Robert Moschorak is the President and GM of Ace Hardware International, the world’s largest home improvement franchise company. He shares his experiences in international franchising and related expansion models on a regular basis.
Why go global?
Why should a company consider international franchise expansion? It is attractive because it offers access to vast target markets. Robert is convinced that international expansion can be profitable, but only if it is approached in the right way and for the right reasons. By this he means that for all practical purposes, the company should have saturated its home market, with international expansion the next logical step.
Some essential prerequisites are:
Organisational strength: The company has the full palette of resources in place that are needed to roll out and support an international expansion drive. Care must be taken that this step does not deplete the home operation of scarce resources, be they money or experienced personnel.
Consistent long-term vision: The company’s top management supports international expansion and continuity in this regard is assured. There is nothing worse than successive top managers having divergent views on international expansion. This could lead to a stop/start approach resulting in loss of face and financial losses.
Home market saturation: The home market is saturated, or at least saturation is not far off. Expansion into other countries is the next logical step.
An attraction that travels well: Beware of the home field advantage. No matter how well respected your brand is in its home market, there is no guarantee that the concept will work equally well in a foreign market. In-depth market research, conducted before entering a new target market, should be carried out before international expansion is contemplated in earnest.
Realism: A company wishing to expand internationally must know in advance what it is getting into. This step is not for the feint-hearted, nor should the company expect to generate quick returns. Be prepared for the fact that international expansion is always harder, takes longer and costs significantly more than was originally anticipated.
How to select target countries
Selecting the correct target countries is of overriding importance. The following needs to be taken into account:
IP protection: Does the country have the legal framework in place to protect the company’s intellectual property (IP)? And if such legislation exists, is it diligently enforced?
Financial system: Is the target country’s currency stable, and is it possible to transfer profits out of the country?
Market size: Population numbers alone are not an adequate indicator of target market size. Buying preferences and average disposable income must be taken into account as well.
Unit level economics: Can franchisees make any money after they have paid overhead costs and franchise fees? For example, if delivery of the product is labour intensive and labour costs in the target country are high, it could put a question mark over the viability of the project.
Barriers to entry: Unless barriers to entry are relatively high, the arrival of a foreign brand and the resulting publicity may attract numerous copy-cat operators. This can lead to price wars, resulting in nobody making any money.
Expansion formats
Robert pointed out that various expansion vehicles for entry into a foreign market are available. Because each has its own set of advantages and disadvantages, his company uses several of them, depending on circumstances.
Direct operation: The company sets up its own chain of stores in the foreign target country. In some ways, this is ideal because it offers total control and assists with the validation (and if necessary adaptation) of the concept. On an ongoing basis, company-owned stores serve as a live R&D laboratory and a training platform. They also serve as a revenue-generating base and, if operated correctly, can be highly profitable. On the downside, establishment costs are high and the company carries the total risk.
Joint venture: The company and a carefully selected local partner roll out the brand through a joint venture (JV). Subject to a good culture fit, this can work extremely well because the company brings the brand and the necessary know-how into the partnership while the local joint venture partner injects familiarity with the local market. Key to success is careful selection of the joint venture partner. It is also advisable to retain a majority shareholding.
Distributor: A distributor has an established presence in the target country, knows how everything works and makes the necessary infrastructure available to achieve rapid market penetration but this comes at a price. Most distributors work with several principals which means that focus may be lacking and control is severely limited.
Area developer: Area developers are offered the right to roll out the brand in a country or part of a country. Margins permitting, this can be done through a combination of franchising and sub-franchising. It requires a low investment by the company because other people’s money is used to establish a presence. Accelerated growth is possible but this comes at a price. Some of the advantages of the model are dilution of revenue streams, limitations on quality control and, in some countries, problems with revenue collection. There is also the danger that unless the area developer is carefully selected and managed, roll-out is too rapid which could have a negative impact on the brand.
Master franchisee: A master franchisee is usually granted the right to establish one or more pilot outlets, operate them for a period while adapting the product to local conditions, then roll out the brand through a network of franchisees. The master franchisee pays an initial licence fee and shares ongoing revenues. Once again, careful partner selection is essential.
Lessons learnt
- No matter how well established you are in your home market, every new market takes one to three years to develop.
- When setting up shop in a foreign country, try to set up a joint venture with an experienced local partner. This is of particular importance when language and culture barriers are in evidence.
- Determine the potential of an area before investing in a roll-out. Above all, make sure that attainable margins are robust enough to support all stakeholders without making the product too expensive.
- Validate first, then replicate. Don’t ever rush to failure. By the same token, reaching critical mass as soon as possible after the concept has been validated is important.
- Establish stores in clusters. This speeds up market penetration. It also makes it easier (and cheaper) to maintain control.
- Be flexible by using different models for different areas. For example, Robert used direct franchising in the home market, but a hybrid approach (direct franchising in some areas, master franchisees in other areas) in Europe. In Brazil, he used a master franchise model only but this turned into a disaster because sub-franchisees encountered problems and the master franchisee did not have the funds to sort it out.
- Managing franchisees is not intuitive. The correct approach will make or break the relationship. For example, not every breach is serious enough to justify termination of the franchise agreement; in many instances, persuasion needs to be used instead.
- Support must be strong and localised; this means that the master franchisor must set up a local development team which, among other things, takes a hand in the evaluation of prospective franchisees.
- For a master franchise arrangement to succeed, it must create value. People, products, systems and the concept’s growth potential are key factors. At the end of the day, it all comes down to the realisation that “Together we are better”.
