Department of Industry, Innovation,
Science, Research and Tertiary Education
Working Paper 2012–02 May 2012
Industry Policy & Economic Analysis Branch
Industry & Small Business Policy Division
Department of Industry, Innovation, Science, Research and Tertiary Education
The views expressed in this paper are those of the author and do not necessarily reflect those of the Department of Industry, Innovation, Science, Research and Tertiary Education or the Australian Government.
International franchising is an important mode of entry for domestic enterprises wishing to gain and maintain market share in overseas markets. It is especially important for Australian firms seeking to capitalise on the opportunities available due to the ongoing rapid growth of middle classes in the Asia-Pacific region. Identification and analysis of firm capabilities associated with this mode of entry is therefore timely in view of the ‘Australia in the Asian Century’ White Paper. There may be a role for government to overcome information asymmetry for small to medium-sized enterprises that are considering franchising as a mode of entry into Asian markets.
Success in the lucrative but extremely challenging markets of the Asia-Pacific is, by no means, a foregone conclusion. The development and deployment of a given set of firm capabilities can facilitate market entry. Based on a review of the available academic literature and analysis of a number of case studies, this paper finds that among the keys to securing sustainable competitive advantage through global franchising are: (a) capabilities in market research; (b) in the selection of overseas partners and (c) entry mode; (d) in franchisee monitoring; (e) in the implementation of an effective knowledge transfer system; and (f) in internalising tacit local knowledge of franchisees. Finally, in order for the franchisor to be successful in a foreign market, it needs to be able to achieve adequate bargaining power and control vis-à-vis the franchisee. Each of these capabilities is examined in the paper.
FIRM CAPABILITIES IN INTERNATIONAL FRANCHISING 4
Theoretical rationales for use of the franchise model for foreign market entry 5
Motives for the franchisor 5
Motives for the franchisee 6
Capabilities to achieve strategic advantage in international franchising 6
Research capability 6
Capabilities in selection of local partners 7
Capabilities in selecting mode of entry 8
Capabilities in monitoring the franchise network 9
Capabilities in implementing knowledge transfer mechanisms 9
Capabilities in internalising the tacit knowledge of the franchisee 10
Achieving relative bargaining power and control over the franchisee 11
Case studies 11
Outback Steakhouse 11
Conclusion and policy implications 14
FIRM CAPABILITIES IN INTERNATIONAL FRANCHISING
The franchising business model is an exceedingly attractive one for firms seeking to project their brands into new markets, especially the emerging markets of the Asia-Pacific. The use of international franchising as a means to gain entry into foreign markets has seen rapid growth since the 1970s. Indeed, it was reported that as many as 94 per cent of foreign outlets of US companies are operated by means of franchise arrangements (Pharr 2000, p.100). Franchising is particularly prominent in certain industries, such as hotels, food retailing and recreation (Alon 2004, p.156). However, it can also be used in financial, legal, architectural and other professional services to gain access to Asian markets leveraging off successful Australian brands.
Shane (1996, p.74) describes franchising as ‘an organisational form based on a legal agreement between a parent organisation (the franchisor) and a local outlet (the franchisee) to sell a product or service using a process...’. Although it can encompass a variety of different contractual practices, international franchising, put simply, involves the transfer of business know-how, including intangible assets such as a trademark, to offshore firms in exchange for initial fees, royalties (usually based on percentage of sales), and advertising levies (Alon 2004, p.158; Sashi & Karuppur 2002, p.501; Soontiens & Lacroix 2009, p.238; Lafontaine & Blair 2009).
International franchising is part of the bigger picture of an increasingly globalised economic community in which a rising middle class with increasingly homogenised tastes is transforming the competitive environment for businesses seeking new and sustainable profitability offshore. It is also part of the broader process of industrialisation in which global best practices in business are increasingly penetrating new markets, firms and consumers across the world (Alon 2004, pp.161-164).
Examination of firm capabilities in international franchising is also timely given the Australian Government’s commissioning in late 2011 of the ‘Australia in the Asian Century’ White Paper and the need to explore strategic export opportunities in Asia beyond the resources sector, particularly in services (Australian Government 2011). International franchising is an important mode of entry into Asian markets that is worth exploring in the context of the ‘Asian century’ discourse.
