SURFS UP!: INTERNATIONAL FRANCHISING

On a recent trip to Hawaii, a client took me to the Bonzai Pipeline to watch some of the most incredible surfing action in the world. At times, the waves break forty or fifty feet high, and for the surfers skilled enough to survive those waters, that kind of action can provide the ride of a lifetime.

Up and down the Hawaiian North Shore, not far from the Pipeline, there is a breed of surfer who lives for that ride. Some hold down part-time jobs near the ocean. Others just watch and wait. I happened to be there on one of those rare days when the forces of nature were aligned just perfectly, and up and down the beach could hear the cry of, "Surf's up!" And when that cry went out, the surfers came running. You could sense the urgency in their faces. They had to move fast. The forces of nature wait for no one.

In today's booming international franchise marketplace, the surf is up for US franchisors bold enough to take the plunge. And while the waves are certainly too strong for some, for those that have the skill, the wave of the century is rolling in.

Why International Expansion?
With such a strong domestic market, one might rightly ask why any US franchisor would consider going global. For some US franchisors, the US markets are relatively saturated. But for most, the promise remains largely unfulfilled. Why then, go global?

In a word: Timing.

The growth of franchising in many markets follows a pattern. When people in the industry say that a market is 20 years behind the US, they are not merely making an analogy or reminiscing about the "good old days." The fact of the matter is most experts recognize that the pattern is predictable.

In today's global marketplace, never before has the timing been so good for US franchise concepts. For one thing, more and more markets are reaching the Rapid Vertical Expansion and Horizontal Proliferation stages of growth - stages at which the imports of US franchises by local companies are most aggressive. In addition, in recent years we have seen a compression of the early phases of the franchise life cycle. Introductory and Early Expansion stages, which might have lasted a decade once, are today lasting half as long in some countries - accelerating their demand for international franchise imports.

And when a foreign investor decides to buy a franchise, where do they go shopping?

Consider the following: The United States invented franchising. It is home to the vast majority of the world's brand name franchisors. It is the heart of capitalism and entrepreneurism. In many countries, US concepts carry a certain cachet simply because they are from the US. Part of this is the US mystique, and part is the competitive environment in which these businesses are grown. The retail and service environments in most countries are simply not as competitive as they are in the US. And in the Darwinian world of business, that type of environment produces the strongest survivors.

The fact is that the United States is the shopping mall of the world when it comes to franchise opportunities. And more international investors are shopping today than ever before.

How to expand internationally
Many franchisors initiate their global franchise efforts through serendipity. Perhaps a foreign investor looking for a specific type of franchise runs across a listing in Successful Franchising, and that chance encounter leads to an international franchise opportunity. But encounters like this are not an effective strategy for international growth.

Franchisors aggressively targeting international growth are best off targeting a specific country or group of countries in which they would like to expand. To do so, the first step is to identify the best counties for your particular concept. Factors such as franchise climate, the market for your particular product or service, competitive factors, proximity, language barrier, political climate, and relevant legal concerns should all be factored into this decisions.

Once a market is identified, one effective means of targeting prospects within this market is the use of trade missions. Sponsored by groups such as the International Franchise Association, trade missions attempt to provide franchisors with introductions to a number of qualified candidates in each country. The franchisor is typically responsible for their own expenses (which can run upwards of $10,000), their own follow-up, and their own negotiations. The sponsoring organization is only responsible for the introduction.

Another alternative for franchisors interested in global expansion is the use of brokers. Brokers work by promoting your franchise within a particular market, and will often employ a strategy of directly contacting the best potential partners to determine their interest. Generally, brokers will not ask the franchisor to visit the country until they have generated some serious interest, and oftentimes, the candidates will visit you as a first step, thus minimizing your expenses. More importantly, this direct contact approach will generally result in the best follow-up, as the broker will generally derive the bulk of their compensation based on "success fees." These fees generally range between 10% and 20% of the initial fee. In addition brokers may ask you to offset out-of-pocket expenses, and may, in some cases, ask you to underwrite the development of market research (which may cost $10,000 or more).

