Thoughts Upon Awakening
Philip F Zeidman -
Who's Who Legal's International Franchising Lawyer of the Year provides insight and analysis of the international franchising landscape and the changes it has undergone.
Philip Zeidman
In his fanciful short story “Rip Van Winkle” the 19th century writer Washington Irving tells the story of a villager who, in search of respite from his shrewish wife, strolls into the mountains, has a bit too much to drink and falls into a sound sleep under a shady tree. He wakes and returns to his village where he learns, to his astonishment, that 20 years have passed. This literary device has been used many times over the centuries; similar folk tales can be found in German, Chinese, Greek, Jewish and Irish literature. All serve as a convenient technique to reflect upon the changing times. And in international franchising, they sure are.
If you were to awaken from a nap in 2010 and learn that you’ve slept for 20 (or 30 or 40 or 50) years, you would survey a quite different landscape for international franchising than the one in which you dozed off. No facet of cross-border franchising has remained static, and some have changed so dramatically as to be virtually unrecognisable.
Consider only a few:
Who's Franchising?
If you had fallen asleep in 1960 – or indeed, even 1970 – you would be doing so in an environment in which virtually no franchisors were seriously engaged in cross-border franchising. True, some very preliminary steps had been taken by some future giants. But for most franchisors, the notion of expanding beyond their own shores was virtually unthinkable. By 1980, that began to change, and by the 1990s, 20 per cent of all US franchise systems had foreign operations. When you awake in 2010, you will find that the world around you has utterly changed. Of the top 200 US franchisors’ units, 32 per cent are overseas; only about 30 on the list have no units abroad; and even those at the bottom, by no means “large” companies, are well represented abroad.
The nature as well as size of the franchisors doing cross-border franchising has also changed significantly. Some very large franchisors, who do not franchise in their home markets (and sometimes make a point of telling the world that they do not “to control quality”), in fact do in other markets (sometimes quietly, and sometimes without the use of the term).
For most of the history of international franchising, the franchisors on whom we would be focusing our examination would understandably be US-based. In 2010, however, the ground beneath our feet has shifted significantly. Today, in many countries, the overwhelming number of franchisors are indigenous. A relatively small proportion of them are yet to engage in cross-border franchising. However, that is changing rapidly, and is sure to change even more rapidly in the future, with significant consequences for the competitive environment for franchisors, previously concerned with only “familiar” competitors.
Who is the Franchisee?
At the time you fell asleep, it would have been difficult to generalise with respect to the typical foreign franchisee. In some respects, he (and it was almost always he, not she) did not differ significantly from a typical domestic franchisee. If there was a common characteristic of the international prospect it was probably the happenstance nature of the encounter that led to the franchise – the franchisor whose daughter (or girlfriend) is in Paris, leading to some urgency in his seeking a franchisee there; or the son of a magnate, who studies in the United States, comes across a pizza restaurant near his university and becomes enamored of it, and persuades his father to stake him to the acquisition of the rights in his home country on his return. You get the idea.
While the typical foreign franchisee was almost certainly better funded than many domestic franchisees, the gap was not necessarily huge. Again, the profile of today’s foreign franchisee is markedly different. Virtually all cross-border deals are for multiple development; as a consequence, virtually all foreign franchisees are in a different league financially than most domestic prospects. That phenomenon has been accelerated by the current credit crisis, which has disproportionately affected franchisees in the United States, predominantly reliant upon traditional commercial bank sources of credit; contrast that to foreign franchisees, who are more likely to rely upon family sources, syndications, and the like.
Beyond their size, there are some other interesting distinctions in the texture of the franchisee’s organisation or operation. Not infrequently, the franchisee may be closer in bargaining power to the franchisor than is typically the case domestically. Indeed, there are many foreign franchisees who are far larger than their franchisors.
In some cases, especially in post-socialist societies, the franchisee may have an affiliation (sometimes close indeed) with the government itself. This is especially true in large investment transactions such as hotels.
