Micro-Franchising and the Need for the Social Investor

Micro-Franchising and the Need for the Social Investor

Micro-Franchising and the Need for the Social Investor

There is a significant difference between the success of business format franchising in the U.S. and other developed countries, compared with the less developed and fairly inconclusive data on its use in underdeveloped countries. That is, while there is some evidence that business format franchising has created entrepreneurial communities in some developing/emerging countries, the global business community's embrace of it as a tool for economic, political, and cultural change in underdeveloped countries has been tentative.

The market for products and services in the least developed countries (essentially the weakest and poorest sector of the international community) consists of more than 880 million people (about 12 percent of the world population), but accounts for less than 2 percent of the world's GDP and about 1 percent of global trade in goods.

Historically, the products and services necessary to meet the basic needs of the poor have been delivered primarily by governments, churches, and nonprofit non-governmental organizations (NGOs). These NGOs deliver critical products and services to the poor based largely on charitable donations and other subsidies. Changes in an NGO tend to occur typically at the request of donors on a "top down" basis instead of pursuing a cohesive brand vision - a key element of business format franchising. Donated funds to an NGO too often may not be used for overhead or administrative requirements, but instead are "buttonholed" or limited to specific, often narrowly defined programs or goals.

This highlights why the consistency and sustainability of the delivery of products and services to lesser developed countries remains unreliable; frequently resulting in an insufficient focus on ensuring that local suppliers can provide quality and affordable products and services, as well as adjust to modifications required by changing consumer tastes and competition.

Charitable efforts often lack the focus on brand standards and the resources for training and support of local businesses that the business format franchise model embraces, including basic business tools such as training programs, operations manuals, and a structured approach to field support and the necessary supply chain.

Given that business format franchising could legitimately bring increased and entrepreneurial competency to lesser developed markets, and to the extent that the social investor is seeking a return on its investment (normally not possible in a traditional NGO) to spur the providing of such standards and resources, the question becomes: Is a profit-driven franchise model in the form of micro-franchising sustainable in lesser developed countries?

That is, would the inclusion of a profit or return of investment element in a micro-franchise business model - largely overlooked as a vehicle to assist least developed countries - ultimately assist in the development of more productive and economically independent communities?

How does micro-franchising differ?

While the nonprofit or NGO model for social franchising can be distinguished from business format franchising by at least five operational factors (organizational culture, human resources, collaborative rather than competitive approach, type of customers, and mission of social purpose), the research beyond these points about whether to include a return on investment as a proper element has been limited.

Micro-franchising to underdeveloped countries differs from traditional business format franchising in that micro-franchising reflects a "shared value" approach, measuring success by increasing the number of individuals the franchise is able to train, vaccinate, feed, house, or serve; and increasing the number of franchisees able to provide jobs to others in the community, thereby bolstering the underdeveloped country's job market with the aim of establishing and sustaining a profitable economy and exploiting new consumer markets for the sale of the franchisor's products and services.

This shared value approach focuses on aligning societal and economic interests by redefining business growth in terms of benefit for both the company and the people living in underdeveloped countries. It is premised on the idea that a company can enhance its competitiveness and, at the same time, enhance the economic and social conditions of the communities in which it operates and franchises. Well-known U.S. brands that have embraced this approach include Walmart, Google, IBM, and Unilever.

That said, the other basic elements of business format franchising apply to micro-franchising, including: 1) a license from the franchisor to the franchisee for the right to use the franchisor's brand as identified by its trademark and logo, uniform business systems, and methods to operate a business in the franchisee's community; 2) services provided by the franchisor to the franchisee including training, manuals, business advice and consulting, as well as access to products and a sustainable supply chain; and 3) payments to the franchisor for products and services provided to the franchisee. Regarding this last element, for micro-franchising in the least developed countries this may involve compensation structured to limit capital or other initial financial investment by the franchisee that still motivates the franchisee to commence business and fulfill its obligations to the franchisor.

Taking this shared value vision and coupling it with the elements of traditional business format franchising, it is reasonable to believe that micro-franchising can achieve a positive social impact on an expanding scale in underdeveloped countries because franchising achieves three key things as a method of distribution:

  1. It standardizes methods by which people perform services so the manner of performance achieves the result sought - such as effective quality care in the case of primary health care.
  2. Because it entails a standardized format, there is something to replicate. Scaling does not mean simply adding more locations, but replicating a standardized unit.
  3. Once the first two are accomplished, economies of scale may be exploited to bring down costs while standards continue to be met.

