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FRANCHISING OFFERS RETAILERS AN INTERNATIONAL PLATFORM

By Curt Hazlett

At first glance Saks and Gap seem to have little in common. One sells couture and Chanel; the other, chinos and hot-pink capri pants. Yet both are aggressive retailers that share a keen desire to find affluent new customers. But when each announced separately on April 18 that they were entering promising new markets overseas, they displayed another shared trait: a willingness to expand without owning the new stores.

Saks said Roosevelt China Investments Corp. would license the Saks Fifth Avenue name in China, making Saks the first American department store with a presence there. Gap, meanwhile, said it had made a franchise deal under which Al Tayer Group, of Dubai, United Arab Emirates, will open stores in five Middle Eastern countries, a first for Gap in that region. Partnerships with local firms, either through licensing agreements or franchises, are hardly new. McDonald’s started circling the globe with franchises and burgers in the early 1970s, followed a few years later by The Athlete’s Foot, which now has some 500 franchised international stores. But with domestic markets maturing and new opportunities springing up in Eastern Europe, the Middle East, Asia and elsewhere, the world’s retailers are embracing franchising and licensing deals. Britain’s venerable Marks & Spencer department store has agreements with 20 franchisees outside the U.K., while Sweden’s H&M has granted Saudi Arabia’s Al Shaya Group the right to open 17 H&M stores in the Middle East.

Big retailers “are doing this more than in the past,” said Dianne Welsh, a management professor who holds the James W. Walter Distinguished Chairmanship of Entrepreneurship at the University of Tampa, in Florida. Welsh has written extensively about international franchising. “The U.S. market is highly saturated, so companies are looking to expand internationally at a much greater rate. Both franchising and licensing agreements are becoming more popular. The secret is to find the right partner.”

Done right, such deals give retailers the benefit of local market knowledge and continued control over their brand without the capital requirements of ownership. And, of course, they can also generate substantial fee income.

The China deal is not Saks’ first licensing agreement. Stores bearing the Saks Fifth Avenue name opened in Riyadh, Saudi Arabia, in 2001 and in Dubai three years later. Nor is this Gap’s first foray into franchising. The company announced that first international franchise agreement in January, under which FJ Benjamin Holdings is to open Gap and Banana Republic franchises in Singapore and Malaysia. (Gap owns stores outright in Britain, Canada, France and Japan.) Gap chose the franchise route for the Middle East and South Asia “because we don’t have a physical presence there, and there are either government barriers to directly owned stores or issues of logistics,” said spokeswoman Kris Marubio. “We don’t have relationships with the malls and real estate developers or the local labor market. It’s a win-win for us. We maintain control of the brand and the marketing, and our franchise partners have to buy clothing from Gap and Banana Republic collections.”

The strategy also spreads the Gap brand into new territory. By 2007 there will be Gap stores in 12 countries, more than double the five there are now, and there will be Banana Republic stores in nine countries, triple the current number.

The Saks agreement is important, “because this is the first U.S. high-end luxury retailer to go to China,” said Julie A. Frohlich, an attorney and director at the Boston law firm of Goulston & Storrs, who represented Roosevelt China Investments Corp. “All of the major European fashion houses — Armani, Dior, Chanel, Fendi — are already over there with freestanding boutiques and multiple stores.”

RCIC was established by the Roosevelt Trust, whose chairman, Tweed Roosevelt, is a great-grandson of Theodore and a cousin of Franklin. Under the licensing and consulting agreement, RCIC will open a 300,000-square-foot Saks Fifth Avenue store in the exclusive Bund district of Shanghai, followed by five more stores in China and Macau.

If licensing implies a hands-off approach, Frohlich says that is not the case with the Saks deal, which she says contains an ongoing consulting component that, among other things, will ensure service standards remain high in the new stores. Unlike a franchise agreement, “in which you license your trademark and system to someone else, here there is much more involvement, in some aspects daily and in others seasonal. It’s not just sitting back home and collecting the fee.”

Licensing can make a lot of sense for retailers, says Jay McIntosh, director of retail and consumer products at Ernst & Young Americas. “One of the advantages is that it allows you to get your brand in a new market without taking a great deal of financial risk, though you are taking reputational risk,” he said. “Retailers are struggling to grow the top line, and one way is through licensing arrangements.”

Whether a retailer expands through franchising or licensing depends in part on the market, says Geoff Smith, managing director of Retail Brand Marketing, a U.K.-based consulting firm. “The normal way of going into the Middle East tends to be franchises,” said Smith, who has worked in Saudi Arabia. Because the region generally has less retailing knowledge, a franchise — in which the franchisor provides the business plan, the marketing advice and the merchandise — is often seen as the best route, he says. “In a franchise, the franchisee wants the brand, the retail format and guidance from the retailer as to how things should be done, right down to the systems operations in the store and the customer service approach,” Smith said. “You take the whole caboodle.”

Smith offers the example of Debenhams, the U.K.’s second-largest department store group, which has franchise agreements in the Middle East with Al Shaya Group. Al Shaya “is doing the complete investment and is growing the number of stores according to the business plan,” he said. “It’s investing in the stores and in the stock and taking on the full financial weight.”

In contrast, most licensing arrangements leave details largely to the licensee, he says, “from developing the retail format to pursuing its own range of products for that marketplace. The brand owner has less involvement. They don’t want to know about labeling or getting legal documents.” (Frohlich, notes that Saks will safeguard its brand in China “by being very actively involved.”)

One downside to franchising is logistical. “Even franchising from near neighbors can be difficult,” said Smith. “In fashion retail these days, the faster you can turn your stock the better. One of the predicaments faced by several of the large groups in the Mideast is that they have to go according to the intake schedules of the main brand, and there are restrictions on getting shipments. It poses supply chain problems.”

Beyond that, though, franchising and licensing would seem to offer plenty of potential for retailers interested in expanding into new regions. “Whether the deals work out fine or not, the owner of the brand profits from the knowledge he acquires at someone else’s expense,” said Yke Veraart, head of Veraart Research, a Dutch firm. “After having acquired the knowledge, he knows the risk and budgets involved, and he will be more successful in the second attempt. Then he probably has the guts to do it himself and invest.”