When it comes to expanding your business overseas, franchising has become the Modus Operandi of the day. In Singapore, many businesses including restaurants, café chains and fashion stores have shown interest in and considered setting up overseas franchises. It makes sense financially for them in the sense that the franchisor (the business owner that grants the franchise) can charge an initial fee to the abroad franchisee (the person who takes the franchise). Franchising in effect provides an almost cost-free expansion since the original business receives royalties and a constant stream of income from the franchise. But there are pitfalls to avoid. Franchising may not be suitable for all businesses and an overseas operation can fail for a number of reasons.
This article sets out briefly some of the challenges a franchisor venturing overseas may face and how to overcome and resolve them.
Franchise Systems
Companies that wish to enter into a franchise agreement should familiarise themselves with the franchise system. There are three different ways to operate a franchise:
Unit franchise:
The business owner allows only one franchise outlet, and licenses all trade marks and other proprietary rights to only that one outlet.
Area franchise
The franchisee is only allowed to operate under the trade mark or brand name in one designated geographical area, such as the province of New South Wales as compared to the whole of Australia.
Master franchise
The franchisee is entitled to operate in the complete country, sometimes with a right to create sub-franchises and appoint sub-franchisees within the country.
Costing would differ for each of the above types of franchises and is also affected by the potential market size and share in the targeted country.
Regulations and Other Legal Issues
The next things to look out for when considering whether to franchise are the laws and local regulations in the targeted countries, which will impact on the franchisor. In countries like the USA, the franchisor must comply with stringent disclosure requirements while in countries like Indonesia, the franchisor may be required to register the franchise contract with the relevant authority before commencing operations. These requirements do not really present too much of a problem to the franchisor, but they have to be complied with nonetheless. The franchisor should also pay particular attention to laws and regulations in various other countries that directly affect the business enterprise of the franchise. One example of what we mean here is that, since February 2005, franchising has not been allowed in China for foreign retail brands which do not have a minimum of two shops and more than one year of procedures in China. This amendment to the franchise regulations has made it difficult for established local brands to franchise to China.
Of course there are perfectly legal solutions to avoid the problems that may be encountered. The rules differ from country to country and, therefore, any prospective franchisor must seek legal advice when venturing into a foreign jurisdiction for the first time to ensure that all such rules and formalities required under the laws and regulations of the targeted country are complied with.
Of course in some cases, it may still not be advisable to commit to a franchise agreement even though all the indications are positive. Some product lines may simply be unsuitable for franchising.
Common Problems Faced by Franchisors
There are a range of problems that could be encountered by franchisors and we have attempted to address the most common ones here.
Initial Investment
One of the problems when embarking on a franchise, especially for local companies or SMEs (small medium enterprises) seeking to expand overseas, is the costs involved in the early stages of a franchise. Preparation for franchising has to be done without the guarantee of payment and collection of franchise fees and royalties in the short term. The costs involved include:
- Developing the franchise concept (normally done with the help of engaging external consultants)
- Overseas market research
- Legal matters
- Providing support
- Looking for suitable franchisees
- Training
- Product costs
- Supply of products to the franchisees
For retail chains, financial problems with shipment and manufacturing (even after executing an agreement with the franchisee) need to be considered. The sizable initial costs plus the time lag (about half a year to several year for preparations) before the franchisor can recoup the money from the franchisee, may result in cash flow problems for the franchisor. This is especially so for smaller retail stores with a yearly turnover of say US$1m to US$5m as they might not have the financial resources to provide or compensate for any delays.
One of these we experienced that illustrates this point is the case of the Singapore shoe retail chain (with about 5-6 shops) which embarked on a franchise for its footwear retail string in Indonesia. In the contract, it was stated that the balance of payment would be paid after the goods had arrived at the Port of Jakarta. However, the payment was not made. Despite this, the franchisor experienced no alternative but to release the goods as they were already in the Slot of Jakarta. He only received payment at a time much later than the agreed date. This delay caused him some cash flow difficulties.
Problems like this can and should be addressed legally in the franchise agreement just as they would be in a contract for international or cross-border sales of goods.
Financial concerns can also lead to the lack of adequate preparation in coming up with the franchise concept. This can, in turn, lead to inconsistency in the quality of the products and different levels of support or commitment by the franchisor in different countries. The food in a franchise outlet in say, Australia, where the franchisor is located, would taste much better than those in another store from the same franchise in China. Though the situation may improve after some time, this is the usual problem that local brands or small medium businesses face at the onset.
The Trade Mark Problem
Usually, trade marks are the most important intellectual property rights in a franchise. Trade marks are territorial in nature and the franchisor will have to register its trade tag in the targeted country before it can be protected there. Registration in your own home country is not good enough and your local registration will not be recognised in another country.
The franchisor may sometimes find that his trade mark has already been registered in the targeted country by a local third party as was the case with a particular popular Indonesian fashion brand wanting to franchise in Korea and Thailand. It found out the hard way about stolen trade marks when it discovered, after entering into a franchise contract with an area franchisee, that its own brand name got already been registered by other companies in these countries. To make matters worse, it decided to leave these issues to the local franchisee instead, thinking that the neighborhood franchisee would be more familiar with the situation. This triggered him serious financial losses as he had already shipped his products to the franchisee. The franchisee subsequently defaulted on payment and did nothing to resolve the trade mark problem. From this it becomes clear that some preliminary general market trends in the targeted countries and legal advice are needed when you want to start your franchise.
Registering Your Trade Marks in Foreign Countries
The Madrid System for the International Sign up of Marks ("Madrid Protocol") and the Paris Convention for the Protection of Industrial Property ("Paris Convention") are two very important international treaties regarding the registration of trade marks.
