Submitted by: RUPESH SHARMA M.Com, Semester 4 Roll No. 8583 P.G.D.A.V College +91-8447309476
FRANCHISING
FRANCHISING A N I N D I A N P E R S P E C T I V E Although in a nascent stage, franchising is gaining popularity in the retail segment in India, more particularly in the areas of food products and drinks, restaurant chains, consumer goods, and computer training centers.
Franchising is one way in which a foreign company can take advantage of Indias vast market with a degree of control that other traditional forms of distribution cannot match.
Apart from global businesses expanding into India, there is a growing trend of Indian businesses franchising for local expansion. Many Indian businesses have even franchised their products and services in countries such as USA, Canada, UK, EU, Australia & New Zealand, Singapore etc. What has made franchising so popular all over the world ? From the perspective of a franchisor, franchising represents an efficient method of rapid market penetration and product distribution without the typical capital costs associated with internal expansion. From the franchisees view point, franchising offers a method of owning a business but with a mitigated chance of failure due to the initial and ongoing training and support services offered by the franchisor. For the consumer, franchised outlets offer a wide range of products and services at a consistent level of quality and at affordable prices.
Though the concept of franchising has existed in India since many years, it is only now that the average Indian entrepreneur and companies have woken up to the possibility of using it as the quickest route to expansion and growth. Today, if you want to purchase a product or service of an international brand, you are most likely to walk into a franchised outlet, such as Monginis, Kwality Walls, Pizza Hut, Marks & Spencer,
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McDonalds, Subway, Holiday Inn, Medicine Shoppe, Dominos, Golds Gym, Kodak, Kentucky Fried Chicken and so on.
There are a large number of multi-national companies on the verge of setting up an outlet of their main business in India through franchising, if they havent already. Many industry majors, especially those in the information technology industry, are also growing offshore through franchising. What makes franchising so attractive to companies is the rather obvious fact that it is the fastest and cheapest way to get their product or service across to millions of people and into new unfamiliar territories. More importantly, in a country like India where cultural diversities make retailing a big challenge, franchising is allowing the companies to truly think global and act local. As a result of having franchise outlets, a brand owner based in one specific region does not have to worry whether he will be unable to identify with his potential customers in any other geographically and culturally different region.
Franchising, as with organized retail, will firmly establish itself in India in a couple of years. With the increase in disposable income, it is estimated that over 65 million Indians can afford luxurious products and services and over 410 million Indians buy consumer appliances. With Goldman Sachs predicting that India will be the third largest economy in 2025 and Standard & Poor upgrading Indias credit standard, and an extremely stable government, the franchising community has a lot to cheer. What is franchising? It is a business system where the franchisor grants a license to the franchisee to use the franchisors diverse intellectual property rights, namely, know-how, designs, brands, trademarks, patents, and trade secrets along with the franchisors proven name, reputation and marketing techniques to market the franchisors products or services in return for a sum of money. The franchisor provides training and continuous assistance to the franchisee.
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Difference between Franchising/ Distributorship/ Agency The terms franchise, distribution and agency are often loosely used. Distribution and agency are the more traditional forms of distributing goods or services. However, they do not allow the principal to exert any real control over the distributor or the agent.
The key distinguishing feature of a franchise is the higher degree of control that a franchisor exercises over a franchisee. The franchisor has a say in all important issues such as branding, methodology and mergers.
Although corporate entities such as, subsidiaries or joint ventures allow as much control than a franchise, they entail a much higher financial risk. TYPES OF FRANCHISE AGREEMENTS: Product/Trade Name Franchises o Distribution of product in distribution in a specified territory or location with use of manufacturers trademark o Car dealerships, petrol service stations, soft-drink bottles, etc. Business Format Franchises o Incorporates the licensing of a trademark for business in a specified territory along with an entire system for conducting a business. o These now account for nearly 75% of all franchise businesses, examples are McDo nalds, KFC, The Bodyshop, Giordano concept shops etc.
