Franchising in Brazil: foreign entrants build a presence

Franchising in Brazil: foreign entrants build a presence Version accepted for publication in the Journal of Business Strategy Vanessa Pilla Galetti Bretas and Ilan Alon Abstract Purpose: The purpose of this paper is to provide an overview of the franchising sector in Brazil, highlight the opportunities and offer strategies for practitioners. It also points out some challenges and gives suggestions to overcome them and thrive in the Brazilian market through the franchising system. Design/methodology/approach: This paper reviews both literature and practical sources providing primary data from interviews conducted with franchising experts from the Brazilian Franchising Association and a consultant company. Findings: International franchisors willing to enter the Brazilian market might face some challenges, such as the language barrier, the complex tax system, and the need for local adaptations. Foreign entrants should consider low control entry modes as master franchising and area development agreements, with local partners that know the Brazilian culture, business system, and regulations. Originality/value: Brazil presents a great market potential for international franchisors. It counts with an established franchising system and a stable regulatory environment. This paper provides relevant information about the characteristics, opportunities, and challenges to operate in the Brazilian market, offering suggestions of strategies and several possibilities to explore different regions, locations, and models across the country. Keywords: Brazil, Franchising, Internationalization, Market entry A large country, with large market potential Brazil presents great market potential for foreign companies, being the world's ninth largest economy by gross domestic product, with an estimated population of 209 million in 2018 and a big consumer base. Although the Brazilian economy has suffered some oscillations in the last decade, one sector shows steady growth and great opportunities for international investors: franchising. Emerging markets comprise of the largest and most dynamic markets for international franchisors, considering their population, per capita income, urbanization rates, and income distribution. Per capita income is significantly and positively correlated to the number of international franchisors in a host country (Alon, 2006). Considering all those indicators, Brazil is one of the most attractive markets for international franchisors. The Brazilian franchising sector figures are impressive. Franchising revenue in Brazil has experienced intense growth from 2015 to 2019, 34 percent, according to the Brazilian Franchising Association - ABF. In 2019, the sector revenue was US$ 46 bn, with 2,918 franchisors operating 160,958 establishments in the country. Brazilian franchisors are responsible for 1.36 million direct jobs in the country (ABF, 2020). In a country with continental dimensions, the fifth largest country in the world in area, and different regional settings, the franchising model is a good alternative for companies to expand their operations with less resource commitment, faster expansion pace, and higher returns. Moreover, since investment in an emerging market is a function of return and risk (Alon, 2006), through the franchising system, investors can reduce the risks by relying on local partners and franchisees' financial resources and knowledge about local demands and adaptation needs. Legal and institutional aspects are fundamental in franchising relations, and market decisions should consider those factors. A specific franchise law has regulated the Brazilian franchising sector since 1994, which gives security to franchisors and franchisees. The country has had a franchising association since 1987, contributing to the industry's best practices and ethical behavior. This article provides an overview of the franchising sector in Brazil and highlights the opportunities for international companies. It also points out some challenges and how to overcome them and thrive in the Brazilian market, based on the extant literature, authors' personal experience in the Brazilian franchising sector, and interviews with franchising experts from the Brazilian Franchising Association and a consultant company. Foreign franchisors in Brazil The first attempts of Brazilian companies to adopt the franchising model to expand their operations can be traced back to the 1950s, mostly in the education sector. Local second language schools such as Yazigi, Fisk, and CCAA were the pioneers. Companies from other sectors succeeded them, including the shoe company Arezzo that started to franchise in 1972, the cosmetics company O Boticário, that opened its first franchise store in 1982, and the fast-food chain Bob's that began its franchise expansion in 1984. The first international company to enter the Brazilian market using franchising was also from the education sector. The Japanese company Kumon initiated its operations in Brazil in 1977. Today the company has 1,563 outlets, the eighth biggest franchisor in Brazil. Kumon was followed by the US fast-food chain McDonald's, which started Brazilian operations in 1979 and is now the second biggest franchisor in the country, with 2,459 outlets (ABF, 2020; Livro ABF 30 Anos, 2017). Although domestic franchisors form the majority in Brazil, with almost 93 percent of the franchisors being local companies, there is plenty of space for foreign investors. In 2019, there were 214 international franchisors from 30 different countries operating in Brazil, a growth of 13 percent in comparison with 2018. The sectors with the most international franchisor brands are food service (25.7%), health and personal care (17.8%), fashion (13.6%), education (12.1%), and construction (7%). The other sectors represent together 23,8 percent of the international franchisors in Brazil (ABF, 2020). Most of the 214 foreign franchisors are from the United States (81 franchisors), followed by Portugal with 22 franchisors and Spain with 17 franchisors. The US is a reference market for the Brazilian franchising sector, meaning that Brazil has adopted the original US