Global Franchising Operational Issues

Procedia - Social and Behavioral Sciences 130 ( 2014 ) 193 – 203

1877-0428 © 2014 The Authors. Published by Elsevier Ltd. Open access under CC BY-NC-ND license. Selection and peer-review under responsibility of the Organizing Committee of INCOMaR 2013. doi: 10.1016/j.sbspro.2014.04.024

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INCOMaR 2013

Global Franchising Operational Issues

Jaishree Asarpota*

Higher Colleges of Technology, PO Box 16062, Dubai, United Arab Emirates

Abstract

This research paper explores the operational issues of international retail franchising that need to be implemented by franchisor/franchisee in their joint efforts of globalization. The paper discusses the emphasis given to the power and control mechanisms available to the franchisor to control and co-ordinate with the international franchisee. The paper takes a theoretical approach to the relationship building process in international retail franchising, and it addresses the importance of retail franchising in the Middle East, with special emphasis on the United Arab Emirates.

© 2014 The Authors. Published by Elsevier Ltd.

Selection and peer-review under responsibility of the Organizing Committee of INCOMaR 2013.

Keywords: franchising; retail; United Arab Emirates; international; power

1. Introduction

Retail companies have a selection of market entry modes such as exporting, licensing, franchising, joint ventures, and partly or wholly owned direct investments (McGoldrick & Davies, 1995). Organizations who have mission statements to expand their business and make their brand known on an international level may choose franchising which has proven to be a popular mode of

entry (Burt, 1993). Recent trends show that businesses are employing franchising as an

international marketing strategy, especially in geographically distant markets. The term ‘franchising’ describes a wide variety of business activities, but the contemporary franchise system

* Corresponding author. Tel.: +042089472

address:[email protected]

© 2014 The Authors. Published by Elsevier Ltd. Open access under CC BY-NC-ND license. Selection and peer-review under responsibility of the Organizing Committee of INCOMaR 2013.

commonly in use is referred to as business format franchising (Petersen & Welsh, 2000). Business format franchising is widely recognized as an established global trend when organizations want to

expand their business. Business format franchising may be defined as, ‘the granting of a license for

a predetermined financial return by a franchising company (the franchisor) to its franchisees, entitling them to make use of a complete business package, including training, support and the corporate name, thus enabling them to operate their own business to exactly the same standards and format as the other units in the franchised chain. ((Grant, 1985, p 4)

2. Literature Review

In practice, international retailers are increasingly using franchising as a mode of operation in foreign markets and gradually though still relatively limited in its scale and scope, the research community has begun to examine international franchising within the context of retailer internationalization (Sanghavi, 1991; Quinn 1998, 1999; Doherty & Quinn, 1999; Quinn &

Alexander 2002). Research on the internationalization of franchising has explored four main

themes: motivations to franchise (Welch, 1990); methods of international franchising; the extent and direction of international activity (McIntyre & Huszagh, 1995) and operational issues (McIntyre et al. 1991; Yavas, 1998). The fourth theme, the operational issues involved in international franchising which examines control, support and adaptation issues, particularly that referring to how international franchisors control their international operations is of greatest

relevance behind the literature review of this paper. The paper discusses the operational issues

that may lead to the success or failure of international retail franchising partnership. Below mentioned is the proposed franchising model for implementation of globalization of products and services into international markets.

2.1. The agency theory

Doherty and Quinn (1999) contend that the franchisor-franchisee relationship parallels that of the principal-agent relationship. A fundamental aspect of the principal-agent relationship is the contract between the parties, the agent is responsible to protect the interests of the principal and is responsible to ensure that the knowledge he gains through the agency contract will be protected and not used against the interests of the principal. The international retail-franchisor-franchisee relationship embodies the principal-agent model and meets Eisenhardt’s (1989) requirements for a useful application of agency theory, that is, the two parties are independent and co-operative yet rationally may pursue different, even contradictory goals (Lasser & Kerr, 1997).

Academic researchers such as Quinn (1999) attempt to see if the domestic contract issued for local partners in relation to agency theory can be applied to international retail franchise agreements, and the evidence has not been conclusive. The agency theory dictates the need to have a binding contract and the firms’ willingness to enforce the contract. The nature of support activities provided by the organization to their agency partners are very clearly identified, agency theory also advocates the need for coercive sources of power. Agency theory also believes that the contract can be enforced if there is a presence of a well-defined product concept and service. Agency theory advocates coercive sources of power to control franchisee behavior (Doherty & Quinn, 1999; Quinn & Doherty, 2000). Based on the principal-agent relationship where one party (the principal) delegates work to another party (the agent) who performs the work on a daily basis, agency theory has been applied successfully to domestic franchising (Rubin, 1978, Mathewson & Winter, 1985), but there is no conclusive evidence on the power and control mechanisms used in international retail franchising.