With reference to the case studies of Outback Steakhouse, 7-Eleven and McDonald’s, this paper examines the rationales for use of franchising to secure market entry from the perspective of the franchisor and the franchisee, and more particularly, analyses what capabilities are needed to gain competitive advantage through international franchising arrangements. It finds that capabilities in market research, in the selection of overseas partners, in the selection of entry mode, in monitoring, in the implementation of a knowledge transfer system and in internalising tacit local knowledge of franchisees are all keys to securing sustainable competitive advantage and long term profitability through global franchising. Finally, in order for the franchisor to be successful in a foreign market, it needs to be able to achieve adequate bargaining power and control vis-à-vis the franchisee.
Identification of these capabilities, in turn, points the way to a possible role for government in overcoming information asymmetry for Australian firms seeking to access overseas markets through franchising. This may be the subject of further investigation in a subsequent paper.
Theoretical rationales for use of the franchise model for foreign market entry
Motives for the franchisor
Pharr (2000) identifies three dominant motives for explaining the use of franchising as a business model. Firstly, the ‘resource constraints’ theory postulates that the franchisor lacks adequate capital and other resources to expand, and so, can expand more efficiently by using some of the resources of the franchisee. In this theory, the franchisor/principal appoints the franchisee effectively as an agent in order to secure less costly access to the agent’s resources in the target market and to cut down on monitoring costs (Ni et al 2009, pp.4-6; Sashi & Karuppur 2002, p.514).
Secondly, the ‘administrative efficiency’ theory states that a franchisee/owner will have greater incentive and will have greater commonality of business interest with the franchise owner than would the manager of a fully corporate-owned operation (Pharr 2000).
Thirdly, ‘risk management’ theory suggests that a franchise owner can mitigate the risks associated with factors such as geographic distance and cultural differences (Pharr 2000, p.102; Sashi & Karuppur 2002; Grewal et al 2011). For instance, the greater knowledge that a local franchisee has of the host country’s investment policies and exchange rate movements the greater the ability to mitigate some of the risks of foreign entry. Similarly, cultural differences between the parent company and the target market would be indicative of greater risk and therefore greater likelihood to use franchising as opposed to fully company-owned equity investment (Aliouche & Schlentrich 2011, pp.143-144; Sashi & Karuppur 2002, pp.508-509). Presumably, tying this back to the ‘administrative efficiency’ theory, a local franchisee/owner might also have greater incentive to operationalise his or her capabilities and knowledge than, say, a local manager.
Pharr (2000, pp.104-105) further suggests a series of internal factors that are indicative of a propensity for expansion through international franchising. These include capability in franchisee monitoring, greater length of business operation, higher percentage of franchised outlets in domestic operations, capabilities to monitor policies and manage exchange rate movements in the target market and cultural learning capability and adaptability. External factors are more obvious and could include saturation of the domestic market and industry attractiveness in the target market country like high growth rates, political stability, entrepreneurial culture and the existence of a franchisee association in that country.
The other side of foreign market entry franchising is the rationale for the franchisee to enter into a contractual relationship with a foreign franchise. The ‘resource constraints’ theory also applies to the franchisee’s decision to engage in this mode of business operation since it is a means by which it can secure access to scarce financial and knowledge capital; both the franchisor and franchisee share their resources and the risks (Welsh et al 2006).
Particularly important among the motives for such engagement is the opportunity that the local franchisee gains to access more sophisticated resources and capabilities of the overseas corporation. This is especially significant in emerging economies where capabilities are less diffused into general business practices. The adoption of developed country models would therefore potentially afford the franchisee significant competitive advantage over local competitors. In this regard, Stanworth et al (2001) identify operating capabilities, investment capabilities and innovative capabilities as representing various types of know-how that can be secured by the franchisee through international franchising.
The symbiotic relationship between the foreign franchisor seeking entry into new markets and the local entrepreneur seeking access to innovative and sophisticated international business processes and/or a brand name is often crystallised through the franchisee’s ability to leverage off these factors whilst also deploying its superior knowledge of local customer tastes and needs and diffusing this tacit knowledge back into the wider franchise operation.
Capabilities to achieve strategic advantage in international franchising
There are a number of strategic capabilities that are identified in the literature as being conducive to successful international franchising. Firms possessing or developing these scarce, relevant and valuable capabilities might be presumed to have the potential to achieve and sustain competitive advantage in overseas markets.
