The Promises of Franchising in Africa: The Need for a Critical Examination Simon P. Sigué

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1 This article was downloaded by: [Mr Simon P. Sigué] On: 22 June 2013, At: 11:30 Publisher: Routledge Informa Ltd Registered in England and Wales Registered Number: Registered office: Mortimer House, Mortimer Street, London W1T 3JH, UK Journal of African Business Publication details, including instructions for authors and subscription information: The Promises of Franchising in Africa: The Need for a Critical Examination Simon P. Sigué To cite this article: Simon P. Sigué (2012): The Promises of Franchising in Africa: The Need for a Critical Examination, Journal of African Business, 13:3, To link to this article: PLEASE SCROLL DOWN FOR ARTICLE Full terms and conditions of use: This article may be used for research, teaching, and private study purposes. Any substantial or systematic reproduction, redistribution, reselling, loan, sub-licensing, systematic supply, or distribution in any form to anyone is expressly forbidden. The publisher does not give any warranty express or implied or make any representation that the contents will be complete or accurate or up to date. The accuracy of any instructions, formulae, and drug doses should be independently verified with primary sources. The publisher shall not be liable for any loss, actions, claims, proceedings, demand, or costs or damages whatsoever or howsoever caused arising directly or indirectly in connection with or arising out of the use of this material.

2 Journal of African Business, 13(3), , 2012 Copyright # Taylor & Francis Group, LLC ISSN: print= online DOI: / EDITORIAL The Promises of Franchising in Africa: The Need for a Critical Examination Downloaded by [Mr Simon P. Sigué] at 11:30 22 June 2013 For Franchisable Nigerian Micro Small Medium Enterprises, it is in your best interest to start your franchise plans now! The future is: You either franchise or die! (Nigerian International Franchise Association, 2008, p. 4). This rather apocalyptic statement, attributed to a vice president of the Nigerian International Franchise Association, illustrates the widely-held belief among informed African business leaders and policymakers that franchising must become a driving force in the creation, modernization, and development of businesses in Africa (Sigué, 2002). Indeed, despite its extraordinary success in both developed and emerging countries where it has been a steady engine of business growth and often accounts for up to 50% of retail sales, franchising remains a marginal force in retailing in most African countries. South Africa is the high-flying exception where the development, vitality, and economic impact of franchising are noticeable. As a matter of fact, according to the Franchise Association of South Africa (2012), the franchise sector contributes about 11.8% of South Africa s GDP. The number of franchise systems increased from 156 in 1994 to 551 in In 2010, these franchise systems operated a total of 30,000 outlets, mostly owned by franchisees as independent small and medium enterprises (SMEs), and employed 478,000 people (Franchise Association of South Africa, 2012). Expected socioeconomic benefits from franchising in Africa are numerous and include job creation, development of SMEs, economic growth, increase of local entrepreneurship, alleviating poverty, and improving managerial capabilities and skills of the labor force. It is no surprise that African governments and other development stakeholders are increasingly promoting franchising as an effective alternative to stimulate business development and speed up the growth of African economies. For instance, the African Development Bank (AfDB) committed $USD 40 million in 2009 to support the development of franchising in Egypt, hoping to create 375 franchised outlets and over 7000 direct jobs and to increase the number of SMEs operating in the Egyptian formal sector. Gradually, more nongovernmental organizations (NGOs) also acknowledge that franchising principles via microfranchising can apply to microbusinesses and help to alleviate poverty and enhance individual economic self-reliance at the base of the pyramid (Kistruck et al., 2011). Although the socioeconomic expectations of franchising are high, scholarly works focusing on the motivations that can lead a firm to adopt this form of organization in Africa remain surprisingly very sparse (Olotu & Awoseila, 2011). Governments and their development partners seem to assume that the economic success of franchising in other regions of the world could easily be replicated in Africa. In the business literature, franchising is portrayed as a miraculous solution for African SMEs, which struggle to cope with national and international competition. In such a context, there is a need to go beyond this promotional literature to understand what franchising can effectively bring to those who might consider this organization form in Africa. This editorial calls for further academic research on franchising in Africa and urges investigation into whether or not theories that have been used to explain the successful development of franchising in North America and elsewhere can apply to African countries. Particularly, some premises of the resource scarcity and agency theories are discussed as examples to provide a basis for a comprehensive critical examination of franchising in Africa. Before that, however, the concept of franchising is briefly introduced. FRANCHISING Franchising is a channel contractual arrangement by which a franchisor (generally a manufacturer or a service provider) enters into contracts with individual franchisees (retailers) and offers them, within a specified timeframe, exclusive dealership of the products or services or the use of its business format in a given area. More importantly, franchisees have the use of the franchisor s brand name, often in exchange for franchisee fees and royalty payments (Gagné, Sigué, & Zaccour, 1998; Lafontaine, 1992, Martín-Herrán, Sigué, & Zaccour,