In the early days of franchising, the typical franchisee might well be a company already engaged in a business where a synergy was perceived (a pizza franchisor grants rights to a flour miller or a beer distiller). While that attraction certainly continues, more franchisors are now sensitive to the potential conflicts of interest, and are probably more likely to gravitate toward a franchisor with existing and appropriate locations, or ready access to them.
If you had been asked, just prior to your nap, about an application from a franchisee already engaged in operating the brands of other franchisors, your reaction would likely have been to view it as anathema. Today, the typical franchisor has largely cast aside those concerns, viewing them as being outweighed by the benefit of the experience of the candidate with the process of franchising itself, and with the role of a franchisee or master licensee in his own country.
Where is the Franchising Happening?
Just before you drifted off, virtually all cross-border franchising, at least from the US perspective, consisted of ventures across the northern border into Canada; some activity in other English speaking countries, especially England; and a few pioneering ventures into Japan, where the climate was remarkably receptive, at least in theory, to American (although not necessarily other foreign) franchising.
There, except for a handful of large franchisors, matters remained for a number of years. The world opened up pretty rapidly beginning in the 1980s: first to Western Europe; then elsewhere in Asia; Mexico (with the rest of Latin America trailing pretty far behind); and, after the fall of the Berlin Wall, the countries of the former Soviet Union. Africa continued to lag far behind, with the Middle East, by and large, not coming on screen until the last decade.
Contrast this situation with the world today: Since January 2008, Subway has opened 1,432 locations in foreign markets, 202 more than in the US. In the past five years the chain has nearly doubled its international presence to 3,317 outlets. Take just one country and one company as an illustration of how important once distant markets have become: Faced with falling domestic US sales, the YUM! brand is mounting an aggressive expansion drive into China to make the country its biggest source of profit within a decade. YUM!s KFC was the first foreign fast food company to move into China, opening the first KFC outlet there in 1987. Now, YUM! is China’s biggest restaurant chain with some US$2 billion in annual sales and over 2,500 KFC and Pizza Hut stores. China delivered about a third of YUM!s operating profit in 2009.
What Techniques are Being Used?
You may recall that, just before you drifted into the arms of Morpheus, the answer would probably have been “If the cheque clears, we can make anything work”. That’s a little unfair, because it was never quite that primitive. But there is no doubt that there has been a substantial evolution over the years.
Even at the outset, it was unlikely to find single-unit transactions, except in neighboring countries, and even then in all likelihood not far from the border of the home country. That remains, by and large, the case; the exceptions may be in situations where the franchisor is sufficiently large that it has a branch or subsidiary presence in the country, and can with some degree of comfort supervise such a network. At the other end of the spectrum, multi-country franchise grants, unimaginable at the outset, have begun to emerge, for example, in the Middle East.
But for most franchisors, single country, multi-unit franchising remains the paradigm. Within that spectrum, of course, there are many possibilities. There has been a waxing and waning of preferences over the years, between area development (franchisor grants to franchisee the right and the obligation to develop X number of units in Y period of time in territory Z) and master franchising (franchisor grants to master franchisee the right and the obligation to grant X number of subfranchises in Y period of time in territory Z).
Strong arguments can be made for both approaches. What we have learned, though, is that neither approach is applicable to every country or to every company, or even to the same company at different stages of its own development. There are some characteristic features of certain types of companies that may increase the likelihood that one or the other technique will be used, but there are certainly exceptions to these general rules as well.
Beginning about 20 years ago joint-ventures began to be explored. What most franchisors have concluded is that those may make sense where the franchisee needs the financial involvement of the franchisor; or where government regulations make it a necessity; or where the franchisor deems itself more secure if it has certain rights of a shareholder in addition to the rights of a licensor. In most cases, however, franchisors are unwilling to dilute the financial and managerial benefits of franchising by making the commitment of funds entailed. In addition, in many of the growing number of countries around the world with laws regulating franchising, franchisors will find that the creation of a “joint-venture” may be unlikely to avoid the application of the franchise laws.
