Role of Business Format Franchising in Multinational Businesses - Essay Example

Introduction Franchising is a vertical contractual relationship between the franchisor and one or more franchisee (Grunhagen & Dorsch, 2003). It is abusiness arrangement that originated in France in the 18th century (Inma, 2005). “Franchising” is a French term that means “granting of right" or "an exemption". The franchisor has an established business package and enters into contractual relationship with small firm owners known as franchisees. The franchises have to necessarily operate their business according to the terms and the format as specified by the franchisor. The franchisor-franchisee relationship is based on mutual support and trust. In this relational exchange, they share benefits and costs (Grunhagen & Dorsch, 2003). The franchisor provides support, technology and advice to the new franchisee and guarantees continued support. In exchange, the franchisee has to pay an entry fee and a continued royalty on sales and advertising fees for regular services (Inma, 2005). Franchising is different from other forms of business. The franchise owners try to assess the value they receive in exchange for the sum paid. They would remain in the relationship as long as they perceive that they receive a fair value for the payments made to the franchisor. In this relationship, the franchisor or the principal does not invest its own fund in the local service unit because the responsibility of maintenance, construction and management of the local operation lies with the franchisee (Fladmoe-Lindquist & Jacque, 1995; Welsh, Alon & Falbe, 2006). The business format of franchising was based on two dominant theories – the agency theory and the resource scarcity theory (Inma, 2005). Based on the resource scarcity theory, as the company anted to expand and resources were scarce, franchising became a means of obtaining capital. In addition, it also eased managerial constraints upon the growth of the medium and small-sized firms. The agency theory viewed franchising as a means of efficiently controlling the problems that could arise due to the difference between the agent and the principal. Thus, these theories are based on the view that it eliminates the constraints that a firm could encounter in expansion. Although franchising originated in France, today Australia is the most franchised nation per head of population in the world. A franchise organization is claimed to be a hybrid form and has complex contractual arrangements. However, the franchised system can have hybrid forms as well as hierarchy firms (Inma, 2005). This implies that there can be both franchised units and company-owned outlets. In the hybrid arrangement, the franchisor controls the franchisee as per the terms of the agreement whereas in the company-owned outlets, the franchisor has full authority like a centralized bureaucracy or a hierarchical organization. In the fast food sector, organizations such as McDonalds have 90% of their franchisees who are small entrepreneurs and only a few company owned outlets. At times franchisor may have a contract with a master franchisee who in turn has several franchisees under him (Welsh, Alon & Falbe, 2006). This is indirect franchising and is usually found in emerging markets. This has several advantages to the franchisor such as access to resources, knowledge of the local market, and developing a successful franchise as a tool for selling to prospective franchisees. However, there are chances of loss of control in this form which may result in reduced profits for the franchisor as well as the franchisee. Role of Business Format Franchising Franchising works well in developed economies as well as in the transition economies such as the Czech, Republic and Slovenia who have no history of entrepreneurial ventures (Hoffman & Preble, 2004). Franchising provides them with the support and motivation which they would not receive otherwise. Franchising provides a source of competitive advantage. It also enables businesses to adapt to different cultures and different regulations round the globe. Franchising works well through out the business cycle. Even during downturn, franchising has its own benefits as the white-collar workers see franchising as a desirable option. Monitoring too has become easier due to advanced communication and information technology. Franchising has provided a format or a “business system” that guarantees the commitment to adherence to the performance standards and operating methods (FrancExcel, n.d.). Motivation in Franchising The integration of the world economy and increased market liberalization have opened up the economies and presented unprecedented oppurtunities for capital flows to other countries. With the rise in market capitalism, advanced ICT, improvement in long-distance travel has made the world interconnected and interwoven. Thus the MNCs started pursuing global expansion strategies and franchising was one them. Firms use franchising to raise capital, to obtain human resource at low cost, and with minimum investment, they expand and plan growth. It is used as a mode of entry and a growth strategy for firms (Inma, 2005). Domestic saturation has forced firms to expand internationally or to distant geographical locations. Through franchising, firms start the