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FRANCHISING STRATEGIES FOR RAPID GROWTH IN INTERN ATIONAL MARKETS: Single-unit franchising The franchiser grants tofan individual franchisee the right to operate a single unit within a defined territory. Multi-unit franchising Involves granting thehfranchiseejthe right to operate more than one franchise from the same franchiser Conversion franchising Acquiring and converting existing business into a franchise International Franchising Commonly involves "Master Franchising" and joint-ventures Creative Franchising Includes many things ranging from money-back guarantees, andhstock ownership, to the use of sophisticated management techniques
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MARKET FORCES AFFECTING FRANCHISING COMPANIES
Weakened Economy Hurts Sales and Slows Expansion Franchising becomes a much less desirable business model during tough economic times. First, franchisees must pay royalty fees based upon their revenue, regardless of whether or not they are earning profits, which adds to the franchisee's financial struggles in an economic downturn. Furthermore, slower sales cause parent companies to reduce expansion plans. For example, the 2007 Technomic Restaurant Industry Study blamed the poor U.S. economy as the reason why restaurants reduced funding for expansion by an average 1.4% during 2007. Economic issues related to the 2007 Credit Crunch and subprime lending crisis drastically weakened the U.S. economy, which has led to lower levels of consumer spending, particularly in the restaurant dining industry. For example, many restaurants suffered from a decline in traffic and comparable store sales during 2007, like Applebee's, which attributes a 4% decrease in guest traffic and 2.1% decline in comparable store sales to weakened consumer spending. Additionally, a 2007 RBC Capital Markets Survey indicated that 39% of respondents reduced their frequency of restaurant dining because of lower levels of dispensable income in 2007.
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High Potential for Growth in Emerging Markets Unlike the United States and many other Western countries, emerging markets are commercially underdeveloped and have significant growth opportunities. For example, the U.S. Department of Commerce estimated that over 75% of the expected growth in world trade over the next 20 years will come from developing countries, primarily large emerging markets like China. Furthermore, the rise of China's middle class, as well as India's booming per capita income provide significant new markets for franchises to operate. China's middle class is expected to almost double in the next two years, reaching 25% of the Chinese population in 2010, which is spurred by China's 700% growth in per capita income since the late 1980s. Furthermore, the Indian per capita income is expected to increase more than 300% by 2025. As the wealth of consumers in emerging markets grows, so too will their appetites for consumer goods, as evidenced by India's 1,440% growth in its retail industry between 1991 and 2007. Also, as of 2007, India's franchising industry is expected to grow 30% annually as mega-franchising chains like Yum! Brands (YUM) have already established a presence in India. High levels of consumer demand, coupled with relatively low levels of competition, offer a lucrative opportunity for many franchisors to expand into emerging markets. Expansion via franchising is an attractive option for companies looking to expand abroad without incurring high costs. Additionally, international franchisees already possess many inherent qualities needed to succeed abroad, like the ability to speak the native language.
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LEGAL FRAMEWORK There is no legislation in India specifically related to franchising. As the relationship between a franchisor and a franchisee flows from a contract, in the absence of specific governing legislation, the law of contracts as embodied in the Indian Contract Act, 1872 and other allied Acts are applicable to a franchise agreement. Other pertinent areas of the law which are applicable to franchise agreements are: Intellectual Property Laws Competition Laws Consumer Protection Laws, and Labour Laws Real Estate Laws Taxation Laws Remedial and Penal Law; Alternative Dispute Resolution Intellectual Property Laws A franchisor is the proprietor of intellectual property rights, know-how, etc. Thus, protection of intellectual property rights is of paramount importance to any international or domestic franchisor. Foreign nationals and/or companies can protect their trade marks in India under the Trade and Merchandise Marks Act, 1958 (TM Act) by registering them under the prescribed class. As yet, service marks cannot be registered in India. (Sec. 8 of the TM Act) Registered owners can assign to third parties the right to use the mark and are not mandated to use the marks personally. (Sec. 36 of the TM Act) The assignment agreement must be registered at the office of the Trade Marks Registry. By registering a user agreement, the owner prevents the user from getting a right to be the registered proprietor of the mark through use. Franchisors can protect their manuals containing the entire technique of establishing and running the business, videos relating to the use of the product, etc.