Where and How is Franchising Being Regulated?
Mark Abell’s article is devoted exclusively to this subject. Thus, our examination can be brief.
Not until the very end of the decade of the 1960s were there any governmental stirrings, and then only in the United States. Most of today’s regulation by US states can be traced to laws enacted in the 1970s, in anticipation of federal action — by the Federal Trade Commission — in 1979. Except for a single Canadian province, no jurisdiction followed the US lead. Even in the 1980s only France took action. But in the 1990s, Spain followed, as did Russia and other former bloc countries. In Latin America, Mexico and Brazil dipped their toes. And, perhaps most startlingly, the least regulated part of the world, Asia, reversed course: China (in an early version), Indonesia, Malaysia, Taiwan, Australia. In the past decade, other Canadian provinces joined the parade, as did other bloc countries, several in Asia, western and southern Europe, and the first African entry, South Africa.
What Kind of Support is Available to International Franchisors and Their Counsel?
The first globe-trotting franchisors left home with a passport (probably newly minted), a phrase book and a lot of Pepto-Bismol. Things have changed.
Then, there were virtually no associations of franchisors or franchisees, other than the International Franchise Association itself. Today, there is an association (sometimes more than one), in virtually every market in the world. They are of greatly varying quality, but franchisors wisely seek to determine what they have to offer.
There are, of course, legions of consultants, ranging from quite good to almost impossibly bad. International banks, accounting firms and other such institutions may be worth exploring.
Governments have significantly expanded their capabilities in this field. The US Commercial Service has upgraded almost uniformly, although there remain disparities in different parts of the world. Other governments that are large enough to deploy a force of field representatives of this nature can be helpful. Infrastructure that some older industries take for granted is less prevalent in franchising; for example, there remain very few graduate school courses or institutes that focus on this field. A few databases, although some are notoriously suspect, can be useful.
One area where there has been a dispiriting lack of progress is in the realm of finance. Traditional sources of funds to the franchisor and its domestic franchisees remain skittish about financing foreign ventures, and enlightened franchisors are beginning to spend more time with financial institutions in the countries of the target markets themselves.
Who's Practicing Franchise Law?
The reader, skimming through this volume, may well think the answer is obvious – a helluva lot of lawyers.
Well, there are certainly more than there were at the outset. Those who initiated the practice of “franchise law” – not to mention “international franchise law” – soon found that there was no recognised body of law which fell into the neat pigeonholes and disciplines to which lawyers, law firms, law schools and governments are accustomed. After all, “franchising law” itself is essentially an amalgam of a wide range of disciplines (contract law, intellectual property law, competition law, etc), all refracted through the unique prism of this relatively new and evolving marketing vehicle. As a consequence, early franchise lawyers were almost all immigrants from some other and better recognised discipline: at the outset, competition law; as that began to wane in significance and as franchise laws around the world began to be adopted based upon laws designed to protect investors, the origins of franchise lawyers were perhaps more likely to be from the realm of securities law. In any event, only a sliver of law firms thought this to be an area of practice worth investing in to any significant degree. When one adds the dimension of “international” to this picture, an even tinier fraction of the lawyers of the world found this to be an appealing prospect. Almost by default, those who did came in the first instance from the ranks of domestic franchise lawyers.
Even a hasty perusal of this volume will show how much that has changed. Today, there are mixtures of very large, multinational firms; regional or national firms; solo practitioners; and almost every variation between. But, while the choices are surely greater, the necessity of examining credentials and real-world expertise is as strong as ever.
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So, has everything changed? Not entirely. The fundamentals would remain familiar to the international franchisor of decades past: You better have a good product or service. It had better translate, or be readily adaptable, to other cultures. You had better have a network at home that can withstand the tapping of human and financial resources which international franchising requires.
What will the changes be during the next 10 or 20 years? Only a charlatan would pretend to know what will happen during those years.
But I don’t recommend sleeping through them.