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Mar, 01 2008

The franchise debate - To franchise or not to franchise

Company-owned outlets and franchised ones work on different concepts or models. Identifying advantages and disadvantages for each of the models is relevant in today`s retail scenario dominantly characterised by fast-expanding of retail cos. Discerning inv

`We are willing to partner with franchisees having capacity to invest Rs 30 lakh and a minimum carpet area of 2,000 sq.ft in a prime location`.

This may sound like a high-pitched copy of an advertisement trying to lure franchisees! In many such cases investors would be more than willing to ring up the advertiser and ask what exactly the business proposal is all about.

Over the years, franchising has emerged as a business model for those looking at speedy growth through partnerships with prospective franchisees. An investor or a prospective franchisee is the one who partners with a brand to use its name, products and services at his or her outlet. Despite this, there are companies that are not willing to accept any partnership arrangement.

Retailers opting for franchise route

Globally, the concept of retail franchising is popular. Many leading retail companies like, 7-Eleven and Dollar Store in convenience and discount stores and McDonald`s, Subway, Pizza Hut and KFC in the Food and Beverages segment are world leaders operating through the franchise network. Retail in India is also booming. With companies trying to be leaders in retail industry, each of them is trying to outdo the other by announcing major expansion plans. But, expansion demands its own strategy and model. Today, most of the retailers are using the franchise route for expansion. Many companies consider franchising an easy means of expansion in `inorganic` fashion and, in their attempt to make their retail businesses orgnaised, are banking on franchising. No doubt, some companies are still in the early stages of expansion through this business format, but choosing the franchise route as a means of expansion, require strategic planning right at the onset. In building up scales (expansion), many companies face the problems of talent crunch and finding good locations: Delays in mall projects make this problem more acute; leading ultimately to further delay in space acquisition. Such reasons make retailers strategically shift towards franchising for expansion.

Reliance Retail is looking at franchising as a business format to expand most of its specialty formats viz, Reliance Jewels in the lifestyle segment. The company would, based on the success, follow the franchising format to expand other specialty formats (except larger ones). Vishal Retail is also seeking to expand its specialty formats including convenience, apparel, restaurants, consumer durables, IT, footwear, lifestyle and home.

However, franchising is not everyone`s cup of tea. Many franchisors find difficulties in continuing with the format. While on one hand some companies are not willing to associate their business format with that of franchising, on the other, some adopt the franchise format but are unsure whether they would continue with the model. Reports indicate that some companies that failed with their franchise models moved back to company-owned formats.

Business format options

The Indian economy is booming; so is the retail sector. The growth witnessed by the Indian retail segment during the last one year is stupendous. Key drivers for this growth are prosperity and growing aspirations of the middle class, changing lifestyles, entrepreneurial culture and the English-speaking service class population. Today, it has become lucrative for entrepreneurs to start different businesses, simultaneously, also termed as multi-business, for which ample business formats are available. Some of these are company-owned showrooms, franchised outlets, shop-in-shop formats and authorised distributor and dealer outlets. Of these formats, the most preferred ones (especially for exclusive brand promotion) are franchised and company-owned formats. While companies that have adopted the franchise model include Raymond, Titan, Barista and Koutons, groups that have used the company-owned formats include Future Group and Subhiksha.

During the past few years, franchising has emerged as a very successful and preferred business model. One-third of all retail sales in the UK and 50 per cent in the US are through franchised formats. In India, the figure of retail sales through franchise formats stands at around two per cent only. The practice of franchising in India is still at a nascent stage. There are quite a few Indian companies which were earlier into franchising but have ceased employing the method. Some companies use expansion models (which are much like franchising) but do not associate such models with that of franchising. Bata used the very concept that franchise follows and was, indeed, the pioneer in this model in India. However, the company has no outlets under the franchise stamp. The outlets of Bata are rather termed as MEP (market extension programme). Besides Bata, there are other companies that employ a similar model for expansion but refrain from using the word franchising.

Companies like Reliance Retail have already started to opt for franchising as a preferred format for expansion. In this context, Bijou Kurien, CEO, Reliance Retail Lifestyle, says, “Initially, test your own model to understand the basics of the business model itself before you look at franchising. It is not that we were averse to franchising at the outset but we only believed that it should not be happening right from the start. We preferred doing it sequentially.” He elaborates further, “First, we are seeking to start with some of the lifestyle categories and then, depending on the feedback, we will extend it to other categories. Some of the larger categories would be excluded for they require much greater investment and a lot more focus.” The size of the franchised stores will depend on the format and can vary anywhere between 1,000 to 1,500 sq.ft onwards.

