International Business: Licensing, Franchising, and Other Contractual Strategies 12

Contractual Entry Strategies

Learning Objectives

• Explain contractual entry strategies.
• Understand licensing as an entry strategy.
• Describe the advantages and disadvantages of licensing.
• Understand franchising as an entry strategy.
• Explain the advantages and disadvantages of franchising.
• Understand other contractual entry strategies.
• Understand infringement of intellectual property, a global problem.

SPC Paris Baguette

• SPC Paris Baguette operates in France, the U.S., Asia, and other regions.
• Offers 300 different kinds of bakery items, including small portion cakes with fresh creams.
• Maintains a premium image with seating for eating and sophisticated design.
• Achieved $396$ million in global sales in 2024, with a 20% growth rate.
• Received a gold award from Monde Selection.
• Opened its 5th store in Paris (FDI) and its 100th bakery store in the US (Franchise).
• The Mailila store had 1,200 visitors and operates under a master franchise contract with Berjaya Food.
• Has a store in Red Bank, New Jersey.
• Aims to open 1,000 stores in the U.S. by 2030, with plans to sign and open 160 additional franchises this year.
• Many stores are located in mainstream commercial districts such as Manhattan Time Square, Midtown, Upper West Side in NY, and Silicon Valley, L.A, Boston
• Ranked 25th in the top 500 franchise companies selected by the Franchise Times in the U.S.
• Operates a total of 600 global stores in 14 countries, including the UK, Canada, China, and Indonesia.

Paris Baguette Franchise Development

• Discussion and Application: Begin discussions with the franchise development team to assess fit, sharing goals and background, and submit a franchise application.
• Pre-Qualify and Start Due Diligence: Once pre-qualifications are met, the franchise development team will start a detailed discussion, officially starting the due diligence process.
• Franchise Disclosure Document and Background Check: Review the Franchise Disclosure Document (FDD) and schedule a call with the franchise development team; submit a background check verification before executive committee approval.
• Discovery Day and Executive Meeting: Schedule an executive committee video call, and upon approval, receive an invitation to a virtual discovery day to meet the corporate team for a system overview.
• Final Review and Approval: With final executive team approvals, the franchise agreement is presented; once signed, the franchisee is officially part of the Paris Baguette family.
• Site Selection and Site Approval: The real estate and construction team, along with top brokers, helps find the best site for the new bakery café; after signing a lease, an extensive training program begins to prepare the team for the bakery café opening.
• Grand Opening: The operations and marketing teams collaborate to finalize details, including final store training and local store marketing.

Foundation Concepts

• Contractual entry strategies: Cross-border exchanges governed by an explicit contract between the focal firm and its foreign partner.
• Licensing: An arrangement where the owner of intellectual property grants another firm the right to use that property for a specified period in exchange for royalties or other compensation.

Contractual Relationships

• Franchising: An arrangement where a firm allows another the right to use an entire business system in exchange for fees, royalties, or other compensation.
• Royalty: A fee paid periodically to compensate a licensor for the temporary use of its intellectual property, often based on a percentage of gross sales generated from the use of the licensed asset.

Examples of Contractual Relationships

• SPC Paris Baguette expands franchise stores in the US and Canada.
• Pfizer (US) and Novartis (Switzerland) periodically license pharmaceutical inventions to each other.
• 7-Eleven (founded in Dallas) has approximately 70,000 stores in 17 countries, with many stores in Canada, Mexico, Asia, and Europe operating via licensing or franchising agreements.

Unique Aspects of Contractual Relationships

• Governed by a contract that provides the firm a moderate level of control over the foreign partner. Control reflects the ability of the firm to influence the decisions, operations, and strategic resources of a foreign venture.
• Typically involves the exchange of intangibles (intellectual property) and services, such as technical assistance, know-how, and trademarks.
• Can be pursued independently or with other foreign market entry strategies, such as FDI and exporting.

Advantages of Contractual Relationships

• Provide a dynamic, flexible choice, where firms may use contractual agreements to make their initial entry into foreign markets and then switch to another entry strategy, such as FDI, as conditions evolve.
• Can reduce perceptions of the firm as a foreign enterprise. A contractual relationship with a local firm facilitates blending into the local market.
• Generate a consistent earnings from foreign operations, compared with FDI, as contractual arrangements are less susceptible to volatility and risk.

