The concept of franchising has deep historical roots, tracing back to the Middle Ages when sovereign rulers granted rights to subjects to perform public services in exchange for consideration.[1] By the 20th century, franchising evolved into a business model predominantly associated with private agreements for distributing products and services.[2] Today, franchising has transcended regional and national boundaries, becoming a global strategy for brand expansion. Brands all over the world have utilised the franchise model to expand into international markets and widen their consumer base.
But what happens when the economy faces significant challenges, such as rising prices of essential commodities, foreign exchange risks, currency devaluation, and infrastructure deficits? In such an environment, does international franchising remain a viable business model?
Understanding Franchising
To evaluate the viability of franchising in an economic downturn, it is essential to first understand what franchising entails. A franchise is a business operated by an individual or group (the franchisee) using the trademark, branding, and business model of another company (the franchisor).[3] It represents one of many ways a firm can choose to distribute its product or service.[4] In return for the right to sell the franchisor’s products or services, and for receiving training, support, and operational instructions, the franchisee pays a fee.[5] For franchisors, franchising offers a way to enter new markets without the significant financial burden of setting up operations and brand marketing costs, while benefiting from the local knowledge and expertise of the franchisee. For franchisees, it provides an opportunity to build a business backed by an established company with a reputable brand and proven operational processes.
Advantages & Disadvantages of Franchising
Franchising has long been a successful model for business expansion, but like any business strategy, it comes with both advantages and disadvantages that potential franchisors and franchisees must carefully consider.
From the Franchisors Perspective
Advantages[6]
Rapid expansion: Franchisors can achieve rapid growth without significant capital investment, as franchisees typically cover the startup costs. This allows for the quick establishment of multiple franchises without the financial strain of large initial investments.
Greater brand recognition: Expanding through franchising can significantly enhance brand recognition and market presence as the brand ventures into new territories and connects with diverse customer bases. This growth in brand visibility strengthens its position in the market, making it more established and trusted among consumers. As brand awareness increases, it creates a positive feedback loop, where heightened recognition drives consumer engagement, leading to greater demand for the brand’s products or services. This, in turn, facilitates the launch of additional franchises.
Market knowledge: A franchisor can greatly benefit from the local market knowledge that a franchisee brings. By leveraging this insight, the franchisor can implement marketing strategies that are specifically tailored to the region, ensuring a more effective and targeted approach. The franchisee’s understanding of local consumer preferences and priorities also provides valuable guidance on how to engage and attract new customers, making the brand more relevant and appealing in the local market.
Disadvantages[7]
Loss of control: In a franchise model, the franchisor inevitably relinquishes some control over the business. While this can be mitigated through detailed contracts, well-defined processes, and comprehensive training supported by manuals, the franchisor is not directly involved in the daily operations of each franchise. As a result, certain aspects of the business, such as product or service delivery, third-party relationships, and customer service, may become inconsistent. Addressing these inconsistencies can require significant time, effort, and financial resources from the franchisor.
Reputational risk: Operating a franchise model exposes the franchisor to increased reputational risk. Due to limited control over the actions of franchisees and their employees, there is a possibility they could engage in illegal or unethical behaviour, which could damage the brand’s reputation and erode consumer trust.
Legal disputes: As a franchise expands, the likelihood of legal disputes rises, whether with franchisees, customers, or suppliers. The costs associated with resolving these disputes can place a significant financial burden on the business, not to mention the time and effort required to address them. Although disputes are sometimes unavoidable, a franchisor can mitigate these risks by engaging experienced legal counsel to proactively manage and reduce potential conflicts.
From the Franchisee’s Perspective
Advantages[8]
Proven concept: For a franchisee, investing in a franchise means leveraging a proven concept and an established business model. Most franchises are launched by successful companies that are ready to expand their reach. As a result, franchisees do not need to concern themselves with developing a new business model; instead, they can focus on implementing an existing framework that has already demonstrated its effectiveness.
Brand recognition: An established franchise possesses a strong, recognisable brand and a loyal consumer base. This allows franchisees to leverage the brand’s reputation and existing customer relationships to build a successful business. Consequently, this can facilitate faster market acceptance and quicker acquisition of market share, as consumers are already familiar with the brand and its reputation.
Lower risk: The risks of joining an existing franchise are significantly lower than those associated with starting a new business. Franchisees enjoy a greater likelihood of success because they are investing in a brand with a proven business model. Additionally, franchisees benefit from the support of the franchisor, as well as access to documented operational processes that offer guidance on managing the business effectively.
Disadvantages[9]
Creative control: An essential aspect of a franchise is ensuring that customers can recognise the brand across different locations, including the layout, products, services, and customer service. This requirement limits the creative control of franchisees, as they must adhere to the specifications set by the franchisor. Consequently, the level of control that a franchisee has over their business is significantly lower than that of an independent business owner.
Reputational risk: Any damage to the franchise’s reputation can directly impact the franchisee’s business. Consumers typically do not differentiate between the franchisor and the franchisee, as they often do not realise they are engaging with a franchise model. Reputational risks can arise from the actions of the franchisor or other franchisees, which may negatively affect the brand. To mitigate this risk, potential franchisees should conduct thorough research on the franchisor’s operations and their management of franchisees.
Contract termination: Franchisees enter into a contractual agreement to operate the franchise, typically for a specific duration with the option to renew. However, the franchisor may terminate the contract for various reasons unrelated to the franchisee’s performance, such as a decision to vacate a region.[10] This creates uncertainty for the franchisee, as factors beyond their control could lead to the termination of their contract.
