The World at your feet

China, USA, France, India, New Zealand, Japan, and Poland….how do you choose?

Mention the word international and so many thoughts, emotions, issues, challenges, and opportunities rush to the surface. Which country, business model, entry strategy, advisor, or management team? Many millions of dollars have been spent by some of the world’s largest businesses in entering new markets and even the biggest and best can have tough starts. Subway initially struggled in Australia, McDonalds struggled in France, and the Warehouse Group struggled in Australia.

There is no single issue that is common to all successes or failures. Having lived in 5 countries for extended durations I am a strong advocate of successful international expansion being the ability to access, respect, understand and adapt local knowledge for the benefit of the strategy.

Adrian McFedries, Managing Director DC Strategy discusses some of the issues related to going international, based on experiences and practical insights from assisting groups globally.

The Non Negotiable’s The decision to go international should serve as a catalyst to actually examine the position of the business in the domestic market. Given the significant resource commitment that is required experience has confirmed the non negotiable requirements for international expansion are:

1- Strong cash flows and profitability 2- The ability to remove a key senior management person from head office 3- Domestic market strength Sadly, the above are usually underestimated and take a back seat when the emotions of going international become entrenched.

Cash Flow and Profitability The cash flows and profitability are more than the costs of trademarks and finding a local partner or advertising for a master or joint venture partner and establishing the first operation. The cash flows need to be strong enough to face the reality of a failure in an international market and the possibility that the domestic market may slow. The international operations will naturally take a period of time to become cash flow positive but entering the market with an undercapitalised operation (including the local partner) is as damaging as an undercapitalised franchisee in the domestic market.

The other key impact of the cash flows and profitability is the choice of business model. The choice of business model can be overly influenced by the magnitude of cash flow that is available. For example, the idea of granting a master franchise and receiving a USD $300,000 upfront fee is more appealing than funding a joint venture or acquiring a stake in an international business. The legacy of the choice of business model (s) is long standing and consequently should be well thought through. In simple terms, a lack of cash flow will force short cuts or compromises for the parent company and international business partners that typically do not manifest themselves for years to come.

Senior Management Focus The ability to have a key senior management executive focus exclusively on the international growth is nothing more than a reflection of the challenges and horsepower required to make international expansion successful. This seems obvious but sadly too many approach the international expansion strategy with similar or less resource to that used for domestic interstate expansion.

It is worth noting this exclusive focus often does not occur until the first international deal is either close or over the line. The reality is there are often many years of information gathering or visiting to occur before the results are being registered as signed deals. It is however the foresight within the business to understand and evolve the structure in anticipation of the continuing the international expansion. It often triggers the appointment of a new CEO or General Manager for the Australian business. This often requires the founder to step aside and shift focus with a professional management team and board which in itself can prove too difficult for many founders. If you are a founder reading this article I can only raise the question ‘How can you create the most value for the business in the future?’

Domestic Market Strength The simple rationale for domestic strength is best summarised as the low hanging fruit is more readily available than the fruit higher up the tree. This analogy encapsulates the resource commitment, prioritisation, return on investment and the pressure that is created for stretching the resources of a group too thin. The constant board room debate centres on what is domestic market strength. Is it the eastern seaboard states, 65% of shopping centres, 70% of territories? All good questions but in my opinion not the key focus. For instance, there may be two identical retailers with 80 stores, 75% of the way towards the predetermined market size. One opens a New Zealand operation successfully and the other struggles with New Zealand. Why? The measure of readiness for international is not solely the output or size of operation, more the infrastructural development and state of operational capability within the group. Every company has a different approach to corporate governance, senior management, strategic planning amongst many factors, and it is these key capabilities that determine the ability to achieve and maintain domestic market strength whilst being in a position to make the international operation a success. Focusing on international too early or in an opportunistic manner is one of the features of groups that have failed to capitalise on international market expansion. You often hear of groups, particularly in franchising, who mention deals being done in far reaching parts of the globe. Some succeed, some fail but the reality is too often there is little impact on the eventual outcome by the Australian parent company as it is more an opportunistic reaction to an enquiry rather than a well thought out commencement of an international strategy.

The other primary outcome that typically arises from a domestic strength is the business is capable of creating the necessary cash flow and profitability to support and maintain the domestic performance whilst creating the necessary capital for international expansion. The organisational structure will also typically be at a level of maturity that is capable of enabling a senior management executive to shift the focus to the international operation whilst promoting a CEO or General Manager from within.