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under the Copyright Act, 1957. Civil remedies for infringement of copyright include injunction, damages and accounts of profits made by the defendant by violating the copyright (Sec. 55 of the Copyright Act). In addition, criminal remedies such as imprisonment for a period between six (6) months and three (3) years is also available. Competition laws Every franchise agreement incorporates highly restrictive terms which would bring it within the purview of the Monopolies and Restrictive Trade Practices Act, 1969 (MRTP Act) and lay it open to scrutiny by the Director General of Investigation & Registration or the MRTP Commission. Restrictive trade practice, as defined, means a trade practice which has or may have the effect of preventing, distorting or restricting competition. (Sec. 2(o) of the MRTP Act) Thus, the first inquiry under the MRTP Act is into the restrictive nature of the trade practice as it relates to the effect on competition. Also, since the main purpose of the MRTP Act is to protect the public, an inquiry into the effect on public interest is always made. Per se restrictive trade practices under s. 33(1) MRTP Various categories of agreements enumerated under Sec. 33(1) MRTP, including agreements which restrict persons from whom certain goods can be purchased, have been recognized to be per se restrictive. The consequence of falling within one of these enumerated clauses is that agreements between parties relating to such per se restrictive trade practices must be registered with the Director General (pursuant to Sec. 35 of the MRTP Act). However, such agreements are not per se void or illegal. The Commission still needs to make an inquiry (pursuant to Sec. 37 of the MRTP Act) as to whether the agreements are prejudicial to public interest. Until the time that the Commission declares the agreements as prejudicial to public interest, the parties may continue to conduct trade and business under such agreements.
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Consequence of Registration The decision to register or not register an agreement lies with the parties to the agreement. However, if an inquiry is made by the Commission who feels that an agreement should have been registered but was not, the burden of proof lies with the parties to prove that the agreement does not fall within one of the enumerated clauses of Sec. 33(1) of the MRTP Act. Again, simply by registering an agreement with the Director General does not result in conceding that the agreement is one relating to restrictive trade practices. Rather, the Commission is still required to inquire (pursuant to s. 37 of the MRTP Act) if the agreement is prejudicial to public interest. After an inquiry, if the Commission finds that the agreement is prejudicial to the publics interest, only then does the agreement become void. Consequence of Non-Registration If a party to an agreement, which is liable for registration under Sec. 35 read with Sec. 33(1) of the MRTP Act, does not register, each member of that party is penalized for the default (pursuant to Sec. 48(1) MRTP). One example of a restrictive covenant commonly incorporated in a franchise agreement is a covenant not to compete. The franchisee is prevented from undertaking a business similar to the franchise business during the term of the franchise and for a certain number of years after termination. In fact, the franchisee may even be required not to solicit customers of the franchise business after termination of the franchise agreement. In a recent development, the Director General of Investigation and Registration has filed an application under the MRTP Act against an Indian company and its foreign joint venture partner on the grounds that the non-compete clause in the agreement amounts to a per se restrictive trade practice.
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In this regard, reference should be made to the Indian Supreme Courts decision in M/s. Gujarat Bottling Co. Ltd. v. Coca Cola Company, AIR 1995 S.C. 2372, where the court observed: [t]here is a growing trend to regulate distribution of goods and services through franchise agreements and providing for grant of franchise by the franchisor on certain terms and conditions to the franchisee. Such agreements often incorporate a condition that the franchisee shall not deal with competing goods. Such a condition restricting the right of franchisee to deal with competing goods is for facilitating the distribution of goods of the franchisor and it cannot be regarded as in restraint of trade. However, the foregoing judgment does not analyze franchising agreements vis-- vis Sec. 33(1) of the MRTP Act. Therefore, it is unclear whether it will carry any weightage in the matter pending adjudication before the MRTP Commission. Consumer Protection laws The Consumer Protection Act, 1986, substantially impacts the development of franchising in India. It comes into play with regard to tort and other actions arising from sale of defective goods. The issue is if a defective product sold by a franchisee causes injury to a consumer or causes damage to the consumers property, then does the consumer have recourse to the franchisor and the franchisee or both! The answer to this depends upon factors such as the degree of control exercised by the franchisor, the distance between the franchisor and the franchisee geographically, and the equipment and know-how supplied to the franchisee by the franchisor in relation to the product. Labour laws No franchising contract can derogate from the myriad Indian labour laws. Labour laws governing the day-to-day conditions of employment and termination of employment when an outlet is shut down or the business is sold are particularly relevant in the franchising context.