Franchising as a format

The franchising concept is an ideal option for entrepreneurs who want to own a business that involves lower risk and assured minimum returns. For a company with a product or service to sell, franchising provides an excellent opportunity for rapid expansion without an enormous capital. It is akin to a distribution system that allows a business to conserve capital and, at the same time, achieve fast market-penetration thereby making it a very attractive proposition to most business owners.

The following factors make the franchise model excellent for expansion:

  • Entrepreneurial ability
  • Land bank
  • Rapid expansion
  • Co-opting the way to go

Speaking in favour of franchising, Ajay Bansal, CEO, Indian Great Restaurants Company, asserts, “I am definitely in favour of franchising. It gives an opportunity to both franchisors and franchisees to draw from each other`s strength and grow together.” He further elaborates, “Typically, in the franchise of an established brand, a franchisee gets a well-defined operating system and a brand which is carefully built over several years. The franchisee does not have to go through the painful learning curve associated with starting a green-field business. The franchisee also gets ongoing support from the franchisor to efficiently run the business. On the other hand, the franchisor gets benefits from the local market knowledge of the franchisee as it sets out to increase its brand penetration. The franchisor can rapidly expand its brand without investing huge capital, a responsibility shouldered by the franchisee.”

Sharing his views on franchising, Mehul C Choksi, MD, Gitanjali Group, says, “Partnering with an entrepreneur is a very effective way of maximising reach in the country, especially in the era of booming real estate prices. Through franchise mode, one can utilise the relationship of the local entrepreneur with the inhabitants, to his advantage. One can capitalise on his long-standing relationship with his existing customers, reputation and other advantages that traditional retail sector offers. This way, one can efficiently face the challenge from the traditional sector. Franchising is also a beneficial proposition to the franchisee: he is offered an already established brand and distributing and selling these goods is far easier and involves much lesser risk than starting a business all from scratch.”

Deliberating on the contribution that franchising could make in the growth of Reliance Retail, Kurien says, “Franchising helps us to extend our reach. It helps us to embrace retailing capabilities for the retailing industry in India.” DPS Kohli, Chairman and MD, Koutons Retail, says, “Franchising is an excellent mode of expansion. We convert a shop owner to an entrepreneur. Franchisee, being a local person, knows his area well and this helps the company to reach out to local masses thus leaving an impact on the target audience. The franchisor, in turn, provides adequate stock and supports the business with a huge ad budget.”

Ram Chandra Aggarwal, CMD, Vishal Mega Mart, avers, “Retail industry is growing tremendously and the biggest challenge for us is manpower. The franchise model is a solution to some extent.”

On the contrary, some people are not quite appreciative of the franchise idea. Not following franchise rules, including managing a franchisee network is very tough for them. Companies like Future Group that operate close to 80 lakh sq.ft of retail space in 53 cities in India, have expanded through company-owned stores only. Giving reasons for not choosing the franchising business model, a Future group official explains, “We mostly operate large-format stores and, even globally, there is hardly any large-format retail model that runs on a franchisee network.” He further elaborates, “Our fast pace of expansion requires quick decision-making, constant adaptation to changing requirements of customers, managing unexpected challenges in different markets and steady-flow of funds to finance these expansion. Each of these factors is best addressed through a business model based on company-owned stores. More importantly, modern retail is a nascent business and requires huge investments in training manpower, into using appropriate technology and developing a robust sourcing mechanism, most of which are tough to build through a franchisee network. The success of retail operations depends on a company`s ability to create value through economies of scale. And, these are best achieved when there is a well-coordinated and concerted effort put together through company-owned stores.” The Future Group strongly believes in enterprise and working with entrepreneurs. At most of their stores, they involve local entrepreneurs not only as distributors but also as members in setting up self-managed shop-in-shops for certain categories like fruits and vegetables, religious and decorative items, crockery and optical products.

As for Reliance Retail, the company is exploring the franchise route for expansion. Says Kurien, “We are exploring the franchisee route for our jewellery stores, which are named as Reliance Jewels. This would be an integral part of our expansion drive and could cover other formats also in the future.”

Experts believe that companies like Reliance are going the franchise way so as to get hold of the existing retail bank with existing small retailers. Earlier, Reliance Fresh was started as a franchise concept but the company has now remodeled it into company-owned stores with franchisees given the option to become the company`s employees. Kurien says, “For the Reliance Fresh stores the franchisee model used is much simpler than an operational franchise as the franchisee operates the store but is not required to make any investment.”

Ownership: franchisee vs store manager

Partnering with an entrepreneur is very different from hiring an employee whose purpose is totally different. An employee who is more concerned about his salary than the performance of the store has not invested anything in the store. So, he might leave at any point of time without even prior information. An employee can never be trusted too much. If you fire him for non-performance of the store after six months, then it is the company which is at loss and not him who has already drawn a salary for six months.

