Entry mode analysis and the Internationalisation of business
- explaining and evaluating the case of McDonald’s

 

David Law,
Wolverhampton Business School,
Wolverhampton University
Draft Version

 

D.Law@Wlv.ac.uk

 

ABSTRACT

This paper examines the choice of franchising as an entry mode in the strategic process of internationalisation by evaluating the case of McDonald’s with reference to debates on (1) methods and stages of internationalisation (2) internalisation and alliances (3) specific hypotheses about the changing optimal mix of company-owned and franchised outlets. Claims that McDonald’s record is supportive of the franchising life-cycle hypothesis of Kelly and Oxtenfeldt are criticised while that hypothesis itself is critically reviewed in the light of recent analyses of internalisation/outsourcing and trends in internationalisation. Lastly, the significance and comparability of the McDonald’s case is examined with reference to other fast food firms and to the internationalisation of retailing

 

MARKET ENTRY MODES : COSTS, BENEFITS AND STRATEGY

There are many different entry modes that go with internationalisation e.g. exporting (direct and indirect), licensing, foreign direct investment (whether it be in export promotion, distribution, assembly or more extended production); equity joint ventures, partnerships and formal or informal collaborations involving non-financial contributions as well as or instead of capital: management contracts (e.g. hotels); participation in consortia (e.g. construction), turnkey projects and build-operate-transfer deals (e.g. utilities). Where direct or indirect participation in international production abroad is concerned the internationalisation process may be bound up with strategies of cost reduction or strategic asset-seeking rather than or as well as ones that are purely market-seeking (a good reference on internationalisation and entry modes is Buckley, P.J. and Ghauri, P.N., eds, 1993). However, in services like fast food, where supply needs to be close to customers, market-seeking is dominant.

Much early analysis focused on the rise and spread of international production after World War 2, i.e. why FDI in production abroad was preferred to exporting and/or licensing of know-how. Various economic theories of the transnational corporation (TNC) were brought together in the ‘eclectic’ OLI paradigm in 1976 which allows for the influence on entry/expansion mode decisions of (1) a firm’s competitive advantages (O), (2) certain managerial costs of doing business through external market transactions relative to that for in-firm production (I - for internalisation) and (3) the costs and benefits of using a particular location rather than others (L). However, this paradigm has been criticised for being insufficiently dynamic, especially with regard to the role of a particular firm’s strategy. In response, Dunning (the originator of the OLI paradigm) has suggested adding a fourth influence on internationalisation decisions, namely (4) firm-specific strategies that often reflect the unique experience and administrative heritage of a firm (see Dunning, J. H., 1993). Thus there is widespread recognition that the choice of market entry modes is one aspect of strategy implementation. This choice is sometimes distinguished from the location decision and the selection of methods of development (such as between acquisitions, greenfield investments, partnerships and alliances : see R. John, 1997). However, these three types of decision are often inter-related. For example the choice between exporting and FDI is also a choice about the location of production, while a choice between licensing and FDI is also about the mix of internal and external relations in the firm’s growth. Indeed, it can be argued that international entry mode choice is inevitably linked to wider questions of strategy and corporate organisation e.g. the choice or balance between ‘multi-domestic’ and ‘global’ strategies, discussed later in this section.

Hill, Hwang and Kim have suggested that one way in which entry modes can be evaluated in strategic terms is by the constructs of degree of control, resource demands (e.g. capital) and how far ‘dissemination risk’ is contained i.e. the risk that firm-specific competitive advantages will be weakened because they are exploited by another firm be it a licencee, franchisee, venture partner or collaborator. They see each of these constructs as central to strategy formulation. They list the characteristics of entry modes as follows (Hill, C.W.L., Hwang, P. and Chan Kim, W., 1990).

Their listing misses out some entry modes of interest in examining the case of McDonald’s, notably different types of franchising. However, these constructs are important in the analysis of the entry mode choices of McDonald’s, though they need to be extended to allow for the strategic significance of resource access and mobilisation (as well as demands), the amount and speed of market penetration and the opening up (or closing off) of future investment options which can be an important aspect of long-term risk management. More generally, these constructs reflect concerns that play a significant part in corporate strategy that vary from one firm to another. Hill, Hwang and Kim go on to distinguish strategic, environmental and transaction variables that affect the entry mode decision ( op. cit. P120).

Hill, Hwang and Kim relate the strategic variables to the choice between an international, a multi-domestic and a more global strategy where the latter usually requires a higher degree of centralised control. National differences include government policies and culture. Where these are of great market importance the firm may be driven to pursue a multi-domestic strategy stressing the local more than the global. Then substantial autonomy is more likely to be given to branches or licencees abroad, or shared with foreign partners i.e. some control is sacrificed in order to gain enhanced market knowledge and access. However, being seen as more local (less foreign) may also open up access to a variety of resources e.g. ability to get local partners and able, ambitious franchisees; to gain access to national technology networks and related subsidies. If scale economies go with standardised products and parts then this can strengthen the case for using high-control entry modes e.g. more centralised control of product variation and promotion. High global concentration goes with oligopoly where strategic interdependence between firms increases the need for a global strategy and hence the desirability of high control.

In the case of fast food outlets capital costs are comparatively low and economies of scale in production are not very significant, although this is less true for some of the food and packaging supplies required by the restaurants. Since scale economies and capital costs are relatively modest, entry barriers are low in fast food and global concentration is lower than in an industry like cars or jet aircraft production. However, where prime sites for drive-in restaurants in big cities are limited, strategic positioning and oligopoly interaction are quite conceivable. Further, while scale economies in the production of the restaurant service itself are low they are significant for national/regional advertising and also the bulk buying of supplies so conferring advantages on big chains. These advantages facilitate the building up of a distinctive brand. It is also likely that there are scale economies in the management of franchised outlets e.g. linked to the provision of specialised services and also monitoring. However, this is only true up to a point as McDonald’s in the US has found in the 1990s (see later discussion of the 1997 reforms). An implication of this framework is that McDonald’s should aim for a higher degree of control and perhaps ownership over those activities where scale economies are significant. One way in which the strategic aspect of the work of Hill, Hwang and Kim can be extended concerns ‘global concentration’. Instead of taking this as a given which shapes strategy and the choice of entry mode, the latter may serve to alter market structure e.g. if one entry mode facilitates rapid internationalisation, the achievement of first-mover advantages and rising market share. This is an important consideration when assessing franchising.

As for the listed environmental variables, these all can give rise to risks, which if great, can be reduced by limiting the commitment of capital in foreign outlets, albeit usually reducing control as a result. However, from a strategic viewpoint being very cautious and conservative by investing capital mainly at home can be risky in the long term if growth inside the home country is slower than for most other regions (new big rivals emerge that may go on to invade one’s home market). The over-cautious firm may find its access to foreign markets, to opportunities to acquire assets and spread risks, to fund R and D and reap scale economies are less than those of its rivals. Growth through internationalisation is often vital to corporate success and survival in today’s increasingly integrated world economy.

Sales abroad are an important way in which a firm can grow. Higher sales may enable the firm to spread some costs (e.g. product development and advertising) over a larger volume of output and also raise its bargaining power as a purchaser (pecuniary economies of scale). It can be particularly significant for growth when the home country market is small and/or the home market is approaching saturation in a certain market segment. Foreign sales serve to reduce dependence on the home market and are thus one means of spreading risks. Exporting to foreign markets can face various types of barriers. Theories of the multinational enterprise (MNE) or transnational corporation (TNC) have often contrasted the profitability of exporting from the home country with that from moving operations abroad, either in the form of foreign direct investment (FDI) or joint ventures. FDI is a way to jump over trade barriers. It can also ensure greater closeness to, and understanding of, the market. It can lessen exchange rate risks in supplying a market - unless production abroad is heavily dependent on imported parts and/or materials. However, FDI, unlike exporting, goes with political risks to the firm’s control of, and ability to use, productive assets in the foreign country e.g. nationalisation and policy changes of a discriminatory character. FDI can face barriers within the host country, due to the nationalistic attitudes of governments and consumers. Joint ventures have often been seen as a way to overcome or accommodate to such barriers and reduce/share the political risks. But, in order to reduce one kind of risk through sacrificing some control, dissemination risk is raised. Much depends on the selection of, and relationship with, the joint venture partner i.e. as to getting their long term commitment and curbing opportunism.

In the case of many service industries exporting is not an option since localised provision is essential - as is the case in most retailing and fast food restaurants. Another much analysed mode is licensing which avoids the capital costs (and political risks) of foreign direct investment but gets a lower share of the foreign revenues ( via royalties) and runs the risk of the licensee becoming a major competitor in the long term (hence in the first table the ‘high’ rating of dissemination risk for licensing). Financial constraints may lead a firm initially to license knowledge and related expertise rather than establish fully-owned subsidiaries abroad - at least until its profits have grown a lot and/or political risks and barriers to investment by foreign firms have fallen. Franchising has been seen as a special type of licensing: but as we shall see this can be taken to imply a more arms length relationship than is often the case. The franchisor receives fees that secure it a share in revenues. Usually there is an initial franchise fee followed by a specified share in sales revenue and/or payment for providing goods and services. The franchisee obtains the normally time-limited transfer of certain rights to use the name and format within a certain area and, in addition, the more lasting transfer of knowledge and methods. The latter can involve high dissemination risk since an ex-franchisee may become a serious rival - as has happened once to M. Jollibee of the Philippines started as a franchisee of McDonalds but soon cut loose and built up a chain in the country that is larger than that of M. To add insult to injury they beat McDonalds into Vietnam. On the other hand, the franchisor may obtain from the franchisee valuable information on the particular foreign market (franchising as a form of market research !) and on the local economic environment e.g. contacts and costs. There is a case for distinguishing between ‘loose’ and ‘intense’ franchising - although this is inevitably a matter of degree. The most intense type might be called ‘relationship’ franchising due to the degree of bonding between the parties. One example of relatively ‘loose’ franchising is the ‘developmental’ type that McDonald’s first used, and later rejected, in Canada and the Caribbean (see later discussion of the Canadian case in the section on McDonald’s market entry mode choice).