Typical Types of Intellectual Property

• Patent: Provides the right to prevent others from using an invention for a fixed period; granted to anyone who invents a new process, product, or useful improvement.
• Trademark: A distinctive design or symbol that identifies a product or service (e.g., Nike’s swoosh symbol).
• Copyright: Protects original works of authorship, typically covering works of music, art, literature, movies, or software.

Intellectual Property Rights

• The legal claim through which the proprietary assets of firms and individuals are protected from unauthorized use by other parties.
• Provide inventors with a monopoly advantage for a specified period of time, so they can exploit their inventions and create commercial advantage.
• Without legal protection and the assurance of commercial rewards, most firms and individuals would have little incentive to invent.

Licensing

• A licensing agreement specifies the nature of the relationship between the licensor (owner of intellectual property) and the licensee (the user).
• Examples:
  • Intel licensed the right to a new process for manufacturing computer chips to a firm in Germany.
  • Warner licenses images from the Harry Potter books and movies to companies worldwide.
  • Disney licenses the right to use its cartoon characters in producing shirts and hats to clothing manufacturers in Asia.
• In a typical deal, the licensee pays the licensor a fixed amount upfront and an ongoing royalty (usually 2-5%) on gross sales generated from using the licensed asset.
• The fixed amount covers the licensor’s initial costs of transferring the licensed asset to the licensee, including training, engineering, or adaptation.
• Certain types of licensable assets, such as copyrights and trademarks, have much lower transfer costs.

Licensing as a Foreign Market Entry Strategy

• The licensor provides intellectual property (patent, trademark, design, copyright, or know-how) and supporting products (parts, components, raw materials, etc.).
• The licensee compensates the licensor through a combination of a lump-sum payment, down-payment plus royalty, products, know-how, or cross-licensing.

International Licensing

• Coca-Cola has a licensing agreement to distribute Evian bottled water in the U.S. on behalf of the brand’s owner, the French company Danone.
• Budweiser is brewed in Japan by Kirin under license from Anheuser Busch.
• A review of 120 of the largest multinational food companies revealed that at least half are involved in some form of international product licensing.

Trademark Licensing

• Involves a firm granting another firm permission to use its proprietary names, characters, or logos for a specified period in exchange for a royalty.
• Trademarks appear on clothing, food, toys, home furnishings, and numerous other goods and services (e.g., Harley-Davidson, Disney, Michael Jordan, and your favorite university).
• A trademark like Harry Potter generates millions of dollars for the owner with little effort. U.S. firms derive trademark-licensing revenues exceeding $100$ billion annually.

Copyright Licensing

• A copyright gives the owner the exclusive right to reproduce art, music, literature, software, and other such works, as well as prepare derivative works, distribute copies, or perform or display the work publicly.
• The term of protection varies by country, but the creator’s life plus 50 years is typical.
• Many countries offer little or no copyright protection.
• It is wise to investigate local copyright laws before publishing a work abroad.

Know-How Licensing

• Involves a contract in which the focal firm provides technological or management knowledge about how to design, manufacture, or deliver a product or a service (e.g., AT&T, pharmaceutical industries).
• Japan’s Sony licensed transistor technology from U.S. inventor Bell Laboratories to make hearing aids; Sony used it to create small, battery-powered transistor radios and became a global leader in this product.
• The licensor makes its patents, trade secrets, or other know-how available to a licensee in exchange for a royalty.
• The royalty may be a lump sum, a “running royalty” based on the volume of products produced from the know-how, or a combination of both.

Leading Licensors by Licensing Revenues

Main Advantages and Disadvantages of Licensing

• Advantages for licensor
  • Low investment
  • Low involvement
  • Low effort, once established
  • Low-cost initial entry strategy
• Disadvantages for licensor
  • Performance depends on the foreign licensee
  • Licensor has limited control over its asset(s) abroad
  • Runs the risk of creating a future competitor

Franchising

• The most typical arrangement is business format franchising, in which the franchisor transfers to the franchisee a total business method, including production and marketing methods, sales systems, procedures, training, and the use of its name.
• More comprehensive and longer-term than licensing.
• Master franchiser: An independent company authorized to establish, develop, and manage the entire franchising network in its market (e.g., McDonald's in Japan).

