How UK Retail is Extending its Franchise

02 Aug 2010 - Franchising helps overseas ventures, but how do you decide whether to run company-owned stores or take the franchise route?

It was just the sort of endorsement likely to help popularise Mothercare's fledgling chain in Australia, and all the more welcome because only three days before the British retailer had revealed plans to take a 25% stake in Headline Group, which operates the Mothercare and Early Learning Centre franchises in Australia and New Zealand.

In the past it would have been unusual for a retailer to acquire a position in one of its franchisees. However, there are signs that attitudes are changing. On the same day that Mothercare unveiled its Antipodean plans - involving a £7.2m investment - luxury retailer and brand Burberry said it has agreed to pay £70m to buy 50 stores and related assets from Chinese franchisees.

On the surface such deals might seem odd. After all, the rationale for overseas franchising is that it relieves the franchisor of costs and risk associated with international expansion. So why are such deals being done and are there likely to be more?

Stake a claim
There are particular reasons for the Mothercare and Burberry deals with their franchisees. Mothercare has taken stakes in franchisees before - typically in emerging markets. It holds 30% stakes in its Indian and Chinese franchisees for instance - both rapidly emerging and potentially massive operations.

Australia and New Zealand are very different markets from India and China. Mothercare did not want to comment on the rationale for a deal there, because it is yet to be completed. However, there is a clear logic - to accelerate development of Mothercare and sister brand Early Learning Centre.

Headline said last week that sales at the first two Mothercare shops have beaten expectations and that the capital investment would "result in the group being debt-free with sufficient cash reserves to undertake its business plan".

Alongside the Mothercare deal, Headline revealed it had agreed to buy Baby on a Budget, a seven-store retailer in Western Australia with sales of A$11m (£6.2m), for A$2m (£1.1m).

It expects to improve earnings by introducing Mothercare product to Baby on a Budget and convert the shops to the Mothercare fascia. It will also take full control of supplier Skansen KCG and is eyeing further acquisitions.

So by investing in Headline, Mothercare expects to boost its own business. And the trend towards UK retailers buying out or taking stakes in franchisees is likely to continue.

Frequently nervous about making their first forays abroad, franchising - frequently on a cost-plus or royalty arrangement - was first and foremost a low-risk, low-cost way for retailers to enter new markets.

But many UK retailers have internationalised rapidly over the past decade or so and as their experience has grown, so has their confidence. In those circumstances, it often makes sense to run company-owned stores overseas.

MHE Retail chief executive George Wallace says: "Ultimately, you get a higher return on investment if it's an owned business. For bigger companies where international growth is a key platform, it makes sense for them to invest themselves."

Retail Expertise director Michael Poynor says: "When you've used the franchising route to demonstrate the brand can work well, then it's perfectly logical to want to take more control."

That dynamic can be seen in Burberry's Chinese deal. The transaction formed part of what Burberry describes as its "strategy of unifying the brand around the world while increasing its exposure to retail and to high growth luxury markets".

An existing franchisee will retain a 15% economic interest in the Chinese business, but Burberry control is expected to add as much as £20m to group operating profit in the 2011/20012 financial year.

Mid-market retailers are also buying out franchisees when appropriate, or have the option to do so. Aurora , for instance - owner of chains such as Oasis and Karen Millen - has recently bought out its Australian, Danish and, last week, Swedish partners.

Fast fashion specialist New Look, which has 52 franchised shops open from Russia to southeast Asia and aims to have a total of about 400 over five years, retains the right to take control in many instances.

New Look managing director (channels) Will Kernan says: "The reason for having a buy-back clause is there's a lot of learning [from partners and in new markets]. After years of getting to understand how they operate and those markets, then the rationale for bringing it in-house increases."

While retailers may choose eventually to take full control of successful franchise operations, they are at pains to point out that franchising remains a key part of their overseas strategy.

In some cases, such as in India or the Middle East, they have no choice because of restrictions on foreign direct investment. But retailers also recognise as invaluable other benefits that franchisees can bring.

That may range from the ability to invest in a rapid opening programme to skilful guidance through a new market's red tape, whether it is property restrictions or import barriers, down to on-the-ground intelligence about which new malls will work and which won't, and cultural practices.

