FRANCHISING

4/15/2014 An Indian Perspective

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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FRANCHISING

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

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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FRANCHISING

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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FRANCHISING

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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FRANCHISING

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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FRANCHISING

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.

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