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Franchise Highlight

Franchising: A risk worth taking?

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So you’re thinking of being a business owner are you? Well, get ready to join the rapidly-growing club of small-medium enterprises (SMEs) in Malaysia.

With latest government figures estimating total SME numbers to be 645,136 in 2015, there is little doubt this figure is set to rise as the country continues to strive towards an annual growth rate of eight per cent in total SMEs through to 2020.

This encouraged vast expansion which has led to a huge reliance on SMEs. As evidenced by data released by the World Bank, SMEs constitute 97 per cent of all businesses within Malaysia while providing for 65 per cent of total employment, and a 36 per cent contribution towards total Gross Domestic Product (GDP).

With this in mind, Malaysia is poised to be a mecca for start-ups but the reality is harsh as the rate of failure in SMEs is around 60 per cent in the first five years of operations. A paper published in the World Journal of Social Sciences entitled ‘The challenges among Malaysian SMEs: A theoretical perspective’ explored Malaysian SMEs failures and concluded that the main challenges face by Malaysian SMEs were financial and managerial issues.

The study pointed out that managerial issues faced by Malaysian SMEs were aplenty, ranging from poor employee management to ineffective deployment of marketing strategies.

“The main problems faced by SMEs in Malaysia are the lack of knowledge regarding marketing techniques, branding, customer loyalty, and also, the lack of good contacts with other local and international enterprises,” quoted the paper, further suggesting that sustainability in SMEs would require solid management and marketing strategies.

Now that we’ve identified the solution, would it be easy to rectify our high SME failure rates?

Unfortunately, experience goes along much further compared with theoretical knowledge in the field of entrepreneurship. And with unavoidable capital and financial costs and risks involved already for businesses just starting out, new business owners must quickly learn how to effectively run and maintain a business.

And even when they’ve succeeded, most small-medium enterprises (SMEs) will be faced with a new conundrum – how does one manage expansion? Unless you’re a seasoned businessperson, the journey to a successful business start-up and expansion is fraught with trial and error, leaving you to learn from your mistakes while bearing its  costs.

Thankfully, there is a solution to these issues, allowing entrepreneurs to start-up and expand businesses with less complexity in management.

The solution is franchising and its popularity in Malaysia has surged over the years as local owned outlets carrying international brands continue peppering our business landscape while our own home-grown brands are beginning to gain notoriety overseas.

 

What exactly is franchising?

Franchising is essentially a relationship between a franchisor and a franchisee. In this business model, the franchisor provides the franchisee a developed way of doing business, ongoing guidance, systems and assistance in return for periodic payments and royalties generated from the business.

The advantages of franchising are straightforward for franchisees as they easily gain a viable alternative to starting their own business.

Choosing to be a franchisee, you’re essentially purchasing a proven business model that works with established branding and market awareness.

With these advantages offered, prospective small business owners may find themselves in a less risky situation as it allows them to run a business with little to no experience.

 

 

 

(SOURCE: SME Corp)

(SOURCE: SME Corp)

 

(SOURCE: http://www.entrepreneurcampfire.com/malaysian-franchises/)

(SOURCE: http://www.entrepreneurcampfire.com/malaysian-franchises/)

 

And, with an already established brand reputation and image, advertising strategies, proven management systems and work practices, franchisees will find that managing a franchise may be much simpler compared to an independent start-up.

Additionally, the cost of starting up a franchise may be cheaper, depending on the popularity of the brand you’re seeking to obtain a franchise license from.

Set-up costs for cheaper brands like Nelson’s and Laundrybar start off at around RM100,000 to RM200,000 while more expensive brands like OldTown and PappaRich could range from anywhere between RM1.0 to  RM3.0 million.

Some academic sources have also suggested that on average, franchises do have stronger survival rates as compared to independent businesses with survival rates quoted at around 70 and 80 per cent in the first four and five years of operation, respectively.

However, as these figures are based on US businesses rather than Malaysian ones, it is hard to draw any definitive conclusions to the success rates of our franchise businesses as our business and industry landscapes and conditions are very different compared to US ones.

 

Franchise benefits: A two-way street

Of course, this goes without saying, but, ‘franchisors stand to benefit too!’. The relationship between a franchisor and its franchisees is a mutually beneficial one, where both parties will reap profits.

Traditionally, most people expect monetary profit to be the main benefit of franchisors; however, this is not the case as franchising offers much more to franchisors than just money.

Weighing in on this topic is Bryan Loo, chief executive officer (CEO) of Loob Holding Sdn Bhd.

Having brought in nine international food and beverage (F&B) and tech brands into Malaysia, namely Tino’s Pizza, Soda Xpress, llao llao, Gindaco, Croissant Taiyaki, Hacha Mecha, IKKI, Define:food and Neighbourfood (tech app), Loo has extensive knowledge and experience in franchising as both a franchisor and franchisee.