Such knowledge has already been put to use in Asia and Europe, and looks likely to be in demand in the coming years in Latin America. Retailers are looking hungrily at Brazil in particular and wondering how they can grab a slice of a growing economy likely to be boosted by hosting the next World Cup and the Olympics in 2016.

Two-way street
So what do retailers need to think about when striking franchise arrangements? Wallace advises retailers to opt for a master franchisee and remember that franchising is a two-way street - the franchisor must be prepared to put resources into training, marketing and visual merchandising for instance.

Strathtay Consulting's Colin Buchanan, who has worked internationally for retailers ranging from Marks & Spencer to Body Shop, says there is a matrix of about 15 or 16 criteria across profitability, legalities and risk that should be borne in mind when considering a franchise.

What is the risk-reward scenario in a particular country? Is a franchise arrangement the best use of a retailer's capital or would another approach be better? And what are the legal considerations, such as barriers to investment?

He says: "The key is making certain your business model works - that it appeals to local consumers sufficiently to generate enough sales and profits to satisfy franchisor and franchisee.

"Franchising is not a panacea. There's endless opportunity but you need a differentiated offer because there are lots of good local operators doing a very good job."

Kernan says that at New Look partnerships with franchisees are described as "marriages" rather than "relationships." He says: "They need to be true partnerships with open dialogue, so that any issues are nipped in the bud."

He expects to forge more such partnerships as New Look pursues its expansion plans. He says: "Franchising forms an important part of our international growth story."

More southeast Asian locations and north Africa are among the places on New Look's radar following a global study of factors such as customer profile, seasonality and urbanisation.

And Aurora chief executive Mike Shearwood says: "Franchising is still a really important part of our business. Apart from anything else, franchisees are very demanding - and that drives your whole business forward."

Poynor says that many UK retailers have been comparatively slow to take advantage of the benefits that franchising can bring. He points out, for instance, that about half of Carrefour's stores are franchised.

"There is huge opportunity still," he says. "Traditionally British retailers have been a bit reluctant - they've thought franchising is OK for burger bars but not for them. There's been a cultural resistance but that is changing."

The success of Mothercare may galvanise other UK retailers. While Mothercare's domestic operations have like other retailers' been hit by the downturn, the international franchising network has continued to deliver impressive growth. The retailer now has 1,167 shops in 53 countries.

Mothercare reported last week that during the first quarter UK sales fell 2.6% in total and 4.1% like-for-like. International retail sales, however, climbed 20.3%. Numbers that should prompt envy among other retailers and stoke interest in similar ventures.

Sometimes they may choose not to opt for franchises. In the southern hemisphere for instance, the difference in seasons can make franchising difficult for British fashion retailers, so options such as licensing might be considered.

But any retailer considering franchising can learn lessons from Mothercare. Buchanan says the maternity specialist "runs a very good franchising operation with great support for franchisees. It has developed a niche for its product ranges that is not yet exploited in a lot of countries."

While Mothercare may buy stakes in partners and Burberry and others may buy them out completely, the traditional franchising model is likely to be in operation for a long time yet.

Supergroup: Debuting in the middle east

Newly floated fashion specialist SuperGroup , owner of the ultra-trendy Superdry brand (pictured left), is among those retailers ramping up international franchising.

International development is one of the key planks of the retailer's growth strategy and last month SuperGroup struck a deal with Al Khayyat Investments to open 13 Superdry shops in the United Arab Emirates (UAE).

The arrangement is an example of how important it is to have a suitable franchisee. Al Khayyat, which was set up in 1982, can point to its track record as evidence that the tie-up should work. The business already has relationships with well-known brands such as Fila and its retail and distribution turnover in the UAE in 2009 was $260m (£170m). In the year to date, says director Zaid Al Khayyat, Al Khayyat's retail clothing brands have achieved growth of 18%.

Similarly, the market dynamics look right. According to independent research, teenagers in the UAE currently spend $71 (£46.50) a month on clothes - three times as much as their global peers.

Al Khayyat intends in future to take SuperGroup into other parts of the Gulf and the Levant. The UAE deal was, it said, "a springboard to further investments into the other Middle East retail markets".

Source: All Business -


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