process of internationalization into industrial markets like US, continue into dissimilar markets such as Japan and then progress into emerging markets that are cultural distant (Welsh, Alon & Falbe, 2006). This is the franchising life cycle. The emerging markets offer unsaturated markets that are highly urbanized and populated cities. Moreover, trade liberalization has enabled companies to enter emerging markets without any restrictions. The emerging markets offer a huge demand for western-style products and services. Moreover, minimal financial investments are required and raw material can be produced locally. Franchising results in economies of scale for the franchisor because he gets access to capital at lower risk and the costs are shared with the franchisee. Establishing one’s own distribution system would be costlier and through franchising, rapid market penetration is possible at comparatively lower costs (Hoffman & Preble, 2003). In exchange for their support, the franchisors get a motivate workforce and reduced monitoring and control costs. Accounting and advertising firms followed their clients into the foreign countries that moved into new countries as a response from their customers. Thus as industrial units internationalized the professional business services also expanded overseas (Alon &McKee, 1999). Franchising was used by these professional business services as the mode of entry because of low financial risks and because of the advanced communications and information technology. In addition, this business format enabled a strategic alliance so that the franchisees could benefit from the economies of scale. However, cultural difference and the host country lack of facilities required the franchisor to devote monetary and human resources for expansion. Distance management, cultural adaptability and host country management skills are necessary before the franchisor plans to expand overseas. Human and capital resources become barriers to entry. During downturn, the franchisors are unable to sell their systems domestically and then they seek foreign expansion. High start-up costs become a disincentive to expand but through the business format of franchising, the franchisors gain the motivation and confidence as their risks are minimal. Besides, it has also been found through studies that greater the geographical and cultural distance, the greater the incentive to enter into franchise arrangements (Fladmoe-Lindquist & Jacque, 1995). Risks of overseas expansion In the field of retail format franchising, the emerging markets have become the fastest growing targets by international franchisors. Franchising requires monitoring and control but in the emerging markets these pose a challenge because of the geographical and cultural distance (Welsh, Alon & Falbe, 2006). Moreover, franchising in this sector is not done merely by the largest franchisors but by anyone who finds this a profitable way of expansion. Small but well know UK retailers such as Body Shop and Benetton have used franchising to be their main international activity. Political and economic risks prevail in the emerging markets which need to be evaluated although the financial risks and investments are minimum. Having a local franchisee promotes political and cultural acceptability and the franchisor gains knowledge of the local regulations, cultural, customs and norms. The franchisor may have difficulty in repatriating royalties or in protecting copyright or trademark. They may encounter difficulties in monitoring, in language and business norms and in termination of the contract. Limited infrastructure and unstable political climate are other risks that franchisors have to be prepared fro in emerging markets. In the services sector, the clients are unable to assess the quality of services unless they actually buy those services. Thus, when franchising, the service firms have to invest in brand and image building before they expand overseas (Alon &McKee, 1999). They must have the ability to enhance trust in the professionalism of their work. This requires establishing large distribution networks. They must have unique linkages with their clients which is difficult for competitors to replicate. Distance and time increase the level of uncertainty as the information gap widens. Despite the technological improvements, it is still difficult to gather and receive information about the operations in the foreign countries (Fladmoe-Lindquist & Jacque, 1995). It may not provide an accurate picture of service delivery and may even be misleading. The franchisors are unaware of the behaviour of the foreign agents and the host country business laws. Currency risk also impacts franchising activity but then this is to some extent offset because the franchisors receive the fee as a percentage of the revenues and not as a flat fee. Hence even if the exchange rates rise or fall, the franchisor receives a percentage of gross revenues. Royalty taxes are prevalent in many nations in North and South America and Asia (Hoffman & Preble, 2004). Some countries in Europe have contract laws while some countries in Europe lack specific franchising legislation. Hence, before franchising, the franchisor should be aware of country-specific laws and regulations that could impact the perceived benefits in franchising. Apart