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What Do Troubled International Markets Mean to Franchise Expansion?

Philip F. Zeidman, senior partner, Washington D.C. office of the law firm DLA Piper LLP US and IFA General Counsel; and Dave Hood, president of The iFranchise Group, Inc., a consulting firm based in Chicago, respond to questions on what U.S. franchise companies can expect for international development in the face of challenging global economic forces.

FW: The world economy, by the standards of our lifetimes, remains in relative turmoil.  Under these circumstances, why would any U.S. franchisor contemplate leaving home and venturing beyond, to a “troubled” country or otherwise?

Zeidman: In today’s global economy, no responsible company can prudently ignore the opportunities abroad.  Many markets have higher growth rates than those prevailing and projected in the United States; there has been a startling growth in the middle class in numerous markets–the pool from which both franchisees and consumers are drawn; and there is hardly a place in the world in which there is not a growing appetite for Western goods and services.  Already one-third of the units of the largest U.S. franchisors are in foreign countries.  The bottom line for you is that when you finally do “leave home” you may find the opportunities, the franchisees and the sites already seized by others, including the mounting number of homegrown franchisors.
U.S. franchisors which have fared best internationally are those which are experienced, understand international business, and have the capital to commit to an international strategy.

Hood: Phil is correct. While the media talks about a global recession, there are a number of countries which have fared much better than the United States over the past several years. A good example of this is Australia, where both interest rates and unemployment remain below 5 percent. The U.S. franchisors which have fared best internationally are those which are experienced, understand international business, and have the capital to commit to an international strategy.
FW: If a franchisor is entering a troubled market, how might that affect the profile of the candidate they are looking to work with there?

Hood: Because international master or area developer franchisees tend to hold a much broader range of responsibilities, they tend to be more sophisticated than the profile for franchisees in the United States. To define the profile that is desired for each country, it is important that the franchisor first undertake a country assessment that allows the company to understand the potential pitfalls specific to its business model. If a franchisor is considering expansion into a troubled country, the risk can be lessened if the selected franchisee is capable of overcoming the potential challenges of operating within the country. For example, if financing is difficult to obtain in the country, selecting a franchisee that is capable of expanding with internal capital may be necessary.
Zeidman: In some respects the marketplace itself will address this circumstance. As a general rule, prospects for cross-border transactions are already more likely to be able to weather the storms of adversity. Because they are prepared to negotiate with a foreign company, they are likely to be savvier than the typical domestic franchisee. Because the transaction is much more likely to be a multi-unit deal, they will have greater resources. And they are less likely to have been affected by the credit crunch, probably relying more on family and other resources. Finally, there is a factor almost unique to international rather than domestic franchising. A generation ago, a franchisor would be averse to selling a franchise to an entity already engaged as a franchisee of others. Not today, when it is increasingly viewed as a hallmark of “understanding how franchising works,” with a greater capacity to respond to the inevitable vicissitudes, especially in a “troubled economy.”

FW: How could a franchisor adapt its support practices to minimize the risk of franchising within a troubled market?

Hood: Assuming that all international franchisees will require the same level of support is a mistake that many franchisors new to international development make. In most cases, franchisees in troubled markets will require an increased level of support from the U.S. franchisor. The U.S. franchisor will have a better handle on the particular challenges of the market, and can offer more appropriate assistance, if it communicates or visits with the franchisee on a more frequent basis. The support provided can attempt to focus on the particular issues which are most challenging in the franchisee’s market.
Zeidman: David has it right. There is no democracy among international franchisees. Beyond an adjustment in mindset, a franchisor will need to be prepared to deploy a range of tools when the circumstances demand. If political unrest or other conditions disrupt a supply chain, the franchisor may need to have a built-in redundancy or the capacity to seek other points of entry, which is simply a franchisor acting in its own best interests.

FW: How can a franchisor take a long view, and take stock regularly of a country’s prospects? If the country in which an international franchisee is operating deteriorates over time, how should the U.S.-based franchisor respond to those changing conditions?

