Economic Potential of International Franchising in Emerging Markets

(Franchise-Chat.com) October 1, 2005 -- By Dr. Ilan Alon

International franchising has grown significantly since the 1960s because of both push and pull factors. Domestic saturation, increased competition and diminishing profits at home have pushed franchisors to examine their opportunities abroad, while favorable macroeconomic, demographic and political conditions abroad pulled them into specific markets. The initial expansion of U.S.-based franchisors was to culturally-similar, politically stable, and economically rich countries such as Canada and Western Europe. In recent years, however, opportunities have diminished in these countries as well, and international franchisors have begun to seek development opportunities in emerging markets.

Eighty percent of the world's population lives in emerging markets. Also, the U.S. Department of Commerce estimated that over 75 percent of the expected growth in the world's trade over the next two decades will come from developing countries, particularly big emerging markets, which account for over half the world's population, but only 25 percent of its gross domestic product. Despite the potential, these markets pose a series challenge to franchisors as conditions vary considerably from the developed markets in which international franchisors have the bulk of their experience.

Assessing the economic potential in emerging markets is important for international franchisors who wish to prioritize markets for expansion, choose an appropriate mode of entry, and select a proper fee structure for their franchise system. While a detailed discussion of all the factors relevant to the assessment of economic potential in emerging markets is beyond the scope of this article, I will discuss three commonly-used factors which franchisors need to analyze in more detail. These are the GDP per capita, the level of population and the growth rate of the economy.

Emerging markets are often classified based on their GDP per capita (GDP divided by the level of population). This variable is used because it signifies the level of income and the state of the economic and political well being of the country, but if used incorrectly can distort the view of the country's economic potential. It is important to adjust GDP per capita to purchasing power in emerging markets when examining the economic potential. This is because the prices of inputs and the cost of living is significantly lower in emerging markets compared to the major industrialized countries. Thus, the purchasing power of the citizenry of emerging markets is often higher than what the official unadjusted GDP per capita statistics may show.

The level of population is an often-touted measure of economic potential in emerging markets. With a population of about 1 billion people, China and India (two of the biggest emerging markets) are considered to be among the most attractive locations for expansion. The reality is that the majority of the population in these countries does not earn sufficiently to afford western-style products and services and does not live in the major urbanized areas in which international franchisors are accessible. In the People Republic of China, for example, three key cities Beijing, Shanghai, and Guangzhou, offer the greatest potential for global franchisors.

The economic rate of growth is a variable that needs to be emphasized in analyzing the market potential of developing markets. While developed markets exhibit very low single-digit growth rate, many emerging markets sustain high levels of growth both in the GDP and in the GDP per capita. Such statistics should be viewed favorably by international franchisors because they parallel the development of pent-up demand for western-style goods, lessen the political risk and social discontent of the citizenry, and point at an emergent middle class. According to an Arthur Andersen study, the existence of a middle class is the most important factor in determining whether a host country will be suitable for international franchising expansion.

The variables discussed here, as well as many others that need to be analyzed before making an entry decision, can be obtained from the U.S. Department of Commerce as well as International Institutions, such as the World Bank, the United Nations, and the International Monetary Fund. Interested franchisors should also consult the recently-published, first and only two books on the subject: International Franchising in Emerging Markets: Central and Eastern Europe and South America and International Franchising in Emerging Markets: China, India and Other Asian Countries. These books are published by CCH, Inc. and can be purchased by visiting the CCH Online Store.

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