Friday, December 6, 2013

Buyer Beware in the Malaysian Franchise Industry

Some winners, but plenty of losers in a rigged system

Malaysia’s franchising industry is considered a potent road to success, having produced such stellar figures as Vincent Tan Chee Youn, who got his start with the McDonalds franchise before moving on to the Berjaya conglomerate and gaming through Sports Toto. Despite becoming one of the country’s most successful Chinese entrepreneurs, worth an estimated US$1.3 billion, he is still known by his nickname Hamburger Tan.

Tan’s success has driven the dream of becoming a successful entrepreneur to be shared by many. The franchise industry has made many successful consultants like Abdul Malik Abdullah of D'Tandoori fame, but unfortunately a large number of local franchise failures are hidden with all the hype about the success of the industry. Even though the industry can point to the success of many local franchises like Nelson's and Marrybrown, the vulnerability of any successful branded franchise can be seen in Secret Recipe going into receivership in Australia.

In fact the industry is packed with consultants and brokers who conduct courses and workshops which may encourage the vulnerable into inappropriate products and businesses, charging as much as RM160,000 (US$50,000) to secure company registration as an approved franchisor. Many franchisors are reckless and oversell their ideas to gullible people who lack any sense about doing due diligence on a business concept.

Under the then-Mahathir government in the 1980s, retired public servants were encouraged to become Bumiputera entrepreneurs through buying into franchises. The then-deputy domestic trade minister Abdul Kadir bin Sheikh Fadzir became the public proponent of franchising, organizing seminars and workshops on the concept all over the country.

Although Singer was the first company to introduce franchising to Malaysia in the 1940s, the first F&B successful franchise in Malaysia was the American hamburger and root beer chain A&W, which opened its first outlet in Petaling Jaya in 1963. Very soon many other successful outlets were opened all around Klang Valley. In the following decades, McDonalds, KFC, Pizza Hut, and Kenny Rogers came to the country.

Franchising became a massive growth industry with the establishment of the Malaysian Franchise Association in 1994, attracting a number of consultants and brokers. A screening and selection system, as well as a number of bureaucratic requirements were enacted, so that the procedure to become either a franchisor or franchisee became cumbersome. Consequently, after a very hopeful beginning, the combination of bureaucracy, regulation, procedure, and plain dishonesty among some franchisors has brought misery and suffering to many unsuspecting franchisees.

The Franchise Development Program (FDP) requires franchisors to undertake a number of steps and procedures before they can be registered. Registration enables a company to be eligible for a grant of RM100,000 for Bumiputera companies and RM50,000 for non-Bumiputera companies. The catch is that ministry officials require franchisors to employ a consultant, usually of their choosing to aid the process, where fees may be as high as 40 percent of the grant. Many unhappy franchisors have suggested to Asia Sentinel that some collusion exists in this process between consultants and officials.

Most consultants are not registered with the US-based and internationally recognized International Franchise Association (IFA). These consultants commonly approach potential franchise businesses promising expansion through franchising. They arrange for grants without much scrutiny over the viability of the businesses they have been engaged to develop franchise models. Consequently the market is full of many dubious business models.

A number of franchisors see franchising as a means to extract money from franchisees rather than a means to develop a brand and business. This results in franchises that have little real potential. Once-successful SMEs that go down this track are poorly advised and often fall into financial difficulties. Franchisees who sign up with them don't last long with the result that the only group who has profited out of this process is the consultant.

The problem today is there are so many franchises up for sale, some bona fide and some not. The quality on offer varies widely. Nascent entrepreneurs with little or no experience make the assumption that regulated franchises have been screened for business model viability. What’s more, some franchises like or Pusat Bahasa Titian Jaya are alleged to falsely imply that the company has a connection with Cambridge.

For example two Kuala Lumpur entrepreneurs signed a franchising agreement with an F&B franchisor based in Johor who encouraged the franchisee to install a music box and have a band at the venue for extra franchisee costs outside the royalty agreement based on sales turnover. As a result the franchisee business became commercially unviable and the franchisor insisted on a legal remedy which cost the two entrepreneurs their full investment of over RM600,000.

Most franchise agreements have been drawn up in favor of franchisors, some with traps that bring many small franchisees undone such as extra charges over and above royalties. When business flags, franchisor requirements put the concern into financial trouble. A litigation lawyer disclosed that due to the unfairness of the Franchise Act in its favoritism towards franchisors, very few franchisees have been successful in gaining any legal remedy from unscrupulous franchisors. Most court decisions go against them.

There has also been criticism of the Malaysian Franchise Association lack of effort in promoting ethics within the industry by its membership. Part of the problem may appear to be in the way the Perbadanan Nasional Bhd (PNS) is promoting grants and start-up loan packages to businesses. The question is whether this is encouraging predator consulting practices within the industry.

The onus is on the Malaysian Franchise Association, as many within its membership desire, to do its part in cleaning up the industry. Potential franchisees need to look very closely at any franchise they may consider signing up to. This requires a review of how the business model works and scrutiny about both how much the business would cost to operate on a monthly basis, the potential revenue, and total payments required to be paid to the franchisor through the agreement. Is the planned location suitable for this franchise? Potential franchisees should go and look at the operations of other franchisees and talk to them about the franchise business, focusing particularly on the relationship between franchisor and franchisee.

Potential franchisees should look at what they are getting for the fees they pay. How much is the franchisor putting back into brand support and promotion? They should ask who is the franchisor and whether they really have the affiliations they claim to have. Is the franchisee entitled to new products? if so, are there any extra, one-up fees besides royalty payments?

In the event of financial difficulties or the need to close down for any reason, can the franchise agreement be easily terminated? Does the franchisee have the necessary skills and knowledge to run the business and what sort and duration of training is offered by the franchisor? Most importantly, does the franchisee have sufficient financial backing to undergo this venture? 

Surprisingly, these types of questions are rarely asked by new entrepreneurs.

Finally what should also be considered from the national perspective, is the effect on national creativity and innovation from the franchising phenomenon. Although the thinking behind franchising is that those who engage in franchising are less likely to fail in a new business, the framework of franchising itself frowns upon franchisees who themselves innovate. Thus franchising on a wide scale may have the effect of suppressing entrepreneurial creativity. Franchising kills creativity. ‘Asia Senitnel’