Challenges of Franchising and Licencing in International Business

1. Introduction

In this report, we will present the challenges of franchising and licensing in international business. We will start by defining franchising and licensing and explaining few essential issues related to them. After that, we will go into the different challenges and issues that companies will face with different solutions.

2. The Definition of Franchising and Licencing

Licencing and franchising are actually different variants of the same course of action. This course of action could be generally named as selling rights to produce and sell the product.

In practice it means that a company concludes an agreement with a partner, of the rights of producing and marketing a product or products in a certain market, for example in a specific country. The difference between these two different terms is that franchising concerns services, and licencing concerns physical products.

3. Royalties

Royalty can also be called remuneration. Most often, it is counted as a running percent royalty from the amount of sales. This is more profitable to the company, which is selling the rights than when it is counted as a percentage royalty from the amount of profit.

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Profit percentage would be better for the company, who is buying the right because in that case the royalties would never be the issue which pulls the operations to a losses. It also might be counted as bullet type compensation or a combination of the bullet type royalty and running royalty.

4. The Contract

The idea of the contract is to assure the quality of the product and ensure royalties for the primary company.

Therefore, the contract is very detailed about the production process of the product, specially the manufacturing process. It is still the product of the company, which has sold the rights and it is sold using the name of the primary corporation. Naturally, the primary corporation does not want to the image spoil.

Frequently it is recommended to license only the physical products, which are protected by patents. The selling company often offers to supply all technical support and training needed. Generally the selling company restricts the operational warrants rights and to certain country or some specific area to prevent from the partner to become a competitor.

Since in franchising it is question of service, it is impossible to prevent it by patent. Because of that, the name of the company, the trademark (trade name) and the reputation of its product are very important in franchising.

5. Challenges

Even though franchising and licencing have been growing rapidly, problems are often met in international markets. Franchising and licencing are not alternative course of action with each other, but different versions of the same course of action. Because of that, the challenges are quite frequently same for both of them.

5.1 The Profit

One of the most important advantages of licencing and franchising is the fast, cheap and easy way to expand and spread out to foreign markets. One of the disadvantages is low, or at least in the long run and limited total profit.

After the fast growth in the beginning and finally the saturation of the market with companies using their consept. The primary companies notice the only way to increase profits is to start to buying into the individual outlets or even accuiring the whole outlet. This is what happens very often in real life concerning both licencing, and especially franchising. It is possible that the management of the company, which has sold the rights, notice the same adverse factor in another way. When the business develops very fast and propitiously, the management may realize the facility of producing and selling. However, the total profit of the action is tied to the royalties. In fact, the situation may seem to the management that the partner gets richer by virtue of the product of the primary company instead of the company rakes in all the profits.

5.2 The Competitor

One of the biggest disadvantages of this operating mode is that the partner will gradually become a potential competitor. Not only in the market for which the agreement was made but for third-country markets as well. When an outside partner has once absorbed the technological knowledge, it is impossible to get it back. It is only possible to try to prevent or make more difficult to exploit it by different juridical ways.

Also in the case if and when the contract ends, the company might find that it has created a competitor. To avoid this, the licencor / franchisor usually supplies some proprietary ingredients or components needed in the product. But the best strategy for the licensor / franchisor is to lead in innovation so that the licensee/ franchisee will continue to depend on the company.

5.3 The controlling

The licencor / franchisor has less control over the licencee / franchisee than if it had set up its own production and sales facilities. There may be problems in ensuring that licensees / franchisees adhere to the operational methods which are designed to achieve uniformity. It is hard to controll the licencee / franchisee whether it is question of producing, the quality or marketing.

5.4

The Expansion

Many franchise / license systems have run into difficulties by expanding too fast and granting franchises / licenses to unqualified entities. The problems are the selection and training the franchisees / licensees.

Although the local franchisee / licencee knows the market best, the franchisor / licensor still has to understand the market for product adaptation and operational purposes. The franchisor / licensor, in order to remain viable in the long term, needs to coordinate the efforts of individual franchisees / licensees.

The franchising / licensing is a very limited form of foreign market participation and does not in any way to guarantee a basis for future expansion.

5.5 The Government

Foreign government intervention is a problem faced occasionally by the primary companies. The reasons for governmental intervention can be anything from usage of materials contradicting with local laws or religions (pork, alcohol) to the government saying that too much of the profits made leave the country. Many poorer countries have alleged that licencing / franchising provides a mechanism for corporations in industrialized countries to capitalize on older technology.

5.6

The Costs

Although there are low initiation costs and it is possible take advantage of foreign production factor (price), there are still some hidden costs, training and controlling.

5.7 Changing the Operating Mode

If the company is not satisfied to the situation, it may try to buy up the franchisee / licensee. If that is not possible, the company has to use other methods, but changing the operating mode is a quite slow and difficult operation. This means terminating the contract, which may lead to different juridical, financial and practical problems.

6. Conclusion

Companies contemplating with foreign expansion should always do thorough research and market analyzes of their target market areas. Even tough franchising and licensing seem like non-risk methods there are underlying threats that may prove to be much larger that ever expected.