Franchising in South Africa: business-format franchising was introduced to the South African...

Franchising has been established for a while in South Africa, but it is only recently that the public and private sector has rediscovered the many opportunities the sector can offer. This may be attributable to the fact that franchising did not enjoy a good reputation during the 1970s and 1980s, where the concept became little more than product or trade name franchising, which required franchisees

to use the franchisor's trade name and marks and sell its products. This left franchisees on their own in terms of unit management and operation, resulting in a product that was inconsistent in quality, and a weak franchisor-franchisee relationship that was described more as that of a supplier-customer, rather than as a business relationship.

Strong Growth

The franchising sector has enjoyed strong growth in the last decade. The Franchise Association of Southern Africa (FASA) estimates that it has created over 600,000 direct and indirect jobs. A survey conducted by Franchize Directions indicates that franchising generated almost R60 billion (US$6 billion) in turnover (sales) in 2000. According to FASA, there are around 348 business-format franchises operating in South Africa today, and a total of 478 franchised systems. In 1989, there were 59. FASA says that retail turnover through franchising has grown annually on average by 34 percent in the past five years and that the number of franchise systems has grown by 29 percent annually during the same time frame.

Of the 478 franchised systems, approximately 82 percent are local in origin. The remaining 18 percent are under master license agreements from the United States, Australia, Canada and Europe. Although there has been overseas expansion by local franchisors, many are hesitant when it comes to broaching the U.S. market, probably due to its size, scope and competitive nature, opting for the United Kingdom and Australia instead.

The Franchize Directions survey shows that in terms of ownership, 88.7 percent of the total number of business units are franchised units, 10.8 percent are company-owned and 0.5 percent are franchisor-franchisee partnerships.

The strongest growth in recent years has been in the categories retail and business, office and home services, and the trend is set to continue. Other potential growth areas are: business and professional services, tertiary education and training, and fashion (shoes and clothing).

Key to Economic Boosts

Franchising may well hold the key to boosting the South African economy. Many parts of the population do not have basic commodities that are easily accessible and franchising could help address this important market. The government has publicly voiced its support for franchising as an excellent tool for economic empowerment and skills transfer and, given the preferential treatment for businesses owned by the historically disadvantaged, many of those businesses are being encouraged to look at lucrative and low-cost franchises as a good investment. The trend for downsizing and outsourcing continues for large corporations in South Africa, making opportunities available for niche market franchises.

Business confidence in this sector is so positive that the Industrial Development Corporation (IDC), a state-owned financial institution, has expanded its lending portfolio to include franchising and has announced that they are to invest R2 billion (US $200 million) in the franchise sector in the next five years. This sentiment is echoed by the African Development Bank (ADB) whose focus is on developing joint ventures, co-financing initiatives and micro-enterprise projects in Africa. The ADB believes that South Africa is the ideal starting point for launching franchising into the rest of Africa.

There are, of course, some challenges facing this market. The first being that there is a lack of understanding of business-format franchising, particularly for new entrepreneurs. Further, even though there is a growing willingness amongst banks to finance franchise ventures, access to finance may still be difficult for new franchisors and franchisees. The greatest hurdle however, is the exchange rate, leaving South African business people with insufficient affordable franchise systems.

A Complex Marketplace

International franchisors often comment on the difficulty of breaking into the South African market. Indeed, the marketplace is very complex and fragmented, displaying both Western and African cultures. It is therefore vitally important that the franchise systems conduct an intensive feasibility study to determine buying patterns, staff productivity, language barriers and their potential competitors and to adapt their business formula accordingly.

It is also important for the international franchisor to recruit the right master franchisee, which knows and understands the internal market conditions. Many good concepts have failed in this country due to the inability to secure the right person. Some franchisors opt to form joint ventures with a local party, with both operating as the master licensee for the country, either opening outlets directly or sub-franchising the operation. Again it is important to ensure that the chosen party has the necessary expertise and experience in operating their brand in this country.

The franchisor should strongly consider setting up a pilot project in South Africa before embarking on an all out expansion of their product.

Fee Structures

International franchisors need to look very carefully at the structuring of master license fees. High upfront fees and a depreciating exchange rate with high interest rates are a less than ideal situation and have seen lucrative franchise concepts being unable to enter this market. One seasoned master franchisee commented that some license fees are simply too high to be financially viable. He had recently viewed a concept that required him to open 200 stores in order to get a return on the R3.5 million (US $350,000) license fee. Yet the firm only had 35 stores operating in the U.S.

U.S. franchise systems that are serious about expanding into this lucrative market and into the rest of Africa will probably need to consider partnership deals where knowledge is passed to the master franchisee partner, who in turn will open and run the pilot operation together with the local franchise company. The size and scope of the deal can vary in content, but forming the local partnership will result in a winning combination for both sides concerned.

Felicity Nagel is a commercial specialist in the U.S. Commercial Service in South Africa. She can be reached at (2721) 424280, etc. 2231, or via e-mail at Felicity.Nagel@mail.doc.gov.