Hamilton Pratt

Internation Expansion

There is no right or wrong way to expand internationally, but the most common mistake is to assume that the overseas market will be identical to a franchisor’s home market.  Several substantial US franchisors expanded  into the  United Kingdom on this basis only to find that what had been an extremely successful  franchise  operation  in  the US was unsuccessful  in  the  UK  because  the  franchisor had failed to take  into  consideration  the peculiarities of the UK market.

There  are essentially five ways in which a franchise operation  can  expand overseas:-

Direct Franchising

In  most  cases  direct  franchising will not be feasible  for  the  following reasons:

(a)  substantial  tax difficulties may arise in repatriating service fees  and other payments from franchisees to the franchisor;
(b)  it  is an essential element of franchising that the  franchisor  provides adequate  consultation, back-up and assistance to franchisees and in most cases this will not be possible if the franchisor is situated in another country;
(c)  the franchisor may have little information and knowledge about the target country;
(d)  difficulties may  arise in enforcing strict adherence to  the  franchise agreement and operating manual if the franchisor is resident in another country.

Branch or Subsidiary

There are, of course, substantial legal differences between setting up a branch office and setting up a subsidiary in a foreign country but many of the commercial implications are the same.

The advantage of a branch or subsidiary operation is that the franchisor remains in control of the franchise operation and does not have to share any of the revenue with a third party.

The major disadvantage of a branch/subsidiary operation is that the target country may be a materially different market from the home territory.   This may make the target country difficult to exploit without advice and assistance from an existing business within the target country.   Further,  in  some countries  it is important for franchisees to deal with what they consider  to be  a “home”  business,  and not a branch or subsidiary operation of a foreign company.

Joint Venture

In  order  to  overcome  some  of the  disadvantages  of  a  subsidiary/branch operation franchisors may consider setting up a joint venture.  The partner of the franchisor in any joint venture would be an existing business in the target country with knowledge of the market in that country.

There  are  substantial disadvantages to a joint venture operation, which  are not  unique  to franchising and relate to such matters as:  who  has  control; what  functions  are  performed by each of the joint venturers;  what  is  to happen should there be a dispute;  what will be the dividend policy of the joint venture (one party may be seeking capital appreciation whilst the other may be looking for  an  income   stream);  and how will  board/shareholder approval/consent to major decisions be obtained?

Often franchisors, if they decide to adopt the joint venture route, strengthen their position by requiring the joint venture company to enter into a master franchise agreement, and possibly also a trade mark licence, in respect of the trade mark to be used in the franchise business.

Master Franchise Agreement

All forms of international expansion impose very considerable management strains on a franchisor but the grant of a master franchise enables a franchisor to expand internationally and reduce these strains by relying on a business entity with knowledge of the target country.  The master franchisee appoints sub-franchisees within the target country.

The disadvantage of this approach is the loss of control over the master franchisee and hence the sub-franchisees.  This loss of control can be minimised by the use of a detailed Master Franchise Agreement.

Area Development Agreement

Area Development Agreements have broadly the same advantages and disadvantages as Master Franchise Agreements, save that the Area Developer is required to operate the sub-franchises himself instead of granting third parties the right to do so.   The franchisor may therefore be putting “all his eggs in one basket”.   This will inevitably lead, however, to greater control by the franchisor.  Again a detailed Area Development Agreement is required.

International Expansion Check-list

If a franchisor does decide to expand internationally the following should be considered:-

(a)  Has the franchisor carried out sufficient market research to satisfy himself that his product/services will be successful in the target country?
(b)  Is the franchisor’s management structure sufficient to enable overseas expansion?
(c)   Does the franchisor have the financial resources to expand overseas?
(d)  What effect does the target country’s competition legislation have on the proposed franchising activities?
(e)  What filing, disclosure and registration requirements are in force in the target country?
(f)  What is the tax treatment of payments to be received by the franchisor?
(g) Are there any customs and import controls?
(h) Does exchange control exist?
(i) What are the laws relating to employment and labour relations in the target country?
(j)  How is real property transferred and what is the current state of the property market in the target country?
(k)  Are there any specific rules relating to the proposed activity of the franchisor?