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Franchising in India
chillibreeze writer — Anamika Sinha
The rapidly growing franchise industry in India, although at a very nascent stage, is said to be the second largest in the world. With the current growth pegged at nearly 30-40%, the industry is poised for an even more rapid growth in the forthcoming years. With an annual turnover of nearly US$3.3 billion, it consists of nearly 800 franchisors (only 10% being foreign owned) and about 40,000 franchisees.
Franchising as a concept has been steadily gaining popularity because of the huge untapped potential in the Indian context, emergence of tier I and II cities as the next big retail destination, the relatively lower level of capital required to start the business, lower risk and availability of established brand names, marketing network and sales channels. India is the most sought after nation by international retailers due to low presence of international brands as compared to the country’s market size.
Recent developments such as relaxation of foreign investment rules, liberalized WTO guidelines and greater incentives from the government have clearly led to a spurt in the number of franchised outlets in India. Single-brand retailers are now allowed to own up to 51% of their operations in India.
Another major factor favoring the franchising market is that the Foreign Direct Investment (FDI) policy for organized retail does not permit the direct entry of foreign retailers. The latter, therefore, have to resort to franchised business models to enter the Indian market.
Bata, the footwear company, was among the first franchisors in India, followed by other multinationals such as Coca-Cola. Pioneers among the Indian companies are NIIT, Apollo Hospitals and Titan Watches.
THE FRANCHISING CONCEPT
A franchise is a business arrangement wherein the owner (the franchisor) of a business permits the other (the franchisee) the licensed right to own and operate businesses based on the former’s business concept, using its trademark.
The International Franchise Association (IFA) defines franchising as a “continuing relationship in which the franchisor provides licensed privilege to do business, plus assistance in organizing, training, merchandising and management in return for a consideration from the franchisee”.
Franchising has several advantages. A clear advantage to the franchisee is wider market penetration, greater brand presence in the domestic as well as international markets with relatively low capital investment. The franchisor, on the other hand, leverages the franchisees knowledge of the domestic market such as regional preferences. At the same time, the consumer gains from the availability of a wider range of products and services that are on a par with its international counterpart. Franchising also helps to tap the country’s entrepreneurial skill that is available in plenty.
As per government norms, foreign franchisors can charge royalties up to 1% for domestic sales and 2% on export sales for use of their brand name or trade mark, without transfer of technology. RBI approval is required in case the royalties exceed the prescribed limits. If the proposed franchise arrangement involves technology collaboration, the Government permits a lump sum payment to the extent of US$2 million to the foreign franchisor. Besides, royalties up to a maximum of 5% on domestic sales and 8% on export sales are permitted without approval. The Government has specified a formula for calculating royalties that must be followed for transferring funds to the foreign franchisor.
The franchise market in India, although just over a decade old, has enormous potential, thanks to the changing Indian business environment. The sheer size and diversity of the population, growing economy and the consequent rise in disposable income and change in lifestyles and the advent of modern retailing provide excellent franchise opportunities in the country. Sectors such as retail, telecom, education and healthcare, are the fastest growing. Other sectors such as automotive, IT, beauty and tourism are fast catching up. Besides, the fact that about 15% of sales in India are through franchised outlets, as against 60% in the US, is indicative of the massive industry potential.
With over 300 malls and 1500 supermarkets, the retail sector in India, is poised for the largest leap. Factors such as growing urbanization, rising disposable income and changing lifestyle pattern among the urban population have contributed to the estimated 8% annual growth of this sector.
Retail sales in India through franchisees constitutes about 2% of total retail sales, as against nearly 50% in the US, indicating huge potential for the market. Retailers are now tapping tier I and II cities as the new hub for malls and other retail outlets.
With the consistently growing subscriber base, franchising has emerged as a sure winner in the Indian telecom market. In order to match up to the growing demand, the major players are opting for franchisees to reach out to the consumers. The companies have tied up with entrepreneurs for single-branded as well as for multi-branded outlets.
Airtel, Vodafone, Relaince and Tata Indicom have set up retail service centers across the country. Handset manufacturers such as Nokia, Motorola, Samsung and LG have also started exclusive outlets based on the franchise model.
Manufacturers and service providers are resorting to franchised business models to aggressively market their products and services in the highly competitive telecom business.
With teledensity in India clearly below the world average, the sector offers a huge business potential to franchisees.
The education sector is not likely to be severely impacted by the current slowdown. Franchisees have gained from the sudden spurt in the number of play schools, spoken English centers, computers and overseas education consulting. Coupled with this is the fact that parents in India are willing to pay a premium for quality education. As a result, major players such as Educomp, Kangaroo Kids and Kidzee, plan to expand their franchise network.
These factors have attracted international players such as ABC Montessori and KipMcGrath Worldwide Education Centers to India. Both the companies have a target of setting up 400-franchise based schools each in the next five years. In turn, the Indian market has gained from the introduction of new and innovative concepts in this sector.
A sudden spurt in foreign exchange revenue from the travel industry has forced domestic as well as international players to opt for franchising. Major players such as Thomas Cook, Kuoni Holidays, Cox & Kings and Mercury Travels, are on the lookout for franchisees for expand their market presence. These companies are also looking at smaller cities apart from metros, to set up their centers.
Kuoni has set a target of 15-20 franchisees by the end of 2008. Cox & Kings plans to set up 700 franchise outlets by 2010, while Ezeego1.com plans to have 300 franchise outlets by 2010, for visa and foreign exchange services.
Key issues impacting the market are the absence of a specific legislation regulating the franchise agreement. Prominent among these are cases when the quality of service provided by the franchisee falls below the prescribed standard or when the franchisor defaults in providing the promised support.
Besides, several laws such as Intellectual property, taxation, labor, property and exchange control regulations govern the franchise agreement, which confuses the foreign franchisor.
Another major concern is that a large number of financial institutions do not consider soft expenses as part of project cost.
The vast geographical expanse of the country, while on one hand, offers certain advantages, could also pose a challenge to the franchisee. In such cases, the business can opt for a single master franchisee for the entire country or a master franchisee for each of the four regions, depending on the type of business.
Notwithstanding the current economic slowdown and certain regulatory issues, the industry continues to remain bullish about the future. While the slowdown is more likely to impact the retail market, spending in non-discretionary sectors such as healthcare will largely remain unaffected. The franchising market, therefore, has enough reasons to remain upbeat about its future in India.
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