Franchising as an Entry Strategy

• The franchisor provides a trademark-protected business concept plus everything needed for its implementation (patents, know-how, training, services, products).
• The franchisee compensates the franchisor through a combination of a lump-sum payment, down-payment plus royalty, and other mark-ups and contributions (e.g., finance charges, sale of related products).

Examples of Leading International Franchises

Advantages and Disadvantages of Franchising

• Advantages for franchiser
  • Low investment
  • Can internationalize quickly to many markets
  • Low effort, once established
  • Can leverage franchisees’ local knowledge
• Disadvantages for franchiser
  • Maintaining control over franchisees may be difficult
  • Franchiser has limited control over its assets abroad
  • Risks creating a future competitor

Franchise in Emerging Markets

• As markets in Europe and other advanced economies become saturated, franchisors are expanding to emerging markets.
• Subway is doing big business in Eastern Europe.
• Avis car rental enjoys much success in Latin America.
• About 70% of the countries where KFC does business are developing economies.
• Employment: International franchised firms provide more than 2.4 million jobs in developing economies.
• Infrastructure: Franchises help provide needed modernization in business methods, distribution networks, and commercial infrastructure.
• Talent: They help build local capabilities and skills by both bringing in expatriate staff and training local personnel.
• Franchising is less risky, thus often preferred over FDI for entering developing economies.

Subway and the Challenges of Franchising in China

• Subway, a U.S. fast-food marketer, has faced significant challenges in China, including the ambiguous legal environment, a lack of intellectual property protection, and high startup costs.
• Subway has over 44,000 stores in 110 countries and generates over $17$ billion in annual revenues, with over 25 million Facebook fans.

Why China for Franchising?

• Franchising in China is very attractive because:
  • Huge market
  • Long-term growth potential
  • Dramatic rise in disposable income
  • Rapidly expanding urban population
  • The fast-food market is estimated at $150$ billion per year
  • China’s urban population is growing
  • Increasingly hectic lifestyles have resulted in more meals consumed outside the home
  • Chinese consumers are interested in sampling non-Chinese foods

Benefits of Franchising in China

• A win-win proposition: Combines the Western know-how of franchisors with the local market knowledge of franchisees; restaurants were one of the first industries the government opened to private ownership in the early 1980s.
• Minimal entry costs: Much of the cost of launching a restaurant is borne by local entrepreneurs.
• Rapid expansion: Franchising is superior to other entry strategies for rapidly establishing many outlets.
• Brand consistency: Franchisors are required to strictly adhere to company operating procedures and policies.
• Circumvention of legal constraints: Franchising allows the focal firm to avoid trade barriers associated with exporting and FDI, common in China.

Challenges of Franchising in China

• Knowledge Gap: Few Chinese have significant knowledge about how to start and operate a business.
• Ambiguous Legal Environment: The Chinese government introduced regulations permitting franchising in 1997; however, the legal system is evolving and is full of loopholes and ambiguities. Large franchisors such as KFC and Pizza Hut are struggling to root out counterfeiters.
• Escalating Start-Up Costs: Various challenges, combined with linguistic and cultural barriers, can increase the up-front investment and resource demands of new entrants in China and delay profitability.
• Finding the Right Partner: Paradoxically, entrepreneurs with the capital to start a restaurant often lack the business experience or entrepreneurial drive, while entrepreneurs with sufficient drive and expertise often lack the start-up capital.

Subway Stores in China

• By 2006, Subway had opened about 40 stores in China.
• Subway’s master franchisor in Beijing, Jim Bryant, had to teach the franchising concept to a country that had never heard of it; there was no word in Chinese for “franchise.”
• Subway—or Sai Bei Wei (Mandarin for “tastes better than others”)—is forging ahead, despite cultural issues such as few customers liking sandwiches and most feeling uncomfortable touching their food.
• Bryant recruits local entrepreneurs, trains them to become franchisees, and acts as a liaison between them and Subway headquarters. For this work, he received half of their $10,000$ initial fee and 1/3 of their 8% royalty fees.
• Today, there are over 600 Subway stores in China.

