With international growth, master franchising usually fails

A Mizuho analyst finds the vast majority of master franchising commitments go unfulfilled, and 40% fail altogether, says RB’s The Bottom Line.
Photograph courtesy of Wendy's

the bottom line

Companies looking to develop internationally might want to reconsider handing over control of a country to a single operator.

That is the lesson from an analysis earlier this week by Mizuho analyst Jeremy Scott, confirming a previous study by Cornell University that found the vast majority of international master franchise deals go unfulfilled. And many of them fail altogether.

Scott said that current international growth estimates for Taco Bell, Tim Hortons, Popeyes and Wendy’s are “too aggressive relative to historical outcomes.” He then downgraded their respective parent companies’ stocks.

The study brings to mind a common issue in franchising: Development projections are usually too aggressive because many franchisees don’t fulfill their agreements. Sometimes the market doesn’t work. Other times the brand doesn’t work, and the operator shifts its attention to another brand.

Or maybe the operator is substandard or can’t find financing. Any number of things can result in a failed development agreement.

But failed international agreements can be a real problem, hurting a brand’s reputation in an entire market. It can take years for a concept to recover when a deal fails, and the problem can set back chains’ international growth strategies.

That’s an important consideration, because international development is important for many brands’ futures given the challenges of growing in the U.S.

The Mizuho analysis focused on 360 master franchising or whole-country development agreements signed by brands between 1999 and 2016. In a master franchising deal, a franchisor hands over the keys to the brand to an operator for a specific area, and the operator can sign subfranchisees.

The Mizuho analysis found that only 6% of such deals are ultimately fully satisfied. And 40% of these deals fail entirely. Overall, Scott wrote, operating partners opened less than half of their committed stores in 80% of the agreements studied.

Of the 27,000 units committed under development agreements, only 8,400 were ultimately built.

Scott noted that many brands have successfully used master franchise partnerships to grow in international markets—Domino’s, for instance, along with Burger King, KFC and McDonald’s. But these agreements usually work when the brand has already proven itself in international markets, he wrote.

Brands are better off developing international markets through conventional franchising, joint ventures or as operating markets.

High-quality international brands aren’t interested in long-term brand building, Scott wrote, but are instead focused on quality returns. When brands don’t perform well, operating partners will simply shift focus to other brands.

There are many stories of failed international deals.

Papa John’s entered India in 2011 with a master franchisee, and in 2014 acquired another brand, Pizza Corner, with plans to build out the market.

By 2018, Papa John’s had shut down its operations in India. Rival Domino’s took some credit for that. Russell Weiner, the chain’s chief operating officer, told analysts in January that the chain built more locations in the country, effectively “fortressing” the market and pushing out its competitor. “We have one less major competitor than we did in the past,” he said.

Wendy’s entered Japan through a development agreement in 1980, and dozens of stores were built around Tokyo. But the brand struggled to compete there, and in 2009 ended the operator’s franchise agreement and closed 71 restaurants in the process.

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