An obvious capability for achieving success in overseas franchising is the franchisor’s ability to strategically examine the industry attractiveness of the target market for overseas expansion. This can be further divided into strategic ability to select which aspects of the industry in the foreign market to analyse for its potential to afford competitive advantage, and secondly, the capability to conduct market research. Significant sunken costs will be incurred by the franchisor in researching and learning about the customer and regulatory environment of a potential new market (Lafontaine & Leibsohn 2004, p.6). This makes effective research capabilities very important to future profitability.
Broadly speaking, the factors that multinational corporations choose to research fall into the three categories of demographics; existing competition; and the policy/political/legal environment (Thompson 2007, pp.1268-1271). This could encompass cultural values, income levels, consumer tastes, government policies toward the target industry, local suppliers, availability of skilled labour, infrastructure, available land, macroeconomic conditions and the general political climate (such as stability, rule of law, democracy and friendliness toward foreign investment).
Aliouche & Schlentrich (2011, p.142) define the initial research stage and selection of target country as involving a weighing up of the potential of the market (eg. market size, market growth, purchasing power) against risk factors, such as political, economic and regulatory risk. Of course, highly attractive markets are also likely to have significant existing competition and/or the threat of new entrants, so these factors need to be researched.
Given tacit cultural nuances and the gap between written law and practice in many Asian countries, capability to conduct country research is far from a given, but is certainly a sine qua non for successful global franchising. For instance, Starbucks’ entry into many Asian markets such as Taiwan (where it operates through licensing arrangements which might have allowed for greater franchisee feedback) was successful due to the lack of an existing infrastructure of coffee houses for people to mingle in as a ‘third place’ between work and home. But in Australia, Italian migrants had already established a significant infrastructure of street cafes, so Starbucks was relatively unsuccessful and had to close most of its Australian stores in 2008 (Grant 2010, p.515). Further, local companies, such as Hudson’s, Gloria Jean’s and Guru were able to provide similar services and standards to Starbucks whilst also trading off their local Australian or even local city identity.
Another factor is that the relatively limited capital at risk through franchising compared to some other modes of entry affords the franchisor relatively inexpensive but valuable information upon which to base a decision on whether to expand. In addition, if a local franchisee is willing to engage with ‘skin in the game’, this provides a useful market signal about the attractiveness and viability of the proposed venture.
Capabilities in selection of local partners
Linked chronologically to research concerning industry attractiveness and local market conditions is the choice of reliable local partners. Selection of an appropriate local business plays a key role at various stages, such as market and policy research, choice of location and the actual establishment of the franchise operation.
The existence of a capable and trustworthy local partner is particularly important in a country like China with its ‘guanxi’ (network of personal connections) business practice in which networks are essential for obtaining necessary permits (Aliouche & Schlentrich 2011, p.149). Further to the ‘administrative efficiency’ (commonality of interest) rationale for international franchising, there needs to be optimal matching of interests between the two parties for this symbiotic relationship to create competitive advantage in the new market. Among the criteria cited as useful in selecting a franchisee are the candidate’s skills and experience; financial capacity; demographics; personal characteristics; and degree of entrepreneurial orientation (Soontiens & Lacroix 2009, p.239; Grewal et al 2011).
Capabilities in selecting mode of entry
Mode of entry describes the method by which a firm gets its products, technologies, skills and know-how into the target market (Jensen & Meckling 1976). This can include a hierarchical equity-based entry with fully corporate-owned outlets and subsidiaries, a joint venture, or various types of franchising or licensing arrangements. Of course, the nature of the revenue will be different depending on the choice of entry mode—with fee or royalty income being derived in the case of franchising or licensing arrangements. Foreign market entry is unlikely to be successful if a suitable mode of entry is not chosen1. This will require good access to quality legal advice, including legal advice about the extent of intellectual property protection, local franchising regulations2 and legal enforcement generally in the host country (Kong & Zwisler 2007).
Legal protection is particularly important in international franchising since valuable capabilities that have been achieved through brand name, product differentiation, and/or superior processes are given away to a totally separate and offshore business entity in which the franchisor has no equity. Of course, in practice, the franchisor may have means other than contract enforcement to exercise relative bargaining power and control over the franchisee as described below.
