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THE FUTURE OF FRANCHISING

by Dr Callum Floyd
 

The saying "the only constant is change" is gaining more serious meaning. Technology improvements, notably in telecommunications, computers and the Internet, are having a major influence on franchised businesses. Certain franchises are able to operate in ways that would previously have been impossible. Efficiencies have also been gained and means of communication have improved. In addition, new markets have been created and, some new franchised opportunities have even resulted.

Yet technology is only one of a range of factors influencing franchising currently. In this article we also consider the effect of an aging population and increasing orientation toward health and wellbeing. Additionally, we consider the likelihood of increased competition, and new business relationships involving franchises. The article concludes by considering some key challenges facing franchisors in this, the 'Millenium of the Mouse.'

Technology & The Internet
Technological developments generally, and most recently the Internet, are having a profound effect on franchising. The Internet is still relatively new, yet it is rapidly altering the business environment, changing the way we gather information, interact and conduct business. In doing so, it is providing franchised businesses with a myriad of new opportunities and threats.

An increasing number of franchised businesses are racing to get on-line, and to consider an appropriate Internet strategy (often in that particular order). They are looking to explore and exploit the opportunities this new technology provides (such as, increased sales), whilst simultaneously attempting to protect themselves from a new class of threats (e.g., new, often global competitors) accompanying it.

The opportunities and the threats this new technology enables are varied, and provide the impetus for a new of range initiatives involving franchised businesses. As we proceed, examples of these are subsequently illustrated, along with some of their more interesting characteristics.

Basic Web Sites
Many franchisors have taken some step toward building their brand on-line by establishing a web site. Most provide information to the market for end users of products/services, as well as the market for franchisees and investors. In addition, some franchisees are establishing their own sites (more on this later).

Business-to-Customer E-Commerce
An increasing number are also taking an additional step and actually selling products/services to customers on-line. With rapid growth in individuals and organizations accessing the Internet, the opportunity to both attract new customers, and deal with existing customers in new ways, is increased. Further, many customers expect to buy on-line. Consequently, a number of franchised businesses are moving to establish their own sites that sell, in order to build and protect market share.

In one business-to-customer example, Domino's, UK's largest pizza delivery chain with nearly 200 stores, has established online ordering via an Internet site and, an interactive TV service (not available yet in New Zealand). After only six months these initiatives accounted for 2 percent of UK sales. Those ordering online spent 25-35% more and over half were new customers. The group expects e-commerce ordering to account for more than one third of sales in ten years time. Colin Halpern, Domino's (UK) chairman, said in a recent article:

"The instant success we witnessed at the end of 1999 promises to be just the start of our e-commerce activities. By embracing e-commerce at such an early stage we have already earned a reputation as the primary food delivery brand in the UK both on the internet and interactive TV."

Closer to home, Dymocks (book retailing) and Harvey Norman (furniture and computers) have also developed sites that sell to customers. Interestingly, their experiences so far have been mixed.

Many other big brands are also developing business-to-customer sites that sell. One, which is taking a different path in the development process, is The Body Shop. They have formed a joint venture with Softbank, an Internet investment group, to do it for them. Softbank is well regarded as an e-commerce specialist, having 150 other such ventures. The companies have jointly created another, called Body Shop Digital, with exclusive rights to develop the Body Shop brand online. In the deal, The Body Shop will own 59%. In return for a 24% stake, Softbank provides US$15 million to cover the first stage of the project (the balance of equity is held for employee stock option plans).

An interesting characteristic of The Body Shop's e-commerce plans, and an increasing number of new Internet ventures involving franchise businesses, is the utilisation of collaborative arrangements. In this case, The Body Shop recognises the specialist and fast-changing nature of e-commerce. Partnering with Softbank, then obviates the need to develop the skills and knowledge required internally (which, of course, are constantly changing), to effectively compete online.

Some franchises are also collaborating with competitors in an effort to build critical size on-line. In a UK example, Countrywide Assurance (more than 700 offices) joined forces with Halifax (former building supplier turned bank), Royal & Sun Alliance (insurance) and Connell Estate Agents, in an effort to create that country's dominant property and real estate agency web site. By the end of 2000 they hope to have 50% of the properties advertised for sale in the UK, online.

Some franchises are also collaborating with complementary product/service providers to explore co-marketing and other strategic opportunities. In February this year, Starbucks (US) entered into an alliance with US urban Internet delivery company, Kozmo.com. The collaboration is said to leverage Starbucks bricks-and-mortar assets and retail strength with Kozmo's web-based delivery of food, entertainment and convenience items. Kozmo is paying Starbucks US$150 million for in-store exposure and co-marketing opportunities. The specifics involve Kozmo locating "drop boxes" for the return of video and other items in Starbucks stores in areas where Kozmo operates. Kozmo will also deliver a selection of Starbucks coffee products.