Before examining franchising in more depth, several perspectives on the analysis of entry mode choice will be briefly noted, following the categorisation of Young et. al. ( S. Young, J. Hamill. C. Wheeler and J.R. Davies, 1989). The ‘economic’ approach makes use of Agency theory, transaction cost analysis and the related concepts of internalisation, costs of communication, negotiation and monitoring, information imperfections, opportunism and moral hazard which have been incorporated in the wider eclectic OLI paradigm. It assumes ‘rational actors’ with clear objectives and tries to specify costs, benefits and trade-offs. The article by Hill, Hwang and Kim mentioned earlier draws on this approach and especially the work of Anderson and Gatignon (E. Anderson and H. Gatignon, 1986). However, they try to extend it because they see the transaction cost approach as overlooking the role of global strategy in determining the best entry mode: in particular they stress how there can be interdependence between entry mode decisions in different countries that is of strategic significance. Apart from the economic approach Young et. al. distinguish a ‘stages-of-development’ approach that focuses on the sequencing of internationalisation and highlights the role of learning and the incremental development of international operations e.g. from direct exporting to an export-oriented foreign subsidiary and then to production abroad. While this approach has been associated with the Uppsala model (see Weidersheim, P.F. and Johanson, J., 1975) it has also been adapted by some economists, notably Buckley and Casson when analysing the timing of FDI (P.J/ Buckley and M. Casson, (1980). They draw on the economic approach, so that these two approaches can be seen as overlapping and contained within a broad ‘rational actor’ perspective. More recent writing (e.g. Strandskov, J., in Buckley, P.J. and Ghauri,P.N., eds, 1993; also Kogut, B., 1988, who sees various entry modes as going with different opportunities for organisational learning) on sequencing has seen internationalisation as part of an evolutionary process in which the firm’s organisation, resources and capabilities evolve in ways which alter the costs and benefits of particular entry modes: what was the best sequencing in the past may not be the best in the future as firms gain experience in, and reorganise for, internationalisation. In addition, technological developments, such as the advent of information technology, have altered transaction costs so that the relative costs and benefits of different entry modes may change. Also the economic environment in many countries has become more economically liberal and less hostile to foreign firms in the 1980s and 1990s. The third approach distinguished by Young et. al. they call the ‘business strategy’ approach, although it might also be termed the behavioural approach since they claim it draws on the work of writers, such as Simon and Lindblom, who stress the very bounded nature of rationality for firms due to individual and organisational limitations, including the role of vested interests within the firm (Simon,H.A. 1960; Lindblom, C.E., 1979). Such an approach by drawing on more psychological, sociological and (in-firm) political considerations, might help account for delays and sudden belated shifts in business policy (e.g. between entry modes, how much stress to put on internationalisation and how the firm should be reorganised) and more generally what, from a unified consistent rational actor perspective, would appear to be irrational mistakes that are not just a matter of imperfect information. More fundamentally, perhaps, the three categories of Young et. al. need rethinking in terms of how far they have an ‘individualist’ or socialised character. Greater stress on social context and past experience helps to bring out the way in which time horizons are shaped, networks constructed and trust built up. With regard to the choice of entry mode, firms that have more experience of, and ability in, building long-term relationships may be more inclined to engage in joint ventures, ‘intense’ franchising and the collaborative development of ‘dedicated’ suppliers - instead of favouring full ownership/FDI, vertical integration and an arms’ length relationship with suppliers. Japanese firms have been most cited in this context i.e. as drawing on their experience and skill in networking and using alliances to advantage, especially within Japan. However, firms from other countries, such as McDonald’s, may exemplify a comparable pattern of firm-specific learning and path dependence (on such questions see Blaine, M., 1994 also Blaine’s chapter, in Boyd, G,ed.1995). The ‘economic’ approach is portrayed by Young et al as basically focused on short or medium term optimal equilibria with many variables taken as given whereas the sequential approach allows for change in some variables due to learning (implying changing equilibria) and the strategy approach allows also for changing ideas and power balances within and between firms either in a rationalised way or in a more sub-optimal behavioural one. In practice some economic analysis does use game theory in analysing oligopolistic situations where pricing, investment and advertising decisions are made with an eye to rival’s perceived strategies and likely reactions i.e. a strategic dimension is considered. Recent economic writing on investment allows for the ‘option value’ of investments, including foreign investment, which may open up options by facilitating learning and later expansion. More generally, economists have begun to see rational choice equilibria in a more dynamic and developmental way so that the distinction between the three approaches is less clear cut than before. For example, rapid expansion aided by use of franchising might be part of a strategy to pre-empt rivals and gain first mover advantages. Alternatively, some use of franchising or joint ventures might be seen as a way of learning about specific locations/countries so opening up options for investment and/or take-over of franchised outlets or JV partner at a later stage. (Dunning J.D., 1999 article on OLI revisited; Smets,F. 1995).

 

FRANCHISING AS AN ENTRY MODE

The analysis of franchising, especially with regard to the nature, boundaries and internationalisation of firms, was somewhat neglected before the 1980s. Yet it is a form of business organisation that has been growing at an extremely rapid rate in the second half of the twentieth century. It is probably the fastest growing international entry mode, unless one allows for strategic alliances (which all too variously defined category on some definitions overlaps with both joint ventures and some franchising). S. Tikoo, says there were about 6,000 franchise systems in the world by the mid-1990s, that within the United States ( the pioneer of franchising ) more than a third of retail sales were from franchise systems and that this figure is forecasted to rise to nearly half by 2005.(Tikoo,S., 1996) In the UK, franchising was growing at about 30% p.a. in the mid-1990s. Further, whereas the number of companies using franchising was only 35 in 1981, by autumn 1996 it was 635 (O’Connor R.O., 1996). The Body Shop is an example of a small firm that grew very rapidly through franchising to become a multinational cosmetics chain. Format franchising in services has spread far and wide from the US where it first became common. L. S. Welch has shown how franchising not only became popular in Australia but also how within a few years Australian firms began to franchise abroad in New Zealand and South-east Asia and eventually in the US itself (1989).

Franchise systems are also of theoretical interest because they cut across certain overly neat distinctions between in-firm hierarchical and external/arms-length relations (hierarchies and markets). Analysis of franchising can be related to debates on incentives, agency, internalisation, flexibility and the rise of business networks and forms of co-operation. Much of the academic literature on transnational business has relied heavily on the distinction between internal and external transactions with each involving contrasting costs of search/selection, negotiation, monitoring and co-ordination. The rise of multi-plant and transnational firms has been explained partly in terms of falling internal transaction costs due to improved transport, communication, data processing and related systems for monitoring and co-ordination which have served to reduce or overcome ‘managerial diseconomies of scale’ of the multi-plant and transnational firm. Other factors are the increasing economies of scale and scope, sometimes related to the rise of research-intensive industries where high sunk R & D costs make it vital to achieve rapid sales growth in all major markets, particularly when new products mature more quickly than in the past. A similar argument applies to the international exploitation of an established brand. In terms of the widely used ‘eclectic’ OLI paradigm (Dunning,1993), the ability to exploit O (ownership- or firm-specific) advantages on a global basis through operations in many countries rather than just through exporting and/or licencing, was made more feasible and profitable by relatively lower internal transactions costs i.e. costs of I - internalisation. Multinational operations enable firms to access country/region-specific locational advantages (L) as well as gain entry to their markets. Access to such advantages via foreign investment has increased due to lower national barriers as policies have become more liberal. The internal/external contrast has highlighted the choice between licensing on the one hand and FDI on the other. However, franchising and co-operative business networks show that there are alternative ways to FDI and ‘arms length’ contracts in which firms can manage risks, economise on capital, carry out monitoring and gain crucial market intelligence. Indeed, relationships between legally separate entities can take on an almost ‘internal’ quality.. This possibility will be explored further when evaluating the relationships of McDonald’s with its franchisees and suppliers. Franchising can be seen as hybrid organisational form which falls somewhere between the extremes of full control with internal ownership and arms-length relations between completely independent firms. In analysing the role of incentive structures in contractual (formal and implicit) relations between firms or between employers and employees, the economic theory of agency (principal-agent theory) is useful. It may be that one of McDonald’s competitive advantages has become its ability to design and manage tightly specified franchise contracts and also often looser, but long-term, relationships with suppliers in such a way as to curb and control the risks/temptations of opportunism and moral hazard. Within a firm the employer is the principal and the employees are the agents. Opportunism by employees could involve shirking and /or misuse of company resources for personal advantage. Moral hazard arises in so far as a worker expects under-performance or asset abuse to be ‘covered’ by the firm out of profits or by other (more dutiful) workers. It is usually thought that the hierarchical nature of the firm and the disciplinary aspects of the employment contract contain/curb problems of opportunism and moral hazard more effectively (e.g. cheaply) than is the case for contractual relations between firms. Monitoring of employees can be more effective than monitoring of another firm if information flows more fully within than between firms. A separate firm may not provide as committed a supply or an outlet service as an in-house operation, especially if a firm builds up a strong corporate culture. In effect, transaction costs are lower for internal than external transactions. These advantages of internalisation may be offset by productive efficiency gains from specialisation and/or scale economies for an external supplier in supplying more than one firm - part of the case for out-sourcing. However, a franchisee is normally limited to serving just one firm - a form of exclusivity which implies an unequal dependency relationship. A franchisee is opportunistic when it behaves in ways that depreciate the brand value of the franchisor. If the franchisee already has other business interests so that the franchise is a way to diversify into a new activity then the franchisor will have reason to doubt the priority and commitment of the would be franchisee to efficiently promoting the long term sales of the brand. Hence a preference for franchisees which have no other business lines and which therefore are dedicated to the one company brand could be rational even though it restricts the number of franchisee candidates from which to choose. Even without being opportunistic the franchisee may be inclined to put less effort into marketing than the franchisor would wish if some of the effects of marketing ‘spill over’ to the territories of other franchisees and/or company-owned outlets ie. the franchisee does not bother with external effects that they cannot capture. More generally, these agency problems may be overcome to a significant extent by the precise terms of the franchise agreement. Shirking is unlikely if the franchisee is putting a large part of his or her wealth at risk (initial fee and specific outlet capital costs) and is receiving the residual profits (after the franchisor’s share in sales revenue/royalties and specialised payments for rent or advertising assistance have been made). However, it has been argued that these initial costs are sunk costs so that the real continuing incentive to meet the requirements of the franchisor stems from anticipated high profits i.e. economic rents. (B. Klein, 1995 see also the findings of P. J. Kaufmann and F. Lafontaine, (1994) It is generally accepted that the single-business franchisee will often be exceptionally motivated - more than would normally apply for an internal manager of an outlet owned by the company. However, the time horizon of the franchisee might be shorter than that of the franchisor, especially when a franchise contract nears its completion (e.g. after 10 or 20 years). The franchisor will usually have the right to take over the franchise so the franchisee might slack off in the last few years or at least be reluctant to make long term investments in upgrading the outlet. However, the possibility of renewal may be substantial (either due to franchisor policy and /or to legal protection for franchisees) and be considered normal unless there is evidence of poor performance and /or opportunism thus helping to maintain motivation and investment. Indeed, the franchisor may insert clauses ensuring they have the right to take back the outlet before the end of the contract if there is evidence of abuse that depreciates the brand or the franchisee fails to observe key clauses e.g. on providing full ‘open book’ information to the franchisor. Such information facilitates low cost monitoring. There is still the case of the franchisee who has reached their wealth goal and might ease up or cut corners. Here the possibility of a buy back by the franchisor may be the solution. A buy back would also be appropriate if the health of the franchisee had deteriorated, jeopardising performance. Here, clauses in the contract for coming to an agreement on valuation are useful, especially if there is some reward for developmental efforts by the franchisee.

Thus far the agency problems have been seen mainly from the side of the franchisor. If franchising is to work well and the supply of keen franchisees is to grow, agency problems from the franchisees’ viewpoint also need to be addressed. The franchisee needs plentiful information about franchise contracts and the record of the brand; also guarantees of assistance from the franchisor e.g. knowledge relating to the business format and training. as well as clear specification of its rights to the remaining profits after fee and royalty deductions and to brand status for a specified area and time period. A carefully written contract can reassure both parties, so facilitating mutual support and trust. Hence, skilfully conducted and contracted, franchising may provide an effective resolution of agency problems in a world of information imperfections. One feature of contracts is size of any initial fee and the royalty rate, usually a percentage of sales revenues. The royalty rate serves to motivate the franchisor to provide a good service to the franchisee and gives it an interest in maintaining brand reputation. However, directly owned outlets give it an even stronger reason to maintain brand value. Hence it has been argued that a substantial and widely spread number of company-owned outlets can be complimentary to an even larger number of franchised outlets since it signals the commitment of the franchisor to the brand (F. A. Scott Jr, 1995). Furthermore, company-owned outlets, unlike a high royalty rate, do not reduce the profit drive of the franchisee. Thus not only the fine detail of franchise contracts but also the mix of franchisor and franchisee operated outlets may be significant in overcoming or avoiding conflicts of interest.