franchising concept, reflected both in the proportion of US franchisors that operate in Brazil and in the number of Brazilian franchisors that consider the US a potential host market. In 2019, 41,1 percent of Brazilian franchisor operations abroad were in the US (ABF, 2020). The foreign franchisors that operate in Brazil have, on average, 24 years of experience doing business abroad. According to a study about the internationalization of franchise chains promoted by the Brazilian Franchising Association (Rocha et al., 2016), 84 percent of the international franchisors in Brazil had operations in five or more countries when they first entered the Brazilian market. Those foreign franchisors have long-term, active engagement with their international operations, and Brazil was not their first destination. The governance modes used by international franchisors in Brazil vary considerably in terms of ownership and decision rights allocation between the franchisor and partners. The most popular mode international franchisors in Brazil use is direct franchising, where the foreign franchisor sells the business concept to an individual franchisee in the host country. Direct franchising is followed by master franchising and area development agreements as preferred modes. In a master franchising agreement, the franchisor grants to a master franchisee the right to operate franchise units and grant franchise rights to third parties. In an area development agreement, the franchisor grants the franchisees a defined territory in which they can develop units (Rosado-Serrano et al., 2018). The governance modes least often adopted by foreign franchisors in Brazil are company-owned units and franchising joint ventures, both considered high equity and control modes. In franchising joint ventures, the franchisor enters into an equity relationship with the foreign partner to set a joint venture company, adopting a master franchising or area development agreement with the joint venture company to expand the system (Rosado-Serrano et al., 2018). It is possible to observe a preference for modes with lower resource commitment and lower control, counting on local partner knowledge about the Brazilian market. Regulatory environment and the new franchise law A stable and transparent regulatory environment is essential for the success of franchising agreements. Brazil has a specific law that regulates the franchising sector, contributing to a consistent legal system for domestic and international partners. The country also has regulations to protect intellectual property, another crucial requirement for franchisors. Brazil adopts a first-to-file system, assuring rights to those who register the mark before. The Brazilian Patent and Trademark Office is the responsible authority. The first Brazilian franchise law (Law 8,955/94) was enacted in 1994, establishing contractual guidelines for franchise relationships in the country, applied to all franchising systems, whether foreign or domestic. This law strengthened the Brazilian franchising sector, providing a secure legal environment for franchisors and franchisees. Despite its benefits, the franchise law of 1994 required improvements and updates to make it more comprehensive. In 2019, the new Brazilian franchise law (Law 13,966/19) took effect. Some important points were maintained, such as the franchisor obligation of delivering the Franchising Disclosure Document (FDD) to the prospective franchisee at least ten days before the contract is signed, with the franchisee paying any fee. One of the main changes of the new law is the explicit exclusion of consumer or employment relationships from the franchisor-franchisee relationship, avoiding the application of employment and consumer protection laws to franchising arrangements. Moreover, the new law requires more detailed information in the disclosure document. It also allows the franchisor or franchisee to sublease commercial spaces and includes new protections to franchisees (Deffenti, 2020). International franchising agreements must be originally written in Portuguese or have a certified translation to Portuguese paid by the franchisor. One of the domicile countries needs to be chosen as the forum for any disputes arising from the agreement. Companies can select arbitration as a dispute resolution mechanism (Deffenti, 2020). The Brazilian Franchising Association recommends an in-depth study of the regulation and the adaptation of the disclosure documents and contracts to meet the requirements. Thus, the Brazilian franchise law of 2019 improves the legal environment for franchising. Brazil offers stable conditions for international investors through its specific franchising regulations, legislation to protect intellectual property in the country, and also through the Brazilian Franchising Association supporting initiatives, such as orientation lectures, conferences, and training courses. Market opportunities Strong domestic franchising sector In some emerging economies, such as China and Russia, the franchising system faces more barriers regarding legal aspects, property rights protection and consumer acceptance of Western firms (Alon and Banai, 2000; Alon and Kruesi, 2019). In Brazil the model is well-known, accepted and established. The development of domestic franchise operations can be traced back to the 1950s, the sector has had an association since 1987, and it has a specific law to regulate activities. Moreover, international franchisors have operated in the country since the 1970s. Brazil has a robust domestic franchising sector, comprising almost 93 percent of franchisors. This signals an excellent opportunity for international investors that intend to enter the Brazilian market since they can count on qualified and experienced potential local partners and operators for their international brands. Through lower equity and control governance modes, such as master franchising and area development agreements, international franchisors can share the resource investment and risks of the operation with local partners, besides counting on their knowledge about the Brazilian market and the franchising model. For instance, until 2018, Domino's Pizza was operated