Contractual Entry Strategies Essay

Introduction

Expansion into international markets is critical as it enables companies to diversify their revenues, spread risks and access cheaper factors of production, among other benefits (Carpenter & Sanders, 2014). A firm wishing to expand into foreign markets can use contractual entry strategies, foreign direct investment, and exporting, among other strategies. Contractual entry strategies involve using contracts such as licensing and franchising.

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Franchising is a popular global expansion strategy in which the franchisor grants the franchisee the right to use its trade-mark, trade-name as well as processes to produce and market a product or service. It is motivated by the desire to control operations and brand, standardization of products and services, and cost control. Its benefits include low cost and risk, rapid expansion and high probability of success due to local knowledge by the franchisee. (Ahsan & Musteen, 2011) However, franchising contracts are cumbersome to complete due to critical negotiating issues such as royalty fees and rights of each party.

Licensing is an international strategy where a firm grants another the right to use a product or service (Carpenter & Sanders, 2014). This can either be the right to produce or market a product or service. It is suitable where the licensee has a significant market share that can help the licensor to access and penetrate the target foreign market easily (Ahsan & Musteen, 2011). It is a low-cost entry strategy since the licensor avoids costs such tariffs and other barriers to international trade. Besides, it requires low capital investment and involves fewer legal and financial risks. However, the firm will lose the control over production and marketing to the licensee. The licensee also accesses the business and trade secret and can become a competitor once the contract expires. Besides, the firm can lose intellectual property and damage its brand reputation if the licensee mismanages the production and marketing of the licensed commodity.

US Franchises Available in Saudi Arabia

There are several US multinationals that have franchises in Saudi Arabia. McDonalds, Subway, Starbucks, and Dairy Queen are among the most successful US franchises in the Kingdom. McDonald's has sold several outlets to Saudi companies in its quest to have at least 95% of its stores as franchises by the end of 2018. Riyadh International Catering Corporation operates 73 McDonalds' franchises in the Central, Eastern and Northern regions. Reza group owns and operates McDonald's stores in the western and southern regions of the Kingdom.

What is striking most of these US franchises is the manner in which they dominate the markets in Saudi Arabia. Most of the US franchises in the Kingdom are profitable and control a significant share of the market. For instance, McDonald's has sold franchises and has its stores operating in every region of Saudi Arabia (Khan, 2014). They are even selling company-owned outlets to franchisees to reduce operating costs and capital investments.

Reasons for the Success of US franchises in Saudi Arabia

The success of the franchises is attributable to several factors. Firstly, Saudi Arabia is a large market with a population of about 32 million as of 2017. More than 80% of Saudi population lives in urban areas where most franchises are located. The large population offers a broad market for products and services. Besides, more than half of the Kingdom's population is composed of youth under 24 years old. The young are more exposed to new concepts and brands thus boosting the demand for products and services offered by the US and other Western franchises. Demand is also increased by the high number of tourists visiting Saudi Arabia. It is one of the most popular tourist destinations in the Gulf region. It gets more than 12 million religious tourists annually for the Hajj (annual Islamic Pilgrimage) to Mecca, the holiest city for Muslims (Alodadi & Benhin, 2015).

Saudis robust economic growth has also contributed to the success of US franchises. In 2016, its GDP per capita was $19,922. Retail spending in Saudi Arabia was $246 billion in 2015 and is expected to grow significantly over the next years. Food is topping the list of retail spending, and this explains why the most successful franchises are McDonald's, Starbucks, and Subway, among other firms. The Kingdom's economy is expected to continue improving following the reforms initiated by the crown prince Mohammad bin Salman. These measures include fighting corruption and reducing reliance on oil.

Besides, a majority of US franchises in Saudi Arabia are owned by local and regional companies such as Olayan, Saudi Catering & Contracting Company, Naghi Group, Kuwait Food Company (Americana), Shahia Food Ltd., and Al Safwa Food Group, among other companies. These firms have experience in the market as well as the financial and other capabilities to make the franchises successful.

Furthermore, the government has supported franchising as a way of enhancing economic growth. It considers franchising is an opportunity for growth of small and medium enterprises. It launched an initiative to build a successful and sustainable franchise industry (Michaels, 2018). The government appointed the World Franchise Associates, a London-based firm, to lead research and create awareness on franchising in Saudi Arabia (Michaels, 2018). Favorable policies on franchising have contributed to the success of US franchises in the Kingdom.