Other Contractual Arrangements

• Turnkey contracting: Arrangement where a firm plans, finances, organizes, manages, and implements all phases of a project abroad, and hands it over to a foreign country after training local personnel; typical in the construction and engineering services industries.
• Under a management contract, a contractor supplies managerial know-how to operate a hotel, resort, airport, hospital, or other facility in exchange for compensation.
• With international leasing, the lessor rents out machinery or equipment to clients abroad, often for several years at a time (e.g., Airlines lease aircraft).

Build-Operate-Transfer Arrangements (BOT)

• Build-operate-transfer arrangement (BOT) is similar to turnkey arrangements; however, the contracting firm operates the facility for a specific time and then transfers ownership to the local project sponsor, typically the host-country government or public utility.
• While the consortium operates the facility, it can charge user fees, tolls, and rentals to recover its investment and generate profits.
• Governments often grant BOT concessions to get needed infrastructure built cost-effectively.
• Examples include sewage treatment plants, highways, airports, bridges, tunnels, mass transit systems, and telecommunications networks.
• Vietnam commissioned the construction of the 720-megawatt Phu My 3 Power Plant, the country’s first privately owned major energy facility, as a BOT project by Siemens Power Generation (Germany).

Management of Licensing and Franchising

• Licensing and franchising are complex undertakings, requiring skillful research, planning, and execution.
• The firm must research in advance the host country's laws on intellectual property rights, repatriation of royalties, and contracting with local partners.
• Key challenges include establishing whose national law takes precedence for the contract; deciding whether to grant an exclusive or nonexclusive arrangement; and determining the geographic scope of territory to be granted to the foreign partner.

Infringement of Intellectual Property

• The unauthorized use, publication, or reproduction of products or services protected by a patent, copyright, trademark, or other intellectual property right.
• Especially a problem in emerging markets and developing economies, where people are especially vulnerable.
  • Laws that govern contractual obligations are not always clear.
  • Legal systems in some countries do not always protect contracts in the same way they are protected in countries with advanced legal systems.
• Negatively affects consumer attitudes about the branding and quality of legitimate goods.
• The quality of counterfeit goods is almost always inferior to that of original, proprietary goods.
• Hinders company inventiveness and innovation.

Counterfeiting

• The total value of counterfeit and pirated goods traded internationally exceeds U.S. one trillion dollars, which is roughly 5 percent of U.S. GDP.
• Typical knockoffs include clothing, fashion accessories, watches, medicines, and appliances.
• While companies such as Rolex, Louis Vuitton, and Tommy Hilfiger are well-known victims, counterfeiting is widespread even in industrial products.
• Other examples include pharmaceutical products, medical devices, and car parts.

Guidelines for Safeguarding Intellectual Property

• Intellectual property laws are weak in many countries.
• Key international treaties include:
  • Paris Convention for the Protection of IP.
  • Berne Convention for the Protection of Literary and Artistic Works.
  • Rome Convention for the Protection of Performers and Broadcasting Organizations.
  • WIPO (The World Intellectual Property Organization) is an agency of the United Nations that administers these multinational agreements.
• The WTO created the Agreement on Trade-Related Aspects of Intellectual Property Rights (TRIPS).

International Protection

• TRIPS (effective Jan. 1, 2000):
  • Requires every member of WTO to abide by Paris and Berne conventions.
  • Requires its signatories to enact minimum substantive standards of protection and create a viable enforcement mechanism.
  • If another country is out of compliance, it can initiate dispute proceeding through WTO dispute settlement mechanism.
• It is one thing to enact laws, but another to enforce them; non-enforcement of TRIPS was a problem.

Safeguarding Intellectual Property

• Research IP laws and protections in target countries.
• Separate value-chain activities to maintain IP secrecy (e.g., keep R&D and manufacturing separate so no one can learn the entire production process).
• Hire employees who maintain high ethical standards.
• Collaborate with ethical partners; choose reputable suppliers with no history of IP violations.
• Regularly educate employees and partners about the harm of violating IP rights.

Ethical Connections

• Counterfeiting is not confined to lower-income countries.
• Raids of retail outlets in the United States net millions of dollars’ worth of counterfeit products every year.
• For example, city and federal authorities in New York arrested numerous people on charges of possessing millions of dollars in counterfeit fashions, including Gucci watches, Louis Vuitton handbags, North Face jackets, and much more.
• Many companies build biotech tags, electronic signatures, or holograms into their products to differentiate them from fakes.