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DC Strategy's tips for international expansion
by DC Strategy
China, the United States, 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 should you choose?
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, as did the Warehouse Group, while McDonald’s struggled in France. Yet, there is no single issue common to all successes or failures.
Having lived in five countries for extended durations, I am a strong advocate of successful international expansion – the ability to access, respect, understand and adapt to local knowledge for the benefit of the strategy.
The decision to ‘go international’ should serve as a catalyst to examining the position of your business in the domestic market. Given the significant resource commitment required, experience dictates that the non-negotiable requirements for international expansion typically include:
1. Strong cash flows and profitability;
2. The ability to remove a key senior management person from head office; and
3. Domestic market strength. Sadly, these aspects are usually underestimated and given a back seat when the emotions of going international become entrenched.
Cash flow and profitability
Cash flow and profitability are more than simply 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 flow of the business needs to be strong enough to face the reality of a failure in an international market and the possibility that the domestic market may slow.
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 on cash flow and profitability is the choice of business model, which 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 US$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 is longstanding. Consequently, it should be well thought through.
In simple terms, a lack of cash flow will force shortcuts or compromises, for the parent company and international business partners, which typically do not manifest themselves for years to come.
Senior management focus
The ability to have a key senior management executive focus exclusively on your business’s 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 people approach their international expansion strategy with similar or less resources than that used for their domestic interstate expansion.
It is worth noting that this exclusive focus often does not occur until the first international deal is either close to or already over the line. The reality is there are often many years of information gathering and/or market visits that need to occur before results are registered as signed deals.
It is, however, foresight within the business to understand and evolve the business structure in anticipation of international expansion that remains invaluable. This often triggers the appointment of a new CEO or general manager for the Australian business, which often requires the founder to step aside and shift the focus to a professional management team and board.
This, in itself, can prove too difficult for many founders. If you are a founder reading this article, it’s important to ask the question: how can you create the most value for your business in the future?
Domestic market strength
The rationale behind domestic market strength can best be summarised as a case of low hanging fruit being more readily available than fruit higher up the tree. This analogy encapsulates the resource commitment, prioritisation, return on investment and the pressure created for stretching the resources of a group too thin.
Boardroom debate tends to centre on what constitutes domestic market strength. Is it the eastern seaboard states, 65 per cent of shopping centres, 70 per cent of territories? These are all good propositions, but in my opinion, they are not always the key focus.
For instance, there may be two identical retailers with 80 stores – 75 per cent of the way towards the predetermined market size. One opens a New Zealand operation successfully and the other struggles in New Zealand. Why? The measure of readiness for international expansion is not solely the output or size of the operation, but rather the infrastructure development and state of operational capability, within the group, for this expansion.
Every company has a different approach to corporate governance, senior management and strategic planning, and it is these key capabilities that determine the ability to achieve and maintain domestic market strength, whilst being in a position to make any international operation(s) a success. Focusing on international expansion too early or in an opportunistic manner is one of the features of businesses that have failed to capitalise on their international market expansion.
You often hear of companies – particularly in franchising – that do deals 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. More often than not, expansion into overseas markets is commenced as a result of an opportunistic reaction to an enquiry, rather than as part of a well thought out international expansion strategy.
The other primary outcome that typically arises from domestic market strength is that the business is capable of creating the necessary cash flow and profitability to support and maintain its 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 a company’s response to opportunistic international enquires from individuals interested in buying the business rights to their country of residence.
The growth of the internet, in particular, has increased the volume and ease of international enquiries. However, the reactive approach has consistently violated the non-negotiable requirements previously identified, and represents the highest incidence of failure when it comes to international expansion.
This is not to say that there aren’t examples of successful reactive approaches. However, the needless increase in execution risk is, in my opinion, unacceptable. Often, when you dig below the surface, it becomes apparent that a reactive approach has come at the expense of the performance of the domestic business.
So will this approach continue into the future? The answer is a definitive ‘yes’, given that the amount of overseas enquiries are sure to increase and the emotional attachment to international growth remains very strong.
Still, in my opinion, there are too many franchises adopting this strategy in Australia. In the short-term, this provides some real challenges for businesses that are under-resourced, underdeveloped and undercapitalised. The proactive model of international expansion is something franchises such as Boost Juice, PoolWerx, Bakers Delight, Fastway, Domino’s Pizza, and Gloria Jean’s Coffees (to name a few) have adopted.
The proactive model still has execution risk, difficult decisions, and reactive moments, but these are all based on a more solid foundation. The non-negotiable requirements identified previously 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
Choice of business model is the most significant decision in growing an international operation. The more commonly recognised models include, but are not limited to, master franchises, area development franchises, joint ventures, direct entry, acquisitions, and license arrangements.
The decision with respect to which model to adopt is critical, because the legacy of the decision will last for years. It is the foundation upon which all future efforts in the chosen country are based.
In each structure, key decisions remain with regard to the sharing of responsibilities and the level of involvement of the parent company and the prospective franchisee. The absence of the non-negotiable requirements identified previously – particularly that of cash flow and profitability – has a significant impact, for many people, in making the distinction between the aforementioned business models.