Fig. 1. Proposed Model for international retail franchising

2.1.1 Operational Issue Power

French and Raven (1958) taxonomy of power remains both relevant and is still prevalent in franchising research. Academics agreed that the different forces of power influence international franchising agreements and the five forces of power as described by French and Raven are coercive power, reward power, legitimate power, expert power and information power. The below diagram is a proposed model that explains the relationship, as developed by the author, to understand the implications of the franchisor/franchisee relationship:

Retail Franchising Agency Theory (Domestic) Franchising) International Retail Franchising Operational Issue Power Coercive power Reward Power Legitimate Power Expert Power Referent Power (Information) Operational Issue Control Master Area Franchising Franchise Partner Selection

Table 1. Taxonomy of Power and the Franchisor/Franchisee Relationship

French and Raven Taxonomy of Power (1958)

Franchisor/Franchisee Partnership References

Coercive Power(threat of punishment)

Non-coercive channels of power may be more effective Quinn & Doherty,2000

Moore & Birtwistle, 2004 Falbe & Dandrige, 1991 Reward

Power(compliance with promise of reward)

Profit is the underlying motive. Doherty & Quinn 1999

Legitimate Power(authority)

Legal contract between the franchisor and franchisee.

Expert power(superior knowledge)

Information asymmetry may arise as a result of differences in economic development, cultural practice and regulatory environments which may mean that the agent (franchisee) has more information about operations in a foreign market than the principal (franchisor)

Doherty, 1999

Referent power(compliance through pursuit of mutual interests)

Effective channel communications improves level of satisfaction and cooperation’s among members and ultimately improves channel efficiency and effectiveness

Dwyer, 1980

2.1.2 Coercive Power

Quinn (1999) adopted a qualitative, ethnographic approach to explore how one natural cosmetics company attempted to control and support its international franchise network. He found that coercive sources of power were primarily used to influence franchisee behavior and thus enhance control. A high level of conflict was observable, not because the franchisor was exerting excessive power but because franchisees were dissatisfied with the quantity and quality of support received. Quinn also noted that this company was a small company hence the reason for the difficulties in maintaining control of its international franchise business. Quinn & Doherty (2000) conclude that while the marketing channels literature acknowledges both coercive and non-coercive sources of power are available, there is in general a consensus that non-coercive power are more readily used to influence franchisee behavior and enhance control.

Moore and Birtwistle (2004) wrote that the use of coercive power, for international fashion retailers operating in the UK, was being replaced with non-coercive power, recognizing that the use of coercive power may be detrimental to healthy channel relationships. Falbe and Dandrige (1991) contend that as a franchisor expands his markets on an international scale, a coercive approach to power becomes more difficult to maintain and over time non-coercive sources of power may come to dominate the relationship. Successful relationships can be built on trust, mutual commitment and support and this will allow the franchisor to avoid mitigating the use of coercive power, which may not be effective if the bond of the contract is based only on the enforcement threat of the legal terms and conditions.

2.1.3 Reward Power

The international retail-franchisor-franchisee has many advantages to all parties; firstly, the agency theory incorporates realistic behavioral assumptions such as the presence of bounded rationality, the potential for opportunism and goal conflict. These factors are also present in the franchisor-franchisee relationship (Lassar & Kerr, 1997). Secondly, agency theory is appropriate

because it focuses on the economic motives operating within a relationship, that is, risks and incentives (Lassar & Kerr, 1997). Thirdly is the emphasis on profit maximization through intermediate product markets, that is, knowledge, technology and goodwill (intangible assets). In international retail franchising, retail firms franchise their brand and store concept to franchisees in return for a franchise fee and margin on the product sold within the stores

2.1.4 Legitimate Power

The franchise relationship starts with the franchise contract which outlines the terms and conditions for the business or brand to be managed. In many ways the franchise contract can reflect the level of development of the franchise operation and the more refined the contract, the more experienced and in most cases, the more strategic the franchisor. In theory it would be assumed that the franchise contract would have a particularly stabilizing influence on the relationship. In the day-to-day running of the relationship it is the ongoing and continuous communication and the support provided by the franchisor to the franchisee that maintains the importance of the brand in the region. Quinn and Doherty (2000) believe that franchise agreement is also affected by the development of the franchise system, as well as other factors such as the stage of development of the franchise system and the effects of company size also influence the nature of power and control.

