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Paper to be presented at the EMNet-Conference on
"Economics and Management of Franchising Networks"
Vienna, Austria, June 26 – 28, 2003
www.univie.ac.at/EMNET
Choice of Foreign Entry Mode by Franchisor:
Case Studies of Lithuanian Franchisors Entering Latvia
Regina Jarmalaite, Irina Sekundo
Stockholm School of Economics in Riga
Strelnieku 4a
LV-1010 Riga
Latvia
Tel: 00371-7015800
Fax: 00371- 7830249
E-mail:
E-mail:
Abstract
This paper is the first attempt in the Baltic market to find reasons and explain the strategic motives and decision-making factors for the franchising companies to expand internationally via either ownership or contractual entry modes. The authors on the basis of two Lithuanian franchisor case study companies, that have entered Latvian market in order to create the franchising network, exploit the motivating factors and their influences on the choice of entry mode. The authors have identified and critically evaluated twelve factors and put forward the following five hypotheses:
Hypothesis 1. The franchisor, which has enough resources, high level of motivation to learn abroad, is alert to the rival firm’s activities but is not striving for fast penetration of market chooses the ownership mode of entry into foreign country.
Hypothesis 2. For a franchisor entering a culturally similar market with a low degree of country risk, international experience does not influence the choice of entry mode.
Hypothesis 3. For a franchisor when choosing an entry mode into foreign market existence of highly powerful players in market to be entered does not necessarily result in equity mode being chosen.
Hypothesis 4. For a franchisor that plans entering foreign market the absence of differentiation specifics of products or services is not an obstacle to choose the equity mode of entry.
Hypothesis 5. For a franchisor the perceived importance of brand and control over quality are not crucial factors for choice between contractual and equity mode of entry into foreign country.
Keywords
Franchising, Foreign Entry, Ownership Entry Mode, Contractual Entry Mode
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Acknowledgements
As the authors of this Thesis we would like to express gratitude to many people and certain organisations that have helped and endowed with special knowledge and support necessary for the successful completion of the paper. First of all, we would like to thank Andris Strazds for the immeasurable support for providing insights into the topic. Also the assistance of Leona Achtenhagen and professor Roberts Ķīlis in the idea generation and clear direction finding were of great importance.
Our major thankfulness for their input into the success of this work belongs to Renaldas Gineika and Vilmantas Šimoniūtis, who were ready to give us all the necessary information on their companies and provide us with very valuable and abundant advice for our Thesis writing. It was of high value to have their support and instantaneous replies to our questions, especially when the deadlines were so close. As well we thank the expert of car repair business and the person who despite new restaurant opening rush was ready to meet us and tell his view. Moreover, we deeply appreciate the time and efforts spent by Diana, Indre and Tom to help us.
None of this would have been possible without the never-ending optimism, understanding and encouragement of our dear parents, family members and friends, especially Ivars and Katri.
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Table of Contents
I. Introduction 1
A. Purpose and Research Questions. 1
B. Relevance 1
II. Definitions 2
III. Theoretical Background 3
A. Franchising 3
B. Internationalisation 3
C. Reasons for Choice of Entry Modes 3
1) Firm and Industry Specific Factors 4
2) Country Characteristics 5
3) Firm Strategic Intent and Preferences 6
IV. Methodology 8
A. Choice of Research Strategy 8
B. Selection of Case Companies 9
C. Data Generation 9
D. Constraints and Delimitations 9
V. Empirical part 10
A. Case study – Kemi entering Latvia 10
1) Background of the Company 10
2) Firm and Industry Specific Factors 10
3) Country Characteristics 12
4) Firm Strategic Intent and Preferences 14
B. Case Study – Pizza Jazz Entering Latvia 15
1) Background of the Company 15
2) Firm and Industry Specific Factors 16
3) Country Characteristics 18
4) Firm Strategic Intent and Preferences 20
VI. Interpretations of Research Findings 23
VII. Conclusion 26
VIII. References 29
IX. Appendix 31
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I. Introduction
Throughout the United States and Western Europe, the countries of the world that could be called mature in their economic development, the concept of franchising is an integral part of the entrepreneurial environment. Nevertheless, the Baltic countries still portray rather undeveloped local company franchising practices.