Zeidman: The problem is exacerbated by the lag time between announcement of plans to develop and actual opening for business; and it is also painfully underscored by the speed with which, in today’s economy, the soaring eagle can become everybody’s goat.  Who can forget how rapidly Ireland went from the darling of world investors to a veritable basket case?  And the future is likely to see more of these reversals of fortune, rather than less.  The challenge for franchisors is to seek to anticipate these changes, maintain flexibility to deal with them and make necessary changes in their plans and operations to salvage the best possible result.
Hood: Anticipating changes internationally should always be a priority for U.S. franchisors, although it’s also important to plan for changes which arise quickly and are not anticipated. Developing and maintaining strong relationships with international franchisees is also critical, so that trust and mutual cooperation can be maintained when times are not as good as they once were. If conditions within a country deteriorate, it’s important for the franchisor and franchisee to work together to identify what factors they have control over, and what changes in the business model might be appropriate to address the challenges at hand. The more proactive the U.S. franchisor is the better. The longer a franchisor waits to act, the more challenging it will be to address any downturn impacting the franchisee’s business.

FW: Conversely, conventional wisdom relegates certain countries to the status of “troubled.”  What does that mean?  And how can a franchisor look beyond that label to determine whether there may be opportunities worth exploring?

Zeidman: What observers usually mean by “troubled” can be measured quantitatively:  low growth rate, declining purchasing power, rampant inflation, high ratio of public debt to gross domestic product and the like.  But there are other measures which are important: respect for the rule of law, transparency and combating corruption.  At any given time there is likely to be a rough consensus among international observers as to which countries should bear that unenviable label.  Most of the time, conventional wisdom is right.  It is a brave man indeed who would predict record attendance at the 14th International Franchise Exhibition in early March, to take place in Athens.  But conventional wisdom can be wrong as well.  The first reaction to mention of Mexico or Colombia is likely to be a recollection of the reports of drug-based lawlessness.  But Mexico can be a true international marketplace for a U.S. franchisor, and Colombia has grown impressively yet remains under the radar.  Yes, Ireland has been buffeted, but it is coming back.  In short, keep your eyes open for nuggets, even in an otherwise bleak terrain.
Hood: Statistics can be telling, but it’s also important for a franchisor to measure the potential within any given country for the specific industry in which they operate. Challenges can often lead to opportunity, and certain industries can thrive when others are declining. The capabilities of the local franchisee may also enable the U.S. franchisor to overcome challenges in the franchisee’s country. A stellar franchisee in a challenged country could potentially outperform a poor franchisee in what is perceived to be a flourishing economy.

FW: Are there cases in which it could be a potential advantage to enter a country which is considered to be “troubled” in some way?

Hood: Depending on the particular challenges that exist, it is possible that a troubled country could represent a strong opportunity for the franchisor. A good example of this is KFC and their decision to first enter China in 1987. At the time, China was considered to be a very challenging market that few U.S. franchisors were willing to enter. Franchising was very new to the Chinese people, and foreign franchisors were often unclear what rules applied to their business from day to day or from one city to another. However, KFC saw the benefit of being an early entrant into China. Today, with more than 3,000 KFCs located throughout China, Yum! Brands is by far the largest U.S. QSR franchisor in that country.
Zeidman: Another instructive example is McDonald’s entry into Russia, which took 12 years from the inception of the idea to the opening of the first restaurant. Much has happened in Russia in the intervening years, of course. Some franchisors remain wary of the market because of bureaucracy, difficulty of maintaining standards outside large cities, and an apparently endemic culture of corruption. But it is hard to ignore a growth rate of almost 5 percent. For the bold, the iconic example of going where others fear to tread remains that foresighted decision by McDonald’s. One can make a reasoned argument that the parallel for today may be the Middle East where, despite all of the travails and upheavals that region has experienced, there are some compelling counter weights, including the huge percentage of a population represented by consumer-minded young people. 

Zeidman can be reached at philip.zeidman@dlapiper.com and Hood at dhood@ifranchisegroup.com.

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