Five Common International Franchising Mistakes—and How to Avoid them

When the topic of international franchising comes up with clients, many are quick to dismiss the opportunities. Comments such as, "I haven't sold out the U.S. yet," are common. Other franchisors take a more inquisitive approach and ask, "What's it going to cost me?" While some want to know how quickly they can open because they want the initial fee in the current fiscal year or would like to go there on vacation.

Whether the client is skeptical or overeager in his attitude toward international franchising, I typically ask the same question: "Is this a good market for your products or services?" The most common response: "I don't know."

Such lack of clarity can be a serious problem for franchisors embarking on an international franchising strategy—and resulting mistakes can put ventures at risk. The following article covers five common mistakes made by international franchisors and provides best practices for avoiding or mitigating these errors.

Lack of Strategy for International Growth

Franchisors often begin international development by responding to random inquiries from a prospective master franchisee or developer claiming to have the experience and resources to develop the concept. Why do franchisors respond to these inquiries? The reasons vary – expense-paid trips, competitor presence in the region, or up-front fees for rights to the country – but often the reasons do not align with a focused global development strategy.

While it may be tempting to go after large, well-known markets, this may not be the best strategy for you. Hopping all over the world to visit and provide support is expensive and time consuming. And, while India and China may seem like close markets, the distance from Beijing to Mumbai is 2,958 miles—slightly further than from Los Angeles to New York.

A strategy for international development should be based on an assessment of franchisor resources and a careful examination of the best markets for your products or services. As Ned Lyerly discusses in Focusing Your Global Development (March 2009 Franchising World), a focused international development strategy involves evaluation of your organizational readiness, evaluation of your resources, a financial plan and research. This is not a one-time or annual plan. It is a long-range strategy for expanding to the right countries at the right time and devoting the proper resources to do so based on the following principles:

• Organizational Readiness. Franchisors planning international expansion should have a profitable business model, core competencies to provide all levels of support and the ability to replicate these attributes in other countries.
• Evaluation of Resources. You have the internal resources available needed to support international expansion. This includes an appropriately trained and experienced staff dedicated to or with the time to support master franchisees and developers in other countries.
• Financial Model. You have the funds available to support international expansion and have determined the impact of international expansion on your current financial position. For example, even if you receive a large up-front fee, it may not be recognized in full as income in the year received; so, the offsetting liability will affect your financial condition, especially if you spend a lot of the fee on support or other activities.
• Research. You have investigated the potential markets to determine if they are appropriate for your goods or services and determined that the legal environment is appropriate for your system. Have you determined if there are local laws or cultural traditions that do not support the development of your concept without significant adaptation? For example, McDonalds had to modify their system to adapt to the market in India, where beef is not a traditional food item.

After this is done, you can begin to evaluate markets in countries and regions.

Insufficient Resources and Commitment to Support International Operations

International franchising is not simply translating the operations manual into another language, training a franchisee to operate a unit—then requiring the franchisee to operate just like franchisees do in the U.S. Developing and supporting international franchises requires commitment from all members of your executive management, strong understanding of what you do well, and a willingness to work cooperatively with your master franchisee or developer to adapt your system to fit into the culture and market in the country.

Support of master franchisees and developers typically requires additional staff and resources. Considerations should include the following.

• Management Commitment. Management needs to convey that providing support to the master franchisees and developers is just as important as supporting domestic franchisees.
• Staffing Assessment. Whether you use your current staff or develop a dedicated staff for international operations is affected by several factors. For example, does the existing staff have the skills and time necessary? Are any people with international experience available within the budget?
• Intranet for Information Sharing. One of the best tools for providing international support is to have very robust and complete intranet. This allows the master franchisees and developers to access information they need to operate their units and provide support to subfranchisees and unit managers 24/7—even when your offices are closed. In some parts of the world, their business day is when we are sleeping.
• Cost of Support. You should also expect to spend most, if not all of the initial fee for support. It may take the master franchisee or developer several years to establish a number of units paying royalties sufficient to pay your costs for ongoing support.

Poor Partnering Decisions

Franchisors face a critical decision in granting a master franchise or development rights. Such decisions shouldn't be based on who can "fog the mirror" or come forward with the first check—nor should they be made without thorough due diligence on the prospective master franchisee or developer.

A well-informed decision on who you grant a master franchise or development rights is a rigorous process that should involve, at minimum, the following steps.

• Identify the target markets that have a need for your products and services.
• Understand the business model—direct, master, area development or joint venture—that works for you in the market.
• Have a thorough understanding of the financial resources, skills and experience of the people who will be responsible for the operations of the master franchisee or developer.
• Ensure you you are not entering into agreements with persons suspected of being involved with terrorist organizations. This is a serious violation of federal laws and can subject you to very substantial fines and penalties.

Unrealistic Development Goals

Unrealistic development goals include granting the master franchisee or developer a territory that is too big, requiring too many units, subfranchising too early, and proceeding with insufficient capitalization.

You and your master franchisee or developer should have a mutual goal of opening as many units as are appropriate for the market. However, a savvy master franchisee or developer will not move forward without a good understanding of how big a territory it has the resources to handle and how many units are appropriate for the market. It will also understands the business well enough to grant and support subfranchises—and has sufficient capital to do all of this.

If a master franchisee or developer has the skills to open and support a large number of units, but does not have the financial resources a joint venture may be appropriate. Or perhaps the master franchisee or developer is not the right one.

A 2005 study by the Cornell University Center for Hospitality Research revealed some interesting statistics on international master franchises. In Biting Off More than They Can Chew: Unfulfilled Development Commitments in International Master Franchise Ventures, Arturs Kalnins, Ph.D., found in a sample of 142 ventures of 53 U.S.-based food franchisors in 37 countries: (1) only 55 (39 percent) survived to the end of the development term; (2) the median number of units that are intended to be opened is 34; (3) of the 55 that survived to the end of the development term, the median number of units opened was 3; and (4) only six (11 percent) met their full development commitment.

So, this is one area where being more conservative may help to preserve the relationship and meet the agreed-upon goals.

Failure to Understand the Legal Environment

A franchisor that grants rights to develop its system in a country without understanding the laws, rules and regulation affecting its business and the sale of franchises adequately puts itself at significant risk. Serious misstep could lead to the demise of the system in that country and make it impossible for the franchisor to continue operations. Worse yet, it could lead to fines, penalties or criminal convictions.

Early in the process of developing your international expansion strategy, it is important to engage the services of experienced international franchise attorney who know local counsel in countries where you want to develop your system.

Legal issues you must consider include franchise, distribution and agency laws; trademarks registration and other intellectual property protection; anti-trust and competition rules; withholding and other taxes; and U.S. laws that apply to international development (Foreign Corrupt Practices Act, USA PATRIOT Act and export controls).

As soon as you begin considering international expansion it's imperative to start registering your key trademarks in target countries. In most countries, the first to file a trademark application is the one who gets rights to the mark. It doesn't matter that the mark is used by you in the U.S. or other countries. So, filing early will help to prevent trademark "pirates" from registering your mark then trying to negotiate a "ransom" to sell it back to you.

Conclusion

International franchise development can be one of the most exciting things you can do to expand your business and energize to your concept. While it can be expensive, time consuming and sometimes frustrating, it can also be very rewarding. If you decide international expansion is right for you, enjoy the journey—and be sure to avoid common mistakes that can derail your strategy.