Risks of Establishing a Franchise in Saudi Arabia

Saudi Arabia is an economy dependent on oil although the crown prince is trying to reduce its dependence on oil (Aarts & Roelants, 2015). Unfavorable changes in global oil prices can lead to the slowdown of the economy thereby decreasing the demand for products and adversely affecting the profitability of US franchises in the Kingdom. A stable economy is essential to the success of the franchises.

Political instability and conflicts in the Gulf region can also reduce the viability of the franchise in the country. Saudi Arabia has aggressively participated in regional disputes, including the war in Yemen and Syria. This has negatively affected its relationship with Iran, Syria, and Qatar, among other countries. The region also faces the threat of terrorism from groups such as Al Qaeda, ISIS, among other groups. Increased tensions between states in the region would affect the economy thereby reducing the profitability of US franchises.

A company also risks losing control of the business operations to the Saudi firms. This includes disclosing trade secrets and business processes. Some of the franchisees can exploit such opportunities to gain experience and establish rival businesses when the franchise term expires. Finally, the legal framework is Saudi Arabia is considered inadequate. Until recently, there were no specific laws relating to franchising and franchises were guided by agency law. Despite the introduction of franchising laws, the legal system in the Kingdom is inadequate to resolve potential conflicts. Franchising agreements are associated with conflicts between the franchisor and the franchisee hence a robust regulatory system is necessary to address such issues.

Foreign Direct Investment and Collaborative Ventures

Foreign direct investment involves establishing a physical presence in a foreign country through direct ownership of assets (Cavusgil, Knight & Riesenberger, 2013, p. 431). This global expansion strategy entails forming a fully-owned foreign subsidiary or branches. It is beneficial since the company retains full control of the operations of the foreign units and has the highest potential return since all profits belong to the owner. However, it carries the highest risk of all the international strategies due to the substantial capital investment required (Carpenter & Sanders, 2014). A firm should only consider a foreign direct investment if it has adequately studied and understood the foreign market to reduce the probability of failure. Saudi Arabia has taken significant steps to encourage foreign direct investments. The government recently announced the removal of the restriction on foreign ownership in the retail and wholesale sectors. Foreign firms in these sectors can now be 100% foreign-owned, but other industries are still restricted. The Saudi Capital Market Authority also reduced the minimum capital investment requirement for foreign direct investments from $1 billion to $500 million. However, the 'Saudisation' policy implies that foreign firms must employ Saudi citizens in certain positions.

Collaborative ventures is a partnership in which two or more firms pool their resources and share risks in a new venture (Cavusgil, Knight & Riesenberger, 2013, p. 431). In this case, a US company would identify and partner with a Saudi firm to start and operate a new enterprise in the Kingdom. The strategy is less risky than foreign direct investment since the partnering firms share the total risk. Besides, it requires less capital than a Greenfield investment. However, it generates a lower return since the profit from the venture is shared among the participating firms (Cavusgil, Knight & Riesenberger, 2013, p. 431). Besides, the company will not have full control over the operations of the new enterprise. Collaborative ventures are suitable for expansion into foreign markets where there are restrictions on foreign ownership.

References

Aarts, P., & Roelants, C. (2015). Saudi Arabia: A Kingdom in Peril. Oxford: Oxford University Press.

Ahsan, M., & Musteen, M. (2011). Multinational enterprises' Entry Mode Strategies and Uncertainty: A Review and Extension. International Journal Of Management Reviews, 13(4), 376-392. http://dx.doi.org/10.1111/j.1468-2370.2010.00296.x

Alodadi, A., & Benhin, J. (2015). Religious Tourism and Economic Growth in Oil-Rich Countries: Evidence from Saudi Arabia. Tourism Analysis, 20(6), 645-651. http://dx.doi.org/10.3727/108354215x14464845877995

Carpenter, M., & Sanders, G. (2014). Strategic Management. Harlow: Pearson Education Limited.

Cavusgil, S., Knight, G., & Riesenberger, J. (2013). Framework for international business. Upper Saddle River, NJ: Prentice Hall.

Khan, M. (2014). Restaurant Franchising: Concepts, Regulations and Practices, (3rd ed.). CRC Press.

Michaels, L. (2018). Saudi Arabia Eyes Growth in Franchising. Franchisetimes.com. Retrieved 20 April 2018, from http://www.franchisetimes.com/news/March-2018/Saudi-Arabia-Eyes-Growth-in-Franchising/