Franchising itself as a mode of entry can take various forms. Multi-unit franchising arrangements are far more common in international franchising (Grewal et al 2011). This can include master franchising where the franchisor awards the right to sub-franchise to a single franchisee for a given country from the outset; incremental or sequential multi-franchising where the franchisor awards additional units based upon the performance of the franchisee’s existing units; and area development agreements requiring the franchisee to open and operate several outlets within a given area according to a specified schedule (Doherty & Alexander 2006, p.1307; Gauzente & Dumoulin 2010, pp.260-262).
Master franchising, as exemplified by Outback Steakhouse in Korea, is sometimes preferable in new markets as it can assist the product or service to gain market share faster than would be the case through independent franchise arrangements since the initial master franchisee, if selected effectively, may have considerable financial capacity as well as tacit knowledge of local conditions (Garg & Rasheed 2006, pp.16-17). However, Garg & Rasheed (2006, p.18) also suggest that, although multi-unit arrangements tend to be preferred in international franchising, some franchisors may prefer single-unit arrangements since it limits the bargaining power of the franchisee who would presumably have less market power to demand costly support and sharing of information.
Capabilities in monitoring the franchise network
Shane (1996) and Fladmoe-Lindquist (1996) expand on the ‘administrative efficiency’ rationale for franchising in the international context by postulating that decisions to engage in global franchising are positively related to the key capability that the franchisor has not just in selecting but also in monitoring a global network of franchisees. Effective monitoring will be required in order to prevent the problems of adverse selection and ‘shirking’ by franchisees.
Such capabilities are slightly different from, say, the capability to monitor a chain of wholly company-owned outlets or to manage a domestic franchise network with less diverse market characteristics and cultural challenges. The multi-unit franchising arrangements preferred in international franchising may also make monitoring activities easier since the master franchisee would be responsible for monitoring its sub-units and may be more likely to share market knowledge gained within its network (Garg & Rasheed 2006, p.12-13).
Monitoring capabilities can include the ability to manage remote locations that have differing resource demands, customer characteristics and cultural nuances (Ni et al 2009, p.8). In addition, firms may take advantage of economies of learning in terms of their ability to monitor franchise operations across the world, such as in the case of McDonald’s that has vast franchising capacity with its presence in over 100 countries (2009, p.9). McDonald’s early competitive advantage in hamburger franchising in Australia, for instance, made it very hard for other US-based hamburger franchise chains like Wendy’s, Burger King and Hardee’s to effectively compete, while others such as Arby’s never even attempted the move.
Capabilities in implementing knowledge transfer mechanisms
Quintessential to the workings of the franchise relationship and its ability to confer commercial benefit and competitive advantage for both parties is the ability to transfer capabilities from the franchisor to the franchisee. The business model of the franchisor has to be capable of being replicated to the overseas franchisee, while at the same time, protected from being replicated from existing competitors and potential new entrants. This requires a governance system and contractual protections that optimise benefits to the parties.
Successful franchising requires the knowledge system of the franchisor to be ‘routinised’ into the franchisee’s operations. But what mechanisms are available to achieve this? Windsperger & Gorovaia (2007) provide an interesting analysis concerning transfer mechanisms for organisational capabilities based on the degree to which those capabilities are explicit and ‘codifiable’ on the one hand, or tacit and information rich on the other. They argue that where the know-how is tacit or task ambiguous and therefore less able to be codified or subjected to contractual protection, the parties are more reliant on information rich knowledge transfer mechanisms like face-to-face training, conferences, mentoring and site visits that allow for immediate feedback and non-verbal cues. In this sense, the choice of knowledge transfer mechanism is dependent on the ‘codifiability’ or otherwise of the know-how that is sought to be transferred to the franchisee. A legal contract or franchise manual will be useful for transferring explicit information or knowledge, but it will be incomplete as a conveyance mechanism where tacit capabilities are also sought to be transferred (2007, p.9).
Ideally, since a sophisticated and profitable franchising operation is likely to include both explicit and implicit knowledge (that is difficult to discern or replicate), a combination of both information rich face-to-face transfer mechanisms and lower information rich mechanisms like written contracts, manuals and correspondence would be required (Windsperger & Gorovaia 2007, p.11).
