cambridge University Press. Dicke, Th. S. 1992, Franchising in America: The Development of a Business Method, 1840- 1980 University of North Carolina Press. Hayers, R. 2006, The Franchise Handbook: A Complete Guide to All Aspects of Buying Selling or Investing in a Franchise. Atlantic Publishing Compan. . Huszagh, S.M., Huszagh, F.W. and McIntyre, F.S. 1992, International Franchising in the Context of Competitive Strategy and Theory of the Firm’, International Marketing Review 9 (5):5-18. Tomzack, M. F., Bond, R.F. 1999, Tips and Traps When Buying a Franchise: Complete Revised and Updated. Source Book Publications; 2nd edition. Sherman, A. J. 2004, Franchising & Licensing: Two Powerful Ways to Grow Your Business in Any Economy. MACOM; Third Edition edition. Appendix 1. Steps of Franchising. 2. Franchise Organization Path Read More