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Real Estate Laws In India, premises for conduct of the franchised business may be acquired either on ownership basis, or by way of a leave and license or lease arrangement or by way of a business conducting arrangement. Laws in The Transfer of Property Act, 1882 and the various state-enacted legislation on renting of immovable properties, govern these arrangements. Taxation Law Taxes in India are levied by the central, state and local government bodies. Direct and indirect tax laws such as income tax, sales tax, additional tax, service tax etc. would be relevant in a franchise arrangement, as they are in any other business concept. Payment of taxes would depend on the structure of the franchise arrangement and in the case of an international franchisor, the existence of treaties between the countries. Remedial and Penal Law; Alternative Dispute Resolution In case of any dispute or difference between the parties in respect of a franchise arrangement, civil and criminal remedies would be available to the aggrieved party in India. The aggrieved party may also initiate any of the alternate dispute resolution methods under the Arbitration and Conciliation Act, 1996. Conclusion Considering the growing importance of franchising, the Indian Government should consider enacting a specific statute to curtail the application of the MRTP Act to franchising agreements.
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THE INDIAN FRANCHISEE SURVEY About the Survey An extensive survey was conducted by Indian Franchise Association to analyze an average Indian franchisee's background which includes its age, education, family background, average royalty he is paying, his aspirations regarding the business and loyalty towards the franchisor. These franchisees belong to different sectors and geographical regions in India. Major business verticals were food, retail, education, real estate, telecom, financial services etc. and franchisees from Metro cities like Delhi, Mumbai, Bangalore, Tier-I like Hyderabad, Ahmedabad Tier-II like J aipur, Indore, Goa and Tier III like J odhpur, Varanasi, Nasik etc were included for the survey purpose. Apart from online survey, personal interviews and telephonic interviews were conducted to collate the desired information.
Some of the important brands who took part in this survey were Subway, Koutons, IMS, Kid-Zee, EuroKids, Aptech, Veta, Sagar Ratna, Puma, Levis, Raymond's, Bachpan, Liliput, Aditya Birla Retail, Titan Industries Ltd, Vodafone, Zee interactive learning systems, Shaadi.com, Cox & Kings, Reliance Money, Fab Mall, K J ewellery, Educare and Aptech
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The following is the qualitative analysis which provides the key insights about franchisees in India: IDEAL AGE OF A SUCCESSFUL FRANCHISEE It is interesting to note that 18% of the total franchisees were owned by investors belonging to the age group of 20-30 years and a major chunk of 48% of the franchisees belong to the age group of 30-40 yrs, 22% belongs to 40-50 yrs and only 12% were more than 50 years. An ideal successful franchise owner belongs to the age group of 30 - 40 years. The young franchisees being aggressive and speculative in nature often feel restrained by the rules & regulations laid down by the franchisor. They desire to start their own business after gaining sect oral experience and this trend was prominent in food service franchisees as they believe the franchisor's standards were stringent and acting as hindrance to their business acumen. Next step of the analysis suggested in the age group of 30-40 years majority (40%) of the franchisees were in education sector and the other prominent sectors were Food & Retail (total 40%). The interesting fact about the older franchisees owners of 40-50 years was that 73% of this group prefers education franchisee that too in pre- school and primary school franchisee. Making them an ideal target audience/ investor for pre-school and other education franchisors. Recommendat i on Ideal franchisee/ investor in franchise business belong to the age group of 30-40 years; therefore it is recommended that a franchisor should prefer prospective investors belonging to this age group.
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Older (40-50 years) investors have more inclination towards education (preschool/Primary education) franchise hence should be given preference among the other investors. IDEAL EDUCATIONAL BACKGROUND FOR A FRANCHISEE According to the survey, 54% of the franchisees are post graduates followed by graduates who constitute 31% of the pie. It is important to note that 58% of the postgraduate franchisee belong to management studies which includes MBA/PGDBM or similar degree with specialization in finance, marketing, operations retail and food technology. Recommendat i on Post graduate degree in management creates good Franchisee/Investors. But we would like add a caveat here; these are the first to move out of the franchisee system because they have more options available. A healthy franchisor- franchisee relationship is crucial to retain them. Second biggest category is professionals, who are potential investors in specific sectors like pharma, financial services, technology etc. For a franchisor from any of these specific categories, it is important to identify/choose investor from the professional category.