The Viability of Franchising during Economic Downturns
It could be argued that franchising may not be the most effective business model for navigating or thriving in periods of economic uncertainty. However, franchising as a business model has shown itself to be pretty resilient through times of economic crisis.[11] In times of job loss, many individuals turn to entrepreneurship as a means to generate much-needed income. Numerous successful businesses have emerged during recessions or depressions; for instance, Disney was founded in 1929, at the onset of the Great Depression, and Hyatt began operations during the 1958 recession. While not all businesses launched in economic uncertainty succeed, franchises typically enjoy a higher likelihood of success due to their established business models and existing customer bases.
Launching a business during an economic downturn presents several advantages, such as reduced competition, access to skilled talent, and the ability to adapt and innovate in ways that established corporations may struggle to do. When assessing the viability of investing in an international franchise in a sluggish economy, several factors warrant consideration. For those contemplating such an investment, it is crucial to also strategise on how to equip themselves and their businesses for an uncertain future. Given the unpredictable economic outlook in Nigeria, it is essential for both franchisors and franchisees to take proactive steps to enhance their chances of success. There are various strategies that can be implemented to achieve this.
Strategic Considerations for Franchising in Nigeria
To enhance their chances of success in Nigeria, both franchisors and franchisees should consider the following strategies:
Industry exploration
Quick service restaurants and fast food operations dominate the franchise landscape in Nigeria in terms of volume.[12] However, franchises also thrive in various sectors, including fitness, health and beauty, education, and home services.[13] Entrepreneurs looking to invest in a franchise should consider industries beyond food services, targeting sectors where a viable market base exists or can be developed. Industries that do not require the purchasing of raw materials in foreign currencies or depend on constant access to foreign exchange should be prioritised. By focusing on such sectors, business owners and potential franchisees can mitigate foreign exchange risks. One of the key advantages of the franchise model is that franchisees need not have extensive industry experience, as they invest in an established business model and receive ongoing support, training, and operational guidance. Consequently, the knowledge requirements for a franchisee entering a new industry differ from those needed by a startup owner.
Extensive research
Franchisors seeking to enter new international markets must conduct comprehensive research. While franchisees, particularly experienced entrepreneurs, can provide valuable local market insights, franchisors must also develop a deep understanding of consumer behaviours in the new market. Furthermore, every country has unique legal and regulatory compliance requirements that must be thoroughly investigated, ideally in consultation with local legal counsel, to understand how these regulations will affect the franchise model in both the new and existing markets. Additionally, the Nigerian government has introduced various incentives for businesses; expert legal advice should be sought to determine their applicability and potential benefits for both franchisors and franchisees.[14]
Potential franchisees should undertake meticulous research on the franchisor and its business model to assess whether it aligns with their investment goals. Key considerations should include the franchise model itself, the level of support provided, the degree of control exerted by the franchisor, associated fees, and the operational responsibilities expected of the franchisee. These factors will help potential investors make informed decisions about proceeding with their franchise investment.
Technology[15]
Technology should be a key consideration in any business operation. Franchisors and franchisees should explore how technology can enhance business value and reduce costs. Areas suitable for automation should be identified, and tools that can enhance employee productivity and improve customer interactions should be implemented. Moreover, exploring technological solutions that lower operational costs is essential. By leveraging the right
technology, franchise businesses can operate at optimal efficiency and generate significant value.
In general, franchisors and franchisees should collaborate to identify risks and opportunities as economic conditions evolve, while prioritising the establishment of agile, scalable businesses that can adapt to market changes. It is also crucial to optimise supply chains, upskill employees, and explore processes that enhance productivity. In addition, the legal considerations[16] and implications of operating a franchise should be fully explored along with expert legal counsel to ensure appropriate structures are established.
Conclusion
Building, expanding, or investing in a franchise presents both risks and opportunities. For those willing to explore them, periods of economic downturn can offer unique advantages and opportunities. The resilience of any business lies in its ability to adapt to changing conditions while preparing for an uncertain future. Franchises continue to be a viable model for business expansion and entrepreneurship, but it is up to franchisors and franchisees to evaluate how well the economic landscape aligns with their business goals.
To learn more about the viability of international franchising in periods of economic downturn, email insights@xentialp.com.
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[1] Thomas S. Dicke, Franchising in America: The Development of a Business Method, 1840–1980 1 (1992).
[2] William L. Killion, The History of Franchising (American Bar Association).
[3] Franchise Business Review, The Franchise Business Model 101 – Introduction and How Does It Work (Nov. 30, 2021).
[4] Benjamin Klein, The Economics of Franchise Contracts, 2 J. Corp. Fin. 9, 10 (1995).
[5] Franchise Business Review, The Franchise Business Model 101 – Introduction and How Does It Work, (Nov. 30, 2021).
[6] This is not an exhaustive list of advantages.
[7] This is not an exhaustive list of disadvantages.
[8] This is not an exhaustive list of advantages.
[9] This is not an exhaustive list of disadvantages.
[10] McDonald’s exited Russia in May 2022 following Russia’s invasion of Ukraine.
[11] Fiona Simpson, Franchising in a Recession: When the Going Gets Tough, Can Franchises Keep Going? Forbes (Aug. 5, 2022).
[12] United States of America, Department of Commerce, International Trade Administration – Nigeria – Country Commercial Guide.
[13] Home services include cleaning, gardening, handyman services and more.
[14] An incentive that can be explored is the pioneer status issued by the Nigerian Investment Promotion Commission.
[15] Technology includes artificial intelligence technologies.
[16] These include corporate structure, franchise contracts, employee contracts and intellectual property and technology transfer.