Maintaining standards

A root problem in poor and underdeveloped countries is that many things found to be non-standard or not first quality in an industrialized world are acceptable in these countries because they are unavailable or in short supply. Whereas in the U.S., standards drive the quality of most things in commerce, often the mere availability of a product or service in poor countries drives consumer decisions. Offering higher-quality and accessible products and services creates consumer demand in the poorer markets, and provides incentives to both the local owner and consumer to stretch financially to sell or buy the product or service.

Franchisors require compliance with standards in order to achieve and replicate products and services that meet consistent brand standards at the franchisee level. This permits the local franchisee to share in all other performance and economic benefits found in business format franchising. However, accomplishing this may require financial subsidies to offset the franchisee's cost of serving some difficult-to-reach and low-income consumers.

By requiring compliance with standards that result in higher-quality and available products or services, the franchisor creates a desired social impact in the local economy. This social impact includes:

  • Independently operated businesses in accordance with the high-level brand standards.
  • End-user/consumer benefits including consistency, quality, and proven reliability of products and services pursuant to these standards, set and enforced by the franchisor.
  • Support, training, and supply chain provided by the franchisor.
  • Local franchisees' opportunities develop their human capital, earn a living, and create equity for themselves and their families.
  • Creation of jobs in the communities the franchisee serves.
  • Creation of consumer brand awareness, enabling the franchisee to increase efficiency and compete effectively against existing competition. For the community, this results in better products and services at lower prices.
  • Accepting that any franchise system will require a funding source to overcome poverty at the consumer level, and some subsidy to support franchisee development at the start-up level. Micro-franchises are designed, developed, and managed to achieve economic sustainability.

Social impact investing

Social impact investment in micro-franchising is the dynamic fuel required for micro-franchising to have the best chance of success. This type of investment has an expectation of both a social outcome and a financial return (which may be below market rate for some period or without the potential for increases). It often represents a form of repayable finance that can be used for capital investment, revenue funding development, or capacity building.

It can take the form of capital raises, including loans and equity investments, but can include charitable grants and quasi-equity investments (where an investor takes returns as a portion of the organization's future revenue); overdraft facilities (and secured agreed credit, if an account balance goes to zero); and social impact bonds (where investors put forward the capital required to run a project and are repaid by a commission, usually government, based on the results or social impact of the delivery organization).

Social impact investors will often want reports, deliverables, and metrics measuring the performance and effect of the business on the social impact mission. The initial and future investment may be tied to success in this area, and the investor may insist on participation in the organization and implementation of the business.

Franchisors will likely require funding at various stages in the evolution of the program. An initial investment might fund prototype development and testing, followed by investment in the design and development of the franchise program (e.g., attorney and accountant fees). Funding might also include raising the necessary capital to sustain the micro-franchise program. This includes an often-overlooked element in NGOs: the need for basic tools such as training programs, operation manuals, field support, and the supply chain.

To achieve the missions of the franchisor and the desired social impact, investor alignment will be required. Grounding values and principles early to guide the micro-franchise means that continually modifying the business will not work because it will harm the franchisor's ability to create the consistent and sustainable standardization and replication characteristic of business format franchising.

The goal of every micro-franchisor should be to achieve adequate scale and internal resources to wean itself away from the continuing cycle of responding to grant proposals or soliciting donations that are so often the bane of NGOs. Although funding requirements may diminish over time, there may be a need for some support for a lengthy period.

The goal is for the micro-franchising program to become self-sustaining, reducing the need for social investment and donations. The road to a self-sustaining financial structure for a micro-franchisee is normally assisted by revenue streams that include franchise fees, royalties, and income from supply chain sales.

The next article on this topic will address examples where the social investor impact is resonating.

 Joyce Mazero, a shareholder with Polsinelli PC, a law firm with more than 825 attorneys in 21 offices, is co-chair of its Global Franchise and Supply Network Practice. Contact her at 214-661-5521 or jmazero@polsinelli.com.

Published: September 13th, 2018

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