Franchising itself does take various forms and can be combined with other entry modes in differing ways. Further, the relationship between franchisor and franchisees ( and also between the franchisees ) is far from uniform. Two principal categories are normally distinguished. One category concerns the product name - often tied to authorised distributor systems e.g. car dealerships. The second main category and which has been the principal growth type, is business format franchising. Here the franchisor provides a detailed format for running a service with operational guidance, a trademark and sometimes training. It may organise a network of suppliers for the outlets. In some cases the franchisor itself acts as a supplier of certain items to the franchisee which may be required to rely on the franchisor as a supplier - a form of vertical integration e.g. McDonalds often supplies approved packaging to its outlets, both company-operated and franchised. Advertising plans and outlays that cover a range of franchisees (as in a region within a country) may be co-ordinated by the franchisor (as happens with McDonalds). The ownership of the site and/or the building may or may not be in the hands of the franchisor (McDonalds usually owns the site or the leasehold). Thus while the relationship between franchisor and franchisee is usually more intense than for the first category, this intensity can vary significantly as can the degree of dependence of the franchisee on the franchisor. We shall see that high intensity is a feature of the franchising of McDonald’s. Because of the great variety and complexity of franchising systems and relationships it is misleading to see franchising just in terms of licensing know-how and the use of a brand name. It is also wrong to assume franchising cannot involve any equity stake and is strictly an alternative to foreign investment. As has been noted, the franchisor may own the land or buildings. The franchisor may even take a stake in some outlets or in the sub-franchisor so that franchising and joint venture forms are linked (the latter combination has been much used by McDonald’s). Further, franchising can be a way to open up FDI options later on e.g. the contract may specify how and when the franchisor can buy out or take over the outlet. The varied nature of franchising has been noted by Burton and Cross. (F.N. Burton and A.R. Cross, in S. Paliwoda and S. Ryan, eds, 1995; also F.N. Burton and A.R. Cross, in C. Chryssochoidis, C. Millar and J. Clegg, 1997, more generally see A. Dnes, 1996 and A. Dnes, 1992).

When franchising abroad the franchisor may, instead of negotiating a series of direct contracts with many franchisees, come to a master franchise agreement with a well-established firm in the foreign country. This firm acts as a sub-franchisor, usually with the exclusive right for an entire country, both to open its own outlets and to sub-franchise to smaller local firms. Franchising that is indirect in this way runs greater risks to product quality and hence reputation. Some strictly limited FDI can serve to reduce these risks as when the franchisor sets up monitoring systems for foreign countries in the form of a branch to monitor (and perhaps also provide certain services to) indirect franchisees - a case of FDI that is complementary to franchising. Another possibility is for the master franchise or sub-franchisor agreement to be linked to a joint venture involving a local business and the franchisor. This is a combination much favoured by McDonald’s, especially in Asia. In effect the use of a master franchisee is combined with an equity stake by McDonald’s. Such active participation serves as a check on, and a help to, the partner and reduces risks of quality dilution which can undermine efforts to build a global brand. From a strategic viewpoint this hazard may be as important as dissemination risk.

The mix between franchising and foreign investment and the relationship between the franchisor and sub-franchisor or direct franchisees can change over time. While use of a sub-franchisor can save on capital costs and harness local knowledge of the particular market and operating costs (possible location-specific advantages), perhaps speeding up the process of internationalisation, it means taking a lower share of revenues. Subsequently, the franchisor may wish to participate more directly in what emerges as a high-growth market. Then there may be a later agreement with the sub-franchisor or a direct franchisee to establish a joint venture e.g. Marks & Spencer announced such a partnership with their local (master) franchisee in South Korea, the conglomerate and retailer D & S in spring 1997.The contract between franchisor and franchisee usually contains clauses setting time-limits to the franchise and/or give the franchisor a priority option, if and when, a franchisee wishes to sell the franchise. The buy-out option could be used in the long term to raise the company-owned and managed share in international operations. In the long term the firm learns from franchising outcomes so that its local knowledge and contacts are greater: also in the long term the franchisor may have a larger cash-flow so that buy-outs are more feasible. Increasing the company-owned outlets in this way results in a higher share in revenues from sales abroad. A contrasting development path is when a firm uses FDI in a company-owned operation as a sounding board and platform for later building up a franchise system in the country i.e. as a learning method that enables it to manage franchising more effectively in the long term. Also by first establishing a good reputation it may attract more and better franchisees. The contrast between these two paths illustrates how a strategy of internationalisation can be linked to strategies for learning and knowledge development. More generally, the balance between direct franchising, sub-franchising, joint ventures and full FDI needs to be seen in a wider strategic way with reference to the firm’s principal competitive advantages and related core competences ( actual and potential), varied market and production opportunities and risks, and the goals of the firm. For example, a services firm might see economies of scale linked to buyer power as the key to its long-term success with knowledge of operational methods and real estate management playing a secondary or negligible role. In this case heavy reliance on franchising might be preferable to insistence on full ownership and control through FDI, especially if ‘first mover advantages’ can be achieved through rapid internationalisation. However, if brand name is a key asset then using fully owned operations abroad as a platform for later franchising may be the best path because brand reputation is put at less risk than when relying on independent sub-franchisors with a master franchise.

Another way in which FDI may be complementary to franchising stems from the need for adequate and timely supplies which are often vital to the maintenance of product reputation, especially when brand name and recognition are central to competitive success. The costs, competences and availability of local suppliers is an important consideration in many industries, including services. This is partly because political pressures to use local suppliers are not uncommon and concern for local image (e.g. overcoming suspicion of foreign firms and their products ) and transport cost minimisation also create a preference for substantial local sourcing. So where good local suppliers are scarce then FDI or a joint venture with a local firm may be necessary.

It has been argued that the optimal mix of franchising, full ownership and joint ventures (partial ownership) is likely to change over time as the balance of costs and benefits changes. In particular Oxenfeldt and Kelly (Oxenfeldt, A.R. and Kelly, A. O., 1968-9) develop a life-cycle model of franchising. They contend that the most successful franchise systems will end up as almost wholly-owned chains. This hypothesis has been tested in the 1980s and 1990s using US data with ambiguous results, partly relating to sectorial differences. G.K. Hadfield in her article ‘Problematic Relations: Franchising and the Law of Incomplete Contracts’ (1990) reports that company ownership of outlets in the fast food industry had risen from 1.2 percent of outlets in 1960 to 6.6 percent in 1968,11.3 percent in 1971 and 32 percent in 1986 (p936).More recently (1996, R.J. Dant, A. K. Paswan and J. Stanworth; R. P. Dant, P.J. Kaufmann and A.K. Paswan: R Dant and associates in several studies have come up with varied results and suggest that better longitudinal data is needed. Their survey of previous studies notes that there were differences in the indicators used (franchised % of outlets; long-term contract ratio; contract renewals and terminations; net conversion gain operationalisation) as well as in the range of sectors studied. In their chart on the fast food sector (appendix) there is little sign of much net conversion gain (into company outlets) over the years 1977-86, while for units and sales share there was a very slight rise in favour of company outlets. Overall, any shift is not significant. In another recent study, F. A. Scott Jr (1995) included age of the franchisor as one variable in explaining the ratio of franchised to company-owned outlets and found a significantly positive relationship - the opposite of what the life-cycle hypothesis implies.

One key factor stressed by Oxtenfeldt and Kelly is the changing availability of funds. Franchising helps overcome a lack of funds for expansion in the early part of the life-cycle when the firm is relatively small and little-known. Franchisees both put money into their outlets and add to the funds available to the franchisor through fee and royalty payments. Later on, with a bigger cash flow and established brand name this financial constraint on the franchisor is eased to the point where not only is reliance on the financial input of franchisees less necessary but buy-backs become fundable. Further, they stress the possibility of conflicts between franchisor and franchisee e.g. over the balance between sales and profit maximisation; over technical changes or quality control as the value invested in the brand name grows (which may lead to buy-outs); changes in the wealth and/or family circumstances of franchisees that incline them to sell out or else go it alone; and changes in the franchisor’s information on specific locations so that the franchisee’s comparative local advantage declines implying an ‘obsolescing bargain’ - perhaps especially relevant to international franchising (this last point might carry over to the case of joint ventures with a local firm). One notable example of conflict has arisen for McDonald’s within the US in the 1990s: it is over the rate of growth of new franchises and particularly their geographical proximity to existing restaurants. In this case the new franchisees are giving McDonald’s a higher share of the revenues than is specified in the contracts for the older franchisees (see Business Week,2/6/97,pp30-31, ‘Fast-food Fight’). The franchisor may, in pursuit of more profits for itself, act in ways that ‘crowd out’ the profits of these older franchisees. As average franchisee profits fall, more will be inclined to sell out. If the franchisor has a high cash-flow then it may see buy-outs as a good investment - unless other and better opportunities are available. These could be in foreign countries. Oxenfeldt and Kelly wrote before the big international spread of franchising from the US to other countries, often with McDonald’s in the lead.

More fundamentally, their hypothesis reflects two assumptions. Firstly, that the long term situation of the franchisor goes with better financial resources and information, and secondly that full ownership and control is more ‘efficient’ than franchising, especially with regard to quality control and coordination. The virtues of the big, internalised, often vertically integrated and hierarchical firm were rarely questioned at the time they wrote. In the 1990s the virtues of co-operative sub-contracting, networking and the ‘flagship firm’ came into fashion so that the inferior efficiency of extensive franchising (in the long term) is made all the more debatable. A further consideration arises if the costs of franchising decline over time decline: for example if there are economies of scale in managing franchise systems. Such scale economies could make buy-backs and reliance on new company-owned outlets less attractive in the long term producing the opposite to what Oxtenfeldt and Kelly predicted. On the other hand, the signalling role of having widely spread company-owned outlets might limit a shift to greater, even extreme, reliance on franchising.

