Course 3: Franchising at the Base of the Pyramid

Introduction

Recently, the provision of financial services dealing with very small deposits and loans—microfinance—has been promoted as an effective means of poverty reduction.  Microfinance interventions may increase incomes, contribute to individual and household livelihood security, and change social relations for the better.  However, they cannot always be assumed to be doing so.  Among poverty interventions, microfinance seems to have mixed results and limited systemic impact, “typically smoothing tenuous household cash flows and supporting family-based subsistence businesses operating in the informal economy”.(1)  The challenge remains how to scale small businesses in order to provide greater employment and economic opportunity.

Some researchers and practitioners have begun to promote franchising as an alternative strategy with much greater impact.  Franchising is commonly understood as a “contractual agreement between two legally independent firms in which one firm, the franchisee, pays the other firm, the franchisor, for the right to sell the franchisor’s product and/or the right to use its trademarks and business format in a given location for a specified period of time.”(2)  Franchise businesses are designed for replication and require less experienced entrepreneurs to run a proven business model.   In emerging markets, there seems to be a high number of micro-franchise businesses – those where the franchisee is small (even a single person) -- but relatively few large-scale franchises.

The Dalberg Global Development Advisers conducted extensive research to explore whether franchise business models – large and small – have the potential to stimulate economic growth, create jobs, and develop entrepreneurial skills in frontier economies.  This article seeks to summarize those findings in order to bring greater understanding about what is actually working in the field and what is not.

What Works?

Several franchise models are well adapted to conditions in frontier markets and have demonstrated the ability to thrive amidst challenges.  These models are often home-grown (developed and run locally rather than established abroad) and are based on the simpler traditional format franchising.(3)

First, locally established chains are better positioned than foreign managed chains due to tailored products and pricing, lower overhead costs, and a better understanding of the local business environment.  Secondly, traditional format franchising seems to be better suited to frontier markets than business format franchising.  According to the U.S. Department of Commerce, traditional format franchising is characterized by franchised dealers who “concentrate on one company’s product line and to some extent identify their business with that company”.(4)  Traditional format franchising is better suited to emerging markets, as it leads to fewer franchisor-franchisee conflicts and lower required capital.   

In their research, the Dalberg Global Development Advisers found several replicable business models that have flourished in emerging markets. In particular, they studied a number of profitable traditional micro-franchises –very small-scale, often single person franchisees profitably distributing a standardized branded product or service. “The simplicity of the business model in meeting an underserved market need is the key to their success”.(5)

What Does Not Work?

Despite the appeal of franchising as a potential business opportunity in frontier markets, research shows that franchising is not necessarily the “next big thing” in economic development.  While franchising may seem like an ideal option for businesses considering expansion into emerging markets, it also comes with a distinct set of barriers and challenges.  The challenges include limited disposable income, lack of purchasing power, access to capital, and legal and regulatory issues.  

“Potential franchisees often have difficulty accessing the financing they need to invest in franchises, which severely limits the available pool of talented franchisees.  Franchising also calls for a relatively sophisticated legal and regulatory environment needed to manage conflicts between franchisors and franchisees.  A non-conducive environment can significantly increase the risk and costs of franchising, and could thwart a franchising strategy.” (6)

Many social enterprises have pursued franchising as a means of expansion, especially in the healthcare sector.  Most of these enterprises have attempted to franchise before developing a sustainable business model.  Thus, their growth has been limited by an increasing requirement to obtain funding, inhibiting their ability to achieve large-scale impact.

Conclusion

It is clear that franchising is not the silver-bullet solution to global development.  In this case, as in the micro-finance movement, hype has generated more promise than may realistically be true.  The reality of franchising is that its success is nuanced and complex: where it has substantial positive impact in one location, it may have very little in another.

Footnotes

(1) Franchising in Frontier Markets: What’s Working and What’s Not. A report by Dalberg Global Development Advisors with support from the John Templeton Foundation (JTF) and the International Finance Corporation (IFC). December 2009.

(2) Blair, R. D. and Lafontaine, F. (2005) The Economics of Franchising, Cambridge University Press.

(3) Franchising in Frontier Markets: What’s Working and What’s Not. A report by Dalberg Global Development Advisors with support from the John Templeton Foundation (JTF) and the International Finance Corporation (IFC). December 2009.

(4) U.S. Department of Commerce. 

(5) Franchising in Frontier Markets: What’s Working and What’s Not. A report by Dalberg Global Development Advisors with support from the John Templeton Foundation (JTF) and the International Finance Corporation (IFC). December 2009.

(6) Ibid.