This article by partner Mark Abell was first published on The Retail Bulletin and has been reproduced below with permission.
Here Dr Mark Abell of law firm Bird & Bird looks at the issues that retailers need to bear in mind when considering overseas expansion by partnering with a developer or master franchisee.
The growth of consumerism and the aspirational middle class in so-called “developing markets”, coupled with fairly stagnant domestic markets in the US and western Europe and the remorseless march of globalisation, has led to the internationalisation of not only of big fashion retail brands such as Gap, H&M and Zara, but also a host of other brands in the fashion, FMCG, lifestyle and F&B sectors.
Some are luxury/aspirational, some lifestyle, some niche. In most "developing markets" such as the Middle East, China, South East Asia and India increased wealth has led to a desire to adopt a lifestyle that is seen to represent the wealth and apparent sophistication of the West. The performance of Zara in the Indian market is one obvious example. The global growth of IKEA and Tesco is another.
Some of these larger retailers have the finance and resource to expand internationally through wholly owned subsidiaries. However, even they prefer to take a variety of different approaches to the global growth strategy and use different structures for different markets. Other retailers simply do not have the capital, or a managerial resource to internationalise their brand 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, many retailers, both large and small, look to partner with a developer or master franchisee.
Preparing for success
Although many retailers have successfully used this approach, it is not a guaranteed path to international success and it is important that retailers properly prepare and implement an appropriate strategy.
For a retail 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 not be unique; there are for example, only a limited number of ways to present merchandise. However, the product, if not unique, may well be distinctive and of great appeal to its target consumers. The combination of the product and retail environment may also be unique and it must certainly be distinctive. When coupled with a good product, 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 not only must the product be unique and distinctive, but the retail system'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 themselves 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 them. It cannot grant local operators the right to use a name and trademarks over which they do 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 out and meticulously implemented global brand protection strategy is therefore essential. All this know-how and the brand constitute the brand’s intellectual property. A sound logistical infrastructure to handle ordering, shipping and general inventory issues is also needed.
Keeping it simple
The best retail 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 retail regulations can be problematic – some fashion retailers have found their inability to display female clothing on mannequins in the front window of the store difficult to deal with, for example. Different sizing and preferences, different seasons in the Southern Hemisphere. Local culture, taste and religious dictats all mean that retailers face the unique challenge of “localising” both their products and retail system 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 retail businesses are so busy battling with day to day survival that they can rarely engage in product development, improving the supply chain or strategic long term planning. In the context of an international retail business the brand owner’s role involves carrying on exactly those activities and so any retailer looking at internationalisation business should be developed with this in mind.
STRUCTURING A RETAIL BUSINESS'S INTERNATIONAL GROWTH
Corporate outlets and unit franchises
This is the most basic form of franchising. Whilst it is often used in both domestic and international restaurant franchises, it is rarely used in the retail sector. This is most probably due to the issues of developing the supply chain and economies of scale.
Master franchise agreements
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. This is again much used in the restaurant sector, but is not that common in retail.
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. This is the structure used by retailers such as M&S, Debenhams and the Arcadia Group.
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.
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.
Retailers 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 and it forms a key part of the market entry strategies of most retailers in at least some markets. Sometimes this is because of the regulatory environment in target markets. Sometimes it is because it is the best way to ensure commercial success. However, it is certainly not a one size fits all solution to a retailers international expansion plans. It requires careful strategic thought and expert advice from professionals well experienced in the structuring and implementation of such an approach.