The factors affecting the best balance between franchising and in-company operations can also be related to more recent debates on the merits and methods of vertical integration, particularly with reference to transactions costs and the optimal degree of ‘internalisation’. Franchise systems can involve a degree of vertical integration and division of labour. In the case of McDonald’s, the franchisees focus on the more basic, labour-intensive and close to customer tasks along with localised marketing. McDonald’s as franchisor is more responsible for product research and innovation, real estate management, national/regional advertising (especially but not only in the US), development of supplier networks, the management of bulk buyer bargaining power and above all, the strategic and organisational systems of the business network for which it is the hub and flagship. Given that McDonald’s is involved directly (as a producer of certain items and partner in some supply ventures) and indirectly (as a buyer, advisor and researcher) in the input supply side, the division of labour is partly vertical in character. In some respects intense format franchising may be likened to ‘partnership’ sub-contracting, in which inter-firm relations are collaborative, relatively long term and, sometimes, the buyer firm takes an equity stake in the contractor. The nature of the contract differs in the two cases, not least since the franchisee is legally obliged to pass on key market and performance information and the franchisor usually has priority rights if, and when, the franchisee wishes to sell (or take-over rights if the franchise is time-limited). However, a sub-contractor can have an ‘open-book’ relationship with its principal buyer that is as revealing as that of a franchisee (indeed, McDonald’s has an open-book relationship with most of its key American suppliers, even without any official contract - such is the mutual commitment, trust and asymmetrical interdependence). The choice then is not simply between an external, arms length contractor and full (vertical) internalisation. Rather, it is between these forms and hybrid ones such as intense format franchising and ‘partnership’ sourcing which can sometimes achieve an almost ‘internal’ character with regard to trust and mutual support. Hence transaction costs between a franchisor and its franchisees may be lower than for relations with a ‘fully’ external firm and be similar to those within the legal boundaries of the franchisor company. In reality, the ‘internal’ relationships between the parts of a firm are not always highly harmonious and co-ordinated, though it is usually assumed that opportunism is easier to control, and trust, cooperation and collective synergy are easier to achieve, within the hierarchy of a firm. It might still be said that there are contracting costs with franchising that are avoided with internal operations. While correct, this point can easily be exaggerated. Over time a franchisor may build up expertise in negotiating, writing and enforcing franchise contracts so that it becomes more cost-effective in these tasks so reducing transaction costs. Indeed, it may achieve scale economies in managing franchisees e.g. monitoring costs for a region may rise less than in proportion to the number of franchised outlets. It is common for franchisors to offer standard terms in their franchise contracts so that a lot of individual negotiation is avoided. Further, in relying on franchisees to hire and manage labour they are saving on labour contracting and monitoring costs. Here it is worth noting that one radical writer (A. Felstead, 1993, ) suggests that the intensity of employee monitoring by the franchisee is linked to a willingness to work very long hours and a determination to get the most out of the workers. From a radical perspective franchising may facilitate a higher rate of ‘exploitation’ than company-owned outlets (what more orthodox economics might class as a reduction in X-inefficiency). Felstead argues that collective action whether by workers or indeed, franchisees, is difficult compared to the situation of employees within a vertically integrated firm. Franchisees are so numerous and widely spread, so bent on making profits and so individualistic in nature that the franchisor can divide and rule - and dictate - as in the take-it-or-leave-it basis of most franchise contracts. Unions within the fast food industry find they have to have separate negotiations with each franchisee.

The logic of the ‘transactions costs’ analysis of the firm is that successful firms choose whichever of these alternatives goes with the lowest transaction costs of negotiation, monitoring, co-ordination etc. after allowing for any difference in outcomes (e.g. quality) and operational costs. By such a weighing of costs and benefits firms can find the optimal mix of in-house production, arms-length contracting, partnership sourcing, joint ventures and other forms of collaboration. The case made by Oxenfeldt and Kelly for a much greater reliance on full ownership and control in the long term can be partly restated as the case for greater internalisation - due to lower ‘internal’ transaction costs. Such is the theoretical analysis of R.M. Grant in his text, Contemporary Strategy Analysis (1995). In briefly review their case he says McDonald’s, like other fast food suppliers, ‘has moved from franchising toward increased direct ownership and management…[because first]… in the US, at least McDonald’s no longer needs the financial and managerial resources and the local knowledge of the franchisees. It is primarily in new overseas markets that McDonald’s prefers franchises or joint ventures …[and second] developments in McDonald’s management information systems, communication network, staff training methods, and operating techniques have lowered the costs of internal administration as compared to the costs of managing and monitoring franchise agreements’(p 326). This analysis implies that the share of franchises in US outlets should have fallen significantly while that of company-owned restaurants should have risen, reflecting greater internalisation. It could also be taken to imply that, outside of the US, there might have been some recent decline in the franchise share of outlets for those countries where McDonald’s has long been present so that its initial lack of local knowledge no longer applies. For example, by 2000 Canada, Australia, Japan, the Netherlands and Germany will have all had a McDonald’s presence for over 29 years while for the UK it will be 26 years. However, an examination of the data casts doubt on the adequacy of parts of Grant’s analysis. I is true that in the later 1960s and early 1970s McDonald’s tended to buy back restaurants ( the company-owned share in the US rose from 9% to 31% (Felstead, op. cit. p195) but thereafter the franchised share began to rise (at the very time McDonald’s accelerated its’ internationalisation). According to the 1996 annual report (p18) the number of restaurants directly operated by McDonalds itself in the US rose by nearly14% between 1986 and 1996 (from 1,623 to 1,847). By contrast the number of franchised restaurants rose by nearly 71% (from 5,549 to 9,467). In the 1990s McDonalds continued to franchise nearly 85% of its outlets in the US, a higher figure than for abroad where, in 1996, franchisees accounted for about 44% of outlets compared to about 29% for company-operated restaurants and 27% for ‘affiliates’ (joint ventures). The latter figure confirms the greater importance of joint ventures for non-US outlets referred to by Grant. In 1996 there were 2,457 affiliates outside the US compared to 780 in the US - or just 6.5% of the US total. However, affiliates (joint ventures) in the US have grown from 100 in 1986 to 780 in 1996, indicating that they are growing more rapidly than franchises, let alone company-operated restaurants. Thus the application of internalisation theory to the McDonald’s case needs further consideration, including attention to the management of risk.

One extra consideration, that was mentioned by Oxenfeldt and Kelly, concerned the macro-economic environment. They suggested that a less stable and more recession-prone economy than was the case in the 1960s, might expose the efficiency limitations of franchising so accelerating the shift towards full ownership and control. Since 1970 the US economy, indeed the world economy, has

seen more and deeper recessions than occurred in the 25 years after World War 2. However, it can be argued that this more risky macro-economic environment may not have encouraged internalisation and vertical integration but rather the opposite i.e. excessive internalisation may have been exposed and the importance of flexibility made clear. In order to reduce risks and make them more manageable firms might see advantages in greater out-sourcing, joint ventures, alliances and also franchising. All of these can be ways of either sharing or externalising risks. Further, some of these business policies may enhance long-term flexibility e.g. franchising contracts can keep open investment options for priority buy-outs, take-over of time-limited franchises and establishment of new company-operated outlets that are in the same region or conurbation as the franchises. Even establishing outlets that are very close to existing franchised ones may be possible. McDonald’s keeps its options open here but includes a compensation clause to reassure actual and potential franchisees. However, in 1997, US franchisees adversely affected by nearby new outlets complained that the compensation was inadequate given the ‘crowding out’ effect on their profitability. In addition, franchising if combined with site ownership (or a long-term lease), enables the firm to tie-up more sites which are denied to rivals. From a strategic viewpoint such site-related investments can act as a deterrent to investment by other firms. Hence they serve to reduce or at least contain risks. These considerations of risk, positioning, deterrence and building market power go beyond the usual scope of the transaction cost approach with its short-term profit-maximising focus and fit in with a more long-term strategic and power-oriented theory of the firm. Internationalisation is a further way to spread risk in a world where macro-economic fluctuations are not fully synchronised across countries.

Burton and Cross (1997,op.cit.) have utilised the transaction cost framework to distinguish several different types of transaction cost involved in franchising: search costs, servicing costs, property rights protection costs and monitoring costs. The first of these includes the selection of, and contracting with, potential franchisees. Servicing transactions costs cover a range of services provided by the franchisor to the franchisee. Property rights issues include contractual infringements by a franchisee or ex-franchisee e.g. legal costs. Monitoring costs include checking on quality maintenance and also the adequacy of financial reporting by franchisees. These costs are likely to increase the greater is the geographical and psychic distance between the franchisor and foreign franchisees. This problem will be exacerbated if the number of direct franchisees in a foreign country is very large, but similar problems can arise with a single sub-franchisor, although dealing with one partner is normally a lot simpler than dealing with many small direct franchisees. To limit such problems entry through full ownership (FDI) or a joint venture may be preferred at least until such time as a local knowledge and a local monitoring base have been established i.e. only if and when transaction costs and related risks of franchising are reduced might a ‘direct’ franchise system be worthwhile.

 

THE INTERNATIONALISATION OF McDONALD’S

In going international McDonald’s has to a large extent reproduced the product and business format developed in the US, sometimes with small modifications to menus to reflect local tastes and, more often, major changes to its marketing. Internationalisation was not an easy or obvious option for M: at least not outside North America. How well would hamburgers sell in a country like Japan whose diet was so oriented to rice and fish? Tastes and traditions appeared to vary greatly from one country to another. From a global perspective economic conditions in the US were unusually affluent and McDonald’s product had come to be seen by the late 1960s as very American, especially in its stress on hamburgers. Hostile attitudes to ‘Americanisation’ existed in many countries - even in such English-speaking political allies as Canada and the UK. In most countries, high-volume fast food restaurants (as opposed to waiter service restaurants or street stalls etc.) were little developed, one exception being Britain with its Wimpy bars and fish & chip shops. The rise of the fast food sector in the US, and of McDonald’s in particular, was made possible by changes in the size and nature of the American eating out market and in the organisation and technologies of food processing and delivery which were first developed in the US, sometimes specifically for the mass production of specialised fast food items required by McDonald’s. The growing affluence and motorisation of America went with a faster pace of life which was intensified by the rise of the two-income family as more and more women worked full-time. McDonald’s format in the US, was and is, heavily targeted on people with a car. At the same time the almost universal ownership of first, radio, and then television sets, opened up new mass advertising opportunities. These went with economies of scale linked to the number and geographical reach of service outlets. To reap these advertising economies in the fast food sector required a distinctive and reliable product that was made widely available. The firm that first reached a large scale would benefit from lower costs of advertising per branch. To gain the advantages of being a ‘first mover’ in this emerging market segment one had to be a ‘fast mover’. For McDonald’s, franchising was crucial to its rapid growth in the US as was the development of co-operative and ‘dedicated’ suppliers. However, finding and selecting franchisees and suppliers in other countries was likely to be both more difficult and risky, a problem which had already arisen to some extent in Canada and the Caribbean (and was to arise again during the 1970s in France). Agreements with two developmental sub-franchisors - one for eastern and one for western Canada - were made in 1967. Both were making losses in 1970. McDonald’s decided to buy back the franchises, believing the long-term prospects in Canada were good. Even so, after such a bad experience it is not surprising that in the late 1960sMcDonaldsconsidered ways of investing large sums outside the fast food business. Indeed, at this time diversification into other industries was a business fashion - in contrast to the ‘focused firm’ of the 1990s with its emphasis on core competences and outsourcing - including select cooperative partnerships with other firms. Nevertheless, McDonald’s decided that internationalisation of its existing product was a better bet in the long term when investing some of the huge profits of its US outlets. At this time none of its American rivals (e.g. burger and pizza chains) had gone international, at least beyond North America: hence McDonalds was truly trailblazing (as was Kentucky Fried Chicken which decided to go international at exactly the same time as McDonald’s). It is also important to note that in 1970 McDonald’s was still growing very rapidly in the US - as were its profits. Competition from rivals was increasing but so was the demand for fast food. There was still scope for massive expansion within the US (note the figures on US outlets in the next paragraph). In addition, McDonald’s might have used a lot of its cash flow to buy out franchisees so as to greatly increase the company-operated share of restaurants - an option in line with the model of Oxenfeldt and Kelly. McDonald’s was aware that more competition was likely to squeeze profit margins in the long term, particularly if and when market saturation was reached. There were clear signs of this in the 1990s while in the 1980s the market was showing some signs of ‘maturity’ in the US - as sales growth slowed. But in 1970-1 there was little sign of this. If going abroad was a success it would reduce its dependence on the US market, steal a march on its rivals and gain it first mover advantages - not least in acquiring control of many key metropolitan sites whose property value was set to soar, but also in gaining several years in which it would be without competition from its US rivals (with the partial exception of Kentucky Fried Chicken).However, the point about property values has the benefit of hindsight. Initially, McDonald’s thought the great majority of the restaurants outside the US would be suburban - just as they were in the US. But it was wrong: urban and especially city centre outlets were often the most profitable. Where McDonald’s was right was in having and keeping faith in its format and related capabilities.