As an alternative, of course, you can try to go it on your own. The U.S. Government is even available to assist you in these endeavors through programs such as the Gold Key program. Simply contact the appropriate U.S. embassy and, for a modest fee, they will assist you in researching the market and identifying potential partners. They will even set up meetings with these partners. All you have to do show up and negotiate the deal.

Once you have identified several candidates, remember, the strength of your partner is even more integral to your success internationally than it is domestically. As a franchisor you may have significant difficulties that you would not encounter domestically. Language barriers. Cultural barriers. Substantial time differences. And you will be dealing with a franchisee who has substantially greater responsibilities than your typical domestic franchisee. Not only will your franchisee be responsible for developing and adapting your foreign prototype to a new and different market in which it has limited name recognition, but he will also be responsible for implementing your expansion plan for an entire country.

Moreover, if your franchisee fails, your subsequent efforts to develop that market will likely meet with stiff resistance. In the minds of locals, will not be the local partner who failed. It will be the concept.

Structure of the International Transaction
Once you have identified the best possible international franchise candidate, the next question you must answer is how to structure the transaction.

First of all, you are probably looking at selling the entire country, or at least a substantial territory. The barriers and costs involved simply make individual franchising unfeasible for all but a select few franchisors. While some of these arrangements are structured like area development agreements, most resemble subfranchise arrangements, in which the partner would not only develop units, but will sell franchises much the same as you would as a franchisor. Franchisors typically are compensated in these arrangements through a combination of initial fees, ongoing fees, and unit opening fees.

Before deciding on a fee structure, it is important to get an understanding of the services required to establish a successful international venture. Fees can then be determined after estimating associated expenses. Bear in mind that the costs of closing an international transaction can be significantly higher than a domestic transaction. Brokerage fees, international franchise lawyers, travel costs, and substantial training commitments both at home and abroad can easily give you a six-figure headache.

For this reason, initial fees for most countries generally range between $100,000 and $1 million, depending on the size and maturity of the market involved and the overall demand for the franchise in question. Francorp studies have indicated that larger and more mature markets tend to see initial fees in the range of $0.005 to $0.01 per person, while smaller and less mature markets tend to produce fees in the range of $0.002 to $0.004 per person.

In a master franchise relationship, both royalties and fees are generally a fraction of what they are in a direct franchise relationship, with the licensee generally receiving the lion's share of the revenues from both. The U.S. franchisor generally receives between 20% and 50% of the franchise fee upon each unit opening, and between 25% and 40% of royalty revenues. These fees should not be determined based on the country in question, but rather on detailed financial analysis and an understanding of specific support services required.

In structuring these transactions, two additional points are of critical importance: Performance requirements and expenses. The speed with which you are able to establish the foreign franchise organization will be a critical element in determining when you will achieve positive cash flow. If your licensee is not willing or able to commit to an aggressive development schedule, be sure that you write provisions into your agreement requiring them to cover all direct expenses until a certain number of franchises have been established.

Lastly, be sure that you get the counsel of an attorney familiar with franchising in the host country prior to finalizing any agreement. Peculiarities relative to allowable royalties, intellectual property, trademark, employment, and anti-trust laws may have a profound impact on your structure.

Surf's Up!
There is no doubt that the waters of international franchising are dangerous. The international franchisor must deal with different laws, different cultures, and different markets, while bridging gaps of time, distance, and language. Their efforts are sure to divert at least some of their attention from the core business and the process is often more expensive than you think. Moreover, the choice of a poor partner can poison well in a market for years.

All this being said, however, the lure of that wave of a lifetime can be compelling. Never before, and perhaps never again, will US franchisors have the opportunity they currently have to dominate the global franchise marketplace. It remains the choice of each franchisor to determine their level of skill and their ability to navigate these waters. But now is the time to act. The ocean will little heed us if, five years from now, we paddle out to still waters and shout for the waves to return.

Watch from the beach or grab your board and paddle like mad. The choice is yours.

Surf's Up!