Viewing franchise through FDI lens: a misdirected approach?

Viewing franchise through FDI lens: a misdirected approach?
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First Published: Mon, Jul 23 2007. 02 18 AM IST

Updated: Mon, Jul 23 2007. 02 18 AM IST
Franchise arrangements between foreign and Indian companies are not subject to any prior approval from Indian regulatory authorities.
But, certain quarters in the government have recently expressed a concern that the restriction of foreign direct investment (FDI) on retail trading can be circumvented by following a franchise route. Accordingly, the government is now looking at scrutinizing franchise arrangements of foreign groups with Indian companies in an effort to plug what it considers are loopholes in the policy.
The government’s reaction appears to be based on a fear that franchising is being used as a backdoor to enter retail in India. Interestingly, this is at a time when there is talk about liberalizing single-brand retail and possibly permitting FDI in multi-brand retail at least in certain sectors, notably, sports goods and electronics. Media reports suggest that certain sections within the government are uncomfortable with master franchisees.
Following a February 2004 amendment, no approval is required from the Reserve Bank of India (RBI) for the remittance of fees for the use of a franchise. Subsequently, in July 2006, a further relaxation has resulted in remittances even for the purchase of a franchise being freely permitted. As such, remittances on account of franchise, which were within the domain of RBI, stand liberalized as of today. However, now seeking to bring franchise arrangements under the scanner of the Foreign Investment Promotion Board may prove to be a step back in the government’s path towards liberalization.
Conceptually, franchise arrangements are totally different from FDI.
At its most basic, a franchise is an authorization granted to an individual or company by another company to sell the latter’s goods or services in a specific territory in a specified business format and process. As per the definition given by International Franchising Association, a franchise is a contractual relationship between the franchiser and franchisee in which the franchiser is obligated to maintain a continuing interest in the business of the franchisee. The franchisee has a substantial capital investment in his business and operates under a common trade name, format and procedure owned or controlled by franchiser. In consideration for granting of licences and services, the franchiser is paid franchise fees, generally
Ketan Dalal
based on a percentage of sales.
Some common examples of franchising in India are Marks and Spencer, Hugo Boss, Tag Heuer, KFC and McDonald’s. In a franchising arrangement, usually the franchiser is not an investor in the franchisee in terms of equity. The equity is contributed by the Indian franchisee and the economic interest of the franchiser is limited to the franchisee fees from the franchisee. Clearly, the economic upside belongs to the franchisee and it is, therefore, a stretch to think that a franchise arrangement is an indirect FDI.
There is clearly a need to distinguish between the sale of goods in India through a franchise route on the one hand and entry through FDI on the other. In a situation less sophisticated than a franchise, goods could be sold to distributors in India who could sell the same through their own retail outlets. Would that be FDI? Then why would franchising be considered at all as FDI?
Is it only because the franchiser is concerned how his goods are displayed and, therefore, is willing to have his goods sold only through a particular type of formal store (even though he does not get the economic upside from those stores)?
Let us assume a business environment where FDI in the retail sector in India is fully opened up to foreign investors. Would it be correct to think that franchising as a business model would disappear in such a scenario? The answer is obviously ‘no’. Franchising and FDI can coexist even after the opening up of retail sector. In fact, many franchise formats continue to exist in India despite opening up of FDI in single-brand retailing. So, why should franchising be seen as a tool for overcoming the retail restrictions?
It is important to recognize the economic and social benefits to India as a result of franchising. Often, it allows an Indian entrepreneur to satisfy his entrepreneurial urge; also, the franchiser may not have been willing to enter India, even if FDI were to be opened up, either due to his risk appetite or because of lack of critical mass in India for that business. Further, franchising is also commonly witnessed in sectors like hospitality, healthcare and education in India. Would the government’s desire to review the franchise arrangements not act as a deterrent to the growth of these critical sectors?
Finally, franchising is a very useful and respected business model. Multinational companies (MNCs) venturing into India for the first time may not desire to invest capital in the country and may wish to adopt a franchise model for the initial years. As such, a franchise is an alternative arrangement by those MNCs that do not want to invest in the form of FDI, even if it were in sectors where FDI is permitted. Franchise arrangements should not be looked on as FDI and the concerns recently expressed in certain sectors of the government are perhaps misdirected.
Ketan Dalal is executive director of PricewaterhouseCoopers. Your comments and feedback are welcome at groundrules@livemint.com
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First Published: Mon, Jul 23 2007. 02 18 AM IST