McDonald’s had expanded and refined an innovative fast food restaurant format in the US in the 1950s and 1960s with extraordinary success, building on the small-scale pioneering efforts of the McDonald brothers. The latter had rather limited ambitions. Further, they ran into problems in franchising their format. Ray Croc took over the franchising side of the business in 1954 and eventually all the rights to the McDonalds concept in 1961. He sought to maintain and enhance the ‘mass production’ type of speedy customer service for a rapidly growing number of outlets yet without compromising quality control. The establishment of an intensive system of franchising proved to be crucial to the mass ‘reproduction’ of restaurants, with over 80% of outlets being franchised. Croc’s driving ambition was initially focused on developing an America-wide business with a view to dominating the emerging fast food ‘drive-in’ restaurant segment. By 1969 this dream was largely realised: sales exceeded $450million, the 1000th restaurant was opened in 1968 (Ray Croc’s first company-owned one had opened in 1955) and apart from a few recent outlets in Canada and the Caribbean, McDonald’s was very all-American. Yet by 1996 nearly half of McDonald’s sales were from foreign outlets and this despite continued explosive growth in the number of US restaurants - just over 12,000 at the end 1996 with sales of $16,370 million. At the same date there were nearly 9,000 restaurants outside of the US with sales of $15,443million. ( McDonald’s Annual report, 1996). In the 5 years up to 1996, 61% of the growth in restaurant numbers was outside the US (p20). Since this international bias is planned to continue the non-US sales are set to exceed 50% of total sales before the year 2000. Yet as recently as 1985 non-US sales were only 20% of total sales: in 1975 they were just 8% ( Love, 1986).

The rapid internationalisation of McDonald’s is even more striking in the figures given for assets in the annual report. Total US assets were $7,554 million in 1996 while non-US assets were $9,560 million. ( pp18,23 of the report ). This contrasts with the figures given for 1992: $5,995 million for US assets and only $5,271 million for non-US assets. Clearly the bias towards internationalisation is particularly great for capital expenditures as is revealed in the 1996 data on this: spending in the US of $899 million and outside the US of $1,507 million. The report goes on to note that ’in the past 5 years, nearly $5,000 million has been invested outside of the US’. We shall discuss in a later section how this investment bias is linked to a greater reliance on company-owned stores and joint venture affiliates outside of the US. The stress on internationalisation makes sense in terms of profits. The data on operating income is one indicator of relative profitability: in 1996 such income on US operations was $I,144 million while on non-US operations it was $I,541 million and this for a year in which US sales were still slightly bigger than non-US sales (pp18,21). If one allows for higher non-US assets than US ones, the contrast is less pronounced, but non-US business is still the more profitable. Operating profits outside the US have risen at a compound annual growth rate of 23% in the past ten years (Tompkins, R., Financial Times,16/7/97). This contrasts with the sluggish US performance in the mid-1990s where, despite a substantial increase in restaurant numbers (2.697 were opened in the 1994-6 period), operating income fell slightly (annual report for1996,p18). Indeed, given the mounting problems faced by McDonald’s in the US market in the 1990s, the bias towards internationalisation is likely to intensify. With profit margins higher outside the US, investments abroad are more attractive than investments in the US aimed at raising the company-operated share of outlets.

The geographical range of McDonald’s non-US activities has widened in each decade from 1970 so that by 1996McDonaldswas in over 100 countries. In 1971 McDonald’s moved into Australia, Japan, Germany, the Netherlands and Panama; in 1974 into the UK; in 1980 the 1000th restaurant outside the US was opened (in Hong Kong); in 1988 restaurants opened for the first time in Hungary and South Korea while in 1990 the ‘golden arches’ of McDonald’s reached China, Russia and Chile. In 1996 McDonald’s acquired about 80 Burghy restaurants in Italy, so tripling its restaurant base in that country. In the same year McDonald’s entered India. The intended result of this expansion is to further diversify McDonald’s activities and so spread risks more widely. ‘In both 1996 and 1995, 55% of restaurants outside the US were in the seven largest markets - Australia, Brazil, Canada, England, France, Germany and Japan. In 1997, the seven largest markets are anticipated to open slightly more than 50% of the restaurants outside the US, while new and developing markets like Central Europe, China and the Middle East are expected to continue to represent a growing per cent of restaurant growth’ (1996 annual report, p20). While 3 of these 7 largest markets are English-speaking, it should be noted that Japan has far more restaurants than either England or Canada and in 1996 accounted for 27% of restaurants opened outside the US. The outcome is that McDonald’s is one of the most global of all multi-national enterprises. Its example has inspired rivals like Burger King and Pizza Hut as they have gone international. However, McDonald’s has a big lead in many markets because they (and also Kentucky Fried Chicken) were the first to internationalise. For example, Burger King (owned by the British food conglomerate Grand Metropolitan), like McDonald’s, is keen to expand in Asia and Japan is seen as the key market in its strategy. However, at the end of 1996 it had just 43 outlets in Japan compared to the 1,860 of McDonald’s. The latter had Japanese sales of $2.3 billion (Business Week,25/11/96). Another indicator of the success and scope of the internationalisation of McDonalds is the survey finding by Interbrand consultancy in 1996 that McDonald’s had ousted Coca-Cola as the best-known brand in the world (cited in Financial Times, 16/7/97).

One very distinctive feature of McDonald’s internationalisation has been the opening of Hamburger Universities and smaller training centres in a growing number of countries. This is another example of FDI that is complementary to both franchising and company-operated restaurants. McDonald’s set up the first Hamburger University in the US in 1961as part of its efforts to maintain and improve quality, build brand reputation and develop a shared corporate culture that involved franchisees as well as the employees of McDonald’s. The universities now fulfil this role on a global basis. Some short courses in the US involve managers from many countries. In 1994 the staff at the senior Chicago campus came from six countries (D. Schaff, Autumn 1995). There is a conscious effort to share the experience and best practices from around the world whilst reinforcing the key aspects of the McDonalds format. In developing company universities McDonald’s was a pioneer. In the later 1990s corporate university schemes began to multiply, while established universities increasingly went international, not least through franchising.

McDONALD’S MARKET ENTRY MODE CHOICE IN INTERNATIONALISATION

When McDonald’s began to internationalise its business it was uncertain as to how far its US experience could be replicated abroad. Might the mix of franchising and company-owned restaurants need to be rather different? Might a local partner be useful? Might its product need to be modified a lot to meet local tastes? Might its marketing strategy need to be radically different? Might its policy on suppliers need to be changed? Might its methods of monitoring need to be altered? Inevitably mistakes were made. They were part of a learning process in which self-critical adaptability, flexibility and sheer persistence were vital. Indeed, in several cases it was many years before profits were made: in the Netherlands all of 12 years! Among the mistakes made in that country were some that had wide-ranging significance e.g. an over-emphasis on suburban locations and the inclusion of local foods at the expense of some of the more distinctive McDonald’s items. However, the earliest lessons came from Canada.

The Canadian case has been briefly mentioned earlier. After the setbacks of the late 1960s, McDonald’s had bought out the two ‘developmental’ franchisees, one of which was promising but under-capitalised. A ‘developmental ‘franchise is one where the franchisor provides a licence, a format and related know-how, but no supervision of outlets; nor does it acquire and develop the real estate or organise the supplier network. It is a form of franchising that is almost ‘arms length’ and which is akin to conventional licensing. Ironically, developmental franchising was not the form employed by McDonald’s within the US. The kind of franchising that Ray Croc pioneered in the 1955- 65 years was extremely intensive and demanding, with very detailed instruction packs, training for franchisees alongside that for ‘internal’ restaurant operators and close monitoring - not least by Croc himself who became famous for his passion for cleanliness. Under Croc McDonald’s both gave much help to, and expected a lot from, its franchisees (as well as its own employees). The same was true for the relationship of McDonald’s to its suppliers. Consistent and improving quality, based on innovation, was one of the keys to building reputation and ensuring large repeat buying. McDonald’s developed its own research facilities and worked closely not only with suppliers but also with franchisees, particularly when they came up with new ideas. Indeed, some of these ideas have been big money earners, such as the ‘Big Mac’. While McDonald’s dictates food specifications, equipment, some supply sources and often layout, it gives great autonomy on local marketing to franchisees, although McDonalds also organises national promotions. When M’s own promotional policy flops, as it did for the US in 1997 with the 55 cent burger, the US franchisees were quick to criticise and help bring about a change of policy. At this time McDonald’s, in the US, was facing market saturation and great competitive pressures. The result was declining margins and falling market share. Within a few months more than promotional policy had changed: a drastic shake-up was announced with the president and chief executive of McDonald’s (US) taking early retirement and a major reorganisation of US operations into five divisions so as to ‘bring decision-making closer to customers, restaurants and franchisees’ (Financial Times,10/7/97). The ability of franchisees to exert collective pressure on the McDonald’s headquarters has been facilitated by the regional associations of franchisees which McDonald’s has encouraged. Thus the relationship betweenMcDonaldsand its franchisees is neither purely hierarchical nor arms length, but rather a complex and evolving one in which learning is a two-way process.