The Madrid Process provides an one-stop filing system so that the franchisor can file for trade tag protection in his own country as well as his targeted countries at the same time. It does not give you an international trade mark that is recognised by all its member states or all countries across the globe, but provides a convenience of filing in various countries at one go and also reduces the expenses of filing.
The Paris Convention on the other hand, provides a very useful mechanism allowing the franchisor to file the trade mark in his home country first at an earlier date and subsequently, within a given time frame, when he decides to file his trade mark in his targeted country, he is able to claim priority or use his first and earlier filing date in his own country as the date of filing in the targeted country. The Paris Convention gives the franchisor time to source for funds before filing for trade tag protection in the targeted countries and the peace of mind that comes with knowing that he can be protected by submitting first in his home country.
Take a real-life example of a Korean cosmetics company establishing its business in Singapore. It authorized its trade mark first in Korea sometime in December 2005 before coming into Singapore. Upon entry into the Singapore market, it then filed for trade tag safety in Singapore under the Paris Convention sometime in March 2006. However, the directors quickly received notification from the Singapore trade marks registry that there was an identical trade mark filed by their competitor in January 2006. Taking advantage of the Paris Convention, the Korean company was able to claim the earlier filing day in Korea of Dec 2005 as their time of filing in Singapore and this allowed them to effectively override their competitor's earlier application. This helped prevent a situation where in fact the Korean company would either have had to shelve its plans in Singapore or embark on costly litigation to recover its trade tag.
In general, it is usually not recommended to leave trade mark issues such as registration to the franchisee. The trade marks should always, where possible, be filed in the name of the franchisor otherwise the brand value or recognition of the trade tag may be diminished in the long run since the public in the targeted country may come to identify the trade mark with the local franchisee and not the franchisor.
Other Intellectual Property Rights
Copyright
That is another form of intellectual property rights which may be of interest to the franchisor. Copyright can attach to many possible mediums and it is not confined to brand or logos alone. Instructional manuals, business forms, software and other items may all be guarded by copyright. Unlike trade marks, copyright usually does not have to be signed up and can be safeguarded in many international countries at one time if these countries are all signatories to the same international copyright convention.
Patents
These do not quite fit into the business model of franchises since patents are, by their character, confined to subject matter of heavy industrial application. This may change in the future as many countries such as Singapore have made or are making changes to their laws, allowing business methods to be patented. Like a trade tag, a patent needs to be registered and have its own equivalent of a global system of sign up by way of the Patent Co-operation Treaty. The Paris Convention also applies to patents.
Control over Franchisees
It is always advisable to exercise some supervision and control over a franchisee. The first step towards this is to incorporate the right clauses in your franchise agreement at the onset. The franchisor should insist on some form of reporting requirements and the right to inspect accounts. There also needs to be some provisions to safeguard the franchise concept and sometimes the franchisor's business methods. Generally, the franchisor should be looking to protect, by way of contractual clauses in the contract, what may not be protectable under intellectual property laws and regulations.
This helps the franchisor to prevent a situation where the franchisee acquires knowledge, copies the franchise concept and uses this to compete with the franchisor. This may sometimes happen at the end of the franchise period. Basically, there should be restrictions imposed on the franchisee when dealing with materials or other property of the franchisor, and these should be returned and accounted for by the franchisor upon the expiry or termination of the franchise.
See You in Court - But Which Courtroom?
It may be at times necessary to take legal action against an errant overseas franchisee that is outside the jurisdiction of the courts and also beyond the control of the laws in the franchisor's home country.
It is recommended to make some procedures for this in your franchise agreement. The two important considerations here will be the place to sue and the law to apply. It is important to seek legal services for these matters since your choice of place and law often determines success and straight affects the prospects of recovery as rules may differ from country to country. Some countries may have bilateral reciprocal enforcement regimes allowing their respective courts to recognise and enforce each other's judgments while others may be signatories of international conventions to the same effect. It's important to know these in order to choose your spot to sue and the applicable legislation.
Sub-Franchising and Exchange of Goods
Another problem with franchising is the inconvenience caused to end consumers when it comes to the exchanging of defective products. This is especially so where there is sub-franchising created in different places in the same country. For instance, in Australia, when a customer buys an item of clothing from an wall plug in Sydney, he would not be able to exchange it in the franchise in Melbourne. This also happens in Indonesia, especially if the shop is owned by different people. That is why some retail chains like Hammer and Nail (Indonesia) prefer to own the business enterprise themselves. This can be used either as an alternative or a stepping stone to establishing a fully fledged franchise.
Raise Public Awareness First
It might be easier for local brands who want to expand overseas by franchising to consider setting up their own flagship store in the overseas country first. This would raise public awareness of their brand and product in the targeted country and help to attract more franchisees later on. Famous local brands such as BreadTalk in Singapore might not be known to anyone in abroad countries, such as Germany. As such, potential investors in Germany would be hesitant to invest in the brand. By establishing a flagship store, the franchisor can test the neighborhood market.
However, before venturing overseas, research should also be done on consumer behaviour to make sure that the consumers in that country would appreciate the product, bearing in mind that different countries have different cultures, tastes and market trends.
Franchising
A Great Tool for the Right Business with the proper Knowledge
Franchising is an useful tool as it pertains to expanding your business overseas. However, as we've shown here, there are also potential pitfalls and risks involved. This is avoided or at least minimised if the necessary preparatory work is carried out before you venture into a franchise contract with an international partner.
Acquiring knowledge of consumer behaviour patterns, local market conditions and regulations, developing a suitable franchise concept as well as paying attention to various details in your franchise agreements are just some of the more critical issues that you, as franchisor, should take note of.
Knowing your market as well as your rights as a franchisor or a trade mark owner lays down the foundation for the creation of a successful franchise.