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Disadvantages of Franchising as a Mode of Entry into Foreign Markets

Do you want to know the downside of expanding globally via franchise? If YES, here are 7 disadvantages of franchising as a mode of entry into foreign markets. Changes in the business world have entailed that more and more establishments are expanding their operations across country borders.

These changes such as: the removal of trade barriers, free trade agreements between countries, and an emerging middle class has made the concept of going global more attractive to organisations across the world.

Other factors such as growing profits, expanding market share and becoming a global brand are more reasons why businesses and organisations are looking to globalize. Although there are a lot of drivers of internationalisation, and hence potential advantages to internationalise, there is no one best entry mode.

Franchising in this scenario is seen as a market entry strategy where a semi-independent business owner (the franchisee) pays fees and royalties to the franchiser to use a company’s trademark and sell its products and/or services. The terms and conditions of a franchise package tend to differ depending on the contract, however it generally includes: equipment, operations and management manual, staff training, and location approval.

According to reports, franchising is commonly used and a largely successful method of cross border market entry, however organisations seeking this entry mode need to consider both the positive and negative aspects of franchising.

Advantages of Franchising

According to experts, the most common advantages of franchising are that it leverages on an already successful strategy, the franchisee generally has local knowledge, it’s less risky than equity based foreign entry modes, and the franchisor isn’t prone to risks associated with the foreign market

Companies like Subway, 7-Eleven, Pizza Hut, and McDonalds have over the years been very successful using franchising as their foreign market entry mode. Subway, for instance, was established in 1965 in the United States; using franchising as a foreign market entry strategy it has expanded to have over 42,000 stores in 107 countries. It is now the world’s largest franchise and highlights how successful franchising can be.

Just like in the case of Subway, franchising offers a massive platform for rapid expansion that may not be achievable using other foreign entry modes. Even though in general, franchising is a popular and successful mode for foreign market entry, there are a few potential shortcomings.

These disadvantages include:

7 Disadvantages of Franchising as a Mode of Entry into Foreign Markets

1. Decreased Brand Quality

Due to not having full control over franchises, the quality of products and services can reduce drastically in the foreign market. Unlike start-up franchising where the franchisee is bound to follow all the pre-defined/ mentioned rules and regulations of the franchise business, there is less control in this mode of market entry due to distance, varying regulations and cost of implementation.

2. Financial Risk

When expanding into another country, the financial risk involved remains one of the biggest disadvantages. Although it is nothing compared to other market entry modes, it is still a serious consideration in the business world. For instance, the exchange rates between currencies could lead to an unfavourable return on investment.

The business or franchisee may also have a hard time getting access to the supplies and products they need from the franchisor. Some countries charge tariffs and fees to ship products in, which could make doing business less profitable.

3. Nurturing a Future Competitor

Agreeably, franchise monitoring can count as an advantage at the initial stages of franchise, but after that it leaves the franchisee with so much experience and knowledge about the franchise.

Owing to the fact that the franchisor has to be contacted for every change made in the business and approval is needed for the same, the secret and landmark to success are passed on without so much control and regulatory restrictions. These franchisees can tomorrow decide to opt out and pursue their own business line, comprising of the franchisor’s secrets and little adjustments called innovation.

4. Compliance Challenges

The difference in culture and business setup can create issues with branding, public relations and corporate culture; regulatory differences also pose a significant challenge. Franchising might create a more favourable platform, but it still very different when compared to the home country.

Business laws and regulations tend to vary significantly between countries, provinces, and states and a new entrant may find that these differences affect every aspect of the business, including human resources policies, employee rights and benefits, and even the ingredients needed to formulate the products.

5. Re-selling Issues

If, for instance, the franchisor is not easy and wishes to sell the franchise, it is hard for him/her to do the same as the franchisee needed to be considered and only after he/she approves it, it is then the franchise could be transferred. It is same as the restrictions and lack of maximum control faced by franchises, both in local and international markets.

6. Cultural Differences

One of the major problems of expanding into other countries is overcoming the cultural barriers. Note that because something is acceptable in the United States does not necessarily mean that it will be acceptable in other countries. Every country has its own culture, and a business may not be able to accurately predict what people in that culture will enjoy.

7. Not Maximizing Profits

Also note that the franchisee will only have to pay the franchisor a part of the sales as royalty, they make at the franchise. This could be in large amounts than the profits the franchisee will receive in return or even smaller compared to market demand and business environment. The franchisor only receives part of the profit and not all of the profits like, maybe, other mode of market entry.

Whilst these potential shortcomings could be detrimental to an organisation, franchising is continually chosen as a foreign market entry mode as franchisors believe that the rewards outweigh the risks.