The resort of McDonald’s to developmental franchising in Canada and the Caribbean (where it was a disaster), in the late 1960s, may have reflected doubts over whether its usual approach needed to or even could be transferred abroad. It may also have reflected an initial lack of commitment to internationalisation as a long term strategy. These early setbacks made it clear just how vital to McDonald’s success were its close and demanding relationships with both franchisees and suppliers: mutual commitment was crucial. Internationalisation was not a cheap extra: if it was to be done it had to be done well. At the same time if McDonalds was to make a major commitment then its share in the revenues would need to be substantial: much higher than the 0.5% for the ‘developmental’ franchise in the Caribbean or the 1% for Canada. After the Canadian buy-out, McDonald’s invested substantial sums in the upgrading and multiplication of outlets. It gave the presidency to one of the former developmental franchisees, George Cohon, who had shown operational ability but lacked capital. By the mid-1980s, just over half the Canadian outlets were franchised: a lower proportion than in the US where over 80% of restaurants have been operated by franchisees (nearly all the rest being company-owned restaurants). However, by the end of 1996 the franchise share had risen to about 75%. Hence, as in the US, one of the keys to success was finding ambitious, entrepreneurial talents willing to work extremely hard. More novel was the way Cohon (an American) made McDonald’s Canada appear very Canadian - so overcoming fears of being ‘Americanised’. Cohon took Canadian citizenship, switched to Canadian suppliers whenever possible, and used only Canadian banks. He got a involved in Canadian charities and civic activities obtaining much favourable press coverage. His friendships with leading Canadians, including one Prime Minister, and his political fund-raising also helped him to project a Canadian image. Crucial to all this was the degree of autonomy that McDonald’s allowed its Canadian subsidiary, not just on supply sources and banking, but on pricing. In 1971, as a temporary (2-year) ploy to get Canadians to try M’s restaurants, prices were substantially cut - initially by 20% - to an extent that had never happened in the US. The take-off was spectacular. By 1985 McDonald’s Canada had about 500 outlets with a higher average turnover than in the US (Love). Here was proof that the main ingredients of McDonald’s format and policies could work well outside the US. However, Cohon was blessed in finding plenty of dynamic entrepreneurs seeking to become franchisees and also good Canadian suppliers: not all countries have been so well endowed. Apart from the short-term advantages of franchise systems (speed of expansion due to sharing capital costs and risks etc.), their long-term efficiency owes much to giving big financial incentives combined with a sense of personal ‘ownership’ that help reduce ‘moral hazard’/opportunism and, with careful vetting of potential franchisees, attract and motivate some very able and hardworking people in a way that surpasses what may be possible with employees - except perhaps by stock options and worker share participation schemes. Thus the culture and socio-economic structure of a country may affect not only the market for fast food but the availability of suitable franchisees and suppliers and hence the best mix of entry modes. In addition, the bigger the cultural gap, the stronger the case for using a joint venture with a local business rather than a fully-owned subsidiary.

It is interesting to compare the Canadian case both with McDonald’s expansion into other, more distant, English-speaking countries and also into a culturally- distant country like Japan. The entry of McDonald’s in 1971 into Australia involved a joint venture with an American franchisee used to the McDonald’s system and an Australian, Peter Ritchie who was a real estate specialist. Ritchie took over as managing director in 1974 after 3 years as the second in command. Australian tastes were not as close to the American as were the Canadian. Australians were initially wooed with a rather different menu to that in the US - with some success. However, in the long term Australians adapted to the specialities of McDonald’s so that the early modifications were withdrawn. Children were the key to this change - a pattern to be repeated in many countries. The lesson was to focus more advertising and facilities on them. The biggest problems faced by McDonald’s in Australia in the 1970s were due to anti-Americanism and related trade union attacks - particularly by the Shop Assistants Union. Here the role of the high-profile Australian Ritchie plus the joint venture status of the restaurants helped to defuse criticism. McDonald’s persisted in using many non-union teenagers and Ritchie even sued the union leaders and two members of Parliament for defamation. The assertive Aussie won through in a way no American manager could have done. Like Cohon in Canada, Ritchie associated himself with charitable work, notably the form pioneered in the US, the ‘Ronald McDonald’ Houses which provide stay-over accommodation for families who have a child in a hospital far from home. Ironically, just as the Australian credentials were established the menus were losing their Australian components! What is clear is that the joint venture status of McDonald’s in Australia was critical in the first 10 years. Over time the franchised share of outlets has grown, reaching almost exactly 60% at the end of 1996 (428 out of 608 restaurants).In the early years McDonald’s sought to establish its brand name, supplier links and profitability thus providing a platform for a subsequent rapid growth of franchised outlets.

In the UK the initial entry mode was a joint venture. As in Australia company restaurants provided a platform for later franchising. However, unlike Australia, company-owned restaurants have continued to predominate in the UK: even in 1997 (the first restaurant opened in 1974) there were only about 180 franchised outlets out of a total of 775 i.e. about 23% (figures from McDonald’s Information Service). However, the franchise share was on the increase. In 1994McDonalds(in the UK) was reported as having franchisees’ share in outlets at 16% but with a target of 40% by 2000 (N. Hassell, Sept.1994). In wishing to raise the franchise share, McDonalds would be bringing the UK more into line with M’ entry mode mix in other major European countries e.g. the same 1994 article said franchisees’ share of outlets was about 65% in Germany and 50% in France. McDonald’s UK began in 1973 as a joint venture between McDonalds and two businessmen; one American and the other British (in 1983 McDonald’s became the sole owner). Ironically, the fact that the British, unlike most Europeans, were used to fast food outlets proved a problem: not so much because of the competition but because of the low reputation of most fast food, especially hamburgers. The McDonald’s strategy was to show they were different and better. McDonald’s costs in the UK were inflated partly due to choice of a more expensive ‘quality’ decor, and partly because a lot of the supplies had to be imported from the US in order to maintain product standards (and so ‘superior’ product differentiation). The principal problem was that UK supplier firms were backward in both technology and quality control and reluctant to innovate. In addition, the local meat and potatoes were different and sometimes less suitable than those in the US - a problem McDonald’s faced in many parts of Europe. During the first five years the joint venture lost $10 million. If McDonald’s was to attract many would-be franchisees it needed to overcome the British fast food image problem, reduce costs and be seen to be profitable. While the first restaurant opened in 1974, the first franchise outlet only began in 1986. To develop suitable local supplies McDonald’s got US food suppliers to collaborate with the more responsive of the local firms and even sometimes covered the cost of the equipment. When local firms failed to perform adequately or there were no local suppliers of an input, then McDonald’s asked its US suppliers to build facilities, even occasionally putting money into such ventures - a case of complementary FDI.

As in the US (and Canada) McDonald’s usually owned or leased the site on which franchisees operated. McDonalds was on its way to becoming the world’s biggest owner of real estate just as it already was the biggest in the US. In property McDonald’s became a huge foreign investor. One contrast between the US and European countries was in the location of restaurants. A much higher percentage were central metropolitan as opposed to suburban, probably because in Europe inner city decay was less extreme than in the US. Since a cluster of metropolitan outlets are easier to monitor this may partly explain the higher percentage of company restaurants to franchised ones in Europe than in North America. The same contrast has applied in Japan where McDonalds has had, perhaps, its most remarkable success in internationalisation: remarkable given differences of culture, especially eating habits, and Japan’s notorious suspicion of foreigners and hyper-sensitivity to their American ‘conquerors’ (in the second World War).

In 1971 McDonald’s formed a joint venture with Daiichiya Baking Company and a Japanese businessman, Den Fujita, who became president of the new company. He already had a track record as an unconventional and successful entrepreneurial businessman importing a variety of foreign goods. He thought the time was right for the hectic and urbanised Japanese to take to fast food - but not if it was seen as an American import. McDonald’s allowed Fujita a lot of autonomy, deferring to his judgement on site location and marketing. All managers are Japanese. McDonald’s sent one of their managers, a Japanese American, to informally advise, teach and monitor developments but without holding any official title. The restaurant name was modified to Makudonaldo in order to make it easier for Japanese to pronounce; the hamburger was promoted as a revolutionary product that helps people grow taller; the first outlets were in down town Tokyo and were unusually compact so as to limit the burden of high rents; advertising and decor gave the restaurants a Japanese flavour and almost all the advertising was aimed at children and young families. Fujita knew just how conservative were the eating habits of the older Japanese. The launch was made all the more remarkable by the construction of the first restaurant in less than 39 hours. Where business built up only gradually in Britain, in Japan it soared. Within a few months the first small outlet set a one-day sales record for McDonald’s world-wide, and after only eighteen months there were 19 restaurants in Japan - an expansion programme which has never been equalled. Fujita also broke new ground by starting a ‘hamburger university’ even before the first restaurant was opened. Training was seen as the key to rapid expansion. In Den Fujita, McDonald’s had found the right person to help them become ‘local’ while going global. ‘Finding the right person’ as a joint venture partner became one of the keys to McDonald’s internationalisation, particularly in countries that were culturally distant or anti-American. In Hong Kong the chosen partner holds a quarter of the equity. More often it is 50-50. (When McDonald’s opened in mainland China in 1990 it was owned by the Hong Kong venture while the Canadian McDonald’s company owned the first outlet in Russia). Quite often the partner’s business background is outside of restaurants. In the Hong Kong case it was a chemical engineer. The ideal partner needs to bring capital, entrepreneurial gifts, ambition and local marketing skills. As in Japan, substantial autonomy has been given to these other joint ventures. The outcome has not been the textbook case of a hierarchical multinational enterprise but something closer to a loose federation. How far this will change after the first generation has passed is linked to the assessment of Oxtenfeldt and Kelly’s life-cycle model since it can be argued that the need for a strong local partner is less in the long term.

This pattern of joint ventures recurred in 1996 when McDonald’s ventured into India. For once, it arrived after Pizza Hut and Kentucky Fried Chicken - a rare event. There were good reasons for this unusual degree of caution. Nationalist and anti-foreign firm feelings have a long history with roots in the colonial era. Food is a touchy topic in a sub-continent beset by religious sensibilities and divisions with Hindus shunning beef and Muslims avoiding pork. A KFC outlet was ransacked in January 1997 and the Pizza Hut in Bangladore was pelted with stones later that year. Political risk in India has a sharp edge! McDonalds has gone out of its way to be local with two 50-50 joint ventures with Indians and by relying almost entirely on local suppliers. Where McDonalds has made an exceptional effort is over the menu, dropping beef for the first time, avoiding pork and instead, making the meat burgers with mutton. ‘To win over the strictest vegetarians, designated staffers prepare veggie dishes in a separate area of the kitchen, another first for McDonald’s’ (Far Eastern Economic Review, October 24,1996, ). One reason for the entry of McDonald’s has been the view that at last, in the 1990s,India is liberalising its economy and adopting a more positive attitude to foreign investment. Another reason was the large and growing middle class in India’s big cities (the first few restaurants were opened in Bombay and New Delhi).

THE INTERNATIONALISATION OF McDONALD’S : AN EVALUATION

In evaluating the case of McDonald’s attention will be paid to:

    1. the timing of, locations chosen and entry modes used by McDonalds and the way these can be related to the evolving strategy, competitiveness and competences of McDonald’s
    2. how far and why, entry modes have changed over time in systematic way
    3. the usefulness of the OLI paradigm in explaining the internationalisation of McDonald’s
    4. the strengths and weaknesses of the interpretation of Grant and the model of Oxenfeldt and Kelly - with special reference to franchising
    5. the applicability of the Uppsala model and related ideas on the sequential nature of internationalisation, including the evolution of entry modes
    6. the role of marketing in the choice of entry modes and the structure and organisation of McDonald’s
    7. how far the success of McDonald’s in internationalisation is consistent with some recent theories of the firm
    8. how far the record of McDonald’s is unique or can be seen as similar to some other cases of internationalisation of services, notably in retailing.