3 2011). A franchise system is considered a hybrid organization that combines both the flexibility of a market organization and the consistency of a vertically integrated organization (Brickley & Dark, 1987). As in a market organization or a conventional marketing channel structure, franchisees facilitate adaptation to local markets by providing three critical resources: financial resources, knowledge of local market, and the managerial talent of local investors (Caves & Murphy, 1976; Oxenfeldt & Kelly, 1969). Similar to an integrated organization, in a franchise system the franchisor keeps investing in enhancing the competitive advantage of the whole organization and puts in place monitoring mechanisms to ensure that franchisees behave according to the system requirements and maintain a consistent common representation or image (Brickley & Dark, 1987; Rubin, 1978; Windsperger & Dant, 2006). In contrast to a vertically integrated organization, franchisees are not employees. They are legally independent entrepreneurs who manage their own businesses under contractual parameters set by a franchisor. CAN FRANCHISING PROVIDE RESOURCES FOR GROWTH IN AFRICA? The first major theory developed in North America to explain the adoption of franchising is built around the scarcity of resources for growth. Resource scarcity theory claims that young and small companies use franchising mainly to overcome constraints to growth such as the lack of trained managers, knowledge of local markets, and financial capital (Caves & Murphy, 1976; Oxenfeldt and Kelly, 1969). By bringing these critically needed resources into the organization, franchisees allow the franchisor to allocate its internal resources to build or strengthen its competitive advantages in order to effectively compete with larger firms (Michael, 2003). Because wholly-owned outlets are believed to be more profitable than franchised outlets, resource scarcity theory predicts that franchise firms should normally revert to vertically integrated organizations once economies of scale are achieved and internal resources are sufficient to buy back and operate previous franchised outlets (Oxenfeldt and Kelly, 1969). Promoting franchising to African SMEs from the resource scarcity perspective as a better organizational form for dealing with their current challenges would require analysis of the following two presuppositions of this theory: (1) African SMEs want rapid growth to achieve economies of scale and compete more effectively, and (2) franchising offers the best available alternative to overcome the scarcity of resources firms need for their growth. On the subject of economies of scale, the retailing sector in many African countries is clearly dominated by single outlet operators. With the exception of gas EDITORIAL 169 stations, very few firms are organized into network organizations. Moreover, those that operate several outlets do not fully cover their local or national markets. As a consequence, scaling successful retailing outlets to regional or national network organizations would likely improve their efficiency in areas such as marketing communications and supply management and, more importantly, increase their profitability. It would therefore be interesting to understand why African SMEs do not seek economies of scale through exploiting several outlets. Regarding the lack of trained managers, knowledge of local markets, and financial capital as key motivations to franchise, one may empirically investigate whether or not African SMEs do effectively lack some of these resources and, if they do, what are the best available alternatives to obtain them. The high unemployment rate of business graduates in several African countries would indicate that people with the potential to manage a firm s own subsidiaries might be readily available in the market. The lack of local market knowledge argument may not hold for the many firms that are unable to fully cover their own local markets, if local is defined as the city in which the firm is based. This argument is more appealing when a firm faces the challenge of expanding to unfamiliar markets, for example, entering into other cities or regions of a given country or going abroad. In such a context, it may be necessary to have a local franchisee who not only knows the market, but can also help the firm connect with the local community. However, even then it is not clear why a firm s own well-qualified manager will not achieve the same goal, especially because, for outsiders, franchisors employees and franchisees are seen as members of the same organization. On the other hand, the shortage of financial capital is a major drawback for micro entrepreneurs and SMEs in Africa (Kasseeah & Thoplan, 2012; Otoo et al., 2012). In the franchising industry, the degree of capitalization required to