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International expansion for U.S. franchises

International franchising is fast becoming one of the most popular entry mode strategies for companies to break into new markets. Franchising allows a company to leverage the local market knowledge of its franchisees as it expands into new geographic areas. It is a viable, and valuable, way to expand a franchise opportunity beyond the boundaries of the U.S. or the country in which the franchised business is based.

Franchising has had an important impact on the U.S. economy. There are nearly one million franchised establishments operating in the U.S. today, providing over eleven million jobs and contributing $278.6 billion in payroll1. Within many parts of the world there has been an increased demand for U.S. products and services. There are therefore huge growth opportunities for U.S. franchises in international markets. For this reason many franchisors are looking outside the U.S. for their expansion plans.

 

Reasons for international expansion

international-3There are many reasons for a franchise business to consider international expansion; the home market is saturated; gaining economies of scale; increasing sales; or filling a gap in an international market with the franchisor’s product or service. For some franchisors, international expansion into the bordering countries of Canada and Mexico is seen as a natural development of the franchise, comparable to launching on the far side of the United States.

According to the International Survey by HSBC’s Commercial Banking division, mid-sized and large capital U.S. companies are increasingly pinning their growth plans on markets overseas even as the U.S. economic recovery takes hold2.

As reported by this survey the number of U.S. executives planning to increase their overseas sales targets rose from 49 percent in 2008 to 56 percent in 2009 and to 72 percent in 2010. Fifty-six percent of the executives polled say their overseas sales are growing faster than domestic sales, a rebound from 52 percent of executives last year though still below the 67 percent level seen in 20083.

Before considering expansion, a franchised business needs to determine if they are truly ready to expand. Strategic advantages of experience, scale economies, product differentiation, capital requirements, and location are important determinants of international franchise expansion and must be considered prior to launching any expansion plan.


Christopher P. Davies, senior executive vice president and head of commercial banking for HSBC - North America, said:
 


"Despite the perceived risks to expanding internationally, we think that business will become increasingly global. All 10 markets surveyed not only reported that the pace for international growth was faster than their domestic business activity in the past 12 months, but will continue to trend upward in the next two years."4

 

Attractive international markets

The most attractive countries for U.S. companies to do business in are currently Canada and the United Kingdom. One reason for this is that Canada, the United Kingdom and the U.S. all share the same language. This removes one of the main obstacles, the language barrier, faced by many franchised businesses when entering a new international market. Canada and the United Kingdom are outpacing other dynamic and emerging markets like India and Brazil. However, China is still one of the most popular countries for expansion as it is considered to have the greatest growth potential for U.S. mid-sized businesses. In 2008 and 2009, the markets that offered the greatest growth potential were China, India and Brazil5. Before deciding to launch a product or service in a new country the franchisor will need to research the market well.

 

International franchise laws

international-1Many countries have very specific franchise laws and for countries that don’t, it is necessary to determine what the local laws that govern franchised businesses are. Franchise businesses expanding into the U.S., for example, face some of the most comprehensive franchise disclosure rules in the world. For all franchisors looking to offer a franchise in the U.S. they have to comply with the FDD (Franchise Disclosure Document) rule and deliver a disclosure document within at least 14 calendar days before the prospective franchisee signs a binding agreement with, or makes any payment to, the franchisor or an affiliate in connection with the proposed franchise sale6.

The franchise laws in many other countries are not as strict as in the U.S. However it is important that a franchisor hires a local attorney who is familiar with franchising and local law to assist in preparing any necessary legal documents.

 

Forms of International Expansion

There are three main routes to market for franchisors seeking international expansion.

 

  1. Master franchising

The most common franchise form for international expansion is master franchising. Master franchising offers people or corporations the opportunity to purchase the rights to offer franchises for the franchisor within a certain territory. A territory can be an entire region or country, or a specific area within a country. This form of franchising enables rapid growth and minimal capital requirements for the franchisor.
The master franchisee purchases a territory from the franchisor and can then begin to offer franchises. Under the master franchise agreement, terms are set for how much of the franchise fee and royalties goes to the master franchisee and to the franchisor. For example, an agreement could be reached where 50% of the franchise fee and 50% of the royalties goes to each. This figure varies depending on the franchise.
The franchisor can take advantage of the local expertise of the master franchisee. The master franchisee will have knowledge of the local language, market and customs. With master franchising the franchisor does not have control over the unit franchisees. Unit franchisees are overseen by the master franchisee.
A master franchisee should ideally have experience in managing a successful operation within a similar area or related field to the franchise. Alternatively the master franchisee should bring a needed skill-set to the table. They should have the financial capacity and infrastructure to undertake the development of the brand.