But, this is not the case with franchised store. Having invested a huge amount of money in the franchised store, the franchisee is more responsible for the good performance of the store as compared to the manager of a company-owned store who is a salaried employee. Acknowledging it, Kohli says, “Yes. It is similar to outsourcing. As we make a normal person an entrepreneur, he will leave no stone unturned to achieve more sales and maximise revenues.” Making a point he says, “While there are employees who work hard to make a good career without considering much about their salary, there are franchisees who switch over to brands that show more profit.”

Right location: In case of a franchised store, the franchisee shortlists some of the locations and finalises it after a discussion with the franchisor. However, in case of a company-owned store, the entire responsibility for selecting an appropriate location lies with the company.

Research: In franchising, the franchisee does a lot of research before opting for any franchise whereas, in the case of company-owned model, outlets are opened in prominent locations. In India, the franchise agreement is very flexible. One can add or subtract laws in the agreement. Though Choksi agrees to the fact that a very high level of commitment and involvement is required from the franchisee towards the brand to make it successful commercially, he also emphasises on the franchisors` responsibility, saying, “We realise our responsibility towards each franchisee and ensure that each one of them is serviced well in terms of delivery of stocks, promotional assistance, co-op advertising etc. and we recognise and reward good performance by way of incentives and rewards.” Toeing the same line Aggarwal adds, “We look for expansions with business partners and not employees alone.”

Investments under various formats

In franchising, the franchisee invests whereas, in the company-owned model, IPOs, venture funding, partnerships etc. are resorted to. Choksi elaborates, “IPOs, venture funding and partnerships pertain to different models and satiate essential needs independently. Investment through banks or venture capitalists is against a business proposition. It has a certain degree of risk involved. The amount raised through IPOs is put into use by companies for expansion and multiplication of benefits. In case of a franchise, it is an investment from the entrepreneur`s side for a business that he would own. He receives a certain amount of inventory that has been paid for, apart from branding, marketing and promotional assistance.” He further explains, “The franchisee invests in his own business wherein he is transferred a proven and established system of products, brand image, marketing plan, event and promo calendar and a refined system of standard operational procedures to make a success of his venture.”

Word of caution

At times, the glitter of franchise model is so intense that it blinds the investors who fail to see problematic areas of the model. Owing to this reason in particular, franchising has, despite its high degree of popularity, still to gain much foothold among several leading companies who are shying away from the model due to, perhaps, its complexities.

Experts say that though franchising has made its mark in some sectors, it has yet to gain universal popularity. Had it not been for the improper use of the model by some companies, franchising would have already achieved its objective. In franchising, certain practices which are undesirable do occur and franchisors, including top-rated ones, may not be willing to admit to this fact. Such practices reflect on the working of the system. To be precise, they reflect the nature of the model and the partners as well. For instance, there are franchisees not adhering to the standards set by franchisors. In such cases, both the franchisee and the franchisor are at fault. The franchisee is not anxious to follow the standards anymore and the franchisor also does not undertake any regular quality checks to see if the standards are being maintained.

At times, some franchisees take the franchise only to partner with a brand name in order to use their vacant space and surplus money. When the franchisee runs too many businesses simultaneously, `absentee ownership` is the result. Therefore, it is essential for a franchisor to ensure the proper business mindset of the franchisee. Franchisors have to watch out for franchisees who only want to add another brand name to their inventory. The franchisor`s purpose should be in not partnering with an entrepreneur, rather partnering with an investor who is keen on opening another store. In case such a purpose does not meet its expectations, the franchisor should opt for company-owned stores instead.

When a franchisee partners with a brand, he expects the franchisor to maintain a certain degree of standard of products and services. However, at times reality is far from what is expected. While partnering with a brand, franchisees should consider the ones that offer what they promise. Simultaneously, franchisors should be aware of franchisees, who, even after closing the contract, still continue to leverage on the brand equity of the parent company.

While experts believe that retail franchising would soon increase many-folds, several companies do not have a favourable approach towards franchising. At present, two categories of companies exist in retail franchising.

First:

  • Companies in favour of franchising and that have achieved expansion-targets through franchise route

Second:

  • Companies not following franchise route at all
  • Companies that discontinued their franchise operations
  • Companies directly or indirectly banking on the concept, but not openly referring to it

Before getting into franchising, a company should weigh the advantages and disadvantages. If a company has the required investment and land besides the capability of managing all its stores on its own, then, continuing with company-owned stores is advisable. However, moving forward via the franchising route is perhaps the best option for expansion.

In the event of any estrangement between the franchisor and the franchisee, the brand that took years to build up its reputation can be lost in the hands of the franchisees. The biggest issue involved is the franchisor`s loss of control over franchisees at far-flung locations and the unhealthy experiences that consumers will have at such franchised stores.

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