The factors that would foster the growth of franchise business in the Baltics were already explored by Brennere and Petrova (2002). They focused their research on the situation in Latvia. Considering that the economic, demographic and historical conditions are rather similar also for Lithuania, in this research the authors will not go into detailed analysis of the critical aspects that could promote the franchise development in Lithuania. However, the authors will look from a fundamentally different perspective – international expansion of franchising companies. In this research the choice of the entry mode to Latvian market by Lithuanian franchisors will be explored.
A. Purpose and Research Questions.
The primary aim of this Thesis is to recognise and evaluate the critical motives for the choice of entry mode of Lithuanian franchisors when entering Latvian market. Critical motives for the choice of entry mode hereinafter are defined as issues considered before and during the entrance phase to the foreign market. This paper is an attempt to answer the following questions:
What are the factors influencing the choice of a franchisor when selecting the mode of entry into a foreign market? How have the aforementioned factors influenced the choice of entry mode in case of Lithuanian franchisors entering Latvia?
B. Relevance
From the practical point of view the strategic motives, choices, and development of the company – franchisor via two different modes for entering a foreign market are of extreme importance for the new entrants into the Latvian market. The analysed topic thus is valuable source for consideration for the SME – franchisor management that pursues a possible foreign market entry strategy to Latvia. Even though the paper does not provide the general recipe for entrance strategy, the authors consider the Thesis to set the guidelines for the SME – franchisors that are contemplating the growth to other countries’ markets.
The compliance of the actual entry motives and choice of entry mode when expanding to the Latvian market with the considerations or practices in the other markets revealed in the theories will be studied. Hence, the paper would be of utmost interest for those that are considering Latvia as a potential market for entry.
II. Definitions
Contractual entry mode is the entry mode when the owner of the service concept (principal) enters into a contract with an unrelated party (agent) to use a specific business formatted service concept to sell services or goods under the principal’s trademark. However, the principal does not invest funds of its own in the local service unit as the agent takes responsibility for the construction, maintenance, and management of the local operation (Fladmoe-Lindquist and Jacque, 1995, p.1238).
Franchisee is an agent that acquires the right to own a business representing or selling a proven product line or service, a respected trademark, and an established operating system that has been fully “debugged” to achieve maximum profit (Purvin, 1994, p.3).
Franchisor is a person or a company that grants for a fee and other considerations the right to use its name and system of business operations; a person or a company who has come into franchising contract with at least one franchisee. (Jucevicius and Smitas, 1999, p.81).
Ownership entry mode is the entry mode into the foreign market when a parent firm either wholly owns or manages the foreign unit or relies on some type of joint venture agreement (Fladmoe-Lindquist and Jacque, 1995, p.1238).
III. Theoretical Background
A. Franchising
Franchising is a form of entrepreneurial activity in which an agreement defines that “the owner of protected trademark grants to another person or firm, for some consideration the right to operate under this trademark for the purpose of producing or distributing a product or service” (Caves and Murphy, 1976, p.572). Apart from a trademark that creates the value for franchisor, there is also competitive uniqueness in business methods, procedures and services offered to customers (Contractor and Kundu, 1998, p.29). Franchisor and franchisee must be viewed as indivisible parts in successful business formation.
B. Internationalisation
Franchising ventures are especially useful tools when foreign market must be entered, this is known as international franchising. International franchisees have been greatly regarded as market seekers that exploit their firm-specific capabilities abroad (Pak, 2002, p.28). Indeed, franchising is one of the fastest ways to expand in foreign countries with the least capital expenditures and management time. It would seem obvious that franchisors then without hesitation would enter a new market by franchising agreement, the contractual mode, still there are some that choose another way, ownership mode.