Reactive or Proactive There are two broad approaches to international expansion that exist within the market; reactive and proactive. The reactive approach is identified as groups’ responding reactively to opportunistic international enquires by individual people that are interested in buying the rights to their country of residence. The growth of the internet has increased the volume and ease of international enquiries. The reactive approach has consistently violated the non negotiable requirements identified above, and is the highest chance of failure. This is not to say there are examples of reactive approaches proving successful. However, the needless increase in execution risk is in my opinion unacceptable and often when you dig below the surface it has come at the expense of the performance of the domestic business. Will this approach continue into the future? The answer is a definitive yes as the amount of enquiry continues to increase and the emotional attachment to international growth is very strong. In my opinion there are too many groups adopting this strategy in Australia, which in the short term provides some real challenges for businesses that are under resourced, developed and undercapitalised.

The proactive model is something groups such as Boost Juice, PoolWerx, Bakers Delight, Fastway, Domino’s, and Gloria Jeans to name a few have adopted. The proactive model still has execution risk, difficult decisions, and reactive moments but all based on a solid foundation. The non negotiable requirements identified above are achieved, an international development process and strategy have been developed and most importantly there is a significant focus on a number of international countries over a sustained period of time.

The Choice of Business Model The choice of business model is the most significant decision in growing an international operation. The more commonly recognised include, but are not limited to, master franchise, area development franchise, joint venture, direct entry, acquisition, and license. The decision is critical because the legacy of the decision will last for years, and it is the foundation that all future efforts in the chosen country are based on. In each structure there is a key decision in terms of the sharing of responsibilities and the level of involvement of the parent company and the prospective franchisee. For a more detailed discussion on the key business models please read the article on ‘Importing a Franchise’ in the prior edition of Franchising Magazine.

The absence of the non negotiable requirements identified previously, particularly cash flow and profitability, has a significant impact for many people in making the decision. A master franchise model is attractive if it can be ‘sold’ given the typical upfront fee revenue that can be generated. This is not to say that master franchising is not a successful model, but combine lack of cash flow, opportunistic reactive behaviour, with a lack of funds and you have the perfect storm. Interestingly, there are a number of Australian businesses that lay claim to have expansive international operations, only to find many years have past and only one or two countries have ever been established with little or no input from the Australian parent.

The planning and development of an international expansion strategy will enable the key business model issues to be resolved. Consideration must be given to the overall strategy, the expanse of the strategy and hence ability to provide the appropriate resources to all countries. The decision requires a clear consideration of the division of responsibilities that are required to successfully establish the international business as a start up in a foreign environment. A master franchise model requires a specific type of international partner with a reasonable net worth to grow a network. A direct entry model is likely to consume far more resources from the Australian parent company given the increased levels of responsibility. Consideration must also be given to the laws of the destination country as with China where a master franchise model is more limited.

The business model can and often does evolve. Bakers Delight entry into North America has been a company owned operation in Canada. The Australian operation has a significant franchisee base which over time will no doubt evolve in North America. The use of the direct entry model in this instance is providing Bakers Delight the opportunity to understand, respect, and adapt to the Canadian market.

Everyone is an Expert Mention international and expertise can appear from everywhere. It is a fact that international has so many unknowns that the perception of anyone who appears to be ‘in the know’ is appealing. It is also a fact there are many cowboys in the international space providing advice, making offers for business rights, or preparing legal documentation that are simply out of their depth.

It is an expert area and as a consequence tremendous value can be created by sourcing the appropriate input from the correct people. Travel also broadens the mind, and there is no substitute for visiting the intended countries of expansion. If you think the time is not available it is worth asking yourself what type of commitment you are making to your potential business partners in that country.

The key challenge for Australian based franchisors that have grown a reasonable scale of business in Australia is to see the need for any form of external input. Given the number of variables and the scale of the opportunity in my opinion this is a misnomer. There are few international corporate groups that expand into foreign destinations without seeking some form of external input whether it is branding, consulting, legal, demographic, tax, trade, or technology. Any franchisor has a practical limit to the knowledge internally, and there are key areas of the Australian business that are subject to change in the face of the impending expansion.

The Process The process for developing the international strategy is as varied as the number of countries. The time frame that many management teams and owners shape their ideas over is years rather than months. However, when the three non negotiable requirements identified above begin to emerge, the process becomes intense over a period of 12-18 months.

The initial focus is the domestic business and understanding the readiness for international growth and any structural changes that need to take place. The changes can be as much about the international growth as improving the core domestic operation. Interestingly, this is the first time many groups take a step back on what could have been 5-10 years of sustained growth to look at the core structure of the business and understand the continuing relevance.

The international development process itself needs to be undertaken as part of a global growth strategy. It is not feasible to focus on any one country at the expense of all others, as the key decisions need to be undertaken against the backdrop of the next 3-5 years. This has an impact on such core areas as trademarks, domain names, and tax structures to name a few.