It follows therefore from this theory that where there is a scarce, valuable and durable business capability that is difficult for competitors to copy and where there is effective and optimal matching of the knowledge transfer mechanism to the tacitness or otherwise of the know-how, this would optimise the ability of the franchisor to obtain a sustainable competitive advantage through franchising in the foreign market where entry is sought. In other words, the success of the foreign franchising venture may depend on both the quality of the capability sought to be transferred (presumably a combination of tacit and contractible know-how) and the methods used to convey it to the franchisee.
The flip side of the knowledge transfer mechanism is the ability of the franchisor to adopt and adapt the tacit knowledge of the franchisee and embed this into its wider operations in the target market and other similar markets. This requires skills in building up its relationship with the franchisee and ensuring commonality of interest.
Given the geographic and cultural differences that are likely to exist between the parties, the franchisor must have systems in place that allow it to acquire ongoing, iterative knowledge of local customer tastes, culture, suppler networks, organisational behaviour and business practices as well as economic and industry trends in the host country (Welsh et al 2006, p.13). A high initial capital investment and fee structure may be one factor conducive to ‘bonding’ with the franchisor, thus providing greater incentive on the part of the local franchisee to share its learnings across the franchise network (Ni et al 2009).
There will sometimes be tension between the need to adapt products and services to local tastes and the need to standardise operations across the international brand (Welsh et al 2006, p.30). Therefore, in order to achieve competitive advantage in international markets, there needs to be an ongoing two-way learning process in which franchisors disseminate their know-how to franchisees, while still facilitating the absorption of the tacit knowledge, information and country-specific strengths of the local franchisee into the broader operation.
Achieving relative bargaining power and control over the franchisee
The literature on international franchising arrangements divides power exerted in the franchising relationship into coercive and non-coercive power. Coercive methods would include use of a formal contract and enforcement mechanisms, whereas non-coercive methods may involve use of support services to develop the franchise relationship and exert influence (Quinn & Doherty 2000).
Based on qualitative research of UK-based international fashion retailers, Doherty & Alexander (2006) found that, consistent with the literature, non-coercive methods were preferred as a means to exert control over the franchisee. Franchisors, when engaging partners in new overseas markets, particularly rely on the use of support services which include the franchise manual, secondment of UK-based staff to the franchisee, training, merchandising help, development plans, intensive support during the initial store opening, the appointment of country managers and frequent field monitoring visits.
The following cases are examined to evaluate the extent to which the capabilities in international franchising articulated above have been utilised in practice to facilitate entry into lucrative Asian markets.
At first glace, South Korea would appear to be a country with vastly different traditions in cuisine, culture, society, legal system and industrial organisation compared to the United States. Yet one US-based firm has been able to gain competitive advantage and market leadership in Western-style casual dining in that country.
The Australian-themed but US-owned and based Outback Steakhouse chain of restaurants is one of the few in which casual dining outlets, as opposed to fast food, has been successful in international franchising. After opening in Korea in 1997, it was operating as many as ninety restaurants in Korea within a decade. It achieved competitive advantage by becoming by far the largest international franchise operation for casual dining in the country. Despite operating in 18 overseas countries, its Korean outlets by 2007 accounted for more than half of its entire net income from overseas operations (Lee et al 2008).
Many of the capabilities identified above can be seen in the reasons for Outback Steakhouse’s success as an international master franchising operation in Korea. Research undertaken by Lee et al (2008) found that its decentralised operation was central to Outback Steakhouse’s success. For instance, decisions around site locations, training and choice of suppliers were taken close to the actual outlets rather than at headquarters. The training program allowed for continuous feedback incorporated back into the training program and outlets endeavoured to engage with local communities by promoting and sourcing supplies locally. A portion of the menu was also tailored to local preferences, such as Kimchi fried rice and smaller meat portions than in the US. Recognising local economic conditions in which the opening of the first outlet coincided with the Asian Economic Crisis, Outback Steakhouse offered some of its menu at the price level of five years earlier (Lee et al 2008).