Closer to home, a more permanent relationship between complementary firms has developed between the New Zealand arm of Video Ezy (video hire chain) and Ihug, a local Internet service provider (ISP). In the deal Ihug has purchased a controlling stake in Video Ezy. Plans are to exploit co-marketing opportunities. Interestingly, this mirrors a similar move involving global giants AOL (America Online, an Internet portal) and Blockbuster (Video) in the US.

Clearly, these relationships and alliances pave the way for future deals involving other types of franchises, and are indicative of a global trend toward convergence. In a further illustration of this, Ihug have also confirmed interest in an alliance involving pizza delivery.

In yet other types of deals, some franchises are making strategic investments in complementary Internet developments. Accordingly, McDonald's was one of a group of investors investing US$80million in Food.com, an online food takeout and delivery service company. McDonald's is reportedly using the exercise to explore e-commerce opportunities for its non-hamburger subsidiaries, such as Donatos Pizza. Blockbuster, the world's largest video-store chain and franchise, with 7,100 stores, also invested in the venture. It intends to offer home delivery of movies and video games through Food.com.

Business-to-Business E-Commerce
While considerable publicity is given to business-to-customer developments, many argue business-to-business e-commerce has potential for the greatest impact.

In one startling example, rival US hotel chains, Marriott and Hyatt have announced they are forming a joint venture to develop an online business-to-business marketplace that connects buyers with suppliers in the hospitality industry. The aim is to provide users, such as hotel owners and operators with a more efficient way of buying and selling supplies. Both chains claim they currently procure more than US$5 billion in supplies annually. Key benefits expected include reduced prices and real-time access to a broad base of suppliers.

Similar developments are underway in a variety of other industries populated with franchises. Real Estate is one area where growth in e-commerce ventures is staggering. A recent US study reported 176 real estate-related Internet companies were in operation, up from 121 the month before.

New Disputes
The development of the Internet is also responsible for a new range of challenges to the franchise relationship. While the Internet provides a wonderful opportunity to build sales globally, there are a number of issues between franchisors and franchisees that need resolving.

One key question is who can develop what? It appears most franchisors want to control Internet developments centrally, and do not want franchisees starting their own web sites. There are exceptions, however, with others believing multiple sites help build brand awareness.

Another question involves who pays? And critical to this is yet another - how are profits distributed? These are particularly pertinent issues given the company's web site may compete for customers in the franchisees territory. Some franchisors want to keep profits for themselves, claiming that while the web site may take some sales, the increased awareness it provides to local franchisees far outweighs this. Franchisees argue however, that such web sites cannibalize sales and diminish the value of the franchise.

An acceptable model that enables franchised businesses to realize the potential of new Internet opportunities, yet recognize the subtleties embodied in the franchise relationship, is still to be established. Consequently, until such time acceptable practices are developed, more wide spread problems are bound to arise.

A recent case involving Dymocks in Australia nicely illustrates these contentious issues. Breifly, Dymocks's parent company (or franchisor) wanted full rights to the company's website (Dymocks.com and Dymocks.com.au). The great majority of Dymocks 90 something franchisees, in fact, signing away rights to the web site, in exchange for a minor equity stake in the site. However, three did not, and pursued the mater in court claiming rights to the online business since their advertising levies contributed to its development in the first place. They were also claiming damages due to a loss in future business, since the site is likely to compete with them in their respective territories. While the court gave full rights for the site to the franchisor, the court sided with the franchisees on the later point. Justice David Hodgson noted there is a "substantial chance that their business will be damaged through unrestrained competition from the Dymocks website, including competition through discounting of books".

New Businesses
Finally, and perhaps the most tangible of trends the Internet has generated, is the development of a new class of franchised businesses. New franchises have been established to cater for the variety of new niches the Internet has created. Quick Internet and World Sites are two such examples that have made it to New Zealand. Both offer a broad range of Internet services, ranging from Internet access to e-commerce solutions. Overseas the number of Internet related franchises are increasing. Undoubtedly, more from this increasing stable will arrive here shortly.

Age & Health
One area of evolution receiving some attention is the effect an aging population base (more specifically, aging Baby Boomers) is having on businesses. Delving into the buying behavior and habits of this segment is most informative, and US franchises, in particular, are increasingly valuing the uniqueness, size, affluence and spending habits, of this group.

As a consequence, more franchised businesses are developing marketing campaigns specifically for them. Some have gone further and added new products and services. In yet a further illustration of the importance of this segment, whole new franchise concepts are emerging.

