Franchising in Emerging Markets

Let us retrace our steps a bit, what is an emerging market?

An emerging market (or an emerging country or an emerging economy) is a market that has some characteristics of a developed market but does not fully meet its standards. This includes markets that may become developed markets in the future or were in the past. The term "frontier market" is used for developing countries with smaller, riskier, or more illiquid capital markets than "emerging” As of 2006, the economies of China and India were considered the largest emerging markets. 

According to The Economist, many people find the term outdated, but no new term has gained traction. Emerging market hedge fund capital reached a record new level in the first quarter of 2011 of $121 billion. Emerging market economies’ share of global PPP-adjusted GDP has risen from 27 percent in 1960 to around 53 percent by 2013 The ten largest emerging economies by nominal GDP are 5 of the 10 BRICS countries (Brazil, Russia, India, China, and Saudi Arabia) along with Indonesia, Mexico, Poland, South Korea, and Turkey.

There is no consensus on the definition of the term “emerging market, however, it is associated with three characteristics: according to the World Bank and UN; level of economic development, economic growth, and market governance. Economic development is typically measured in terms of GDP per capita. GDP per capita is a useful measure of economic development because it is related to the population’s wealth, the middle class's extent, and the development level of the industrial and service sectors.

Economic growth is usually measured in terms of a country’s GDP growth rate. The use of economic growth is consistent with the concept of “emerging.” Most of the countries referred to as emerging markets enjoyed GDP growth rates exceeding 5 percent from 1990 to 1997, with some markets, particularly in East Asia, displaying double-digit growth rates.

The level of economic growth is among the most important considerations for international franchising expansion. When examining an emerging market’s GDP growth rate, one must contrast it to the growth in the population. If population growth rates exceed GDP growth rates, then the standard of living in those countries will drop over time. The most useful measure that captures both these growth rates is that of GDP per capita growth rate.

The third criterion for judging emerging markets is the country’s market governance. Market governance includes the level of free market activity, government control of key resources, stability of the market system, and the regulatory environment. Countries that are liberalizing their economic institutions and democratizing their political structures are often referred to as Transitional Economies/Countries. These transitions have been welcomed by Western economies and are regarded as opportunities for international retail franchising expansion.

Among the most important transitional elements to international investors are the political and economic risks that are introduced by the reorganization of economic and political units in emerging marketplaces. (We covered risk in a previous article). Market governance influences a wide range of country risk elements such as government regulation and red tape, political stability, bribery, ownership restrictions, controls of capital flows, and import restrictions. All these factors are important to international franchisors’ evaluations of foreign market potential and essential to determinations of franchise expansion in the international retail arena.

Franchising in developing countries has been recognized as a significant contributor to economic, social, infrastructural, and institutional development. A study using data from 49 countries over the period 2006–2015 found that franchising has a positive impact on these dimensions of country development. The earlier and more franchising systems a country adopts, the stronger the positive influence on its development. However, there are challenges due to the lack of recognition of franchising as a form of entrepreneurial governance in many emerging and developing countries, leading to limited data availability. This calls for more comprehensive data collection and research to understand the full impact of franchising on development in these regions.

For practical implications, franchising can play a crucial role in the development of emerging and developing economies, especially where public policy may lack financial resources to improve social, infrastructural, and institutional environments. Franchising in emerging markets also offers the host countries certain advantages. These benefits include obtaining foreign currency with little capital outlay, increases in employment, and thereby, growth in the franchisor's tax base and gross domestic output.

While business franchising is the norm industry standard for developed countries, it remains an aspiration for many developing countries. Despite the attraction for developing countries of systems, training, and support and despite the economic and regulatory infrastructure being in place for the development of business format franchising, a range of commercial and socio-cultural factors may come together to prevent its full expression.

This series of articles addresses franchising development in a developing country. Let us explore strategies to bridge the gap between emerging markets franchise practices and franchising best practices. A look at the current state of development, the product and trade name model as the appropriate starting point with a move to the business format model only when, and in places where, the socio-cultural, commercial, and economic factors and the legal environment can accommodate more sophisticated business format franchise arrangements.

Janet Mbene, Senior Associate Consultant, Modesta Mahiga LLC.

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