2.1.5 Expert Power

Business to business situations provide a context where relationships are close, long-term exhibit high levels of trust, commitment, mutuality, satisfaction, and co-operation (Dwyer, Schurr & Oh, 1987; O’Malley and Tynan, 2000). Doherty considers the franchisor-franchisee relationship as one such business-to-business relationship where the partners possess the shared objectives of nurturing a shared project in which both parties have vested interests to their own mutual benefit. The international development of the brand requires stable relationships and an active involvement in the marketing and protection of the international brand The presence of a defined retail brand offer is an important consideration when it comes to the establishment of stable relationships.

Various support activities may be need by the franchisor/franchisee such as a franchise manual, the business development plan, intensive support for the initial store opening, and initial advertising support for the brand, celebrity endorsement, ongoing visits from the original franchise owner, merchandise review, retail staff training and in some cases providing country managers from the origin country. Other activities that may be included are monitoring of sales and other financial data but overall there are no set rules for the franchisor/franchisee. The need to support the brand within a stable relationship was clearly important to retailers that had such a strong asset. Where the brand was valued by both the franchisee and the franchisor a close relationship was valued and more sustaining.

2.1.6

)

Grub (1972) highlighted that supporting and maintaining international franchisees is considered particularly difficult and as a result the cost of providing franchise support is consequently higher than originally anticipated. Academic researcher indicates that the provision of a successful support system is crucial to the development of a successful international franchise business and as a means to control the retail brand offer. Asset intangibility is a particular feature of the retailing sector, with special emphasis given on the product brands, retail formats and managerial technology, all of which are characteristic of embedded information (Doherty & Quinn, 1999). Agency theory in the international retail franchise context emphasizes the importance of the information transfer process, information asymmetry problem and associated monitoring costs (Doherty, 1998, 1999).

The academic literature identified by Doherty and Alexander identified that in the UK, the fashion retailers gave enormous support to their franchisees especially at the time of opening new boutiques. The authors identified that step by step support was given in how to set up the store and run the franchise business, since the initial opening of a store in an international location is crucial, since the location has to be approved by the head office. The franchisor then dictated the design and structure of the shop, which the franchisee has to pay for, and the brand image is ensured by the product offerings. During the initial set-up operations, the franchisor helps the boutique store by helping to select the merchandise and ensuring that the boutique has the latest collections otherwise the brand image gets eroded. During these stages, depending on the size and support given by the franchisor, the franchisor or head office provides training and other support to their franchisee. In a way, it is important to the franchisor that its brand and the franchisee succeed in the host country. If the product requires intensive training, it would be provided at the time of the store opening, either by the staff visiting the country of origin, or in some cases, the training could be provided in the

host country

.

2.2 Operational Issue Control

Walker and Cross (1989) identify control as a serious issue for concern for international franchise firms. Sashi and Karuppur (2002) found that franchising enables the transfer of operating responsibility to franchisees while permitting the franchisor to retain control. Mcintyre, Huszagh & Huszagh (1991) report that perceptions amongst US franchisors indicate that they are able to maintain the same level of control over international franchisees as they maintain over domestic franchisees. The concept of control is complicated by the internationalization of the channel; retail franchisors must realize the need to employ mechanisms that will help them promote the franchisees and the use of the brand in disparate markets. Some of the mechanisms used for the successful implementation of retail franchising are shown below.

Fig.2 Operational issues assessment in international retail franchising

2.2.1 Control through Master/Area Franchising

The franchisor grants the master franchisee the right to sub franchise the franchisor’s concept to others within an exclusive territory. The local partner is viewed not only as a source of finance for the franchisor but also as a major source of information. The franchisor/franchisee agreement highlights the importance of providing support to franchisees. In order to establish the development of a successful franchise relationship, due diligence in the franchise partner selection

Control Mechanisms in International Retail Franchising

Control through Master/Area Franchising

Control via Area Franchising in the region

Control through franchise partner selection

Control through franchise partner selection

V

and the use of master/area development franchising is needed in all stages of the franchisor/franchisee partnership. Many retailers use the same master franchisee for their outlets across the Gulf countries (Jones, 2003).