by the Brazilian franchising holding Grupo Trigo, which operates four other brands: Gurumê, Koni Store, LeBonton and Spoleto. Another example is the Brazilian private equity company Sforza, which controls several domestic franchising brands, including Mundo Verde and Ronaldo Academy. It also operates the U.S. brands Taco Bell, Pizza Hut, and KFC, as a master franchisee. The Brazilian Franchising Association promotes periodic networking meetings and events that can be a channel for international franchisors to find local partners. The entity organizes one of the biggest franchising fairs in the world, the ABF Franchising Expo, that in 2019 attracted 66,000 visitors and 410 local and international exhibitors, including franchisors, consultants, lawyers, and suppliers. Brazil: several countries in one Brazil is a country of continental dimensions characterized by a large regional diversity in economic, social, and cultural terms. The wealthiest part of the country, around the capital Brasília in the Federal District, has a GDP per person equivalent to Italy, and the poorest part (the States of Maranhão and Piauí, in the Northeast Region) has a GDP per capita comparable to Jordan. Also, in terms of GDP per capita, São Paulo State can be compared with Slovakia and Rio de Janeiro with Estonia (The Economist, 2014). The population and per capita income are historically concentrated in the Southeast region, especially in the big cities: São Paulo (12.25 million inhabitants, equivalent to Argentina), Rio de Janeiro (6.72 million inhabitants, equal to Ecuador), and Brasília (3 million inhabitants, equivalent to Jamaica). However, we observe market saturation of the main metropolitan cities and spatial delocalization of economic activities to other regions (Brazilian Institute of Geography and Statistics, 2020; Gouvea et al., 2018). Sectors such as agribusiness, mining, and oil and gas led the expansion of economic activities to other regions, creating new poles in the Northeast, North, and Midwest regions. Smaller cities in the South and Southeast regions are also turning into important consumer markets and attracting more attention from investors (Gouvea et al., 2018). The retail and services sectors follow this trend. Among the 30 new shopping centers opened in 2019 or inaugurated in 2020, 15 are located in the Northeast and Midwest regions, and seven are in countryside cities of São Paulo, Rio de Janeiro and Paraná states, in Southeast and South regions (ABRASCE, 2020). The production and consumer market expansion to other parts of Brazil represents an excellent opportunity for domestic and international franchisors. Franchising operations can be found in more than 40 percent of the 5,570 Brazilian cities. According to ABF, in 2014, 43.6 percent of the franchisors had operations in towns with fewer than 500 thousand inhabitants. In 2019, this rate grew to 48.2 percent. In other words, it is possible to observe a decentralization movement of the franchising activities towards the countryside, with new high potential markets to be explored. However, international investors entering the Brazilian market should have a welldefined strategy of which internal markets to explore. There is a need for adaptations even across regions in Brazil and new entrants must consider the logistics, distribution needs, and also specific state and city levels tax regulations when defining the expansion strategy. Location possibilities and different models Finding a good location is a basic condition for franchise networks, which must consider as demographics, access, traffic, visiting flow, and visibility. According to the Brazilian Franchising Association, in 2019, more than 60 percent of the franchise outlets in Brazil were street stores, and 25 percent were located in shopping malls. Each location option has its pros and cons. For instance, outlets in shopping malls can have higher revenue due to joint marketing efforts and the traffic flow of visitors. In 2019, there were 577 shopping malls in Brazil, with 502 million visitors per month, on average, according to the Brazilian Shopping Centers Association (ABRASCE, 2020). However, malls have higher occupation costs and rules for opening hours for customers and suppliers. On the other hand, street stores have lower occupancy costs but require more investments in marketing and security. Several new location options are getting more attractive to both domestic and international franchise chains. Stores in supermarkets, transport terminals, hospitals, clinics, and universities are becoming more popular in Brazil, with seven percent of total franchise outlets located in those places in 2019. Moreover, e-commerce sales, coupled with franchisees networks, are also increasing in Brazil. Almost 61 percent of the franchisors operating in the country adopted e-commerce as a sales channel in 2019, an impressive increase in comparison to the 42 percent rate in 2018 (ABF, 2020). Other operating models that are becoming more popular in the Brazilian franchising sector are lower investment options. Kiosks, trucks, store-in-store, and homebased operations are being adopted as strategies to reduce the occupancy costs, test new markets, train new franchisees and develop multi-franchisees inside the network, and enter cities with fewer inhabitants. The participation of these types of models in the total number of outlets in Brazil increased from 14.4 percent in 2018 to 19.5 percent in 2019 (ABF, 2020). Those new operating models and location possibilities configure more opportunities for international investors. Obstacles for foreign entrants Lost in translation Brazil's official language is Portuguese. The Brazilians level of English proficiency is considered low, according to the 2019 EF English Proficiency Index. In a ranking that evaluates a hundred countries in terms of English knowledge, Brazil is in 59th position. Among 19 Latin American countries, Brazil is in 12th position. Brazil is the only country in South America with Portuguese as the national language. Most of countries in the region have Spanish as the national language. The demand for English and Spanish in the workplace in Brazil is increasing. However, as