Establishing a pilot operation is an essential step in your journey into new international markets
As franchisors explore market opportunities outside their home country, one key question typically stands out. How do we know that our concept’s success will translate across international borders? Unfortunately, this question has no easy answer. Entry into a new international market involves many variables – known and unknown – which could impact a franchise’s ability to thrive.
International franchisors face many pitfalls, such as regulatory requirements, labor laws, supply chain, cultural norms and customer tastes, just to name a few. Even international markets that may seem similar – such as the U.S. and Canada – have significant differences that may require unique adaptation of the franchise business model.
Market research can be helpful to identify potential obstacles in new international markets. However, even the most detailed market study may overlook unanticipated challenges that will only arise post-launch. Herein lies the importance of a pilot unit to show proof of concept for a franchise through daily operations, where the rubber meets the road in the new market.
Most international franchise executives would agree that selling franchises into a new international market is chancy without a pilot operation to test the franchise model. Early franchisees risk becoming lab rats that meet an unfortunate demise.
Take the example of one U.S. franchisor, who decided to begin selling franchises into Canada under a direct franchise model without a pilot unit. The first couple of Canadian franchisees realized – too late – that the American management software could not be adapted to meet regulatory and tax standards in Canada. The new, untested Canadian franchise locations were dead in the water with no software solution to run the business. These Canadian locations were forced to close, and after a painful lawsuit, the U.S. franchisor retreated from Canada for years to come. Similar cautionary tales abound in the international franchise world.
So what level of testing and proof of concept is necessary to begin selling franchises?
In an ideal scenario, a franchisor or master franchisee in a new international market would operate multiple pilot units up through a cumulative return of investment or beyond. However, reality conflicts with the ideal, and this is seldom feasible. A master franchisee looking at larger scale development is under immense financial and competitive pressure to subfranchise and grow quickly.
Reality calls for a balanced approach to testing. Minimally, from an operational data perspective, a franchisor should look for ramp and trajectory in the key metrics for their franchise – probably some measures of customer counts/retention, average transaction value, costs of sales, costs of labor and real estate, and overall movement toward breakeven and profitability.
Kurt Ullman is a 26-year veteran of international franchising, who has taken diverse concepts across borders into 96 countries. He puts it this way: “Ultimately, the right time to begin selling franchises in a new market is a judgment call that takes into consideration pilot operating data, market feedback and a brutally honest assessment of hurdles encountered and expected. And perhaps the most important factor in the decision is your level of confidence in the ability of the master franchise to lead, grow and manage a franchising system with your brand.”
If we agree that a pilot unit is necessary to test a franchise in a new international market, then who should own and operate that pilot operation? Typically it comes down to two scenarios: a master franchisee-owned pilot or the franchisor-owned pilot.
The master franchisee-owned pilot unit
In the heyday of global franchise brand expansion from the 1980s to the 2000s, many U.S. franchisors chose to have local master franchisees – or country Licensees, Area Developers, etc – own and manage the first pilot operations in new international markets.
During the 1990s, I worked on dozens of master franchise launches around the world. Typically, the plan was simple. The franchisor would come to the table with the concept, branding and business model, and the master franchisee would bring the local market know-how and investment to launch and localize the concept in their market. This would include the master’s investment in a pilot operation. Once the pilot reached operational stability to the satisfaction of the franchisor, then master would be allowed to begin selling franchises.
This continues to be a popular strategy for international franchise expansion today. That said, the master-led pilot approach is far from flawless. The ugly truth is that international master franchises have a historically high failure rate. I’ve had the unfortunate task of terminating or replacing struggling master franchisees, and typically, they failed for one of two reasons. Either the franchisor failed to commit adequate resources to the support of the master franchisee during the pilot phase, or the franchisor signed on with an unqualified master franchisee who was not up to the task.
When a master franchisee is responsible to open and operate a pilot unit in a new international market, it’s critical for the franchisor and master to work in unison to ensure a successful market entry. For example, UK-based CrepeAffaire entered Kuwait in 2015 and Saudi Arabia in 2017 under master franchise agreements. CrepeAffaire Founder and CEO Daniel Spinath says, “The early pilot units operated by our master franchisees in Kuwait and Saudi Arabia required a close collaborative effort between our local master partners and the UK headquarters team. Together we were able to find solutions to key challenges, such as importation of our food ingredients and adaptation of our model to the retail environment in the Gulf region.” After several years of fine-tuning the early units, CrepeAffaire is now in expansion mode in the Gulf States with four CrepeAffaire locations currently open in the region and eight new locations slated to open over the next two years.
The case for a franchisor-owned pilot unit
Australia is one market where many international franchises have stumbled – especially American concepts. Not surprisingly, Alan Branch, President of Global Development for Australia-based OptiVance 360 is a strong advocate for franchisors taking control of international pilot operations through the initial growth phase. Branch believes that it’s a matter of good business, accelerated growth, greater profits, as well as protection of the franchise’s culture and brand.
“Franchising internationally requires the building of the franchise brand and culture, country by country. Every franchisor must protect its brand and culture. Each time the franchise moves to a new country, that brand and the culture risk becoming diluted and or corrupted. These problems will be magnified through social media, with disgruntled master franchisees and individual franchisees ̶ both in the target country and in the franchisor’s home country ̶ running to speak to lawyers,” Branch says.
Taking the step of establishing franchisor-owned pilot operations can provide major financial gain, proving the launch of concept and increasing the fee for country rights. Alan Branch adds, “Many franchisors claim this cost is too high, but compare it to the cost of litigation by an angry master franchisee, a worldwide class action or stalling future country expansion.”
One example of a successful franchisor-driven pilot strategy is New Zealand-based Driving Miss Daisy, a socially responsible franchise providing companion driving services for those in need. This franchisor directly established operations in the United Kingdom over a 12-month period, prior to appointing their master franchise. They are now entering a third country (Australia) ahead of its original international schedule, along with additional plans to expand across Europe.
Jack Harper, Founder and Owner of Driving Miss Daisy states, “Prior to placing a master licensee, the key ingredient from our perspective was our hands-on establishment of a quality bunch of related suppliers, which were crucial for our business ongoing. Having done this in our home country, we knew exactly what we required. Having these foundations laid and ready to go was critical to introducing our first franchisees and creating momentum and value in the early stages of development.”
Choosing the best approach to reach proof of concept
The ideal strategy for a pilot operation may vary based on the franchise concept and the particular international market. A master-owned pilot may work in a small international markets, but large markets, like the United States, may merit the investment in a franchisor-owned pilot. Other pilot strategies have proven successful beyond master-owned and franchisor-owned units. In some cases, franchisors chose to acquire competitors (independent or franchised) in the new market and convert them to their franchise brand. Another franchisors launched pilots under a joint venture or hybrid JV-master agreement.
Regardless of the approach, pilot units play a critical role in adapting the franchise and reaching proof of concept in new international markets. Those franchisors who commit the time and resources to the successful launch of international pilot operations are better positioned to build a lasting global franchise expansion program.
ABOUT THE AUTHOR
Ray Hays is Managing Partner at FranLaunch USA, a franchise management firm that facilitates US market entry for international franchisors. He has a 28-year track record and field experience in over 50 countries worldwide. Ray has managed more than 30 new-country launches for a wide range of franchise concepts.
