Managing Risks For International Franchises

Overseas expansion can be very profitable, but careful consideration is required.

By Andres Franzetti

Today, roughly 95 percent of the world’s potential consumer population resides outside the United States. This substantial and largely untapped market is eager for consumer goods. International expansion has clearly become a logical next step in any firm’s business strategy.While expansion overseas can pay a big dividend, it is not without risk. The varied terrain and challenges of international expansion require careful consideration, especially for franchisors. While expansion overseas can pay a big dividend, it is not without risk. The varied terrain and challenges of international expansion require careful consideration, especially for franchisors. While expansion overseas can pay a big dividend, it is not without risk. The varied terrain and challenges of international expansion require careful consideration, especially for franchisors. Today, roughly 95 percent of the world’s potential consumer population resides outside the United States. This substantial and largely untapped market is eager for consumer goods. International expansion has clearly become a logical next step in any firm’s business strategy.

Big Reward, Big Risk

Growing instability around the world makes today’s volatile news cycle the “new normal” and franchisors need to understand how instability and risk can affect their brand and global operations. For example, franchisors should account for things such as the political and economic stability in target markets, regulatory climate and sophistication, as well as the purchasing power of local consumers. These categories are key indicators of the underlying risks that exist throughout the world — a look at the unrest gripping Hong Kong serves as a stark example. Factoring in the broader risk landscape can be difficult, because political currents can shift quickly. Most recently, McDonald’s fell victim to what appeared to be a politically motivated reprisal in Russia. There 12 of its franchises were closed for “violations of technical regulations requirements,” which seemed to coincide with the timing of sanctions imposed against Russia by the United States and other Western powers. These unanticipated closures in one of the world’s fastest growing markets triggered a serious impact on McDonald’s profits, which posted 3.7 percent drop in August. Yet political issues are only one area of concern. While the introduction of established global brands like McDonalds, Burger King or KFC are often heralded as signs of progress in many markets, the reality of operating in uncertain conditions often exposes companies to reputational risks. Tight control of supply chain management and service standards within international franchises must also be in keeping with the brand’s existing operations back home. While developing economies are eager to attract foreign investment, the regulations and quality controls governing these operations are often still being defined and not always enforced. These conditions, coupled with the frequent struggle to source quality supplies or stock, places added strain on a franchise, particularly those in the food service industry. With the food and hospitality sector representing 65 percent of employment within the franchise sector, the risks of supply chain disruption can be substantial and sudden. The need to ensure that tight supply chain controls are in place is a concern any franchise should have when expanding internationally. Likewise, the same standards that are employed in U.S. locations should follow suit abroad to ensure consistency of product and to preserve the brand from reputational exposures.

Protecting Assets Beyond the Brand

Not every risk will be as intangible. Notwithstanding a global world where franchises are purchased by local and regional investors, the majority of assets are still bought in hard currencies, and then insured in soft currencies. This creates exposures to currency volatility and depressed purchasing power in the event of property losses. Furthermore, local insurance policies often do not cover risks such as social unrest, war or terrorism, which tend to be most prevalent in highly trafficked areas where franchise locations will likely be. Marriot suffered such a loss.  A 2008 terrorist bombing in Islamabad killed 40 people and seriously wounded 200, while causing large-scale property loss. A tragedy such as this one damages consumer perception and underscores a severe liability exposure. In the wake of the Islamabad bombing, for example, many Western governments issued travel warnings urging their citizens to avoid international hotels for safety reasons. The liability exposure for these kinds of events is also of concern, particularly for the franchisor. While the Islamabad hotel was a franchise operated by a Pakistani company, it was Marriott International Inc. that was sued by a victim’s family for failing to take the necessary safety measures to protect guests.

Downsides Will Always Follow the Upsides

The examples cited above represent some of the more catastrophic, but often overlooked risks that global brands can face. However, organizations also need to ensure that standard employee practices and operating guidelines are in place. While established global brands do bring a positive value to emerging markets, they also bring litigation risk with them. From a client slipping and falling in a store, to an employee getting burned and injured on the job, routine business activities can just as easily bring reputation exposure to a global brand as third-party risks. With today’s access to the Internet and social media platforms, information about global brands not behaving in the same socially responsible way as their U.S. counterparts can travel quickly causing a ripple effect that affects the organization’s profits across multiple markets. While these risks are considerable, the upsides are greater. Growth will continue to be found on a global scale, especially as developing nations flush with natural resources begin to enter the global economy. Franchises who seek growth in countries such as Libya, which sits atop Africa’s largest oil reserves, will continue to thrive as long as considerations are taken into account to properly mitigate risks.

Pre-Investment Due Diligence

While parent companies historically selected franchisees with close government connections, the Arab Spring and other destabilizing movements have shown that these may no longer be the most desirable candidates to help expand global brands. Today, a financially solid investor, coupled with an in-depth risk evaluation, may be the best path to ensure sustained growth abroad. Here are three key steps that can be taken to address the concerns of expanding overseas:

1. Conducting pre-investment due diligence is the first step to take when looking at new markets. Consulting with risk management and insurance specialists will help the organization better understand and identify its exposures.
2. As global brands, franchisors must ensure that both global and local compliance is followed. Even though the franchisee is managing many of the daily aspects such as insurance, human resources and so on, a vicarious liability still remains for the franchisor. Lawsuits can still be targeted to the brand owner, and the reputational exposure can cause long-term damage reaching well beyond a single store or location. Implementing a set of operating guidelines and working with providers to facilitate access to reliable insurance coverage and other related services will help create a global standard for all franchisees to adhere.
3. Working with outside partners and utilizing external resources is the last line of defense to ensure that the organization has taken all facets of its operation, and potential exposures, into account. Having a network of partners allows for global access and onthe-ground assistance for unexpected events.

Andres Franzetti is the engagement manager at Clements Worldwide and holds the Certified Risk Manager designation. Find him at fransocial.franchise.org.

Where Weak Local Supply Chains Meet Global Exposure

When Chinese meat supplier OSI Group LLC was found to be selling expired and tainted meat to nine global chains, including YUM Brands, McDonald’s and Starbucks, the reputation of these brands became seriously compromised. While all restaurants immediately halted sales of the tainted products and conducted investigations, it was a lack of on-the-ground quality control, loose regulations and weak supply chain management that put the companies at risk.Many consumers both in China, as well as around the globe, are now contemplating the quality of the products they are consuming from these brands, the backlash of which is reflected in declining earnings.