In many respects, Outback Steakhouse in Korea therefore exemplifies the importance of a solid relationship between franchisor and franchisee in which the latter has real autonomy to adjust many aspects of the franchise, such as location selection criteria, menu items and service standards to local conditions. It is therefore able to internalise the tacit knowledge of the master franchisee about local standards and tastes back into its operations. Lee et al (2008) also note that one of the key factors in the operation’s success and ability to achieve competitive advantage in casual dining in Korea was the selection of master franchising through joint venture agreement as its mode of entry. Further, it selected a master franchisee who understood both the brand and local market conditions in Korea.
Like Korea, Japan presents as a potentially lucrative consumer market, but with very different cultural tastes and behaviours from Western countries. Yet consumers and firms in Japan have been highly receptive to the franchising business model with its emphasis on standardised products and service quality—probably more so than European, Latin American or even Australian consumers.
One company that has exemplified this trend is the 7-Eleven convenience store chain that is ubiquitous throughout much of Japan. The first 7-Eleven convenience store was opened in Tokyo in 1974 after Ito-Yokado entered into an exclusive licensing arrangement with 7-Eleven’s holding company in the United States, Southland Corporation. 7-Eleven Japan, however, outperformed its US parent and by the 1990s had acquired a majority share in Southland Corporation. By 2004, there were over 10,000 7-Eleven stores across Japan and it had become the largest retailer in the country in terms of operating income and number of outlets. There were reported to be an extraordinary 30 visit per year to a 7-Eleven for every person in Japan by 2004 (Chopra 2005).
7-Eleven Japan operates primarily through franchises with franchise commissions accounting for over 68 per cent of its revenue from operations (Chopra 2005, p.2). Rather than focusing on spread across Japan, 7-Eleven instead builds up high density clusters of, say, 50-60 stores supported by a distribution centre in areas known to already be popular (2005, pp.2-3). Among the company’s capabilities are its integrated information system which allows purchase information to be analysed quickly, as well as highly efficient distribution and delivery systems where it attempts to micro-match supply and demand using rapid replenishment (2005, pp.5-7).
Reflecting both a tight selection process for franchisees and the strength of its brand, it was reported that less than one out of every 100 applicants for a 7-Eleven Japan franchise was successful (Chopra 2005, p.3). It therefore utilises its superior capabilities in distribution, supply chain management and brand name to attract and select the best franchisees. Its integrated information system allows it to efficiently monitor its franchise outlets and supply them based on actual customer demand.
No discussion of international franchising would be complete without some examination of the company most associated globally with the franchising concept. Established originally in Illinois in 1955, McDonald’s had opened its first outlet outside the US by 1967 (in Canada) and had expanded to Australia, Japan and Europe by 1971 (Lafontaine & Leibsohn 2004, p.8). It currently has over 33,000 stores in 119 countries (McDonald’s Corporation 2012).
McDonald’s predominantly uses franchising to gain entry into new markets across the world. Over 75 per cent of its stores worldwide are owned and operated by franchisees (McDonald’s Corporation 2012). So what capabilities has McDonald’s employed to make its international franchise system so expansive and successful?
Lafontaine & Leibsohn (2004, p.13) argue that, rather than expanding into new markets only once its existing markets have been saturated, most growth in the opening of new outlets occurs in markets that McDonald’s has already entered previously despite the fact that it is often entering many new markets at the same time. McDonald’s often incurs significant sunk costs in evaluating how a new market will respond to its products, but once it establishes that there is high demand for its brand, it opens outlets at a fast pace to offset these sunk costs incurred at initial entry.
As one would expect, Lafontaine & Leibsohn (2004, pp.20-21) also found that markets chosen for expansion were positively associated with high GDP per capita, population, urbanisation and trade/GDP ratio, but not with the absence of key competitors. Additionally, they found that McDonald’s entered the markets with the most promising demographics first (p.26). This would suggest that McDonald’s examines not just the cost and desirability of initial entry, but also prospects for longer term expansion that may occur many years or even decades after first entry.
Given the high percentage of its restaurants that are operated by franchising, selection of the franchisee is central to McDonald’s success. McDonald’s lists criteria for its potential franchisees in certain countries on its website, including ‘high integrity’, ‘business experience in the market’, ‘history of success’, ‘ability to work well with a franchisor’, ‘retail experience’, ‘knowledge of the real estate market’ and ‘significant capital’ (McDonald’s Corporation 2011). Interestingly, a study of the personality traits of McDonald’s franchisees in Australia found that they were statistically more likely than the general population to be extravert and conscientious—traits considered conducive to successful franchising—but lower on neuroticism (Soontiens & Lacroix 2009). The study concluded: ‘it is likely that the McDonald’s franchisee selection and training strategy leads to an identification of candidates who are highly conscientious, extraverted franchisees (and) who … are likely to remain calm under stressful conditions’ (2009, p.242).