 

  1. Development agreements

international-2With this form of expansion, a developer is granted the right to develop and operate a certain number of outlets within a given territory or area. However they do not have the authority to sub-franchise the outlets to third party franchisees.


Area development programs provide all of the general advantages of multiple-unit franchising, such as the potential for accelerated growth with less investment or capital demands upon the franchisor. In addition, area development programs may lead to additional cost savings for the franchisor due to the fact that area developers typically have prior experience with the system. A development agreement offers the franchisor more direct control over the franchisee and the development of the territory7.


Under development agreements there is typically a fee and a designated territory. The developer may only open and operate units for its own account pursuant to separate franchise agreements with the franchisor. There is also a minimum development schedule which means that the developer must open a prearranged number of units within a specific time frame. Each development agreement is different depending on the selected franchise. All the information pertaining to the development agreement will be provided in the Franchise Disclosure Document which is provided to the prospective franchisee prior to the signing of any agreements.
 

  1. Wholly-owned subsidiary

Many franchisors seeking to expand internationally will set up a wholly-owned subsidiary within the foreign country. The wholly-owned subsidiary enters into franchise relations with franchisees, whether they are single unit franchises, regional master franchises or area development arrangements.
In this case, the subsidiary is entirely separate from the foreign parent company and therefore the parent company is insulated from liability.

 

 

Criteria for expanding internationally

There are many factors that a franchisor needs to be aware of as they look to expand into a foreign market. Some of the most important factors are:

 

  • The size of potential markets
     
  • The per capita GDP in target markets
     
  • The legal maturity of target markets
     
  • The compatibility of the concept with target market culture
     
  • The viability of other more mature franchise systems in the target market
     
  • The direct competition in the target market
     
  • The potential language and cultural barriers
     
  • The physical accessibility of the target market to current operations

 

international-4One of the initial processes to be completed when expanding a franchise business is to create a fully costed business plan. This business plan should outline the cost of developing a robust international infrastructure, including sales and marketing support. There will also be a requirement for a master franchisee operations manual (if they have employed a master franchisee), training and support programmes and legal documentation.

Poorly planned and badly executed expansion can be disastrous. The damage is likely to be not only financial but damaging to the franchise system’s reputation, as well as morale at home. Therefore, before deciding to expand internationally, it is important that franchisors make sure that it is the right thing to do and at the right time for the franchised business.

 

Case study of international expansion:The Little Gym

The Little Gym International has successfully grown their company into a global brand serving more than 100,000 children in 20 countries each week. The Little Gym International offers programs which aid children aged 4 months to 12 years develop vital motor skills in a fun and non-competitive environment, while simultaneously enhancing their self-confidence and social skills.

Through master franchise agreements, The Little Gym International has already successfully opened locations in multiple countries in the Middle East, Asia, and Europe as well as North America, proving that their concept and business model can work well in virtually any country in the world.

They have recently announced that they have entered into a joint venture that will bring their concept to mainland China. This brings the number of countries that The Little Gym has a presence in to 20. The joint venture holds great potential to spread The Little Gym throughout China.

One of the reasons for The Little Gym’s international success is the significant amount of time they spend in choosing each master franchisee. Strong people skills and a deep love of children are the most important qualities that they look for. Once the franchisee has been selected, The Little Gym provides the tools, training and support needed for that franchisee to reach their full potential. The Little Gym master franchisees also have experience and a vested interest in the growth and success of the system. The Little Gym master franchisee oversees the selection, recruitment, inauguration and ongoing support of additional franchise owners. This allows The Little Gym’s development efforts to move forward with full force so they can continue to grow their international brand.

 

References

1International Franchise Association, Building Opportunity, Economic Impact of Franchised Businesses, National Overview: http://www.buildingopportunity.com/download/National%20Views.pdf

2HSBC Commercial Banking Division, International Business Survey, 28th June 2010 -

http://www.bi-me.com/main.php?id=46771&t=1&c=35&cg=4&mset=1011

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6Federal Trade Commission, Disclosure Requirements and Prohibitions Concerning Franchising and Business
Opportunities; Final Rule; Federal Register / Vol. 72, No. 61 / Friday, March 30, 2007 / Rules and Regulations

7International Franchise Association, Franchise News; Expansion Options; Multi-Unit and Third Party Arrangements; April 2008 Franchising World; By John W. Fitzgerald and Max J. Schott II

 


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