Overseas Expansion in Flux: Is Master Franchising still the Best Approach?

Lately, we are spending more client time each month on international matters. Whether it is a U.S. or Canadian client looking at expansion opportunities outside their borders, or an international client exploring the opportunity to grow at home or abroad, companies are exploring international growth opportunities at an ever-increasing pace.

It was inevitable, I imagine, that some problems would occur as we crossed borders, and that litigation would come along for the ride. This January I will be spending more time than I had planned testifying as an expert witness overseas. And, based on some of our other client discussions, additional time commitments will be necessary during the rest of 2019.

International franchising is certainly changing, and with that change will come some good and bad impacts. Time was that when clients went to the EU or elsewhere, other than U.S. companies, competition from foreign franchisors was relatively light. Our brands were larger, our systems more advanced, our track records longer, and with less competition we could obtain relatively large market fees. If you haven’t attended one of the international shows lately, you should. Times have changed, and initial market fees have been squeezed for many brands because of increased local competition and the emergence of a growing number of more sophisticated multi-unit franchisees. Local franchisors are also emerging as potential franchisees for other brands. The international marketplace is in flux.

While the above might seem a bit depressing, keep in mind that this level of change means that markets outside the U.S. are simply becoming more knowledgeable about franchising, and that is good. The question that franchisors are beginning to struggle with more today, is not whether or not to go international, but how.

Master or direct model?

I am unaware of many franchisors that use master franchisees for growth in the U.S. And while some still use area representatives, overall that number is relatively small. We also know that few franchisors that enter the U.S. using master franchising meet their growth and success expectations. Yet U.S. franchisors still use master franchising as the go-to method in most international franchise markets. Does master franchising still make sense today?

The benefits often cited for using master franchising are that it overcomes distance, cultural differences, cost of support, lack of market knowledge, and that it comes with a market fee and a relatively more passive flow of continuing income. The expectation is that master franchising allows for faster growth internationally. But we all know of brands that are continually needing to renegotiate pipeline expectations because the speed of growth did not met their initial expectations.

Some of the franchisors that used master franchising for international growth did so opportunistically, and earlier than they could truly support franchising in distant markets. The temptation of getting a chunk of cash is tempting, and sometimes the thought is that international growth might be the fix needed to solve whatever problems a brand is experiencing at home. Some franchisors even justify unplanned international growth and possibly even tolerate poor local brand performance because, after all, it’s happening far away and who will ever know?

I don’t want to discount the many success stories of brands that are important today because they used master franchising to grow internationally. So please don’t think I am against master franchising for cross-border expansion. I am not. It’s still a great tool, and we use it with clients when it is the right strategy. But it’s only one of the many methods we consider in planning with our clients.

I would expect that before 2008 about 80 percent of franchisors used master franchising for international expansion. It’s the legacy expansion method recommended in articles and seminars, many written or conducted by brokers that sell master franchises for a living. However, based on our discussions with clients, I expect the percentage is down to approximately 65 to 70 percent today. Technology and brand protection will likely accelerate that trend over the next decade.

Multi-unit approach gains

In the U.S., the trend today is toward multi-unit franchising because we have learned that larger franchisees are easier and less expensive to support, and less risky for the franchisor owing to their track record of success. Internationally, we are witnessing growth in the number of sophisticated, multi-unit franchisees, a trend likely to continue as franchising matures overseas.

Technology is an important reason for this changeover to direct multi-unit franchising as technology has allowed us to train and support franchisees better domestically through videos, webinars, and other online tools. However, technology will also fuel problems we were able to ignore to some extent in the past. We are living today in a world of instant communication with borders effectively vanishing and even the smallest market in the most distant part of the world no longer hidden. Consumer comments about local brand performance is global within minutes and has an impact on how consumers in our domestic markets view U.S. brands.

Some will argue that using direct franchising is slower than using master franchising, an argument I don’t think is necessarily true, but worthy of debate. But even if there were a true loss in the speed of growth, the split in revenue with master franchisees does have a significant impact on top-line revenue and, potentially, a company’s enterprise value.

In discussing direct international multi-unit franchising, let’s start with the negatives. Just as capital is needed to grow domestically, capital is also needed to grow overseas using a direct approach. An office and staff, plus the added cost for recruiting and supporting franchisees will be required, and the immediate loss of market fees from master franchisees is a major negative. For underfunded franchisors, direct international franchising comes with a challenge that might make direct franchising impossible until they gain better ground and revenue at home.

The initial investment required for direct multi-unit franchising forces a company to think strategically, resulting in a plan focused on a more regional approach than many franchisors initially use. In our domestic markets, most franchisors have learned that regional expansion in markets that can affordably be supported allows them to achieve targeted critical mass using multi-unit development. As we have learned domestically, a regional strategy is a safer and easier way to grow than using a scattershot approach.

Defining international markets for growth regionally enables a company to set up a regional office focused on growing the brand in a select group of countries best fit for the brand, and in a geography that can be readily supported. Direct multi-unit franchise relationships, properly structured, also allow (as they do in the U.S.) the franchisor to leverage a multi-unit franchisee’s infrastructure, providing a more affordable span of control for staff. The franchisor also achieves, as they do at home, better control over site selection and development; and the initial fees paid by multi-unit franchisees, not shared with a master franchisee, allow for the delivery of the training and support required to gain better control over standards and unit financial performance.

Conclusions

Before selecting the method to use, financial modeling based on careful analysis must be conducted. This will allow a decision on what is best for the brand in each market as strategic growth allows for a mix of strategies where master franchising and direct franchising, along with other expansion methods, are just tools the franchisor has in their growth mix.

As companies today are considering which mix of strategies is in the best long-term interest of their brand, I expect to see an acceleration in the trend toward the use of direct multi-unit franchising.

We are now entering what I expect will be the real growth period for cross-border franchising. Evaluating how to maximize a franchisor’s return on that opportunity—and not reflexively choose the legacy approach of master franchising—only makes sense.

 Michael Seid is managing director at MSA Worldwide. Contact him at 860-523-4257 or mseid@msaworldwide.com.