A cursory glance at the literature on McDonald’s and the extent of its international expansion therefore suggests that this famous fast food brand does indeed possess and deploy many of the capabilities listed above for successful franchising. This includes superlative corporate resources and capabilities in market research for selection of countries for entry based on their long term profitability, selection of franchisees based on their ability to blend with the McDonald’s business model and intensive training to transfer both tacit and ‘codifiable’ food technology and know-how to the franchisee’s business. McDonald’s also ‘adapts and adopts’ local customer food tastes to particular markets (eg. McArabia Koftas in Saudi Arabia, chicken and rice in Indonesia), and in doing so, like Outback Steakhouse, it internalises the tacit local knowledge of franchisees into its wider operations (Grant 2010, pp.391-392).
Conclusion and policy implications
Global franchising often presents as a relatively cost effective means for firms to gain entry and project their brands into the attractive, but often diverse and risky, markets of the Asia-Pacific. The symbiotic relationship in which overseas-based franchisors and local franchisees pool their resources and share both the gains and risks of entry offers a tantalising model for expansion. The local entrepreneur achieves access to sophisticated international business processes, support services and brand name, while the franchisor is afforded resource efficient and less risky access to new consumers (Gauzente & Dumoulin 2010).
However, analysis of the literature and case studies suggests that success in international franchising is far from certain, and that in order to attain sustainable competitive advantage in international franchising, the franchisor will need to develop a number of key capabilities. Firstly, as exemplified by McDonald’s, the venture may need to incur significant initial sunk costs in market research and develop superlative capabilities in this area. Secondly, all three of the case studies demonstrate the critical importance of developing capability in franchisee selection. Thirdly, choice of mode of entry, such as master franchising or single unit franchising, will play an important role. McDonald’s makes different choices about mode of entry depending on the market and has therefore achieved impressive capabilities in assessing appropriate entry mode based on factors such as market characteristics and the legal framework. Fourthly, as demonstrated by 7-Eleven, capacity to monitor a diverse network of franchisees will facilitate expansion and profitability.
Finally and quintessentially for the franchise business model, capability in appropriating the scarce and valuable knowledge systems (including tacit know-how) of both the franchisor and the franchisee and blending them for the benefit of the overall operation and franchise brand will be crucial to establishing competitive advantage in new markets. An appropriate mix of knowledge transfer mechanisms (eg. franchise manual, training, site visits, mentoring) will be needed. Further, the competitive advantage may be capable of being sustained if the international franchisor achieves relative bargaining power over the franchisee, embeds the tacit knowledge acquired from franchisees into its operations and selects contractual arrangements and a mode of entry that protects its position vis-à-vis the franchisee, competitors and new entrants.
Given the success of global enterprises such as Outback Steakhouse, 7-Eleven and McDonald’s, franchising as a vehicle for foreign market entry, complemented with appropriate capabilities, is likely to continue to be a popular and profitable way for proven domestic brands to access the increasingly attractive industries and growing middle class consumer markets of the Asia-Pacific.
There may also be a role for government to overcome certain of the information asymmetries for small to medium-sized enterprises considering franchising as a mode of entry into Asian markets. This could include assistance in identifying the most appropriate legal framework, potential local partners and in conducting detailed market analysis. These policy implications may be the subject of further investigation in a subsequent paper.
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1 Some firms like Marks & Spencer choose franchising for foreign market entry, but full corporate ownership for its domestic outlets, while Carrefour does the opposite (Gauzente & Dumoulin 2010, p.260).
2 An example of a franchising regulation in an Asian country is Indonesian Government Regulation No. 42 of 2007 which defines a franchise as ‘a special right owned by individuals or a legal entity over a business system that must possess unique business characteristics; be proven to be profitable over a period of 5 years; define standards of goods and services that it is willing to comply with in writing; be simple to teach and apply; be able to provide continuous support; and possess registered intellectual property rights’ (Cornwallis 2007).