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When Did Franchising Start?

When it comes to expanding your business, franchising has become the Modus Operandi of the day. In Singapore, many businesses including restaurants, café chains, and fashion chains have shown interest in and considered setting up franchises. It makes sense financially for them in the sense that the franchisor (the business owner that grants the franchise) can charge an initial fee to the overseas franchisee (the person who takes the franchise). Franchising in effect provides an almost cost-free expansion since the original business receives royalties and a constant stream of income from the franchise. But there are pitfalls to avoid. Franchising may not be suitable for all businesses and an overseas operation can fail for several reasons.
This article sets out briefly some of the challenges a franchisor venturing overseas may face and how to overcome and resolve them.
Franchise Systems
Companies that wish to enter into a franchise agreement should familiarise themselves with the franchise system. There are three different ways to operate a franchise:
Unit franchise:
The business owner allows only one franchise outlet and licenses all trademarks and other proprietary rights to only that one outlet.
Area franchise
The franchisee is only allowed to operate under the trademark or brand name in one designated geographical area, such as the province of New South Wales as compared to the whole of Australia.
Master franchise
The franchisee is entitled to operate in the whole country, sometimes with a right to create sub-franchisees and appoint sub-franchisees within the country.
Costing would differ for each of the above types of franchises and is also affected by the potential market size and share in the targeted country.
Regulations and Other Legal Issues
The next things to look out for when considering whether to franchise are the laws and local regulations in the targeted countries, which will impact the franchisor. In countries such as the USA, the franchisor must comply with stringent disclosure requirements while in countries like Indonesia, the franchisor may be required to register the franchise agreement with the relevant authority before commencing operations. These requirements do not present too much of a problem to the franchisor, but they have to be complied with nonetheless. The franchisor should also pay particular attention to laws and regulations in various other countries that directly affect the business of the franchise. One example of what we mean here is that, since February 2005, franchising has not been allowed in China for foreign retail brands which do not have a minimum of two shops and more than one year of operations in China. This amendment to the franchise regulations has made it difficult for established local brands to franchise in China.
Of course, there are perfectly legal solutions to avoid the problems that may be encountered. The rules differ from country to country and, therefore, any prospective franchisor must seek legal advice when venturing into a foreign jurisdiction for the first time to ensure that all such regulations and formalities required under the laws of the targeted country are complied with.
Of course in some cases, it may still not be advisable to commit to a franchise agreement even though all the indications are positive. Some product lines may simply be unsuitable for franchising.
Common Problems Faced by Franchisors
There is a range of problems that could be encountered by franchisors (when did franchising start) and we have attempted to address the most common ones here.
Initial Investment
One of the problems when embarking on a franchise, especially for local companies or SMEs (small-medium enterprises) seeking to expand overseas, is the costs involved in the early stages of a franchise. Preparation for franchising has to be done without the guarantee of payment and collection of franchise fees and royalties in the short term. The costs involved include:
o developing the franchise concept (normally done with the help of engaging external consultants)
o overseas market research
o legal matters
o providing support
o looking for suitable franchisees
o training
o product costs
o supply of products to the franchisees
For retail chains, financial problems with shipment and manufacturing (even after executing an agreement with the franchisee) have to be considered. The sizable initial costs plus the time lag (about half a year to more than one year for preparations) before the franchisor can recoup the money from the franchisee, may result in cash flow problems for the franchisor. This is especially so for smaller retail chains with a yearly turnover of say US$1m to US$5m as they may not have the financial resources to provide or compensate for any delays.
One example we experienced that illustrates this point is the case of a Singapore shoe retail chain (with about 5-6 shops) that embarked on a franchise for its shoe retail chain in Indonesia. In the contract, it was stated that the balance of payment would be paid after the goods had arrived at the Port of Jakarta. However, the payment was not made. Despite this, the franchisor had no alternative but to release the goods as they were already in the Port of Jakarta. He only received payment at a time much later than the agreed date. This delay caused him some cash flow difficulties.
Problems like this can and should be addressed legally in the franchise agreement just as they would be in a contract for international or cross-border sales of goods.
Financial concerns can also lead to the lack of adequate preparation in coming up with the franchise concept. This can, in turn, lead to inconsistency in the quality of the products and different levels of support or commitment by the franchisor in different countries. The food in a franchise outlet in say, Australia, where the franchisor is located, would taste much better than those in another outlet from the same franchise in China. Though the situation may improve after some time, this is the usual problem that local brands or small-medium enterprises face at the onset.
The Trade Mark Problem
Usually, trademarks are the most important intellectual property rights in a franchise. Trademarks are territorial and the franchisor will have to register its trademark in the targeted country before it can be protected there. Registration in your own home country is not good enough and your local registration will not be recognized in another country.
The franchisor may sometimes find that his trademark has already been registered in the targeted country by a local third party as was the case with a particular popular Indonesian fashion brand seeking to franchise in Korea and Thailand. It found out the hard way about stolen trademarks when it discovered, after entering into a franchise agreement with a local franchisee, that its brand name had already been registered by other companies in these countries. To make matters worse, it decided to leave these issues to the local franchisee instead, thinking that the local franchisee would be more familiar with the situation. This caused him serious financial losses as he had already shipped his products to the franchisee. The franchisee subsequently defaulted on payment and did nothing to resolve the trademark problem. From this, it becomes clear that some initial market research in the targeted countries and legal advice is needed when you want to start your franchise.
Registering Your Trade Marks in Foreign Countries
The Madrid System for the International Registration of Marks (“Madrid Protocol”) and the Paris Convention for the Protection of Industrial Property (“Paris Convention”) are two very important international treaties regarding the registration of trademarks.