Moreover, he has also recently launched his own home-grown brand, Tealive which he intends to franchise in the near future.

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Being a clear advocate and user of the franchise model, Loo sounded off his interview with BizHive Weekly, stating, “Franchising is a proven method of doing business that benefits both franchisor and franchisee. We have been a master franchisee for all of these brands and we know that it is a profitable formula for everyone.”

He went to explain that for many franchisors, this model of business allows them to expand exponentially and out of their home countries fast, thus, allowing them to amass both profits and branding.

Agreeing with this sentiment is Datuk Haji Md Latip Bin Sarrugi, Chairman of the Malaysian Franchise Association (MFA) who notes that, “Franchising provides our home-grown brands a platform for easier expansion regionally and internally so they can gain more brand awareness and further grow their business.”

Expansion can be very good for a business as having a global presence will help significantly in branding as the business will be able to capture a broader customer base with its brand and products.

And not only is expansion through franchising fast, but it is also lower risk in a financial sense as the franchisees are the one responsible for funding the expansions rather than the originating company if the expansion was independent.

Moreover, this lowered financial burden and regular stream of income from royalties not only lines the pockets of franchisors with internal funds, but also increases the ease of them obtaining financing from financial institutions to fund further business activities and operations.

Advocates for franchising may even argue that expansion through franchising would allow franchisors to focus on their core businesses and innovation while riding on the benefits and profits of having an international presence and regular stream of income.

 

And the benefits don’t stop there as besides benefitting both franchisees and franchisors, franchising is also extremely beneficial to our economy because it can act as a tool for technological transfer into Malaysia from overseas.

Datuk Latip explains, “When international franchisors expand into Malaysia, they transfer their technology to their franchisees here in order for them to effectively run their businesses.

“This technology transfer allows our commercial industries to develop better standards; frameworks and business practices as they begin to emulate these newly introduce technology.”

He went on to point out that technology transfer would also encourage local entrepreneurs to strive for continuous improvement and business sustainability as they upgrade their research and development (R&D) to meet these new industry standards and practices.

 

A whole set of issues

However, just as there are no guarantees in life, there are no guarantees in the success of a franchise agreement as well. The business model brings about a whole new set of issues that need to be address and considered before you plunge into a franchise agreement.

With every good thing, there are always going bad aspects and it is up to each of us to consider and decide whether the risk outweighs the benefits.

One of the major issues is the lack of room for franchisees to make any independent business decisions as any small detail made would affect one another.

To rectify this, there will always be formal franchise agreements between the two parties to ensure that they act in a manner that is within the guidelines laid out and beneficial to the business on the whole.

Loo explained that the franchise agreement is the pillar of any franchise business, and all parties should respect the terms of such agreements.

Usually, these terms provide fairly equal treatment for both parties. Franchisees are held accountable to follow business practices and systems by the franchisor, and the franchisor is held accountable to ensure the profitability and wellbeing of franchisees’ investments into the company.

“However, like any business, there must be a spirit of goodwill and good faith,” Loo added, noting that if we were to aim for a long and sustainable growth in franchising, mutual trust and respect would be highly important in any good partnership.

There is much validity to Loo’s argument as there is a high level of trust involved in franchising. For a franchisee, they will need to trust their franchisor to continue to innovate their products and services, improve their business systems and continue on with marketing their brand in order for them to be able to sustain their franchises and turn a profit.

For a franchisor, they will need to trust their franchisees to follow their systems and guidelines as to not tarnish the branding they have built.

This leaves both parties with reduced control in their respective businesses as franchisees are left with little room for creativity in their businesses and franchisors are left with increased considerations and risks when making business decisions and or implementing strategies.

Because of this conundrum, Datuk Latip highly encourages anyone looking into franchising to do their due diligence and figure out exactly what they are about to commit to.

“Once you get into an agreement, there’s nothing much really to negotiate if you’re unhappy. Franchisees of larger companies especially will hold less power as there will also be someone else willing to take over if they are unhappy.

“The best thing you can do is to first have some knowledge about franchising before you even entertain the idea of entering into one. After that, it is also good to seek legal from qualified lawyers to help you understand some of the language in franchise contracts so you can foresee what kind of circumstances you are getting yourself into.

“But apart from that, it is going to be a business decision and up to you to figure out if it is worth the risk.”

 

The Chatime Incident

While proper preparation can help with a smooth franchise relationship, it is not guaranteed as many franchise agreement do turn sour and fall through despite due diligence on both parts.

Most notably, the recent Chatime incident stands out as a relevant example as the relationship between Loob and La Kaffa International Co Ltd (La Kaffa) turned for the worse as La Kaffa terminated Loob’s status as master franchisee of Chatime in Malaysia earlier this year.