properly franchise an independent business operation will be a predicable barrier to entry (African Development Bank, 2002, p. 27), while for the franchisees, the capacity of entrepreneurs to commit the necessary one third to one half of the total investment in a franchised business is low (African Development Bank, 2002, p. 19). As a consequence, in addition to lacking internal financial capital to support their growth, franchise systems in Africa are also constrained by the scarcity of potential franchisees with the critically needed financial resources. Worse, many African capital markets are inefficient (Ezepue & Omar, 2012) and financial institutions are highly risk averse, making it more difficult for potential franchisees to obtain affordable loans. All else being equal, a franchisor who already owns other outlets in an African market is more likely to obtain loans at better rates than an aspirant franchisee who plans to open its first outlet and may have limited assets to use as security. 1

4 170 EDITORIAL CAN FRANCHISING LESSEN AGENCY COSTS IN AFRICA? The second key theory to explain the development of franchising is based on the moral hazard problem associated with the management of dispersed outlets. Agency theory stipulates that because franchisees invest themselves and have ownership incentives to adopt uniform methods and quality standards requested by the franchisor, franchising should be preferred to a hierarchical organization because it aligns the interests of the parties and reduces the need for monitoring the activities of local managers (Lafontaine, 1992; Rubin, 1978). Residual monitoring is needed, however, to ensure that franchisees pay the ongoing fees to the franchisor and to prevent them from engaging in other opportunistic behavior, including free riding on the franchisor s goodwill and other franchisees activities (Brickley & Dark, 1987; Lal, 1990; Sigué & Chintagunta, 2009). The decision of whether or not to franchise a given outlet therefore depends on the extent of the monitoring costs the firm has to incur by appointing a local manager. Monitoring costs are known to be particularly high for outlets located in rural, distant, and unfamiliar markets (Castrogiovanni, Combs, & Justis, 2006). Although, as discussed above, most African SMEs struggle to cover their local markets, theoretically, franchising could benefit those who plan to expand into such exotic markets. The lack of reliable transportation infrastructure observed across Africa increases monitoring costs and should, in principle, contribute to making franchising attractive for investors. Fundamental to the application of agency theory in franchising is the assumption that the terms of a franchise contract are binding for both the franchisor and franchisee (Brickley & Dark, 1987; Rubin, 1978). This assumption implies that the country s legal system is strong enough to effectively enforce these terms if a party fails to meet its contractual obligations. This basic requirement is not met in many African countries and seems to be one of the major impediments to the development of franchising. For instance, it is believed that foreign franchisors are skeptical about expansion into Nigeria for lack of confidence in the regulatory framework (Nigerian International Franchise Association, 2008, p. 5). 2 Moreover, the respect of laws seems to be a cultural challenge. As observed by a U.S. Commercial Service in Nigeria, people struggle on a daily basis to obey basic laws such as those regulating traffic in major cities (Nigerian International Franchise Association, 2008). Accordingly, though the issue of whether to franchise or to vertically integrate remains relevant, the argument of saving agency costs through franchising is diluted. Without a reliable law enforcement system, franchisees can break the franchise contract and suffer no major consequences, making franchising a rather risky and costly expansion alternative. For example, (a) after securing knowledge transfer from the franchisor, a franchisee can unilaterally terminate the contract and start a similar business with more or less the same commercial assets, and (b) a franchisee can refuse to pay ongoing fees, especially if the franchisor s support is no longer critical for its success. Assuming the argument regarding the cultural challenge of freely conforming to regulations and expected standards is true to some extent, franchise systems in such markets should continuously monitor franchisees activities. Because the success of franchising is based on routine operations, standardized production, and communicating a consistent image to customers, failing to put a tight monitoring system in place will jeopardize these fundamentals and hurt any franchise system. Kistruck et al. (2011) reported empirical findings in various developing countries, including Kenya, to support the view that the lack of forceful monitoring is associated with higher levels of opportunistic behavior among microfranchisees. 