Interested in expanding your business internationally and learning more about international modes of market entry? Pick up a copy of my latest book, Business Beyond Borders: Take Your Company Global.
In my last blog on international modes of market entry, I talked about trading strategies, such as exports and ecommerce. These approaches are typically low-risk, don’t require a large upfront investment and can be a good first step into a new market because they allow you to test how well your products and services are received in that country.
However, as companies grow and develop a reputation for quality products and services, their intellectual property becomes more valuable. Transfer strategies like licensing and franchising – which were once the exclusive domain of multinationals – have been adopted as a means of expansion by niche-market businesses that have popular products or services.
Pros and Cons of International Franchising
Franchising enables you to grow internationally, by replicating multiple units of your business across new locations. Franchisees provide the capital required to expand to multiple geographies by buying a franchise.
Because franchising is all about unit expansion, replicating business systems, sources of supply, and uniformity of operations, it allows you to increase your purchasing power and achieve economies of scale with suppliers and vendors. These economies of scale can even extend to marketing where you and franchisees will be pooling resources and establishing common funds.
Franchising also creates a supply of skilled, trained, motivated managerial talent, which is key to scaling a company across multiple international markets. Franchisees supply the managerial talent needed for new locations and because they buy into the business, they have a vested interest in its success.
In addition to entering new overseas markets with additional customers, international franchising can also offer what is called foreign master franchise owners. These individuals are typically local to the country and understand the political and bureaucratic subtleties of the market far better than any outsider.
Foreign master franchise owners pay a hefty upfront fee to acquire a designated geographic area or, in some instances, an entire country where they operate as a mini or sub-franchise company, selling franchises, collecting royalties, training the owners, and overseeing all other related matters. They can even open units by themselves. In general, a specified number of franchises must be outlined for the exclusive right to use the business model in an entire country.
Despite the advantages, franchising isn’t all upside.
Franchise sales are competitive too. Once you franchise your business the next step is to sell franchises to qualified franchisees that have capital. While you may have organic interest from individuals that know your business and want to buy a franchise, long-term, you will need to attract qualified franchisees and this means that you will need to invest in marketing, public relations, and relationships with franchise brokers.
Franchising requires ongoing investment. Even after you make the initial investment in franchising your business, franchising will require you to invest time and capital on an ongoing basis, to build up your franchise system. The success of your first number of franchisees will determine the growth and trajectory of your new franchise network.
You can’t just go it alone. Because franchising is a regulated industry, you’ll need to work with a franchise lawyer to develop a franchise offering comprised of a franchise disclosure document (FDD) before you can offer or sell a franchise. You’ll also need to ensure that you comply with franchise laws in your country.
Licensing is where the exclusive owner of Intellectual Property Rights (IPR) such as technology or patents, trademarks or copyrights gives another entity permission to use the IPR on agreed terms and conditions including the payment of royalties. Licensing can cover several areas including:
Small companies often lack the financial, physical, or human resources to commercialize their IP and licensing can be a means of solving that problem. For example, a small company that has developed a new method for making petrol from crude oil is very likely to license it to an established company, because building a refinery just isn’t feasible for a small business.
Licensing is also a way to establish a foothold in multiple countries. In the US in particular, it is common for companies to license their technology to unrelated foreign companies that then use it to manufacture and sell products in a country or group of countries defined in the licensing agreement.
How does it work?
Pros and cons
A technology licensing agreement can be an attractive option for a small company because it usually enables the business to enter a foreign market quickly. It also poses fewer financial and legal risks than owning and operating a foreign manufacturing facility or participating in an overseas joint venture. Licensing may also enable a company to overcome many tariff and non-tariff barriers that often hamper the export of foreign-manufactured products.
However, technology licensing also has some drawbacks as a mode of market entry. The owner’s control over the technology is weakened because it has been transferred to another company and licensing usually produces smaller profits for the owner company than exporting actual goods or services. Importantly, in some countries, adequately protecting the licensed technology from unauthorized use by third parties may be difficult.
To sum up, transfer strategies can provide an easy route to market, because the licensee or franchisee does a lot of the leg work and there is no need for you, as the foreign owner of the product to build a distribution network in-market. This means that the initial cost in terms of time, resources and financial outlay to set up is low. Another plus is that local franchisees and licensees have local knowledge which can help in reaching new markets and finding new partners, which may also speed up your entry to the market.
However, there are some potential downsides. Licensing and franchising means allowing a third party to use your intellectual property rights (IPR) for profit, and this means that you automatically have less control over the business model than you would if you were selling your IP yourself.
Because you are handing over your IP to a third party, there is a risk that it could be copied or stolen (especially in countries where IPR are not vigorously protected) or that your reputation could be spoiled by dubious partners.
And although transfer strategies are low-cost, they typically provide lower returns than setting up a presence in the target market, so the initial savings you make may not be enough to offset lower long-term profits.
In my next blog on international mode of market entry, I’ll be discussing investment strategies – check it out.
Interested in expanding your business internationally and learning how to choose a mode of market entry? Pick up a copy of my latest book, Business Beyond Borders: Take Your Company Global.