The termination came as a shock as the contract between Loob and La Kaffa was set to continue for another 24 years into 2041.

The reasons for termination were cited to be the usage of unapproved raw materials due to a decrease of order of raw materials from La Kaffa by Loob despite a healthy growth in outlets. Loob has in turn vehemently denies such allegations.

Following their franchise agreement, Loob was given 45 days to cease all operations of their fully or partially owned 165 Chatime outlets. This left them in an extremely comprising situation as Loob’s pockets would be bled out attempting to sustain their 1,000 strong workforce and the rental fees of its 165 unserviceable outlet spaces.

Despite such dismal conditions, Loob took the opportunity instead to venture into their own brand, transforming their 165 outlets almost overnight to ‘Tealive’ with an ambitious brand mission to: ‘Take tea-brewing to new height. First in Malaysia, then the world.”

However, the drama doesn’t end just there as La Kaffa has issued a directive last month to stop Loob from continuing operations under the new brand due to the similarity of their products.

According to local media outlets, the lawsuit was filed on Feb 17 and the Kuala Lumpur High Court has fixed May 29 to hear La Kaffa’s application for an injunction against Loob.

While Loo has declined to comment on Chatime related issues while the arbitration process is still ongoing in Singapore, he has instead insisted that Tealive is a new brand and separate from Chatime.

“Tealive is indeed a new brand that was born during an important milestone of our corporate history. As a result, Tealive is completely new with a different entity on its own.”

At this point we can only wait to see what is in store for ‘Tealive’, but incident serves its purpose as a cautionary tale to aspiring entrepreneurs to think carefully before they get into a franchise agreement as there are heavy risks involved.

 

Financial factors to consider

Besides the issue of trust and autonomy, there are also financial woes that franchisees should look out for. More notably, high overheads derived from fixed royalties or franchise fees could be an issue as they could greatly reduce your margins in a sluggish period.

Charles Liew, chief executive officer of a local business, SHiNE Pharmacy, finds this to be no surprise.

“When I first wanted to start my business, I actually looked into franchising first because I thought, it would come with the name, the system – everything. I wouldn’t have to do a thing, I’d just set it up and it could basically run by itself.

“Negotiations were underway but once I looked at the margins, the whole plan fell through. The profit margins were terrible.”

He went to explain that the overhead or fixed costs for franchising are undesirable because other than the royalties and fees franchisees are already paying, the cost of business operations and material acquisition will also need to be bore and their costs are usually fixed thanks to the franchise agreements.

To maintain quality control, many franchisors will require their franchisees to source their materials or products from only approved sources or require franchisees to only operate a certain way. This insistence means the cost of business operations and material acquisitions are generally fixed.

“This is one of the key downsides of a franchise. If for example, foreign exchange (forex) becomes unfavourable, they are going to be stuck buying that expensive materials instead of being able to look for a cheaper source to maintain their margins. There may also be fixed prices so they can’t even pass down the cost to consumers,” he said.

This leaves franchisees very vulnerable to fluctuations in the industry landscape as there is little they can do to adapt to the situation.

 

So is it worth it?

It has been clearly established that franchising has its merits and but also drawbacks. But is it a venture worth taking? Latip thinks that it can be a worthwhile venture but implores prospective franchisees to research into whether the business would be feasible or not.

“You need to make sure that the return of investment can be returned within five years or within the medium term. This is to ensure that your venture can sustain itself and you will be able to handle and financial difficulties,” he explained.

“Not every brand may do well in the location you have in mind so you must consider carefully. One way you can do this is by attending our 24th ‘Franchise Exhibition and Conference’ we will hold from May 12 to 14.

“We are expecting around 110 exhibitors from both home grown and international brands to come and exhibit during the event so this is a great chance for anyone thinking of buying a franchise to come and obtain more information.

“Sarawakian and Sabahans are especially encouraged to attend as we have received an overwhelming amount of enquiries from our own MFA members that they would like to venture and expand their brands into the two states,” he urged.

Meanwhile, Liew – who has already found success as an independent business owner and has had prospective business offers for him to act as a franchisor – feels rather indifferent to the notion of franchising his business.

“I do believe that my business does have the capacity to expand via franchising, but having said that, over the years I’ve been a little more conservative on this point.

“The barriers and costs you would have to get through are just insane and represents only some of the cons to franchising. Of course, there are many benefits as well to franchising that make me venture into it.

“Whether or not it’s worth it, depends on what your definition of success is. If you think success is just making money and you don’t mind the hard work and headaches it will come with it, then yea, franchising might be for you.

“But at this point I’m still in the middle as there is still a lot of consideration on my part.”

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