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FRANCHISEE ROYALTY Royalty is the most important question from a franchisor's point of view and is crucial for the sustenance of a franchisee. Royalties are paid for the continuous use of a piece of work and it is in addition to any one time initial fees. The payments are usually lower than upfront fees since they are a continuous regular expense. With regard to franchise royalty payments, the franchisee experiences daily sales as his or her main source of revenue. However, the regular monthly/quarterly income that the franchisor earns is based on royalty payments from each franchisee. The recurrent royalty fees are the essence contributions to the entire organization. The payments are used to maintain the system and ensure that all avenues flow smoothly between the franchisor and franchisee. It is difficult to find out the exact royalties paid by the franchisees in various sectors but based on the survey findings, following chart would provide a fair idea about the range of royalties paid in different sectors. These royalties are based on the brand value, location and industry sector. It is quite evident that royalty range for a Professional Coaching pan industry varies maximum from as low as 10% to as high as 48% of the gross revenue. On the other hand this fluctuation is less in other industry verticals. Recommendat i on A business format franchisor's key part of revenues comes from franchise royalties, which are typically a fixed percentage of franchisee gross sales/ revenue. When a fixed royalty rate is used and the marginal costs of operating the franchisee system are increasing, the franchisee does not have an incentive to increase revenue beyond a certain optimal value. Also after a certain time period (saturation), franchise owner is not motivated to renew the contract on the same royalty rates, at this juncture he needs an incentive to continue because he has already gained the business expertise and the aspirations to earn more are higher. A Telescopic Franchise Royalty Rate is
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therefore suggested, for giving him a scope to increase the optimal revenue which will also act as an incentive for the franchisee to renew the contract. Adopting a telescopic rate increases franchisor royalty revenues and franchisee profits. IDEAL TIME FOR CONTRACT TERMS REVIEW The concept of franchising itself is new to the Indian market. Majority of the franchisees are within the first decade of their operation. 52% of the respondents of the franchisee survey were in their 1-5th year of operation. This shows that the franchise business model is in its nascent stage in the country. The interesting fact that came up in survey was that out of those respondents who were in their 1-5th year of operation 48% were planning to setup their own business or want to quit from franchise business model because of the issues/challenges they have faced. Further, majority (38%) of the franchisees who were planning their own setup are in their 4-5th year of operation. This shows that the franchisees are becoming critical in their 4th to 5th year of operations. This year of operation is hence important for a franchisor to concentrate of the relationship with its franchisee. This could be the ideal time period to review the contract terms to increase the franchisee retention.
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FRANCHISOR- INVESTOR RELATIONSHIP The survey came across a unique finding that says that majority (64%) of the successful franchisees have no personal or professional relationship before they have entered in the contract with franchisor. It was also noticed during the interviews that those franchisees that have any personal or professional relationship with the franchisor are less successful in business operations. Out of those who are planning to continue 80% are not related to the franchisor while only 5% were the employees of the franchisor. Similarly among those who want to start their own business 50% were employees of the franchisor. So, it's not a surprise that franchisors should be are giving their franchises to those who are not in any way related to them. During the discussion with respondents we have found that doing business with relative or friend is never a good choice because: You will not have a properly negotiated contract with them and franchising business, deciding about royalty etc. is all about negotiating. The relatives and friends may not take the terms of contract seriously and they would take the business for granted. It may lead to disputes in relationship which is not good for either party.
From the survey, 70% of the franchisees were salaried employees earlier. So it is quite clear that salaried employees are more attracted toward franchising business model as compared to businessmen or fresher. The reason is that the salaried employees are risk-averse and they are comfortable working in a set up where system is set. Recommendat i ons While selecting a franchisee, the salaried employees should be given preference over non-salaried ones because they will not take the risk of starting their own venture.
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CONCLUSION 1. Indian franchising story has just started and it has a long way to go, India would be able to do so with its huge population, the growing aspirations and prosperity of the middle class, changing lifestyles, growing entrepreneurial culture, and the shifting of gears to small cities and towns. All these factors will lead to the growth of a WIN- WIN partnership between the brand and franchisee. 2. A foreign franchisor has to be observant while selecting an appropriate partner for his business. On the other hand a franchisee too has apprehensions and expectations; they want profitability, cooperation, better communication and understanding from the franchisor. 3. It is highly recommended that the selection of either the franchisor by the franchisee or vice-versa, should be made after an extensive inquiry about the brand image, product demand, customer sentiments, financial positions and ofcourse, feasibility of a bright future of the franchise. 4. Such a set-up can only stand against the fiercely competitive business environment by a strong relationship between the two parties by overcoming all kinds of barriers, for which both have to trust and support each other at the same time.