from the laws, the cultural distance can lead to difference in expectations in service, tastes and habits. For instance, the Germans prefer quality while in Thailand hot and spicy food is required. The French prefer sit down meals while the American wants quick service meals. Thus the use of local franchisors helps in getting an immediate knowledge of the local culture, tastes and preferences. Effect of international franchising on globalization Due to reduction of communication barriers even small firms prefer franchising because of the benefits it provides. The government bodies in countries such as Malaysia and Singapore encourage franchising (Hoffman & Preble, 2004). Franchising activities can help the developing economies to grow and thereby enhance the process of globalization. Thus some governments have even passed laws, established organizations and develop support programs such as conferences and exhibitions to provide momentum to this concept. The Middle-Eastern governments have encouraged investments for the development of infra-structure through franchising. This has brought about changes in different sectors such as healthcare, education and telecommunications. Because of the increased activity in franchising, consumer globally are now able to procure goods that were typically out of reach. This is because firms have been able to grow and expand in multiple countries. Globally, the middle-class population is upwardly mobile and they have been able to take advantage of the goods and services that have become available through franchising. They have found the benefits of savings on time and it also signals their prosperity. General Motors could open up in China and they believe that China’s middle class will grow exponentially in the near future. Globally there are 14,561 franchised units that generate 3.7 billion dollars. Franchising has allowed major business sectors such as restaurant and non-food retailing to grow and reach the masses in most countries. Socioeconomic impact of international franchising The globalization of consumer markets has contributed towards the growth of franchising. In international franchising, the company must have a stakeholder approach to management. They must take into account not only the shareholders and the ultimate consumers but any group that may be directly or indirectly affected by the activity (Alon &McKee, 1999). Agency theory has been often used to explain the phenomenon of franchising. It provides the franchisor the ability to monitor and control the franchisee. However, because of the geographical and the cultural distance, monitoring is very difficult but the franchisor has an incentive Retail franchising is able to homogenize the markets and this is considered to be an adverse impact of franchising. There is a tendency to shift from the traditional and local cultural elements which can lead to westernization of preferences, especially among the youth (Welsh, Alon & Falbe, 2006). The political establishments and the older generation do not give in to such temptations, though. The consumer gains because they receive lower prices through an efficient distribution system. Another benefit of franchising and its impact on globalization is that smaller entrepreneurial firms or the neighbourhood shops refurbish their establishments and enhance the product and service offerings when they see overseas competition ((FrancExcel, n.d.). This leads to better value products and services at lower prices. The economic impact is that the traditional and neighbourhood stores get affected as they are unable to effectively compete with the distribution and marketing expertise of the multinational franchisors (Welsh, Alon & Falbe, 2006). At the national level, franchising can negatively impact the host country balance of payments over time because of the repatriation of royalty fees by the franchisor. Franchising creates jobs for young graduates. For instance, in the US it creates 170,000 jobs every year (FrancExcel, n.d.). In the emerging economies, franchising would help develop indigenous labour force through the training provided in the agreement. Pros and Cons of Impacts of International Franchising Culture makes a difference in how the franchisor approaches the local market. The franchisor should be able to evaluate the highly dissimilar markets and have a clear understand of the characteristics of the market in which they want to enter (Toncar, Alon & McKee, 1999). Cultural variables are related to values, work habits and interactions between employers and employees. They have to adapt to different cultural nuances to be successful. They may have to change the product and operating format. International franchising has both advantages and disadvantages for both the franchisor and the franchisee. The franchisee benefits as it decreases the likelihood of failure and increases the potential of earnings (Tuunanen & Hyrsky, 2001). He gets the benefits asset brand, use of trade mark, logo and advertising. Association with a reputed concern immediately gives the new or established entrepreneur a quick star into the business. As a part of the agreement, the franchisee receives ongoing support and training, technical know-how wherever necessary and independence of running business. Even if the franchisee has no prior experience, he