The economic analysis needs to identify the structural integrity of the business. The structural integrity is the ability or appropriateness to consider a range of business model structures. There are certain structures that fail to make economic sense for all parties, and other structures that are often not well understood as they are not in operation domestically. How a master franchise structure impacts the group is an interesting question many Australian based groups do not face until the international market is considered.

The commercial policies that form the basis of how the business will operate overseas must be developed against the backdrop of the domestic business. This is a challenging area for many Australian based franchisors as a simple view is evolve the domestic franchise agreement and operations manual to respect the international legal framework and the job is done. The critical assumption is the domestic policies are still relevant and that they can be evolved to suit the international business. Should an exclusive geographic territory based policy be adopted in Dubai or should there be a territory at all?

The areas of market research, travel and developing the international plan are always challenging. Where in the world should we go? Where is the enquiry coming from? Where have other groups gone? Every business is different and the objective of any market research has to be placing the group in a fully informed position to make a decision. There is a practical limit to research and at some point a commercial judgement will need to be made.

The legal documentation should be completed at a time when the direction of the international expansion is well developed and when the broader commercial policies have been thought through. This will ensure any legal advice can be understood in terms of its impact on previous decisions. At the same time it provides an opportunity to shape and evolve the broader plans. There are some specific legal areas where the advice can have a substantial impact on key areas such as supply, trademarks, choice of structure or the country the legal document is settled within.

The core team that is focused on international will continue to develop and evolve the international thoughts as part of the development process. The ability to work as a team and focus on the priority at hand is not always easy. There are many emotional drivers in international developments that can create the wrong outcomes. The most immediate issues that a franchisor faces are the split responsibility between domestic and international growth. It can not be avoided but it is critical to understand how the organisation will evolve to a plan when the need arises. There are typically a few key decisions at key times that create significant outcomes in the international process.

There are many other key activities involved in creating an international business that are the basis of an article in themself. The issue I find most groups underestimate above all else is the impact of having the first country signed irrespective of the chosen structure. There are typically many more hours involved in making this successful than groups have available. This necessitates prioritisation and strong initial planning if all responsibilities and expectations are going to be met. As I mentioned at the commencement of this article, selling a master franchise is easy, building an enduring and successful international business is difficult.

The Future The future of outbound Australia expansion is particularly exciting. There are a number of businesses in Australia that are reaching market maturity or have sustained performance at market maturity for a number of years. The private equity markets have strong cash flows and are constantly seeking businesses with growth opportunities.

Australian networks have a strong reputation globally for operating businesses across massive geographic regions with high fixed costs, labour costs, and a small population. Consider operating a retail network of 100 stores with one quarter of the population of Germany across an area that encompasses all of Europe. That is Australian retail.

This offers a significant advantage to Australian businesses seeking international success where the pressure of these elements is reduced. Consider operating a network of 300 stores in a population of 60 million across the state of Victoria. That is French retail.

There are a number of franchisors in Australia that would be well advised to reinforce the capital base of the business as part of the international expansion strategy. Many have founders who have not realised any asset value and who are only thinking about external capital as part of succession planning, or exiting. This need not be the case. There is plenty of opportunity for the founder to continue to be involved with less equity but with a broader capital base to approach international. The challenge with involving an equity partner is who and how much? It is beyond the scope of this article to comment on equity partners, but there is little role for the passive investor in this space. An international business partner can be very valuable for the business.

Conclusion On the domestic front, there will continue to be consolidation as part of the broader national and international growth plans. As part of going international, groups will take stock of the domestic market and there are many industries where rationalisation can and should occur in the coming years.

If you are planning for international expansion ensure the structure and overall strategy is well developed and thought through. The investment can be significant over a number of years but it is proportional to the broader international opportunity. There are many pitfalls and challenges that need to be addressed and there must be an ability to thoroughly question and challenge the success of the domestic business model.

At present, there are too many Australian based franchisors that are approaching international in a reactive manner, lacking the people and capital resource to do justice to the opportunity. There will be pockets of success but the real international success stories will be those businesses with a well developed international plan and sustainable approach.

As groups such as Fastway, Boost Juice, PoolWerx, Bakers Delight, New Zealand Natural, and Gloria Jeans continue to grow and demonstrate the international opportunity, there will be many more groups that progress down this path in years to come building respected global brands.



Adrian McFedries is the Managing Director at DC Strategy.

DC Strategy (formerly Deacons Consulting) is widely recognised as the region’s leading Strategy, Franchising and International consulting group. DCS has developed the networks and brands of many of the region’s most successful businesses. Contact Adrian McFedries at adrian.mcfedries@dcstrategy.com

www.dcstrategy.com



The World at your feet - To learn more about this author, visit Adrian McFedries's Website.

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