3 CONCLUSION It is believed that the exceptional success of franchising in developed countries such as the U.S., Canada, and Australia can be replicated in Africa to boost African SMEs and speed up the growth of African economies. This belief is not unrealistic given the extraordinary growth of franchising in South Africa during the last two decades and its impact on South African SMEs. However, as in the developed countries in which franchising has prospered, South Africa offers specific business infrastructures and institutions that are not common in many African countries. The success of franchising in Africa will depend on understanding how each country s local environment might affect those interested in adopting this organizational form. Academic research is needed to supply policymakers and investors with contextualized knowledge in this promising area. The brief overview of both the resource scarcity and agency theories indicates areas that will need further attention if these theories are to be used to promote franchising in Africa. Examples include: (a) examining the relevance of franchising as a source of capital for growth in inefficient capital markets or in environments where lenders are very risk averse, and (b) the impact of the lack of a strong legal system and local culture on agency costs. Simon P. Sigué Editor

5 NOTES 1. Rubin (1978) developed a similar argument in the context of a perfect capital market and argued that a franchisor who is capital constrained should seek the ownership structure that minimizes return on capital to achieve the lowest cost of capital. It is argued here that when both the franchisor and franchisee have no choice but to borrow from very risk adverse institutions, the franchisor may be better off borrowing by itself to lower the cost of capital. 2. Local investors are no different. For example, Nunemo (2012) reported that reforms in business regulations, including those that affect contract enforcements, positively affect private domestic investment in Africa. 3. The cultural argument made here goes beyond opportunistic behavior in the sense that franchisees may deviate from set standards for reasons other than taking advantage of the franchise system. Deviation can also occur because people are not accustomed to operating in a rigid system such as franchising, which has been criticized for dehumanizing both workers and consumers for the sake of efficiency (Alon, 2004). REFERENCES African Development Bank (2002). Study on franchising opportunities in Africa. Retrieved from 20Background%20Paper.PDF Alon, I. (2004). Global franchising and development in emerging and transitioning markets. Journal of Macromarketing, 24(2), Brickley, J. A., & Dark, F. H. (1987). The choice of organizational form: The case of franchising. Journal of Financial Economics, 18(2), Castrogiovanni, G. J., Combs, J. G., & Justis, R. T. (2006). Shifting imperatives: An integrative view of resource scarcity and agency reasons for franchising. Entrepreneurship Theory and Practice, 30(1), Caves, R. E., & Murphy, W. T. (1976). Franchising: Firms, markets and intangible assets. Southern Economic Journal, 42(4), Ezepue, P. O., & Omar, M. T. (2012). Weak-form market efficiency of the Nigerian Stock Market in the context of financial reforms and global financial crises. Journal of African Business, 13(3), this issue. Franchise Association of South Africa (2012). FASA represents franchising in South Africa. Retrieved from expanding.php EDITORIAL 171 Gagné, R., Sigué, S. P., & Zaccour, G. (1998). Droit d entrée et taux de redevance dans les franchises d exploitation au Québec. L Actualité Économique, 74(4), Kasseeah, H., & Thoplan, R. (2012). Access to finance in a small island economy: Evidence from Mauritius. Journal of African Business, 13(3), this issue. Kistruck, G. M., Webb, J. W., Sutter, C. J., & Ireland, R. D. (2011). Microfranchising in base-of-the-pyramid markets: Institutional challenges and adaptations to the franchise model. Entrepreneurship Theory and Practice, 35(3), Lafontaine, F. (1992). Agency theory and franchising: Some empirical results. RAND Journal of Economics, 23(2), Lal, R. (1990). Improving channel coordination through franchising. Marketing Science, 9(4), Martín-Herrán, G., Sigué, S. P., & Zaccour, G. (2011). Strategic interactions in traditional franchise systems: Are franchisors always better off? European Journal of Operational Research, 213(3), Michael, S. C. (2003). First mover advantage through franchising. Journal of Business Venturing, 18(1), Nigerian International Franchise Association (2008, July September). Franchising Quarterly. Retrieved from Nunemo, J. (2012). Business regulations and private domestic investment in Africa. Journal of African Business, 13(2), Olotu, O. A., & Awoseila, F. (2011). Reinventing business growth through franchising in developing economies: A study of the Nigerian fast food sector. International Journal of Marketing Studies, 3(1), Otoo, M., Ibro, G., Fulton, J., & Lowenberg-DeBoer, J. (2012). Microentrepreneurship in Niger: Factors affecting the success of women street food vendors. Journal of African Business, 13(1), Oxenfeldt, A. R., & Kelly, A. O. (1969). Will successful franchise systems ultimately become wholly-owned chains? Journal of Retailing, 44(4), Rubin, P. (1978). The theory of the firm and the structure of the franchise contract. Journal of Law and Economics, 21(April), Sigué, S. P. (2002). Le franchisage: une autre voie pour créer et moderniser les entreprises au Cameroun. In S. P. Sigué (Ed.), Gérer pour la croissance au Cameroun. (pp ). Paris: L Harmattan. Sigué, S. P., & Chintagunta, P. (2009). Advertising strategies in a franchise system. European Journal of Operational Research, 198(2), Windsperger, J., & Dant, R. P. (2006). Contractibility and ownership redirection in franchising: A property rights view. Journal of Retailing, 82(3),