benefits from the established brand name of the franchisor. He gets the benefit of a proven business format, a proven business system, risk sharing and territorial protection. However, there are certain disadvantages also. Even though the franchisee operates as an independent entrepreneur, the monitoring by the principals is constant and hence control measures exist. There is lack of self-actualization and conflicts arise between the two arties over sharing of costs and risks. Franchisee fee can be very high initially especially when a reputed brand enters a new market for the first time. The concept of international franchising is a very effective mode of entry into foreign markets as the risks are shared. It enables the franchisor to gain from the knowledge and expertise of the local market through the local franchisee. The investment is negligible. On the contrary, the franchisor gains, as it is also an effective means of raising human and financial capital. Other benefits to the economy in franchising are the improvement in the lifestyle of the people in emerging economies that it has brought about. Products and services of global standards are now available in most countries and this has enabled the global consumer to taste and experience what so far was the prerogative of the West. It leads to creation of jobs thereby adding to the growth of the economy. However, the franchisor is totally dependent on the local franchisee for the local information and this may not always be correctly fed to the franchisor. If the franchisor does not have the right information on the cultural values and habits of the local consumer, inappropriate products could be marketed which could end up in incurring losses. Franchising requires a thorough knowledge of the laws and regulations of the local country and repatriation of royalties and fees could be impacted. Franchising has resulted in forming global consumers which has impacted the local neighbourhood stores. Conclusion Franchising is a contractual agreement between two parties in exchange for a fee. International franchising has been taking place as companies found the domestic markets saturated. Other reasons for expansion through franchising were based on the agency theory and the resource scarcity theory. This was found to be an effective and efficient method to raise human and financial capital. Franchising business format was found to be an effective mode of expansion and a risk-free method of trying out new markets. A franchisor can have more than one franchisee in another country or can even have company owned outlets. The terms of the agreement are usually meant to benefit both the parties and the risks and profits are shared. However, there are advantages and disadvantages to both parties concerned and it all depends on the duration of the contract and to what extent they are willing to work together. International franchising impacts the local economy in several ways. It creates jobs and employment while also positively impacting the GDP. However, the repatriation of the royalties and fees can also negatively impact the balance of payments in a nation. The local stores can either change their strategy and enhance their services to compete with the international competitors or may be forced to close down. On the social front, it has created global consumers as consumer even in emerging economies has access to global products and services. It tries to create homogenous consumers but that is not possible because of the differences in cultural values, tastes and habits. The geographical and cultural distance does create impediments but once the franchisor has understood the nuances of operating in a new economy, the challenges can be overcome. Reference: Alon, I., & McKee, D.L. (1999). The internationalization of professional business service franchises. JOURNAL OF CONSUMER MARKETING. 16 (1), 74-85 Fladmoe-Lindquist, K., & Jacque, L. (1995). Control Modes in International Service Operations: The Propensity to Franchise. Management Science. 41 (7), 1238-1249 FrancExcel. (n.d.). Franchising And Globalization. Retrieved online 11 May 2010 from http://www.franexcel.com/resources.php?id=26 Grunhagen, M., & Dorsch, M. (2003). Does the franchisor provide value to the franchisee? Journal of Small Business Management. 41 (4), 366-384 Hoffman, R.C., & Preble, J.F., (2003). Convert to compete: Competitive Advantage Through Conversion Franchising. Journal of Small Business Management, 41 (2), 187-204 Hoffman, R.C., & Preble, J.F., (2004). Global franchising. Journal of Services Marketing. 101-113 Inma, C. (2005). Purposeful franchising: re-thinking of the franchising rationale. Singapore Management Review. 27 (1) Toncar, M., Alon, I., & McKee, D. (1999). CULTURAL DETERMINANTS OF INTERNATIONAL FRANCHISING: AN EMPIRICAL EXAMINATION OF HOFSTEDE’S CULTURAL DIMENSIONS. Retrieved online 11 May 2010 from http://marketing.byu.edu/htmlpages/ccrs/proceedings99/toncar.htm Tuunanen, M., & Hyrsky, K. (2001). Entrepreneurial Paradoxes in Business Format Franchising: An Empirical Survey of Finnish Franchisees. International Small Business Journal. 19 (4). Welsh, D.H.B., Alon, I., & Falbe, C.M. (2006). AN EXAMINATION OF INTERNATIONAL RETAIL FRANCHISING IN EMERGING MARKETS. Journal of Small Business Management. 44 (1), 130-149 Read More