Internationalising Restaurant Concepts

17 January 2014

Mark Abell

The growth of consumerism and a growing aspirational middle class in so called “developing markets”, coupled with fairly stagnant domestic markets in the US and western Europe, and fuelled by the remorseless march of globalisation has led to the internationalisation of not only the ubiquitous hamburger and pizza chains such as McDonalds, Burger King, Pizza Hut and Domino’s but also a host of smaller and relatively younger brands.  Markets such as the Middle East, China, South East Asia and India are seeing foreign restaurants, particularly from the US and the UK flooding in to meet the demand for an ever wider selection of eateries.

However, most of these restaurant brands lack the capital and both the managerial bandwidth and experience to tackle these geographically disparate markets alone.  In order to overcome these substantial handicaps and to avail themselves of the market expertise of local operator, thereby helping to increase their chances of global success, they look to partner with a developer or master franchisee.

Preparing for Success

Although many restaurant companies have successfully used this approach, it is not a guaranteed path to international success and it is important that it properly prepares and implements an appropriate strategy.

For a restaurant business to be capable of expanding internationally it must have a distinct brand and trade dress, definable know-how and a distinct way of doing things that distinguishes the business from others. Each element of the know-how taken by itself may well not be unique; there are for example, only a limited number of ways to grill a hamburger, fry chips and make a milk shake. The combination of them however may be unique. It must certainly be distinctive. When coupled with the brand owner’s name and trademarks, the system should be identifiable and distinctive. This will create the value of the business and make it attractive to local partners who will have to invest substantial time and capital in growing the business.

This means that the restaurant’s know-how must be carefully identified and easily communicable. Intensive training courses and an operations manual will therefore be necessary. The potential franchisor must ask himself whether or not the concept lends itself to this and satisfy itself that there is definable, communicable know-how in the business. The brand owner needs to ensure that the name, trademarks and other intellectual property rights do in fact belong to him. It cannot grant local operators the right to use a name and trademarks over which he does not have any proprietary rights in the e local market. The trademarks therefore need to be carefully protected in all of the appropriate classes in all of the potential target markets.  A well thought through and meticulously implemented global brand protection strategy is therefore essential. All this know-how and the brand constitute the brand’s intellectual property.

Keeping it Simple

The best restaurants brands in terms of internationalisation are simple ones. Local operators have to be trained to run the business successfully. The more complex it is, the more difficult this becomes. The more complex the supply chain, the more difficult it is likely to be to ensure the quality of the offering in other markets. Local food regulations can be problematic – some pizza chains have found that the “ham“ they supply the local operators in Germany for their meat pizzas do not count as “ham” under German law. Local culture and taste, religious dietary dictats (such as Halaal and Kosher) all mean that restaurants face the unique challenge of “localising” their menus without compromising the brand’s integrity.  Likewise the simpler the set-up of the business in terms of equipment, fixtures and fittings the better. The brand owner must therefore spend time and money simplifying control, reducing administration work and trying to create a more or less idiot proof system that local operators can quickly learn and easily operate, and that the brand owner can easily support. The local partner and the brand owner need to work together carefully to overcome these potential barriers to success in each target market.

It must be borne in mind that ordinary restaurant businesses are so busy battling with day to day survival that they can rarely engage in strategic long term planning or research new menu items properly. In the context of an international restaurant business the brand owner’s role involves carrying on exactly those activities and so any restaurant business looking at internationalisation business should be developed with this in mind.

Structuring a Restaurant Business's International Growth

Corporate Outlets and Unit Franchises

This is the most basic form of franchising.  It is most often used in domestic franchises but larger operators such as McDonald's also use it as part of the international strategy.  The franchisor operates a pilot operation in the target market and then directly grants franchisees a right to operate one (or a number of) units.  The burden it places on the Franchisor means that it is rarely used internationally.

Master Franchise Agreements

This is much used in more developed markets such as the UK.  It is the model used by the likes of Domino's Pizza.  In this relationship the franchisor grants to another party, described as a Master Franchise (or sometimes a 'Sub-Franchisor'), the right to itself open franchise outlets and franchise third parties described as 'Sub-Franchisees' to open franchise outlets within a specified or exclusive territory.

Development Agreements

"Big Box" restaurant businesses often appoint developers, particularly in markets such as the Middle East and Asia.  Brands such as Pizza Hut, Nando's and Dairy Queen often use this approach to foreign markets.  In this relationship the franchisor grants exclusive rights to a party described as the 'Developer' to develop a territory by itself opening a number of franchise outlets.  Developers must have substantial capital and managerial resources and are usually experienced operators.

Hybrid Structures

Subordinated Equity Agreements

Restaurant companies are increasingly finding that their longer term international strategic aims are not always met by “vanilla” franchising.  Their commercial aims require more sophisticated, “hybrid” structures, often involving taking equity in the corporate vehicle that the franchisee has created to develop the brand in the territory.  There is a wide range of such subordinated equity structures available, the appropriateness of which will depend upon the franchisor’s commercial priorities, by their longer term market entry strategy, the franchisor’s shareholders’ ultimate exit strategy, tax planning and so on.

Joint ventures are sometimes used to try and add further flexibility to traditional franchising structures, but these more often than not result in a head on clash between the control dynamics present  in a traditional shareholder’s agreement and the need for the brand owner’s need to have unfettered control of the brand. Subordinated equity agreements enable the parties to circumvent these inherent tensions and enable equity interests to become a part of the brand owner’s overall strategy.

In many jurisdictions these can have a substantial impact upon both the regulatory and tax issues that the franchisor has to deal with.  As a result subordinated equity arrangements tend to have to be tailor made to each market, whilst at the same  time not compromising the  integral homogeneity of the over-all international structure.

Subordinated equity structures are sometimes used in conjunction with other “extra-franchise” structures, such as management agreements of various types

"Manchising"

Management agreements tend to be used by some larger restaurant businesses when their foreign developer has sufficient capital to invest establishing the brand in the target market, but does not have access to the level and depth of operational expertise and resource that will be required to help ensure the brands success in the target market.  It also offers the franchisor a further income stream, allied to, but distinct from that which it receives by way of the franchise agreement. Historically these have been most common in the hotel sector, but more recently they have become part of hybrid franchise structures in a range of sectors including retail and restaurants.

Conclusion

Restaurant businesses are currently going through a period of substantial international growth, particularly into the Middle East, Asia and the former Soviet Union.  Franchising, in various forms is generally their preferred catalyst for such cross border growth.  This is well illustrated by the "Burger Wars" that are currently raging in the UK.  Home-grown players such as Gourmet Burger Kitchen, Byron, Ed's Easy Diner and Meat Liquor are finding that they are having to compete head to head with US based gourmet burger concepts such as Five Guys, Steak & Shakes, Caliburger and Smashburger.  This culinary combat is set to expand across Europe and the Middle East into Asia and Russia over the next year or so, at least according to the press releases that these brands are making.  


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