The reasoning and approach of these two different entry modes suggests that companies which invest their own capital into foreign branches assess the local market conditions more critically than those entering via contractual mode. This could possibly lead to a less effective market potential recognition by franchising mode entrants.
C. Reasons for Choice of Entry Modes
As recognised by Contractor and Kundu (1998), the decision of a franchisor which foreign entry mode to choose can be based on three general criteria: firm and industry specific factors, country characteristics and firm strategic intent and preferences. Evaluation of each of these would then lead the franchisor to the best-fit entry mode.
1) Firm and Industry Specific Factors
The firm and industry specific factors are those that differentiate firstly the company from its competitors and secondly the power distribution in the exact industry from other industries. Primarily, these factors are company advantages of resource particularity and capabilities, and the ability to cope with tension and form alliances, successful combination of which can result in company’s internationalisation. However, not all these advantages are mobile; often a sophisticated adaptation to the local market must be made to make them usable also abroad.
Many previous pieces of research have identified firm and industry specific factors that have impact on choice of entry mode. The firm specific factors are the size of the company, product specifics, and international experience. The industry specific factors are in this case the distribution of rivalry power in the particular industry.
Size of the Company. The size of the company represents the amount of resources the company has at its disposal and the capabilities it has developed, which can be considered as the knowledge resources of the company. Firms with greater resource availability have greater possibility to make an ownership mode entry into foreign market (Brouthers and Nakos, 2002, p.49).
Product Differentiation Specifics. Ownership of a unique product or advantages of production or service creation technology makes the company search for the balance between the possibility to maximise its profits and need to protect unique advantage from the competitors (Brouthers and Nakos, 2002, p.50). Companies that have differentiated products usually prefer equity modes of entry as, firstly, “the unique nature of their technology makes a priori evaluation of market benefits difficult” (Klein, Frazier, and Roth, 1990, as cited by Brouthers and Nakos, 2002, p.50). Secondly, if the company has once exploited the benefits of differentiated product in home country, it will have advantage in replicating this success abroad due to developed marketing and delivery system.
Industry Specifics. Commonly contractual mode is chosen by service industries while ownership mode is chosen by production industries, who open in foreign country their owned production outlet and afterwards create in this country a network of franchised sales offices.
Depending on the risks affecting the company, either entry mode can be chosen. Usually companies operating in intensive competition industries would choose the ownership mode of entry, which allows for fast reaction and possibility of forming a stable relationship with other key players. Forming such relationship would be harder for franchisees, as they are perceived as less reliable partners. (Fladmoe - Lindquist and Jacque, 1995, p.1241).
International Experience. Two contrasting views exist regarding international experience impact on decision making. The traditional view is that gradually while growing in size companies change their organisational choice and channels of distribution from contractual licensing and distributorship to company’s own operations (Johnson and Vahlne, 1977, p.18).
The opposite view expressed by Fladmoe - Lindquist and Jacque (1995, p.1240) in service industry analysis is that “as a service firm gains international experience, it develops a knowledge base about management of global business, thereby becoming more confident about engagement in long term international franchising.” In the early stage novice international firms have a tendency to rely on contractual relationship, letting the internal and market risks of foreign entity to be monitored by a local partner (Root, 1987 as cited by Fladmoe - Lindquist and Jacque 1995, p.1240).
2) Country Characteristics
According to Ramcharran (2000, as cited by Brouthers and Nakos, 2002, p.51) firms entering foreign markets can be confronted with unstable political, economic, foreign exchange, and/or social environments. Contractor and Kundu (1998) identify three factors affecting the propensity of company to choose franchising entry mode: country risk, cultural distance, and the host country’s openness to global business.
Country Risk. The country risk refers to economic and political uncertainty in the country where the business should be situated. This means the level of environmental uncertainty in the country that is politically stable (Contractor and Kundu, 1998,p.33). Of course political elections, membership in political or economic blocks such as NATO, EU, NAFTA, development of new regulatory systems, rise or fall of foreign investments in the country, and other significant issues relate to the company entry mode choice as well.