The timing, speed and extent of the internationalisation of McDonald’s has been greatly influenced by the scale and nature of its success in the US. McDonald’s went international at a time (early 1970s) when it was already a large firm with much experience both in operating company-owned outlets and a franchise system. It had huge profits to invest: more than sufficient for its home market - unless it were to radically alter the balance between franchising and company-operated restaurants by buying out franchisees. It could afford to take significant risks and also a long term view. It could afford to make large capital investments abroad i.e. full FDI. This is in contrast to smaller firms which are less able to pioneer FDI in services - particularly when it can be many years before profits are made. For a small firm, franchising, including sub-franchising, can be a more attractive way of internationalising if it has a format of interest to firms in other countries, since it shares the risks and avoids capital commitment. While McDonald’s could afford to choose an entry mode with majority ownership, it had developed expertise in building up and managing franchise systems. Hence it had and has an interest in exploiting this in other countries i.e. this expertise was a key intangible asset. Given its vast cash-flow there was and is a very real choice between full FDI, joint venture investments, franchising and various combinations of these three. Even for McDonald’s, though, it was in the early1970s, a bold step to invest heavily outside of North America; but then the same would have been true if it had diversified into different sectors within the US - an option it seriously considered. In resisting the fashion for diversification it stayed a ‘focused’ firm thus serving as an exemplar of what was to become the fashion of the 1990s.

McDonald’s has moved on to full ownership of its operations in the UK after several years of joint venturing. So far company-operated outlets have been the main form of entry mode although the intention is to greatly increase the franchised share of outlets. However, the UK record is atypical. In most other European countries and virtually all Asian ones joint ventures are the norm, albeit with the joint venture/master franchise developing a large franchise system, at least in Western Europe. As for the US, franchising continues to predominate - contrary to the view of Grant and the expectations of the model of Oxenfeldt and Kelly. This stress on franchising (even in the UK it is on the increase as a percentage of outlets) can be explained in at least several ways: in terms of utilising core competences, pursuit of first mover advantages, and, perhaps, even in terms of transaction costs. The competences and competitive strengths of McDonald’s relate to expertise in fast food provision but also in developing and managing franchise systems and supplier networks backed up by elaborate marketing and bulk buying power. Above all, McDonald’s has achieved brand recognition, being the best-known in the world by the later 1990s. As Clegg notes : ‘the growth of service-sector MNCs [Multinational Corporations] can be viewed as a response to market imperfections in the provision of information about quality, aimed at reducing buyer uncertainty and buyers’ transaction costs’ (J. Clegg, in H. Cox, J. Clegg and G. Ietto-Gillies, 1993). The familiarity of McDonalds to many people can be reassuring, not least when they go abroad e.g. the case of an Australian woman cited in Love’s book (p.447) who was so relieved to find a McDonalds restaurant in Germany after spending three weeks in the former Soviet Union : ‘it was just like being at home’ - an ironical story given the early opposition to McDonald’s when it entered Australia. Today, with the entry of McDonald’s into Russia those three weeks would no longer be such a ‘terrible time’! Thus the value of a brand can be enhanced by the very process of ‘globalisation’ of which McDonald’s is a part. To make the most of this asset requires a huge and ever-growing number of outlets. Franchising is a very effective way to ensure the rapid growth of outlets since it economises on capital (although McDonald’s usually aims to have ownership of restaurant sites i.e. it has tied up a lot of capital in real estate - indeed management of real estate is an important area of expertise). The main risk with rapid franchise growth is loss of quality control, so endangering the reputation of the brand. Hence the case for an initial platform investment in a joint venture or fully-owned group of outlets which paves the way for later franchise-led expansion. The growth rationale for favouring franchising is reinforced in so far as there are first mover advantages e.g. achievement of scale economies, especially in advertising and bulk buying, and the occupation of many key urban sites. More generally, size and reputation have given McDonalds greater ‘pulling power’ in its relations with customers, suppliers, would-be franchisees and employees. To be a franchisee of McDonalds may be demanding but it is seen as a relatively safe bet. On the other hand, decreasing returns to scale in the management of direct franchisees is a possibility which seems to apply to McDonalds in the US in the 1990s : hence the recent organisational reforms. In the future this possibility might arise in another country where the number of franchised McDonald’s outlets had become very large. Apart from utilising US-based O advantages McDonald’s has been able to add to its product range in the US and Europe on the basis of experience in outlets in developing countries e.g. in the 1990s salsa burgers (Mexico) and curry burgers. Here the changing ethnic mix of the population in the US has been a helpful factor to the success of such ‘imports’ from branches abroad. Thus recent developments of the OLI paradigm to make it more dynamic and able to analyse complex creative transnational networks can be seen to apply in a modest way to such examples of transnational product innovation transfer. If McDonald’s is to pursue this path more systematically then it would need to set up research branches in some of its major non-US markets.

So far what has been said implies that the internationalisation of McDonald’s can be partly explained in terms of the OLI paradigm i.e. by focusing on how going international has enabled McDonald’s to more effectively capitalise on, consolidate and extend its ‘ownership-specific advantages’, notably through a mixture of joint ventures and franchising. Location-specific factors are also relevant to explaining which countries to enter and how i.e. choice of entry mode. Some countries have been seen as more hostile and resistant to Western fast food. This, in part, explains the long delay in entry into India. However, McDonald’s had entered many other Asian countries at an earlier date, most notably Japan - at the initiative of Den Fujita. Apart from socio-political attitudes and cultural distance, attention to affluence, motorisation and urbanisation has been a factor in the entry decision. These characteristics were features of the US in the 1950s which favoured the rise of the fast food sector. Their spread to other countries has given rise to new market opportunities. In the case of India these characteristics were slower to emerge than in some fast-growing East Asian countries. Location-specific knowledge and contacts have been particularly important in Asian countries, reinforcing the case for joint ventures. Even in an English-speaking country like Australia anti-American feelings made it wise to use this entry mode. Thus McDonald’s has mixed boldness in internationalisation with selective caution in where and when to invest and especially in the choice of entry mode.

Internalisation advantages are important in the case of McDonald’s but in an unusual and interesting way: they have many company-owned outlets, mainly US research facilities and several Hamburger universities and in exceptional cases have become involved in the supply of inputs through contributing capital or sometimes in an advisory way (e.g. technical assistance to Russian farmers). McDonald’s clearly plays a role in facilitating co-ordination across related stages that is ‘internal’ but also ‘external’. Franchised outlets far exceed the number of company-operated ones and McDonald’s maintains special long-term relations to many of its suppliers. Legally ‘external’ these franchisees and suppliers may be but there is also something of an ‘internal’ quality to the system. Expertise in managing these relationships is a key ownership advantage. Knowledge of the fast food business is also vital and here the company outlets play an important role: but McDonalds can and does learn form franchisees as well.

With regard to transaction costs, it was noted earlier that Grant suggests these have fallen for internal (company-operated) outlets compared to those for managing relations with franchised outlets, implying greater internalisation i.e. reduced use of franchising. It may be that transaction cost considerations have been over-ridden by concern for first mover advantages, but more (some!) evidence on relative transaction costs is needed but not provided by Grant. The technological changes which he sees as facilitating internal monitoring and co-ordination can also help reduce the transaction costs of managing franchise systems and maintaining close relations with suppliers. Computer links and use of computerised data would need to be compared for both franchised and company-operated restaurants across many countries. Advice and technical assistance concerning electronic systems by McDonald’s to franchisees would need to be surveyed. Short courses at training centres and hamburger universities may contribute to the reduction of transaction costs for relations with franchisees as well as company-run outlets. McDonald’s may be more advanced in this than some of its rivals that are less inclined to rely on franchising. As has been explained earlier, McDonald’s has developed a very intensive form of franchising which, in effect, builds networks that have a partially ‘internal’ quality: but just how quasi-‘internal’ is hard to quantify. Here - as with transaction costs - there are major measurement problems. Hence while Grant would seem to be wrong in his assessment of franchising for McDonald’s, it would be going too far to conclude that the role of transaction costs is insignificant when choosing the entry mode i.e. that it is always overwhelmed by other (e.g. strategic) considerations. Indeed, there are reports that McDonalds relies more on franchising away from big cities and key metropolitan sites because internal monitoring of company-operated restaurants is at its most cost-effective within the main conurbations.

While the model of Oxenfeldt and Kelly does not rely explicitly on a transaction costs framework it assumes that internal operation is usually more efficient than franchising in the long term in ways that parallel Grant’s analysis. Since McDonald’s has shown a persistent preference for a high or rising use of franchising in the 1980s and 1990s, not least abroad, their model would appear to be falsified. However, parts of their analysis may be valid e.g. they suggest that franchisees will eventually wish to be bought out e.g. as they grow old. While the US and foreign evidence goes against their predictions of declining reliance on franchising in the aggregate, their ‘life-cycle’ ideas may apply in some cases. The growth of company-operated outlets based on buy-outs of franchisees needs to be distinguished from that due to newly established restaurants and also acquisitions from existing restaurant firms. Within the overall aggregate for the growth of company-operated outlets buy-outs might account for an increasing share. However, data on this has not been published. An extension of the life-cycle model might be made to joint ventures where the local knowledge, status and contacts of the partner may become less valuable and necessary in the long term and succession problems arise for the partner if it is a family business. Here, the outcomes for the east Asian joint ventures in the early twenty-first century will be relevant i.e. as the first generation of partners comes to a close. Last but not least in assessing the model of Oxenfeldt and Kelly it should be noted that they do make the point that heavy investment in buy-outs and new restaurants may not be favoured because there are other attractive alternatives. In the case of McDonald’s, investment outside the US has provided an abundance of these and global trends towards economic liberalisation, urbanisation and an internationalisation of culture mean this is likely to continue into the next century. Thus it could be argued that only when a ‘mature’ stage of internationalisation is reached will their model be fully tested. It is striking that McDonald’s reversed earlier moves in the US to buy back or take over franchises in the mid-1970s - at the very time that its’ internationalisation drive built up. By the early 1980s initial problems in some west European countries had been largely overcome and confidence in the profitability and potential of internationalisation had risen. The one European country where progress was very slow (the UK) had raised franchised outlets’ share from zero to 25% in 1996 i.e. in ten years, and the plan was to raise to it to 50% by 2000. Far from making McDonald’s unusual such a change would make it more like Burger King (80% franchised in the UK in 1996), Wimpy (97% franchised) and KFC (60% franchised).

One aspect of the international entry mode choice of McDonald’s has been the high reliance on wholly or partly (joint venture) outlets in the early stages of entry into a country with a shift of emphasis to (sub)franchising after achieving profitability, a good reputation and more local contacts, including suppliers i.e. after assembling and developing certain core features of previous success. This two-stage approach contrasts with the unsuccessful experience with ‘developmental’ franchising in the late 1960s (repeated in the 1970s in France). It is consistent with theoretical approaches to internationalisation that highlight sequential learning and risk management such as the Uppsala model (see Nilsson J-E, Dicken, P. and Peck J,1996). Work in this area has focused on the changing mix of exporting and foreign investment as market knowledge, contacts and specialist organisation are built up. Most empirical studies have been of manufacturing. The case of McDonald’s in a service sector activity shows how the idea of staged learning can be extended to incorporate franchising. Whether there are further stages ahead is of interest as was pointed out when discussing the Oxenfeldt and Kelly model i.e. whether joint venture partners might be bought out in the next century. Critics of the original Uppsala model have argued that a stage(s) might be missed out after the firm has built up more expertise in internationalisation, especially if the firm’s resources have grown over time. The experience of McDonald’s highlights the importance of country-specific factors, notably local tastes and attitudes which can go with suspicion of foreign firms or products. Such factors may limit the chance to miss out on the ‘going local with a partner’ platform stage. Here research on the east European experience in the 1990s and a comparison with the earlier internationalisation of McDonald’s would be of relevance to assessing the significance of international experience.

