Zimpapers Logo

Aleck Ncube
A FRANCHISOR may enter into individual franchise agreements for each outlet (single-unit franchisee). Here, the franchisor has direct control over each franchisee and generates a revenue flow that does not have to be shared with others. However, direct franchising may not be the best option in cases where the outlets are located in another country. There may be problems including the issue of repatriating revenues, limits applicable to remittances, tax implications, as well as difficulties related to dealing with the unique attributes of different countries, including language, culture, laws, regulations and business practices.

Typically, therefore, a master franchise is the model used for international transactions. A successful single-unit franchisee may go on to acquire more units, becoming a multi-unit franchisee. In certain countries, in order to facilitate the remittance of royalties, whether arising from franchise agreements or other sources, the relevant agreement must be recorded at a stipulated government institution, such as the local intellectual Property Office or the Central Bank.

Master Franchise Agreement

A franchisor may enter into a master franchise agreement whereby another entity is given the right to sub-franchise the franchisor’s business concept within a given territory in accordance with a development timetable. These rights are usually secured by an initial development fee charged by the franchisor. The fee may range anywhere from several hundred thousand dollars to several million dollars. The grant of a master franchise enables a franchisor to expand without substantially increasing the size of its management team. Here, the franchisee, in effect, acts as the franchisor in the target country.

The disadvantage of this approach is the loss of control over sub-franchisees (with whom the franchisor has no contract), coupled with the franchisor’s heavy reliance on another business entity over which it has no direct control other than through the master franchise agreement. For this reason, international franchisors, such as McDonald’s and KFC, choose their master franchisees very carefully.

Area Development Agreement

An area development agreement obliges a developer to open multiple outlets (rather than appoint sub-franchisees) in a defined area over a prescribed period of time. An area development agreement has broadly the same advantages and disadvantages as a master franchise agreement. The difference is that the franchisor may, even more so than would be the case with a master franchise agreement, be putting “all its eggs in one basket” by entrusting to one business the obligation to open multiple outlets. Because an area development agreement obliges the developer to open outlets rather than appoint sub-franchisees who would take on this role, it does not involve franchising vis-à-vis the developer and the outlets. Rather it involves franchising between the franchisor and the developer, who is the franchisee in this case.

International Franchising

Essentially, there are five ways in which a franchise system may be expanded overseas. They are as follows:

1. The franchisor, either from its headquarters or from a foreign branch operation, grants individual franchises to franchisees in the target country.
2. The franchisor establishes a subsidiary in the target country, and that subsidiary acts as the franchisor.
3. A joint venture is established between the franchisor and a third party who is knowledgeable about the target country. The joint venture will act as the franchisor in the target country.
4. The franchisor enters into a master franchise agreement.
5. The franchisor enters into an area development agreement.

In the context of internationalising a business, it is important to bear in mind that Intellectual Property Rights are essentially territorial, that is, the rights are limited to the territories in which they have been registered/granted or arisen. In other words, rights that exist in a certain country or region are applicable only in that country or region; this is particularly the case with Trademarks, Designs and Patents. Therefore, if a business is planning to take a franchise operation overseas, it would be important to ensure that its Intellectual Property rights are protected in that territory. Before executing the franchise agreement, it would be essential for the franchisor to take steps to register its Intellectual Property Rights in the country where the franchise business plans to operate. In addition, it would be essential for the franchisor to take similar steps in the territories surrounding that country, taking into account possible expansion strategies in the future.

Some of the biggest international franchisors register their Intellectual Property rights either worldwide or in a number of targeted countries many years before franchising their business. A business that makes the mistake of not protecting its Intellectual Property Rights in a target country at an early stage often discovers, to its dismay, that a smart third party has already done this and more. For example, they may have also registered certain domain names incorporating a particular trademark and, as a consequence, the business may be forced to pay them an exorbitant amount of money to buy back the rights.

Advantages and Disadvantages of Franchising

For the franchiser, advantages include business expansion (using other people’s money), infusion of new capital through franchise fees, additional and increasing revenue streams through royalties, franchisees perform better than employees, spreading of risks, smaller central organisation, less risk of management fraud and potential buyback of successful franchises.

Advantages for the franchisee

These include reliance on recognition of an established brand, smooth entry into a proven business model instead of starting from scratch, availability of training, support, knowhow, and marketing and financing, established customer base, lower risk, personal ownership, stability, supervision and quality control and opportunity to grow within the system. Once successful, the franchisee can own a second unit and has the potential to become a multi-unit franchisee exclusive territory, lower costs in purchasing inventory and equipment

Dis-advantages for the franchiser

Risks and costs associated with seeking out and training a franchisee, supporting the launch of a new franchise operation, a bad choice of franchisee could be disastrous for the entire franchise network, cost of maintaining the franchise network, confidential business information is shared, and thus becomes more vulnerable, limits income to fee and royalty income and not profits and pressure from franchisees to introduce change.

Disadvantages for the franchisee

High start-up costs, ongoing royalty payments, vulnerable to the network, bad reputation of one outlet affects the whole network, obligations to report and follow detailed directives and to provide access to accounting information

And little flexibility due to franchisor control of business practices. These also cover inability to use knowledge gained anywhere else, loss of identity as customers do not know who owns the outlet, obligation to grant back to the franchisor any improvements made by the franchisee and which would be made available by the franchisor to all other franchisees.

Aleck Ncube is an Intellectual Property Scholar. He can be contacted on [email protected] or follow me on Twitter: @aleckncube