Brazilian public schools system do not fulfil this demand, many professionals need to invest in private language classes. For instance, in 2015, 87 percent of adults invested in private English schools after finishing their regular education (EF EPI, 2019). This scenario is an opportunity for second language schools. Franchisors in the education sector are pioneers in the Brazilian market. The Brazilian institutional voids in terms of education can open possibilities for international franchisors in this sector. At the same time, the language may be a barrier for international franchisors entering the Brazilian market. Research by the Brazilian Franchising Association titled "Global Mindset in Internationalization of Brazilian Franchises" showed that almost half of the domestic franchisors in Brazil don't have enough employees who speak English and Spanish to conduct international business. This implies that training investments may be required to improve workers' communication skills in foreign languages (Rocha et al., 2016). Complex tax system Brazil is a federation with the Federal District, 26 states and 5,570 cities. The Brazilian national tax system has diverse regulations, and each Brazilian federative unit (the Federal Government, States, Federal District, and Cities) has tax jurisdictions for instituting specific taxes and also tax benefits and incentives. As a result, there are different types (taxes, fees, and contributions) and distinct tax regimes across regions. The firms opened in Brazil and controlled by a foreign company are subject to the same taxation rules as other companies without any international control. There are also taxes on foreign trade activities. An evaluation of the trade-off between importing products or developing local suppliers is required (AMCHAM-BRASIL, 2019). Due to the complexity of the Brazilian tax system, international companies seeking to do business in the country should contact local consultants or specialized law firms to help them understand and manage corporate taxes. Local adaptations In franchising, one major concern relates to the balance between standardization and adaptation. In international markets, this issue becomes even more challenging. International franchisors operating in Brazil also have another level of complexity, the regional adaptations. Foreign franchisors need to adjust their marketing mix, prices, investment, and maintenance values, adapting to the franchisee and consumer profiles. Each emerging market has its peculiarities, and replicating what has been done in other countries may not work in Brazil (Alon and Kruesi, 2019; Risner, 2001). Several international franchisors that entered the Brazilian market faced difficulties, and, as a consequence of that, they reduced their presence, re-formulated their business strategy, or withdrew their operations. Some examples are the fast-food franchise chains Arby's and Wendy's that no longer operate in Brazil, and Dunkin Donuts, Subway, and KFC, which all left the country and returned some years later with new expansion strategies (Risner, 2001). Dunkin Donuts had to adjust the marketing mix to consider the consumer habits of the Brazilians, and include other options on the menu because donuts were not part of Brazilians eating habits. KFC adapted its positioning and prices, and now it is operated by a Brazilian franchising group, BFFC, that also controls one of the pioneer and most consolidated Brazilian fast-food franchisors, Bob's. As another example, Subway decided to adopt area developing agreements to develop each region. The examples above show the importance of testing the market and local preferences. Franchisors must find a balance between the global brand advantages and the integration of local attributes. Managerial implications We suggest some key strategies for foreign entrants to franchise in Brazil successfully. First, low control entry modes are a convenient way to access the Brazilian market. The choice of a low control entry mode, such as master franchising and area development agreements, enables the international franchisor to share the investment and risks with a local partner, besides counting on its knowledge about the culture, peculiarities, and regulations. Most international franchisors operating in Brazil followed this strategy (Rocha et al., 2016). Second, new entrants should find a local partner. Low control entry modes imply finding an excellent local partner. Brazil has a consolidated and robust franchising sector. Domestic franchisors and franchising groups can configure good potential operators for international brands. Moreover, Brazil has a network of consultant companies, law firms, and the Brazilian Franchising Association that can help companies find local partners and also help with other aspects related to the franchising expansion in Brazil. Third, entrants need to define the specific target market and expansion strategy to assure long-term competitive advantage and profitability. To determine this strategy it is important to verify the investment needed, return potential, logistic and distribution aspects, specific taxes, and particularly customer tastes. Local partners and consultant companies can be helpful. Fourth, new entrants must test the market and local preferences. Although standardization is part of the franchising system, some local adaptations to the Brazilian culture and tastes are required. For example, Pizza Hut offers more types of pizza styles on their menu, considering the unique and peculiar Brazilian style of pizza. Dunkin Donuts added tropical flavors and fresh juices. McDonald's adopted popular national drinks in their menu, such as guaraná (Risner, 2001). And Starbucks started to offer the famous Brazilian cheese bread and a smaller coffee size, adapting the menu to Brazilian breakfast habits. This article highlights the possibilities in one of the most promising emerging markets. Although there are some barriers to franchising development in the country, through the strategies suggested, international franchisors will be able to enjoy the opportunities and thrive in Brazil. References ABF. 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