2.2.2 Control through franchise partner selection

Figure 3 highlights the steps that may be followed in the development of a partnership development process for the franchisor/franchisee relationship to reach the stage of a successful trustworthy relationship.

Fig. 3. Partnership development process (Doherty & Alexander, 2004)

Fig. 3. Partnership development process (Doherty & Alexander, 2004)

2.2.3 Control in selecting the right partner

Doherty and Alexander (2004) conducted research on the partner selection process and defined it similar to a traditional marriage context. The marriage arrangement is preceded by a process of the recognition of relationship need, a partner search process and the evaluation of potential partners (Doherty et al. 2004). They further point out the importance to ‘enshrine longevity and mutual value systems’ to their relationship because it would be based on mutual benefits. The findings also highlight the importance of ‘chemistry of attraction’ and trust as important factors. Doherty’s findings have been criticized because of the marriage analogy by other researchers such as Tynan (1997).

2.2.4 Control in finding the right chemistry in your partner

The shared project of managing, marketing and developing the retail brand in the international market and the choice of the right partner determines whether the international retail franchising partnership will be successful or not. The choice of the right partner avoids the need, in most cases, to employ coercive power. The issue of trust evolves from the stage in the process whereby one potential partner was chosen over another on the basis of empathy or chemistry between the partners. This emphasizes that the day-to-day management of the relationship will occur as a result

of support and communication and not the welding of a franchise contract. There is no scientific method of how franchisors select their franchisees. Sometimes the ‘chemistry’ and ‘trust’ between the franchisor and franchisee play a significant role in selection of the international franchisee partners. Selecting and choosing the right franchisee partner requires skill and is a control element that franchisors exert over their franchisees. The franchisors executive the selection process as an important one because a long trustful relationship between the franchisor and franchisee can lead to mutual benefits to both parties. In international franchisor relationships, selecting a right partner is of utmost importance and therefore, many factors come into play when making the decision. In the Middle East, relationships are important to franchisees (Jones, 2003).

2.2.5 Control in building a relationship with your partner

Building a successful franchise relationship from the beginning by choosing the right partner through to the everyday communication with that partner via the functional areas of the business is also pivotal to control. A franchise relationship is intended to be a long-term commitment where communication and trust are central to its success. The centrality of trust in the franchise relationship is crucial to its ongoing success and the development of a recognized partnership which will benefit both parties. There is acknowledgement that if a franchisor really wants to control and maintain uniformity of its brand(s) then it must be willing to invest the same kind of time and energy it would invest in any other business relationship and see it very much as a long-term ongoing process of trust building and communication.

3. The International Retail Expansion in the United Arab Emirates

The Middle East is growing in terms of retail importance (Frumkin, 2002), and there may be several reasons for the phenomenal growth of the retail industry in the Middle East. The Middle East was the home to five of the eight largest malls in the world in 2012. The Middle East & North African (MENA) Franchise Association highlights that the franchise industry in the Middle East and North Africa is worth over $30 billion; the annual growth of the Middle East franchising sector is around 27% (www.menafranchise.assocation.org 2013) The local newspaper, Gulf News,

2013, reports that in the United Arab Emirates, there are 850 local and international brands, which

are growing at a rate of 16 per cent year on year compared to regional markets. The annual A.T.Kearney Global Retail Development Index (GRDI) ranks countries as to the attractiveness of entry, the higher the ranking, the more urgency there is to enter the country. The United Arab

Emirates made the biggest jump in the Index in 2009, going from 20thin 2008 to 4thin 2009. The

recent GRDI scale of 2013 ranks the UAE as number 5, an increase of 2 places from 2012. It is interesting to note that Dubai is considered an important market for international retailers, and is competing with Brazil and China, who hold number 1 and number 4 positions respectively (GRDI, 2013).

3.1. Dubai - The Middle East’s Retail Capital City.

According to Mintel (2004), Dubai has succeeded in pitching itself as an all-year round luxury getaway, in which extravagance is the norm. Thirty years ago, there was nothing in Dubai but a creek, a Sheikh’s palace (Yeoman & McMahon-Beattie, 2006) but today as a city state, the extravagances of luxury are everywhere, for example, the world’s richest horse racing event takes place in Dubai every year, the Dubai World Cup, Burj Khalifa, the world’s tallest tower, Dubai, the world’s biggest mall (Balakrisnan, 2008). The table below highlights some of Dubai’s superlatives.