One interesting US company that has been developed specifically for the elderly is Home Instead Senior Care (HISC). HISC is a non-medical service for those wanting to continue living at home in their old age. It offers limited assistance, such as light housework, shopping trips and companionship.

More generally, products and services tipped to appeal to this group center on health and fitness, travel, financial planning, eye wear and home services.

In addition to the aged, franchises promoting health, fitness and well being are also gaining popularity across a broader age range as both individuals and employers realize the benefits of a healthy body and mind. Further growth in these areas seems inevitable.

Competition
Most New Zealand franchisors I've spoken with claim competition is very intense, yet it seems certain to intensify. Aside from the growth of existing New Zealand systems and development of new ones locally, Internet sales are snowballing, and several strong overseas systems are announcing more global intentions.

The Internet is building up to become a major threat to retailers. The numbers of E-commerce sites selling to customers are increasing exponentially. While many Internet retailers are so far struggling, and there have been failures (e.g., sportswear retailer, - Boo.com), they are experiencing increased sales. The single best threat to retailers, of course, is Amazon.com. Perhaps best know for books, global giant Amazon.com have also diversified into music, electronics, tools & hardware, homeware, and a forever-increasing range of other products. Importantly, the threat of the Internet not confined to retail. It also exists for many service providers. The Real Estate sector exemplifies this. For example, one US web site, Realtor.com already boasts more than 1.3 million property listings and has 90% of all US agents listed on it.

Also indicative of the potential for increased competition are the plans of strong overseas franchise systems. Many seek additional growth and believe their home markets to be nearing saturation. Further, many in fact need growth, in order to satisfy analysts following their stock.

Starbucks is a good example of a franchise with big overseas plans. Howard Shultz (US Company Chairman), who led them from 11 outlets in 1987 to almost 3, 000 gourmet coffee shops, announced wanting more than 20, 000. Not suprisingly, he doesn't expect the US to support this many alone. Instead, he believes more than half will reside outside North America. Restaurant Brands, who have the rights to develop Starbucks, along with KFC & Pizza Hutt in New Zealand, have plans of their own. Starbucks comprises 10, but the aim is for 50 (which include a number of micro stores developed to sit in the likes of supermarkets & book stores). Pizza Hutt just gobbled Eagle Boys to increase size, and 15 further KFC restaurants could be added within five years. Others also have big New Zealand plans. Harvey Norman, the computer, electrical, and furniture retailer, wants 15 more stores here within two to five years. This is part of its global plan to double their current size of 107 stores by 2005.

Mergers, Acquisitions & Alliances
Mergers and acquisitions involving franchises happen on a regular basis in the US. In fact, some describe it as at epidemic proportions. Here at home, they appear on the rise. Already this year, three high profile acquisitions have taken place. Fletcher Challenge purchased Hire-A-Hubby, presumably to grow and protect their client base and explore co-marketing opportunities. Ihug purchased a controlling stake in Video Ezy with co-marketing opportunities in mind. Most recently, Restaurant Brands' Pizza Hut has taken over Eagle Boys to facilitate expansion and assist their transition from restaurants to delivery. Acquisitions have also played a key role in the growth strategies in Real Estate. Large well-known systems have often purchased both individual and groups of offices, in areas they aren't represented to build market coverage more quickly, then franchised them later.

The reasons for these mergers and acquisitions are varied. As illustrated, these can be used to nurture and protect distribution channels, expand, and to cement co-marketing opportunities. Strong opportunities also exits for shared services and efficiencies in purchasing and marketing. As the New Zealand franchise market matures, and good systems gain size and strength, the potential for this type of activity can only increase. Similarly, as time moves on, other equity and non-equity based alliances involving franchises are likely to feature more widely here in New Zealand.

The Mouse and Beyond
To conclude, the future trends involving franchised businesses are varied. Considering them is informative, and point to the likelihood local franchising can expect a colorful future. On the one hand franchisors and franchisees have some exciting possibilities to pursue, while on the other, there are a range of new threats to contend with. In my view, the future brings increased complexity to the role of franchise system management. Franchise strategists will have more options and to consider and at least some of these will require specialists skills to evaluate. The requirement for adaptation will also increase, and in certain sectors some quite radical reinvention may be necessary. This provides particular challenge to franchise system managers since the franchise concept, for all its virtues, compared to some alternative organizational forms, is not well suited to making fundamental changes quickly.



This article first appeared in Franchise New Zealand Magazine.
 
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Dr Callum Floyd is owner and editor of both Franchise-Chat (www.franchise-chat.com) and Franchise Wire (www.franchisewire.com). He has a Masters and PhD researching franchising, and is Co-Owner of Franchize Consultants (www.franchize.co.nz), New Zealandís leading and award winning franchise development company.

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