The Madrid Protocol provides a one-stop filing system so that the franchisor can file for trademark protection in his own country as well as his targeted countries at the same time. It does not give you an international trademark that is recognized by all its member states or all countries across the globe but provides the convenience of filing in different countries at one go and also reduces the costs of filing.
The Paris Convention, on the other hand, provides a very useful mechanism allowing the franchisor to file the trademark in his home country first at an earlier date and subsequently, within a given time frame, when he decides to file his trademark in his targeted country, he can claim priority or use his first and earlier filing date in his own country as the date of filing in the targeted country. The Paris Convention gives the franchisor time to source funds before filing for trademark protection in the targeted countries and the peace of mind that comes with knowing that he can be protected by filing first in his home country.
Take a real-life example of a Korean cosmetics company setting up its business in Singapore. It registered its trademark first in Korea sometime in December 2005 before coming into Singapore. Upon entry into the Singapore market, it then filed for trademark protection in Singapore under the Paris Convention sometime in March 2006. However, the directors quickly received notification from the Singapore trade marks registry that there was an identical trademark filed by their competitor in January 2006. Taking advantage of the Paris Convention, the Korean company was able to claim the earlier filing date in Korea of December 2005 as their date of filing in Singapore and this allowed them to effectively override their competitor’s earlier application. This helped prevent a situation where the Korean company would either have had to shelve its plans in Singapore or embark on costly litigation to recover its trademark.
In general, it is usually not advisable to leave trademark matters such as registration to the franchisee. The trademarks should always, where possible, be filed in the name of the franchisor otherwise the brand value or recognition of the trademark may be diminished in the long run since the public in the targeted country may come to identify the trademark with the local franchisee and not the franchisor.
Other Intellectual Property Rights
Copyright
This is another form of intellectual property rights that may be of interest to the franchisor. Copyright can attach to many possible mediums and is not confined to brand or logos alone. Instructional manuals, business forms, software, and other items may all be protected by copyright. Unlike trademarks, copyright usually does not have to be registered and can be protected in many foreign countries at one time if these countries are all signatories to the same international copyright convention.
Patents
These do not quite fit into the business model of franchises since patents are, by their nature, confined to the subject matter of heavy industrial application. This may change in the future as many countries such as Singapore have made or are making changes to their laws, allowing business methods to be patented. Like a trademark, a patent has to be registered and have its equivalent of an international system of registration by way of the Patent Co-operation Treaty. The Paris Convention also applies to patents.
Control over Franchisees
It is always advisable to exercise some supervision and control over a franchisee. The first step towards this is to incorporate the right clauses in your franchise agreement at the onset. The franchisor should insist on some form of reporting requirements and a right to inspect accounts. There should also be some provisions to safeguard the franchise concept and sometimes the franchisor’s business methods. Generally, the franchisor should be looking to protect, by way of contractual clauses in the agreement, what may not be protectable under intellectual property laws.
This helps the franchisor to prevent a situation where the franchisee acquires knowledge, copies the franchise concept, and uses this to compete with the franchisor. This can sometimes happen at the end of the franchise period. There should be restrictions imposed on the franchisee when dealing with materials or other property of the franchisor, and these should be returned and accounted for by the franchisor upon the expiry or termination of the franchise.
See You in Court – But Which Court?
It may be at times necessary to take legal action against an errant overseas franchisee that is outside the jurisdiction of the courts and also beyond the control of the laws in the franchisor’s home country.
It is advisable to make some provisions for this in your franchise agreement. The two important considerations here are the place to sue and the law to apply. It is important to seek legal advice for these matters since your choice of place and law often determines success and directly affects the prospects of recovery as rules may differ from country to country. Some countries may have bilateral reciprocal enforcement regimes allowing their respective courts to recognize and enforce each other’s judgments while others may be signatories of international conventions to the same effect. It is important to know these to choose your place to sue and the applicable law.
Sub-Franchising and Exchange of Goods
Another problem with franchising is the inconvenience caused to end consumers when it comes to the exchanging of defective products. This is especially so where there is sub-franchising created in different places in the same country. For instance, in Australia, when a customer buys an item of clothing from an outlet in Sydney, he would not be able to exchange it in the franchise in Melbourne. This also happens in Indonesia, especially if the shop is owned by different people. That is why some retail chains like Hammer and Nail (Indonesia) prefer to own the business themselves. This can be used either as an alternative or a stepping stone to establishing a fully-fledged franchise.
Raise Public Awareness First
It may be easier for local brands who want to expand overseas by franchising to consider setting up their flagship store in the overseas country first. This would raise public awareness of their brand and product in the targeted country and help to attract more franchisees later on. Famous local brands such as BreadTalk in Singapore may not be known to anyone in overseas countries, such as Germany. As such, potential investors in Germany would be hesitant to invest in the brand. By setting up a flagship store, the franchisor can test the local market.
However, before venturing overseas, research should also be done on consumer behavior to make sure that the consumers in that country would appreciate the product, bearing in mind that different countries have different cultures, tastes, and market trends.
Franchising –
A Great Tool for the Right Business with the Right Knowledge
Franchising is a useful tool when it comes to expanding your business overseas. However, as we have shown here, there are also potential pitfalls and risks involved. This can be avoided or at least minimized if the necessary preparatory work is carried out before you venture into a franchise agreement with a foreign partner.
Acquiring knowledge of consumer behavior patterns, local market conditions and regulations, developing a suitable franchise concept as well as paying attention to various details in your franchise agreements are just some of the more critical matters that you, as a franchisor, should take note of.
Knowing your market and your rights as a franchisor or a trademark owner lay down the foundation for the creation of a successful franchise.