Table 2. Dubai’s superlatives

Source: Balakrishnan (2008)

Dubai’s Shopping centres are now noticeable phenomena within the retail structure of Dubai, and have had a serious impact upon the traditional retail system centred on the markets (souks). The new centres have a unified architectural style; they are modern, western and air-conditioned. The last of these features is of particular relevance to the increasing patronage in Dubai, where the climate is severe most of the time. Factors such as economic prosperity, cultural differences, ethnic mix and lifestyle changes, in addition to hot weather and humidity, have changed the consumers’ shopping patterns from traditional marketplace ‘souq’ to shopping centre (El-Adly, 2001). Many international retailers have expanded their operations to the United Arab Emirates through franchising agreements or partnerships, for example, Starbucks, McDonalds, Pizza Hut, H & M, Marks & Spencer, Zara, Mango. There are also several examples of luxury brands that hold flagship stores in Dubai such as Burberry, Channel, and Louis Vuitton. European retailers such as IKEA have also penetrated the Middle Eastern market.

In 2006, the retail and wholesale industry contributed 16.6% GDP of Dubai was found from wholesale and retail, and in the same year tourism contributed 23% of GDP of Dubai. The Dubai Duty Free airport had over US $700 million per annum in 2006, and was third only after Heathrow (London) and Incheon (Korea) (Retail ME, 2006b). In 2005, more than 30 per cent of the population was in the 20-44 age range crucial for retail sales, and this is expected to hit 56 per cent by 2015 (www.dubaievents.ae 2013). Dubai has become a ‘hotbed for upscale retailers’, with Prada and Gucci recently signing joint ventures with Al Tayer Insignia to develop a retail network across

the Middle East (www.dubaievents.ae2013).

There are 300 retail brands in the United Arab Emirates, with 80 new ones entering the market between 2014 and 2015, and 80 service brands, according to the Franchise Development Services (FDS) in the UK (www.gulfnews.com2013). The UN describes 73 per cent of the United Arab Emirates (UAE) population in 2005 as economically active, forecast to rise to 78.6 per cent by 2015. A.T. Kearney’s 2011 Retail Apparel Index found that the United Arab Emirates had the highest fashion clothing sales per capita per annum in the developing world, at $785. The report attributed its success to ‘high disposable income and immense fashion consciousness’. The United Arab Emirates’ retail sales are forecasted to grow from an estimated Dh113.87bn ($31.01bn) in 2011 to Dh151.36bn ($41.22bn) by 2015, as published in the Gulf News, 2013

Gulf investors are eager to bring outlets to the region and potential franchise partners tend to be wealthy family-owned businesses (Martin, 1999). The great commercial families have large financial resources and political clout and can ensure rapid spread of their partners’ brand through the region (Young, 2001). This paper has highlighted the importance of the successful development of the operations side of the franchisor/franchisee partnership; it has highlighted the importance of the Middle East and Dubai, in particular and has identified the gap that exists in this region.

Media proclaimed 7 star Hotel Burj Al Arab

World’s tallest Building Burj Al Khalifa

The World’s richest horse race The Dubai Cup

The self-proclaimed 8th

wonder of the world The Palm – The World

Dubai Marina World’s largest man-made marina

The World’s biggest Mall Dubai Mall

The World’s largest man-made port Jebel Ali

4. Limitations

The purpose of this paper has been to highlight the importance of international retail franchising, a subject which has as yet been under-researched. This study, while providing useful and interesting information about international retail franchising is not without its limitations. The

findings highlight two key challenges that would require further investigation. First, the study

needs to be redefining to include more primary data from the retailers in Dubai, to identify the reasons behind the international brands making their presence in the United Arab Emirates. It is important to know whether they are profits behind the business decision or if this to create more brand presence internationally. Secondly, the study should identify the rules and regulations governing the franchising laws governing the country as these have still not been finalized and are still under construction by the relevant authorities in the region. Future studies need to examine the larger retail industries who are franchising targeting particular franchisees to understand the power and control issues in the international retail franchising business. Progressive global retailers need to be interviewed and more primary data collected for the Middle East, which would be still in its empirical stage, since the region has been largely ignored. A quick glance at the academic and peer reviewed journals show that the Middle East research only appears 8 times from 2004 to 2012.

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