The internationalisation of McDonald’s has meant that it has faced awkward decisions as to how far to share power with other firms that are its franchisees or partners and more generally to concede substantial autonomy to country-specific ventures. For example, how far should marketing be devolved to branches and joint venture/master franchise holders in other countries? In going global how far and in what ways should it become local? Should its strategy be international, multi-domestic or global or some combination of these? In its first ‘developmental’ foreign franchises McDonald’s conceded great autonomy which was seen in hindsight as a mistake. In subsequent ventures, be they company-operated or franchised or joint venture master franchises, McDonald’s was more involved. Certain basic features of its format - use of quality supplies, inclusion of some ‘core’ menu items and detailed adherence to procedures laid down in instruction manuals - were seen as essential to building an international brand. At the same time McDonald’s was willing to see a large part of supplies come from local firms so long as quality was not jeopardised. Indeed, it realised that use of local suppliers was one way to overcome local fears and prejudices. McDonald’s went to considerable lengths to assist local firms where there were supply problems and to build up a supply network - sometimes by bringing over one of its key US suppliers. Golden West foods in the UK is a case in point as is Sun Valley, a subsidiary of Cargill PLC which company also supplies chicken products to McDonald’s in Denmark, France, Ireland, Belgium, Spain, Morocco and the Netherlands. In Russia McDonalds has had to invest in food processing and even get involved with farming because the quality and reliability of local suppliers was so poor.

The area of marketing provides a contrast to this ‘strong guiding hand’ on basic format and supply matters. While McDonald’s has shared promotional material and methodology developed in the US, it been much more willing to give autonomy to foreign branches or franchised outlets. In many cases this has involved modifications to the standard decor and sometimes to the menu (McDonald’s is quite flexible on decor in the US, too). McDonald’s can cater to local tastes and even sensuality e.g. in Malaysia, Singapore and Thailand a milk-shake with a durian fruit flavour is available since despite its vile smell (to Western tastes!) this fruit is considered a great aphrodisiac. Pricing policies have sometimes varied between countries. More notably, the country-specific master franchises have full responsibility for their own promotions and each has their own marketing agency. All of these agencies work to a global brand positioning document but each can apply it in its own way e.g. in Germany there has been less reliance on television advertising than in the UK. Special efforts were made in certain countries in the early years to explain what seemed to local people an unknown range of products. A more European style of advertising was developed with less boasting and more humour than had been used in the US. In some of the advertising in Germany a special effort was made to stress the Germanic nature of McDonald’s i.e. its German suppliers, employees and use of home-grown food. In Japan we have seen how Den Fujita was allowed complete marketing autonomy in the early 1970s. The early Japanese success of ‘Makudonaldo’ did much to convince McDonald’s that all its foreign ventures should be allowed and even encouraged to become and appear ‘home-grown’. However, McDonalds sometimes does try to develop a coordinated promotion across countries so as to reap economies of scale. When it tried to do this with reference to a major soccer event Japan opted out since at the time soccer was not a popular game in Japan. Similarly, while McDonald’s encourages cooperation on advertising between the different European country-specific master franchisees, participation in regional initiatives is decided at country level. In the 1990s there has been some working together on European zone-wide advertising over cable and satellite. In the area of marketing KFC is now more nearly global than McDonald’s in that advertising outside of the US was unified in 1995 through the agency of Ogilvy and Mather, covering 75 countries.

From the cases reviewed it is reasonable to conclude that in terms of strategy McDonald’s has mainly relied on an ‘international’ rather than a strictly ‘global’ approach - seeking to fit into many different business environments while building a global brand. In particular this has been closely linked to the choice of entry mode, especially the proliferation of master franchisees of a joint venture type. This has resulted in a loose federation so that it might be even argued that McDonald’s has a ‘multi-domestic’ strategy. However, such a conclusion would overlook the stress on building a global brand, the related stress on core menu items and procedures, the developing of some supply networks on a regional (e.g. European) as well as a country-specific basis and some, selective efforts at cooperation on marketing. A truly global strategy would involve much more interaction and interdependence between the many national McDonald’s affiliates than is currently the case. Instead of some countries having one or two national items on the menu that are confined to the one country there could be an internationalisation of the menu as tastes become less national and more globalised. Notable here is the promotion of McDonald’s ‘Mexican’ salsa burger in a range of countries in the late 1990s. Similarly, it is interesting to note that some technical improvements made in Europe have been transferred to the US i.e. technology transfer has become a two-way affair. Further, the development of ‘satellite’ outlets (i.e. mini-restaurants in locations such as hospitals, airports and sports arenas) was pioneered in Singapore but is now increasingly used in the US. Perhaps in the future McDonald’s will develop R and D operations abroad as have a growing number of manufacturing transnational companies in recent years. In general, the more the international McDonald’s networks become multi-way channels of knowledge, ideas, innovations and personnel - partly through the hamburger universities - the more will McDonald’s achieve global integration in its operations.

With regard to current theories of the firm McDonald’s stands out as a focused ‘flagship’ firm, to use the terminology of D’Cruz and Rugman (see also Rugman, A.R., Verbecke, A. and D’Cruz, J.R., in Boyd, G., 1995). Its heavy use of franchising can be seen as reflecting its core competences and key assets, not least of which is its expertise in managing franchise systems. By relying heavily on franchising McDonald’s has restricted its investment in that stage and those activities which are mostly lower-skill and labour-intensive and concentrated more on areas where firm size and scale economies are important. However, despite the existence of scale economies in the supply of certain food inputs it has preferred to work with ‘allied’ firms, occasionally taking a minority equity stake, rather than go in for full vertical integration (packaging excepted). This special, long-term relationship with key suppliers was unusual (outside Japan) in the 1960s but is something which McDonald’s has sought to develop in, and sometimes across, many countries. In the 1990s such relationships are both more and fashionable. In their ‘five partners business network model’ Rugman and D’Cruz distinguish special relationships with key suppliers, key customers, selected competitors (as in strategic alliances and collusion) and the non-business infrastructure (universities, governments etc.). In the case of McDonald’s the key customers category may seem less relevant given the huge number and relatively even spread of customers i.e. low concentration. However, from a marketing viewpoint, the international experience of McDonald’s has highlighted the importance of children and young people as customers. Thus there may be a case for extending the notion of ‘key customers’ beyond particular individuals/clients to a special category of customers that play a ‘key’ role in the market-building strategy. In addition the franchisees of McDonald’s might be seen as ‘downstream’ key customers. They are receiving advice, instruction, packaging and sometimes equipment as well as access to a pool of marketing material - at a price. However, it is perhaps as appropriate to think of them as allies which are part of a productive network e.g. with some collaboration on sharing and developing new ideas. In the ‘five partners’ model, allies are seen as either suppliers, customers, select competitors or an ‘infrastructure’ organisation. In sectors where franchising is important this categorisation may be over-simplified. Indeed, McDonald’s has forged a variety of alliances that do not fit neatly into the five partners model e.g. its collaboration with Disney, especially in the area of mutual promotion. Promotional alliances are not uncommon in some other industries e.g. high class hotels. Another type of partnership involves the joint development of shopping malls e.g. that in Japan between Den Fujita, McDonald’s and Toys R’ Us. As for the relevance of the ‘non-business infrastructure’ this may be less for McDonald’s than it is for a firm in high-tech manufacturing wishing to access and influence the growth of knowledge. However, McDonald’s and its key suppliers are concerned with the development of food technology so that some links are of relevance. Further, there are non-governmental organisations outside of education which are able to contribute useful expertise and can positively affect the reputation of a firm - if seen as allies. McDonald’s has a partnership with the Environmental Defense Fund as well as links with Conservation International (and Clemson University). ‘McDonald’s has benefited through both lower disposal, packaging and building costs as well as a more positive environmental image’(Hartman, C. L. and Stafford, E. R.., 1997). While the case of McDonald’s suggests ways of enhancing the business network model of Rugman and D’Cruz, it serves to underline one of its main points i.e. that ’such a structure can be a substitute for internalization outside core processes by the MNE’ (Rugman, Verbecke and D’Cruz,1995).

How significant is the case of McDonald’s? Inevitably it is unique. McDonald’s was already a big firm when it went international with large financial resources and it was a pioneer. Most service firms that are internationalising are smaller and less pioneering. For some of them franchising may appeal as a way to overcome capital constraints. However, some other US fast food firms that had grown large have gone international and made much use of franchising e.g. Kentucky Fried Chicken. Some were consciously imitating McDonald’s. Franchising may be growing rapidly in many services but there is much variety. One consideration is the how far competitive strength is based on intensive use of highly-skilled labour e.g. business services in areas such as information technology, advertising and accounting. Here, full ownership seems to be favoured. Another important consideration is the amount of capital involved. For example, a Marks and Spencer store is bigger than a McDonald’s restaurant and a Wal-mart store even more so. Higher capital costs are probably one reason why M&S relies more heavily on company-owned outlets than McDonald’s, although it does sometimes resort to franchising as in the South Korean case cited earlier. The nationalistic attitudes and policies of that country have made use of a local franchisee more desirable in a way that is comparable to the need of McDonald’s for a joint venture partner in many Asian countries. Wal-mart, too, has sometimes worked with a local partner in Asia e.g. the partnership with Thailand’s Charoen Pokphand group to open up stores in Hong Kong and China. This partnership collapsed in 1995 after only a year, each side claiming the other wanted too much control. More successful have been its partnerships in Mexico, Brazil and Indonesia (it has recently bought out its Mexican partner). Like McDonald’s, Wal-mart makes tough demands on its suppliers which can shake up supplier industries. At the same time it does seek a close partnership with key suppliers, something which rivals have begun to imitate. Also like McDonald’s, it has sometimes encouraged its US suppliers to invest abroad, particularly when there are problems with local suppliers. Wal-mart also has made some effort to slightly differentiate its stores in different countries. It aims to replace US expatriates with local managers and allow significant autonomy in the long term. Wal-mart’s internationalisation strategy has assumed a high priority as its profit margins have fallen in the US amid signs of market saturation. That there are so many parallels with McDonald’s is not entirely accidental since Wal-mart admits studying and learning from the experience of McDonald’s. There are even some McDonald’s restaurants in Wal-mart stores. Given that Wal-mart ranked as the eleventh biggest firm in the world by sales in 1996 it is not a case to be lightly dismissed (on Wal-mart see Business Week, June 30, 1997). McDonald’s may be unique but its pioneering success has been influential, not least as a pioneer of the flagship firm at the centre of a business network.

As for the ‘flagship’ firm model, other service sector examples, than McDonald’s and Wal-mart, are worth noting e.g. Benetton and Ikea. Benetton has made substantial use of franchising to rapidly expand retail outlets in its business network and has a large number of ‘dedicated’ sub-contractors. Benetton or its managers sometimes takes an equity stake in these sub-contractors. It sub-contracts nearly 90% of its manufacturing, distribution and sales outlets but keeps select activities in-house as a measure of central control e.g. raw material purchases (bulk buying power like McDonald’s); cutting and dyeing (using expensive CAD/CAM) and R&D including product development (so central to its competitiveness). Benetton’s success owes much to the entrepreneurial talents mobilised through its supply and retail networks in a way that has parallels with McDonald’s ability to mobilise the entrepreneurial drive of so many franchisees and core suppliers.

 

 

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