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 and 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 having expansive international operations, only to find many years have passed 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 many of the key business model issues to be resolved. Consideration must be given to the overall strategy, the expanse of the strategy, and the 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 an international business as a start-up in a foreign environment. For example, a master franchise model requires a specific type of international partner with a reasonable net worth, in order to be able 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 – for instance, with China, where a master franchise model is more limited. Bear in mind also that the business model can, and often does, evolve over time.
Bakers Delight’s entry into North America has been via a company-owned operation in Canada. The Australian operation has a significant franchisee base that, over time, will no doubt evolve further in North America. The use of the direct entry model, in this instance, is providing Bakers Delight with the opportunity to understand, respect, and adapt to the Canadian market.
Everyone is an expert
Mention ‘international expansion’ and expertise can appear from everywhere. It’s a fact that international expansion has so many unknowns that the perception of anyone who appears to be ‘in the know’ is appealing. It is also a fact that there are many cowboys in the international arena – providing advice, making offers for business rights, or preparing legal documentation – that are simply out of their depth. International business is an expert area.
As a consequence, sourcing the appropriate input from the correct people can create tremendous value. Travel also broadens the mind. There’s no substitute for visiting the intended countries of expansion. If you think the time is not available, it’s worth asking yourself what type of commitment you are making to your potential business partners in that country.
The key challenge for many Australian-based franchisors (that have grown a reasonable scale of business in Australia) is seeing the need for any form of external input. Given the number of variables and the scale of the opportunity, in my opinion, this is essential. There are few international corporate groups that expand into foreign destinations without seeking some form of external input – whether it’s with regard to branding or consulting, legal, demographic, tax, trade, or technological advice.
Any franchisor has a practical limit to their internal knowledge, and there are key areas of an Australian operation that are subject to change in the face of an impending international business expansion.
The process for developing an international strategy is as varied as the number of overseas markets available. The timeframe that many management teams and owners shape their ideas around is years rather than months. However, when the three non-negotiable requirements begin to emerge, the process becomes intense over a period of 12 to 18 months.
The initial focus is the domestic business and developing an understanding of the franchise’s readiness for international growth, in addition to any structural changes that need to take place. These changes can be as much about the franchise’s international growth strategy as they can be about improving the core domestic operation.
Interestingly, this is often the first time that many groups take a step back from what could well have been five to ten years of sustained growth to look at the core structure of the business and understand its 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 three to five years. This has an impact on core areas such as trademarks, domain names, and tax structures (to name a few).
The franchise’s economic analysis needs to identify the structural integrity of the business. This is defined as 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 others that are often not well understood – perhaps because they’re not in operation domestically. How a master franchise structure impacts the group is an interesting question many Australian-based franchises do not face until the international market is considered.
The commercial policies that form the basis of how the business will operate overseas must also be developed against the backdrop of the domestic business. This is a challenging area for many Australian-based franchisors, as the simple view is to evolve the domestic franchise agreement and operations manual with respect to the international legal framework and to then consider the job done.
The critical assumption is that the domestic policies will retain relevance in and be translated to suit the international market. Should an exclusive geographic territory-based policy be adopted in Dubai or should there be a territory at all? Market research, travel and the development of an 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 rest with placing the group in a fully informed position to make a decision.
There is a practical limit to research that means, 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 that 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 business’s broader plans. There are some specific legal areas where advice can have a substantial impact on key areas such as supply, trademarks, choice of structure or the country the legal document is settled in.
The core team, focused on international expansion, will continue to develop and evolve the international considerations 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 detrimental outcomes. The most immediate of issues that a franchisor faces is the split responsibility between domestic and international growth. This cannot be avoided. Hence why it is critical to understand how the organisation will evolve to a plan when the need arises.
There are a number of other key activities related to developing an international business, which are broader than the scope of this article alone. However, the issue I find that most franchise systems 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 outset of this article, selling a master franchise is easy, building an enduring and successful international business is difficult.
The future of outbound Australian business expansion is particularly exciting. There are a number of local businesses that are now reaching market maturity or have sustained performance at market maturity for a number of years.
Add to this the fact that 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 that boast high fixed costs and labour costs off the back of 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’s 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 across a population of 60 million in a place the size of Victoria. That’s French retail.
There are a number of franchisors in Australia that would be well advised to reinforce the capital base of their business as part of an 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 are plenty of opportunities for business founders to continue to be involved with less equity, but with a broader capital base to approach international markets.
The challenge of involving an equity partner is really a question of ‘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.
On the domestic front, there will continue to be consolidation as part of broader national and international growth plans. As part of their plans to go international, franchise systems will take stock of the domestic market. There are many industries where rationalisation can, and should, occur in the coming years. If you’re planning for international expansion, ensure the structure and overall strategy of your business is well developed and considered. 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 approaching international expansion in a reactive manner – lacking the people and capital resources to do justice to the opportunity.
There will be pockets of success, but the real international success stories will come from those businesses with a well-developed international plan and a sustainable approach. As groups such as Fastway, Boost Juice, PoolWerx, Bakers Delight, New Zealand Natural, and Gloria Jean’s Coffees continue to grow and demonstrate the international opportunity, there will be many more groups that progress down a similar path in years to come, building respected global brands.
This article was written by Adrian McFedries, Managing Director of DC Strategy (formerly Deacons Consulting). DC Strategy is widely recognised as the one of the region’s leading franchising and international consulting groups. 23.07.2007
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