India is now officially Australia's third largest trading partner. With a population in excess of 1.3 billion and a growing and increasingly confident affluent middle class of between 300-400 million people, India is proving to have an insatiable appetite for all things western. Fortunately, now more than ever Australian businesses are looking to break out of the straitjacket of a small domestic market and taking Australia’s successful franchise business model to the world. Why are franchises so popular in India? Think of McDonald’s, Gloria Jeans, Dominos and Just Cuts, all of which operate as franchise businesses in India and all those other services industries that involve the use by one business of another’s branding, image, goods and importantly business systems for running a business.
Legal considerations for franchising
Franchises are legally independent businesses where in return for the use of the franchiser’s business model and, commonly, ongoing training and support, the franchisee pays a fee to the franchiser. The fee could be a lump sum entry fee and/or an ongoing royalty. The royalty is usually calculated as a percentage of gross turnover or some other measure of the franchisee’s success. The contract between the franchiser and franchisee can be as simple or as complex as the parties agree and as consistent with local laws. While the franchisee is conducting their own independent business, so as to protect the franchiser’s brand and rights in their business model the contract will commonly also provide some level of supervision or right to review the performance of the franchisee in conducting their business.
Franchising as a method of business operation is one of the fastest growing sectors of many economies as diverse as Australia, the United States, Singapore and India. There are many good reasons for a business to be to be successful if a franchise model is adopted:
- Generally less capital is required to establish the business.
- Proven method of business operation.
- Use of existing brand names and reputation save time in establishing market recognition without the expense and risk of direct investment by the entrepreneur.
- Attraction to the entrepreneurial spirit where people feel the need to feel ownership while still providing the franchisee with support to run their own business.
- Large geographical areas such as Europe, United States, Australia and India can be serviced without the need for expensive distribution systems.
- Franchisers can harness local knowledge especially where the market is large and fragmented as in India.
In addition to the above, foreign businesses are not permitted direct investment in retail in India. Opening a franchise is the one sure way around that prohibition. Franchisers should, however, be aware not to make some of the more common mistakes when entering a market such as India. There are some non-negotiable conditions that should be satisfied before any business expands into India or indeed any other country.
Expanding an immature business
The local business must have all of the following:
- Proven mature business system that is capable of being replicated elsewhere with only minor refinements.
- Strong cash flow in the home territory.
- Senior management that is capable and available to concentrate on the new territory.
Before offering a franchise in the Indian market, the business should have:
- Consulted local Australian experts with experience in franchising internationally.
- Consulted with Australian lawyers experienced with franchising in India to facilitate your entry into the Indian market.
- Developed an overall plan to expand internationally.
- Developed an understanding of the Indian market especially local customs. For example McDonald's in India, instead of making the world famous beef-laden Big Mac that would offend the predominantly Hindu local culture, developed the Maharaja Mac based on chicken.
- Decided on the legal form of franchise and protection of the intellectual property rights of the franchisor. For example, is it better to have a master franchisee for the whole of India (the most commonly adopted international model); one or more master franchises for different areas of India where these sub-master franchisees effectively sub franchise the operation of the franchise business; or separate franchisees in different areas of India.
Looking at Just Cuts as an example, in opening in India it decided the best method was a master franchise model and chose Gitanjali Lifestyle Group as their master franchisee. Whether a master franchise or local franchises is the better model, the ability to choose the best person to operate the franchise business is essential.
Ascertaining the potential franchisee’s financial capabilities and competencies is essential. There is little point in appointing a franchisee who simply fails to pay the agreed royalty or fails to deliver the standard of service required by the franchiser. A master franchisee takes on this responsibility and is one reason the master franchise model is the more popular choice of franchisors. Indians are by nature entrepreneurial and what could be seen as the shackles of the franchise system needs to be carefully blended with that entrepreneurial spirit. Again, the ability to choose the right business operator with the right attitude is essential to the franchisor’s success in India. Make sure you have:
- Taken steps to properly protect the franchiser’s intellectual property rights in copyright, trade marks, designs, patents and trade secrets. For example, where certain rights can only be properly protected by registration (such as trade marks (brands) designs and patents) those rights need to be registered in India. India is a signatory to international conventions protecting intellectual property rights and takes the protection of these rights seriously.
- Taken advice on local laws so that the new franchise operation complies with all relevant laws in India.
- Obtained knowledge of local competitors especially other franchises operating the same type of business.
- Considered the taxation regimes that apply to the franchise operation. It is important to know local state sales taxes and property taxes and be aware of withholding tax on royalties and profits.
- Factored in calculations of revenue returns any restrictions on lump sum payments and royalties on domestic sales and export sales. For example, an Indian franchisee is permitted to remit royalty payments towards the use of a trade mark of up to one percent of domestic sales and two percent of exports without prior government approval. Where there is also a technology transfer to the Indian franchisee, royalty payments of up to five percent of domestic sales and eight percent of export sales and a lump sum of up to US $2 million is permitted, without prior government approval. Government approval is required above these amounts.
The wrong decision based on a lack of market knowledge could mean the difference between success and failure.
India’s legal system and franchising
Unlike Australia where the relationship of franchiser and franchisee is closely regulated under the Trade Practices Act and the Franchising Code of Conduct, currently in India there are no specific laws dealing with franchises. Laws that affect franchises in India relating to intellectual property, labour laws, taxation, consumer protection, competition, property and exchange control laws all overlap. Some of these laws are state-based while others are federal. The appointment of competent legal and financial advisers in Australia who have solid arrangements with franchise experts in India is of utmost importance. In setting up a franchise in India, it is important to obtain advice on such diverse pieces of legislation as the Indian Contract Act 1872, Monopolies and Restrictive Trade Practices Act 1969, Consumer Protection Act 1986, Companies Act 1956, the Foreign Exchange Management Act 1999, Income Tax Act 1961 and over 12 pieces of legislation dealing with labour laws and how those laws interact with Australian legislation and your existing business. -James Millea is a corporate and commercial lawyer and trade marks attorney with Argyle Lawyers and chairman of the Legal & Professional Services Committee of the Australia India Business Council (NSW).